Market Update-Caution Rules Today, But No Reason For Fear

In Greek mythology it was Icarus who constructed two wings out of feathers so he could flee imprisonment. Icarus, having ignored his fathers warning, flew too close to the sun, which then melted the wax which secured his feathers resulting in him crashing into the sea below. Investors both individual and institutional, on the other hand remained overly cautious and as such underinvested in equities entering 2013 fearing the ill effects of higher capital gains and nominal tax rates. Having largely missed the gains the market provided in 2012 and being the “fiscal cliff” turned out to be more of a mole hill for the markets, investors have been playing catch up ever since. To the layman this can be evidenced by the shallow nature of any attempted sell-offs and the aggressive buying that follow immediately. The latest example is the recent 5% correction bouncing back to within 1% of all time highs after Friday’s 207 point rally in the Dow. But, first let’s get to the dete’s (that’s details in geek speak). The market has gone virtually straight up since January 1. Market technicians, myself included here, grew ever more watchful as we historians can note over and over again the market can or will go up only so far without some degree of correction (selloff). The longer the time frame and percentage gain, the higher the probability and severity of the correction….most times. I posit we are not living in normal times. We just barely survived a near global financial collapse. The life blood of capitalism, free flowing markets nearly froze, seizing the flow of corporate funding necessary for payrolls, accounts payable and quite simply utility bills to keep the lights on. The Treasury and Federal Reserve took coordinated extraordinary steps to stave off the second coming of The Great Depression. So, back to the here and now. Some nervous Investors having fled to the shore early following the old ditty of “Sell in May go away” were looking for a reason to sell and lock in gains. They looked too hard for the bogeyman under the bed and believed they finally saw one in the Federal Reserve Chairman’s statement that merely mentioned one day they would have to end their monthly $85 billion asset purchases. Thus, the choppy near 5% selloff in the various indices. To GSA, they misread or misunderstood the Feds statement as they said One Day not Today, they’d ease off their asset purchases. Thursday’s price action, being down 115 points on the Dow at one point only to finish up +80 followed by Friday’s +207 point rally suggest just such a reconsideration of current conditions, Federal Reserve policy and valuations. Now to the digits: Housing: What a comeback. Arguably the one area of the economy responsible for nearly crippling or collapsing the US is roaring back. While housing starts in April took a breather, permits, which looks to the future, boomed 14.3% suggesting an annual run rate of over 1 million new households. The highest levels since mid 2008. Leading Economic Indicators: April’s LEI reading came in at +.6 after March’s figure was slightly negative. Taken within the context of the average six months would support the current expectations of modest GDP expansion in the range of 2 ¼%-2 ¾% gaining strength later into 2013 and a stronger 2014. Industrial Production: IP is a volatile figure when looking at the month to month basis. IP fell .5% after solid gains the prior two months. The year over year figures comes in at +1.9% which again supports a good not great environment. Factory Capacity Utilization or Cap U eased to 77.8. On an historical basis this leaves ample capacity to absorb any upticks in inflationary pressures. Inflation- Consumer Price Index/Producer Price Indices both remain well anchored and are of no concern currently. The Federal Reserve continues fighting a potential deflationary spiral attempting to prop up asset prices. Nuff said. The ISM Purchasing Managers Index-Manufacturing PMI dipped to 49 below the all important 50 which suggests a contracting economy. Responders pointed to sluggish demand from the EU and China. They also point to buyers holding off in anticipation of price cuts from commodity input costs dropping. Further they point to a stall in Government project awards due to the spending cuts along with a somewhat stable environment right up until mid month where demand slacked off. On the flip side The ISM Non-manufacturing or Services Index came in at 56.5% solidly in expansion mode. We saw strength in new orders and employment. Respondents in IT spending pointed to an overall improving environment heading into the second half of the year. On the other side Healthcare professionals pointed to the sequestration and Obamacare as “having a strong negative impact on business”. So, a very positive reading but worth watching for any weakness. JOBS: Friday’s non-farm payrolls came in at +175,000. At best a simmer not a boil. The economy is operating back in the Goldilocks zone. Not too hot, not too cold to put the Feds hand to adjust their Quantitative Easing program just yet. I look for more of the same until we get to the third or fourth quarter. Going forward: The Federal Reserve has been and continues to be the most transparent ever in telegraphing policy moves. Recent commentary surrounding the eventual tampering of asset purchases provided a terrific buying opportunity for the brave and or underinvested. The most recent economic data suggests we’re experiencing a slow patch amid continued economic expansion. Europe is on the mend, China while slowing is also continuing on the path towards greater domestic consumption and less reliance on an export driven economy. The picture for US corporate earnings and revenues appear much more favorable as the inflation outlook remain tame, monetary policy favorable and a gradually improving jobs market gains momentum into year end and out to 2014. We now look for S&P 500 earnings of $110 share. Attaching a 15.5x price/earnings multiple brings us to our new year end target of 1705. At this point we at GSA believe our 2013 target is conservative and see reason for considerable optimism for 2014. Housing and Autos, which dragged us into this near financial abyss are now releasing some pent up demand accumulated over the dark days of the near collapse. The current low interest rate environment should continue to support sales going forward. So, Automobile sales along with Construction and home sales should help lead us out of the current sluggish patch the economy has hit. We remain constructive and maintain our aggressive exposure to the markets but will be wary for any potential Canary’s in the coal mine Thank you for your continued support and confidence in these very challenging times. Yours in pursuit of the KWAN.