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Today's Commentary: 07.12.05
Traffic Signals

There was a comment passed around the floor of the NYSE last week following the post-London bombing, New York City rush hour. When the city and ones like it on the eastern seaboard were able to get to work undeterred using mass transit, the 3% loss the pre-market anticipated disappeared. The markets breathed a sigh of relief and rallied much the way they did following the attacks on Madrid. For the markets to be hanging on the news of no-news is another in the growing telltale signs that something is amiss.

Year-to-date, the Dow has been stuck in a state of benign-ness, lethargic most days and sometimes exuberant on others but otherwise not doing much of anything. Holding steady at a 3.10% loss, the DJIA for the year seems to be navigating a detoured route through traffic. Yet the most difficult challenge ahead for investors is determining what kind of market this is based on the signals it is sending.

It is easy to see the next six months as a clear indication that the signal is red. For instance, we have an uncooperative fixed income market. Remember the Greenspan's conundrum? Those less than appetizing yields have remained low and as a result have sent investors away from traditional bond offerings and in many cases, quality equities in a search for riskier yields. That kind of yield can only be found in the junk bond arena which is now populated by giants the likes of Ford and GM.

It is important to note what many of the red-lighters have overlooked. The Dow has a relatively good track record over the last 52 weeks; not great at 2.31%, but not bad either and that's with the dividends excluded.

Oil has proven to be another traffic stopper for the investor. Companies have already written the higher cost of this commodity into the cost of doing business right up until it hits $75 a barrel. Companies are counting on inflation to begin to take hold by then in a measurable way and to do so without scaring customers away. One way is to take it out on the Chinese who seem to be in a position to absorb the tariff arrows the Bush administration intends to hurl on behalf of big business. The other will come with a stronger dollar, which is benefiting from the failure of the European Union to, well, er, unite. By default, they made our currency look stronger than it really is, skewing yet another handful of shaky economic reports on trade and deficits. Investors are not so sure those are necessarily appealing indications to begin to move back into these markets and because of that, they wait.

Europe and the dollar aside, inflation has shown up in a much more benign way. Careful scrutiny of shelf tags at your local grocers, not always the most cited evidence and one conveniently dropped from the reading used by the Feds, but telltale nonetheless, shows a marked increase. Check out the cost per ounce (or whatever comparable unit measure a product might use) and you will find that those prices have risen while the box while its contents have decreased in size by the same percentage. That box of cereal may cost and appear the same, but you will get less. Look for this deceptive use of inflation to spread across other industries as well.

Individuals are using a yellow light approach when it comes to housing. They understand the speculative nature of this investment but are having a difficult time ignoring it. They see that benign inflation at work here as well although there is little they can do to stop it.

The inflationary side of the housing boom may not be just in the prices. Corners are being cut in the housing markets as builders are selling higher priced homes built with limited life materials which are beginning to turn up as problems for their highly leveraged owners - and not that long afterwards the purchase. Couple the code-legal practice of sub-standard materials with inflated home prices and its no wonder investors believe we have hit a choke point.

Those hot housing prices, while driving the markets just enough to keep them neutral, are poised for a collapse, at least on a percentage level. 25% of the homes purchased last year involved risky financing with no down payment. Almost half of those homes went to first-time buyers. The prevalence of interest only loans and the interest rate sensitive adjustable rate, all seem to be suggesting than even the slightest economic bump in the road will set the whole alignment of the market off kilter.

If short-term interest rates keep rising and there are numerous indications that they will, investors may feel as though all hope will be dashed for gaining any ground this year and remain cautious.

The failed "eighth inning analogy" from some months back now looks more like baseball it sought to compare itself to, an open ended game whose strengths lie in its bucolic pace and good pitching. Each new rate hike leaves investors struggling with the notion that Greenspan & co. have not finished. Promises and hopes that a reversal in the agonizingly slow increases in rates have now been pushed to next year.

If those rates keep rising, there is the possibility that housing will stay speculatively hot. These speculative souls are now responsible for driving 55% of the increases in home prices in only 40% of the markets. History has attempted to tell us numerous times that speculation never helped an already overheated market. Cautiousness is just prudent.

In order for the light to indicate green, the average investor needs to overcome some major mental roadblocks. Not only are there interest rates and yield problems, housing and oil prices, a stronger dollar with low inflation, but the investor is now being asked to digest the possibility that March may be the best month we are likely to have this year.

The price/earnings multiples have failed to break out of their recent funk, which would certainly help investors get involved. Earnings season has begun yet again with many analysts having lowered their quarterly forecasts. This investors fear is a clever way of setting us up for surprises of surpassed expectations. Won't we be excited when a company that has offered lower guidance that has analysts flocking to agree suddenly and to the delight of shareholders near and wide, beats "the street" and comes in with higher earnings than expected? Remember how the cereal makers sold you less product for the same price. P/E's are now being packaged in a similar manner.

Evidence of this new, generally accepted lower expectations could not have been more visible than in the dissection of the June Jobs Report. What was widely expected was an increase in new jobs of 200,000. It is important to note that June is a big hiring month with all of those kiddies and their teachers out looking for summer jobs in the service sector. That is the same sector that has provided the greatest amount of low paying jobs for previously higher paid and now disparaged workers. This group who has given up trying to replace their old jobs with similar paying ones is currently estimated to be in excess of 5 million. Had they been counted as actively looking for work instead of taking whatever job was available, the 5% unemployment number - that was rounded down from the previous month's 5.1% - would really have been somewhere around 8.3%.

The Labor Department reported that only 146,000 were actually added and it seemed as if that was okay. There were revisions to the two previous months, but heh, does it really matter? We are still shy of the needed 300,000 jobs a month to call this a recovery. The moving average is now about 176,000 since the first of the year.

It is important to remember this one fact: 150,000 new job hunters enter the marketplace each month. Freshly minted collegiate and high school grads aside, these job seeker have just become of an employable age. So the optimistically received number for June failed to find enough jobs for even this group of fresh faced workers.

So as the markets continue to give mixed signals, investors seem willing to wait it out on the sidelines, cash in hand, for a clear indication that the road ahead is all green lights.

BlueMoney Report

The Blue Money Report
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