The Market Coming Down the Home Stretch

Grand Street Advisors
Fourth Quarter
Outlook 2009
Short and Sweet! I first need to announce I am putting together a petition drive that I believe will be the first ever to receive 100% support and zero detractors. I propose replacing the annual clubbing of the baby white seals (as fun as that has been) with “The First Annual Skinning of The Bears”. I know what you’re thinking, Brilliance! However I cannot take full credit. This year they have been highly visible, overly aggressive and annoyingly persistent which makes for easy targets. I’m looking forward to easy passage and celebrating every October.

The economy is inarguably in recovery mode. Consumer confidence is on the mend, though fragile. Home sales, both new and existing, is undergoing much of the same. Auto sales are stabilizing at close to a ten and a half million annual run rate. Wall Street? They are making money like they printing it. Oh, yeah, they are printing it. If everything is going so well, what’s the hold up? Well the “S” on this boy wonders chest stands for Sustainability. Corporate America right sized, and actually got it right this time. Much like the Federal Reserve, while late in recognizing the collapsing of the economy and end demand, once engaged they went full throttle on the guillotine, slashing head count and slicing inventories.

Now that the incentive programs for home purchase and autos has expired, will consumers retreat back to savings mode? Or do what he does best, buy buy buy. It all hinges right here. The good news is the global economy is not sitting back and holding its breath on the US consumer. This time around it’s not necessary. Domestic consumption in emerging economies is picking up some of the slack and doing some of the heavy lifting.

The, thus far, orderly retreat of the value of the US dollar is having the desired effect of making our goods more attractively priced overseas. The result, exports are up again and with imports down our trade deficit contracted again. I have to admit George W actually got this one right and acted on it when questioned about support for the value of the dollar. He responded with, “There is such a thing as a strong dollar policy and the wrong dollar policy”. By propping up the US dollar for the last three decades, US goods were at a decided disadvantage. Now the currency markets are searching for its equilibrium and not the pegged levels that hamstrung the US in the past. As long as the retreat is orderly, we should be fine. This needs very close monitoring. Based upon Fed comments and foreign central bank commentary we are approaching levels where we should begin to level out.

Lastly, on the glass half full view side. As I’ve stated in the past, earnings are spring loaded to impress to the upside. We are currently in the sweet spot, timing wise. The market is searching for the catalyst to determine the path of least resistance. Earnings should identify that rather clearly. Analysts are finally catching on. Estimates are being revised up almost daily. Current numbers for the S&P 500 for 2009 are targeted for $62.00 share up from $40.00 share a short time back. For calendar year 2010 estimates are coming in at $75.00 share and as of now, $92.00 for 2011. To give some clarity around how analysts come about their projections, use a 16-17 multiple. This brings targets to 1250 for 2010 and 1380 area for 2011. Now, for me it is way too early to give projections for 2010, let alone 2011. Too much can change between now and year end. It is a fluid process with new data coming in weekly. Really, an exciting time.

Now the caution. We need to be on high alert for any feint signs the China recovery is petering out. Any dents in the armor here, and all bets are off. Clearly we are taking our lead and some comfort from China recovering along with the emerging markets. Just last week Australia’s Central Bank hiked rates. Let me emphasize what a bold statement that was. The Australian Bank Officials must have felt confident in the sustainability of their economic recovery as the last thing they want to do is flip flop. Hike rates too early, have the economy stumble and have to revert back to an easy money posture. They understand they would lose street cred (Wall Street that is) and most likely their jobs as being viewed as out of touch and incompetents. Now the question becomes, who will be next to hike?

Worth keeping a close eye on is any breach in the developing trend of lower monthly payrolls. Progress continues, coming from losses of 700,000 to most recently 255,000. Still, while making progress, we’re not creating jobs just yet.

We’ll be on the watch for continued progress in home sales. This too is an Achilles heel. The stated inventory figures are coming in around 4 million + homes and a roughly 8 month supply. Taken alone, not bad. However, adding in the shadow inventory, (homes taken off market, on bank balance sheets, in process of foreclosure) let’s add back in another 5 million homes. We see that inventories really are closer to a 2 year supply. This problem and overhang will be with us for 4-5 years. And that is assuming home builders don’t begin ramping up production again further exacerbating the overhang.

Finally, I must admit I am constantly frustrated with reports of the market having rallied 50% off the market lows and the need to take a pause. When did we begin calculating returns from peaks and troughs and not year to date calendar? But, this feeds right back to my original purpose, which was to garner support for my First Annual Skinning of The Bears. With those out there using the March lows and not January one when calculating total market returns, they’ll be watching the markets continuing ascent, confused, while sitting on the sidelines. This makes for plenty of the furry beasts when my petition passes and pelts for everyone when the season kicks off.

I continue to be optimistic this market move still has some positive upside left in it. I will continue to monitor economic releases, the dollar, precious metals, cash flows, geopolitical tensions and signs for a market topping out and be in contact immediately should we need to adjust our strategy.

I thank you again for you patience and confidence in allowing me work with you in these incredibly challenging times. I am equally honored and humbled by both.