The Day that Was - December 5th 2007

I want to address a comment that was posted to our pre market commentary. The headline this morning was "Productivity revised to 6.3%, best in four years", now let’s take this apart. The Productivity Index change data is essentially a useless piece of data in my view. Look at the chart below, this is the productivity index from 1974 to today. Can you spot recessions on this chart? No, you can’t. Because the productivity index has wild swings, even in times of a recession. In case you want to know I highlighted the recessions on the chart with black bars, and the official recession dates from the last 30 years are below the chart.

 

 

 

 

 

 

 

(Source: U.S. Department of Labor, Bureau of Statistics)

Official Recession Dates:

· November 1973 – March 1975

· January 1980 – July 1980

· July 1981 – November 1982

· July 1990 – March 1991

· March 2001 – November 2001

·

Notice in late 2000 that the productivity index hit 7.4, and that was the highest reading in 7 years! But guess what, we still went into recession just months later! You can never base the health of the economy by looking at this one piece of data. The productivity index is useless information with regard to predicting a recession. So when the headline today said “6.3%, best in four years”, just remember to get past the headline and look at history.

Now let’s talk about the Unit Labor cost data, the headline “Unit labor costs fall 2% in the third quarter, signaling low wage inflation”. Now let’s take this one apart. Just like the productivity index, the unit labor cost is not an accurate predictor to the economy. In the chart below is the unit labor cost data history and notice the black bar beginning March 2001 – that is when the economy officially went into a recession. Notice the unit labor cost data was low, so why did this data still show a low unit labor cost? Because it is based on the cost spent on an employee per measured product output and is not a gauge of the overall economy. If the amount of money a company spends on their employees (salary and benefits) goes up then so does the unit labor cost. If a company starts cutting back on health benefits for their employees then this will show up as a lower unit labor cost. So while the headline of lower unit labor cost sounds good on the surface, it has little value in determining where and when a recession will happen.

 

 

 

 

 

 

(Source: U.S. Department of Labor, Bureau of Statistics)

Now for some data that does have an impact on the economy, especially the average worker. As I discussed in the first chart, the unit labor costs go down when the amount of goods produced is high vs. the money spent on the employee. So with the headline showing that unit labor costs were down you have to be a private investigator and find out why that is. The chart shown here is the total compensation that employees (non Government) receive. Since 2001 the trend has been dropping. When you apply a moving average to this data you will see that the amount of money being spent on the employees (salary + benefits) has been trending downward. A company is able to report better earnings when the cost to produce their goods is low, and you achieve low production costs by outsourcing some work overseas, buying cheaper materials needed to make those products, find better ways to produce the products, or you cut back on the benefits and/or salary you pay the employees. We know that raw material costs have been skyrocketing so it can’t be that, we know that many companies have been contracting their work to other countries so that does have an impact on company growth, but what about the employees left here in the U.S.? The answer is in the chart, salary & benefits paid to employees are going lower, not going higher. So as the cost of living keeps going up and the compensation the employee receives works its way lower, it places that worker (consumer) in an even greater hardship.

 

 

 

 

 

 

 

(Source: U.S. Department of Labor, Bureau of Statistics)

As the cost of living goes up, many companies used to keep adjusting the salaries and benefits to match, that trend is no more. The trend over the past 7 years has been a reduction in benefits, especially health care. Now throw on top of this the rapidly declining housing values, the high cost of living (food, fuel, heating, medical, and so on) and you have an average American worker who is stretched thin. Recall I said last week that the recession we are entering is a “consumer induced” recession. And this is why.

Now what about the unemployment data from ADP this morning. First, the ADP data is known to be all over the map with regard to their accuracy. But regardless of that it is the trend that I am more interested in, not an individual snapshot. Just like in stocks where we say “The Trend is Your Friend”, the same holds true for analyzing the direction of many other things, like the employment situation. The chart below is the unemployment data since 1997; it is easy to see trends on this chart. At the start of 2007 the trend reversed, just like when we do a trend analysis on a stock chart, a break away from a trend is a significant sign. I drew a trend line on the chart below so you can see how the unemployment, starting in 2007 stopped going down and has since been ticking upwards. So when a “snapshot” of data says the unemployment data has improved don’t get caught up in the snapshot headline, instead find out what the trend is! For there you see the real direction.

 

 

 

 

 

 

 

(Source: U.S. Department of Labor, Bureau of Statistics)

And it was also mentioned today that “The US dollar was improving”, another headline. So just how much has it improved? Look at the long term chart shown below and you tell me in the grand scheme of things just how much has it improved?

 

 

 

 

 

 

There is a long way to go before we can say the dollar is improving. When this chart shows the US Dollar has broken out of the down trend then we can say the dollar is improving, until then it remains in a down trend, period.

So the market today was all excited over the “snapshot” headlines. But there is nothing any different than another day of volatile “which way to go” by the market participants. Lots of buying and selling today, remember I said this morning that we would be watching to see just how much selling was taking place on price advances. What we saw was just as much selling as has been evident in previous ‘rallies’. So there are still people out there who are selling into the strength. Will the market rally for the rest of the month? That depends on how many more “headlines” we get!

