A September to Remember?

As we work our way through the early days of September we’ll no doubt be hit with a tidal wave of reports, exclusives and exposes wishing to reflect on the one year anniversary of the Lehman Brothers collapse. We lived through that epic period together. I’ll leave the story telling and history lessons to the talking heads in search of ratings. Me, I’ll focus on the current conditions and future.

Those investors that fell victim to the catchy sounding “sell in May and go away” mantra missed out on the opportunity to participate in the roughly 8% market ascent. While not clear how September will play out, investors should remain cautions, but in my opinion engaged. First things first. The economic data continues to suggest we have resumed a positive growth trajectory as reflected by GDP.

The Leading Economic Indicators (LEI) posted a fourth straight gain of +.6. This is a terrific gauge of future economic activity. Digging into the LEI we see more reasons for optimism. Six of the ten indicators were showing increases. Among them, manufacturing average hourly workweek and new orders for non-defense capital goods.

Industrial Production (IP) increased .5%. The first increase since October 2008. To be sure the 43% improvement for light vehicle assemblies needs to be monitored. We’ll have no more coins for clunkers to lure wary consumers back to the showrooms. Will this result in a crash in car sales? Was the pick up in the IP a mere a blip as dealerships restock inventories? Or was there real pent up demand finally being released? I’ll be watching closely.

The real estate market continues to show signs of stabilization. Existing home sales rose 7.2% in July, the fourth straight month of improvement. New home sales popped 9.6% matching the fourth straight month of improvement. The potential fly in the ointment here is the $8,000.00 tax credit which expires at the end of November. New home buyers may have rushed in to meet that November deadline. That is the current argument. It may have some teeth, however, remember that home buyers also agreed to take on the $180,000.00-$220,000.00 mortgage that came with the tax credit. Also these new home buyers had to qualify for loans under much more stringent underwriting criteria. Again, I tend to believe there is pent up demand being released here. I’ll be watching very closely.

Inflation and interest rates are expected to remain at depressed levels for an extended period of time. Capacity Utilization at 68.5% leaves significant slack in the system. Couple that with worker productivity advancing at a 6.4% clip in the second quarter, the fastest since 2003. You would realistically like to see this type of number when the economy is humming along running at trend growth or above, not at the trough. When productivity spikes down here, employers don’t need to add headcount. Don’t forget (like anyone could) the current unemployment rate of 9.7% and rising. Employers remain in the driver seat. Wage based inflation is not a big concern, at this point in time. Which brings us to interest rates. As posted in the Federal Open Market Committee (FOMC) statement, rates shall remain low for an extended period of time.

A quick thought on the Obama Economic Recovery Plan and jobs. We currently have an unemployment rate of 9.7% and 14.9 million unemployed out of a workforce of 153,600,000. The administrations original projections had been to create or save between 2-3 million jobs. Let’s take the mid-point and agree 2.5million jobs created and no further deterioration in job losses. I’m being very generous on the latter. While the trend in job losses has dramatically improved the job market still contracted by 216,000 slots, a far cry from adding headcount. Back to the numbers. We’ll assume the workforce remains static and add back in 2.5 million to the rank of the employed. This brings down the number of unemployed to 12.4 million and a rate of 8%. For my example not one of the 2.5 million jobs was a save, it was counted as a new hire. Due to space I won’t go into why. To hit this 2.5 million goal we’d need a huge reversal of draining 200,000+ jobs a month and adding a like amount which comes to a 400,000 swing. Why bring this up? To prep you. Expect elevated levels of unemployment for the next 18-24 months. Unemployment has not peaked yet, and most likely won’t until the first or second quarter of 2010.

The market appears to be fairly valued at current levels. Seasonally we’re entering dicey waters as the earnings pre-announcement period begins. Technically, the charts suggest we’re currently a bit overbought, but are working off that condition. Foreign markets, China, India and Brazil, which had lead this rally and dragged the US along for the ride have taken a breather. China has technically entered a bear market, or some would have you believe. The part they omit or conveniently leave out is the China market rallied 100% before a bout of profit taking took back 20%. Those spouting the China bear market story are most likely talking up their positions, or more accurately put, their lack of positions. Many managers missed this move and or had the unfortunate and painful experiences of shorting the market into what they believed were unsustainable rallies. Time is running out to make up lost ground. We’ve only got four months for these investors to catch up to their respective indexes in performance. There is roughly $3.6 trillion sitting in money market funds earning less than 1%, some of which will be the fuel for the next leg of the current bull market. However, caution and prudence for the next few weeks will be mandatory, from current levels. I hesitate to ever dig in my heels, and I wouldn’t say definitively we’ll have positive returns for September, which reminds me of a saying I took with me from working on Wall Street. If your opinion is wrong, lose your opinion (implied, before you lose your position). The turn in the economy and market began showing signs awhile back, granted you may have needed a powerful set of binoculars to see the bear market exit up ahead. However, once you missed the turnoff, your best tactic is not to gun the accelerator. No, take the next exit, breakout the roadmap and get back on track. Some did, many did not, and still have not, and are now only acknowledging the error. This is why, thus far, even the strongest retracements are met with very willing buyers of weakness.

It remains my position any pullbacks will be contained within the 5%-8% range, and chatter of the need to have a 10%-15% pullback are those still waiting for the full retracement to the March lows. Of course they could be right or they could be just talking up their position.