Friday, July 2, 2010

Changes in Employment DO NOT predict Future

Market action has been dominated by “traders” who bid up prices and sell quickly. In addition to the traders who sell quickly, driving prices downward, this downward momentum sometimes causes many ill informed individual and institutional “investors” to panic and add to the downward momentum by “getting out before it gets worse”. In addition, many traders not only sell quickly; some also make big “bets” that the market will decline. (I think sometimes these traders actually enjoy and profit from extreme volatility, changing their strategy after they witness those “ill informed individual and institutional investors” finally throwing in the towel.)

I never recommend significant adjustments to a sound long term investment strategy unless we see some indication that markets will fall far enough and stay low long enough to justify the risk of missing the gains when markets recover from excessive fear. At this time there does not appear to be any indication of a deep decline that will last a significantly long period of time. Continue to diligently monitor the situation, searching for any such indication.

I would not expect most investors to become macroeconomists, but there are a few good websites that they should visit from time to time: Conference Board—Publisher of Leading Indicators and Consumer Sentiment Data: ; ISM—Publisher of Purchasing Managers Indexes: ; Association of American Railroads who publish rail traffic and other economic data: ; and’s page for the Baltic Dry Index . Reviewing the information tells one to be very careful with hyperbole (hype) from the press.

A look at the Baltic Dry Index shows a drop in shipping rates in late May. This might indicate a reduction in global trade, but a look at it over a longer period of time indicates such short term fluctuations are normal and it appears the index is “on trend” to recover to past highs. A look at rail traffic: carloads for the week ending June 26, 2010 “up 11.4 percent compared with the same week in 2009” and intermodal traffic “up 20.5 percent from a year ago and down only 1.1 percent compared with 2008.” JPMorgan Global Manufacturing PMI (Purchasing Managers Index) at 55 for June—“growth remains solid overall and above long-run trend” and June ISM at 56.2—“New Orders, Production and Employment Growing, Supplier Deliveries Slower, Inventories Contracting. Leading Indexes for the US, China are Germany are all UP.

So what is it that so many are worried about? The economy does not appear to be creating jobs fast enough to satisfy some. In 2009, there were 53 million jobs lost and 48 million created. For employment to improve, more jobs need to be created than lost. Well, the latest information, today on July 2, 2010, indicates there were 83,000 net jobs created by private employers in June 2010 and unemployment fell from 9.7% to 9.5%. However at that rate, those nearly five million jobs lost in 2009 will take a very long time to replace.

The momentum of growth has clearly slowed, but most statistics indicate that growth is continuing. Many fear that with chronic long term high unemployment, the economy is doomed to slow growth, no growth or maybe even the terrible “double dip”. And, many do not like to hear that governments around the world may begin to reduce deficits and government payrolls, which many fear will contribute to economic slowing.

My comment regarding fears about reduced government spending: Priming the pump is wise and necessary, but it is only a temporary solution. Once the pump begins to function, continued priming to make the pump put out more and faster is wasteful and foolish. High unemployment is always a sad situation, but unemployment of 9.5% does not necessarily mean a decline in corporate profits and stock prices. The 90.5% of the workforce that are working may be productive enough and spending enough to make the economy quite healthy. Not as healthy as if unemployment were 5% but healthy nonetheless.

Probably the most important economic statistic that is seldom mentioned is the dramatic improvement in productivity that has occurred in the past year or so. It is not so much a bad economy that is keeping unemployment high. It is this improved productivity that is keeping unemployment high. Companies can produce and are producing significant profits with fewer employees. Many believe that the “new normal” for unemployment is much higher than in the past. So, slow increases in employment and continued high unemployment may not justify a reduction in stock prices.

Many still estimate that earnings for the S&P500 will reach 79 for 2010. With a P/E of 15, this would result in an S&P500 of 1185 or a 16% increase from the end of June level. (The estimates for S&P500 earnings vary from 70 to 87 and estimated P/E ratios range from 12 to 18, for a range for the S&P500 from 840 to 1500—now that’s uncertainty!)

The recent fears about a slowdown in Europe are probably what started this recent “panic”. Reality is that it probably will cause Europe to buy less from us. The offset of this is that the recent change in China’s currency rate policy will probably cause us to sell more to them. What we lose in Europe may be offset by what we gain from China.

It has been said that markets are only “right” five (5%) percent of the time…and they are “wrong” ninety-five (95%) percent of the time. In the short term--the markets express emotion; they measure corporate profits in the long term. My prediction is: corporate profits are on the road to recovery. This road may not be straight and it may be uphill, but it’s general direction is toward improvement. It is very unlikely that we are making a U turn. Corporate profits may fail to meet analyst’s expectations, but the trend is still likely to be UP. The best assets to own during a time when corporate profits improve are stocks.

Employment is not a leading indicator—corporations hire AFTER they are making profits—not before.

The most important thing for investors to consider is not what the S&P500 will be in 2010, but rather, what will it be in 2015. The important questions are: “If markets drop, are they likely to recover within 12-18 months?” and “Are we on track to achieve annualized returns of 8-12% over the next five years?” as well as “How should my portfolio be positioned to achieve my long term financial goals?”

When traders and gamblers are fearful and uncertain, predicting the “bottom” or the lowest point that markets reach is a futile exercise—it is unknowable. And, there are always risks regarding events that are unexpected or that are very unlikely, but possible. That is why the only money that should be invested now is that money that you do not need for at least five years—with a long term strategy, short term fluctuations based on market crowd “emotions” are really of no concern.

I never recommend significant adjustments to a sound long term investment strategy unless we see some indication that markets will fall far enough and stay low long enough to justify the risk of missing the gains when markets recover from excessive fear. At this time there does not appear to be any such indication.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.