Will a rate cut from the FOMC reverse this course? Will the Governments plan to freeze mortgage interest rates for the troubled borrowers stop the declining housing market? Will the cost of living drastically drop and make the consumer better able to spend money? To us, we still see the makings of a recession and bear market. When it happens depends on just how “creative” the Government gets with applying band aids and splints to the injured economy. What happens to a person that gets covered in bandages and splints? They don’t walk very well after that, and fall down a lot!

Mid-day Update

The Dow has edged up this morning after gapping higher.  It has been holding 13416 so far.  AIG reports it has no exposure to SIV’s.  I’m not going to argue with them, they’re bigger than me.  Moody’s sees a bigger capital shortfall in MBIA (MBI) than previously thought. The average cost of a home in Britain declined 1.1% to 194,895 pounds ($400K) from a month earlier, a report by HBOS showed today. Prices last fell for three months in a row in 1995.  Just a little reality check.

Have I mentioned how much I dislike 200 point swings on the Dow every few days? 

Pre Market - December 5th 2007

ADP released numbers this morning which were a surprise to the upside. ADP has a checkered past with regard to their accuracy, but regardless of that, the market is taking the ADP data as a short term sign that the economy is not as bad. But this creates a problem because the market has been pricing in a rate cut. If the ADP number is accurate then the fuel that the FOMC will need to justify cutting rates again next week will have run dry.

Those that are looking only a few feet ahead will be buying in this early rally, those who are looking a mile down the road will be selling on this rally. We have a big battle setting up today. Significant resistance ahead on the major indices and selling on strength will make today’s action wild. It also needs to be noted that some of the pre market buying is actually short covering from day traders who were holding shorts on the expectations of bad news this morning. So while the pre market futures look like the world is beautiful could in the end be nothing more than a trail of popcorn being placed on the ground to lead the bulls to their death. We will be watching very closely at how much downtick volume (selling) is taking place today. We are going to be watching for large share dumps on small share buys and that action will tell us the strength of this rally will fail.

To us, nothing has changed today except a freeze frame of time has captured an aberration in the economy which many other forms of data shows is declining. The next time you have a lazy Sunday morning, get your coffee and examine stock charts and index charts, you will find that many times a stock and index will appear to rocket upwards just before the big down trend starts. That is referred to as an exhaustion, as in ‘last breath’. Could the markets be experiencing it’s last breath? Maybe not it’s last, but it does have chronic emphysema.

The market this morning may be enticing to start buying stocks left and right, but that is what the sellers who jump on the strength want you to do, they want your money! Today is a fantasy land in the market. If a stock achieves a buy point go ahead and take it, but if you don’t watch it with both eyes you could have your money pulled right out of your pocket before you know it. We call today a "pick pocket delight", the smart folks will be roaming the streets looking to pick pocket the wallets right out of the back pockets of the tourists.

The Day that Was - December 4th 2007

The Chinese Bubble - may be near a bursting point

A story hitting the Wall Street Journal tonight is that some mutual funds are now backing away from Chinese stocks. The story reports that mutual fund managers believe that China’s market is a bubble that will burst sooner than later.

Now, it does not matter if you agree with the sentiment of those fund managers or not. But the fact that they are backing away from the Chinese stocks is something that should make you take a good look at your portfolio. Do you have any Chinese stocks in your portfolio? If you do then you need to establish trend lines on all of your stocks, and set stop limits that will protect your gains. For if a Chinese stock breaks below an upward trend line, it may not be temporary this time. Lisa and I agree with the fund managers, China has been touted for way too long as "the hottest thing going". If the Asian markets start pulling back, and the many Asian stocks that trade on our exchanges follow suit, then our markets will have lost yet one more safety net. Mutual funds, hedge funds, and other institutional money is what moves markets. If mutual funds begin to back off the Chinese stocks then the money that is needed to raise your stocks is removed. Retail money does not move stocks, it is the big money that makes stocks move over the long term.

A couple of months ago we wrote about the earnings estimates of companies and how they were showing signs of getting weaker. When a company released their quarterly earnings report and on the surface it appeared to be "a blow out" you recall we wrote how we were skeptical because in the details buried deep down it actually was showing signs of weakening. It was also said by some talking heads on TV that the earnings growth of companies would hold up the markets, now tonight we have new economic calculations of what the Q4 earnings will end up looking like. Based on the already released earnings, and earnings projections of companies (i.e. financial and consumer discretionary sectors) the overall consensus of earnings growth for Q4 is now 2.1%, that is an 80% drop from the consensus just a few months ago.

The new York Attorney General has subpoenaed several Wall St. firms. The AG is seeking information related to the packaging and selling of debt tied to subprime mortgages. This just keeps getting more and more ugly.

On Thursday we will find out if the Bank of England and the European Central Bank will cut their bank rates. With the rate cut we saw this morning from Canada, this is looking more and more like a world wide economic slow down. And mutual funds backing off Chinese stocks, a rate cut from our FOMC may make people happy for a little while, but it will just be another fresh gauze on the hemorrhaging wound that this economy is experiencing. Our markets today traded with total confusion, bulls had no desire to step in and start buying, and the bears nibbled away at bits and pieces. The markets remain very dangerous and risky.

There is a sign post ahead, it says ‘caution’