Monday, August 31, 2009

Come Tumbling Down

The market bulls' and v-shaped recovery advocates' are beginning to crumble. This morning, foreign markets trended lower as the realization that corporate profits have been the result of reduced expenses and not higher revenues. The U.S. markets followed suit, in spite of economic data which was better than the street consensus.


Not only have profits not been based on revenue improvements, but some companies have reported better earnings and reduced revenues. Even a neophyte business person knows that one cannot cut their way to success. What about the consumer coming back online and spending the economy back to health? That is probably not going to happen. Consumers cannot borrow as they had in the past. This is not just because credit is tight in general, but because lending practices are more prudent. Many consumers who had credit in the past cannot get it now and should not have received it before. It appears as though stock jockeys are wishing, hoping and betting that consumers receive access to easy credit. That probably won't happen now as it will take banks a few more years before they repeat their mistakes of the past or make new creative mistakes.


Realists are even appearing more frequently on Kudlow and Co. Guests, who Larry probably scheduled as bearish foils for his own and his cohort's bullish tones, are winning the debate. Guest Doug Kass of Seabreeze Partners put forth the argument that consumer spending will be buffeted by a weaker dollar, higher interest rates and business and consumer unfriendly tax policy. He stressed that it is consumers who lead to business growth and not the other way around. Finally, someone actually acknowledging that consumers will not be able to borrow and spend our way out of this. I have mentioned previously that economic growth could be reminiscent of the post-war era. Mr. Kass is thinking along the same lines. He told Larry Kudlow that consumers could be returning to a mentality of preservation as they were post depression. I think Mr. Kass is right on.

Markets usually overshoot on the way up as well as on the way down. Mr. Kass correctly called the bottom of the U.S. equity markets in March and now he is calling a top to the market now. With business data not supporting current market levels and market participants returning from summer vacations, we could see profit taking during the next several weeks. The traditional autumn market swoon could be upon us.

Corporate bond investors should also take heed. Corporate bond spreads have tightened dramatically. Ten-year industrial bonds, such as Wal-Mart are trading inside 80 basis points to treasuries and banks such as JPM are just over 100 basis points above treasuries. These are now withing historical spread ranges for good economic environments. I do not suggest selling high-grade bonds here if they were purchased for income. However, the trades among us may want to take some money off of the table. This is especially true of preferreds shares and more so for high yield bonds. Levels appear rich considering the head winds which probably lie ahead. Preferreds and high yield bonds look rich at these levels.

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