Durable Goods Orders were reported this morning and were stronger than expected. This is a very volatile datum. Continuing Jobless Claims were also reported higher than expected. The markets ignored the Jobless Claims number and gained strength on the Goods number. Markets are desperate for good news. Consumer confidence is neither a leading nor lagging indicator. It may be the most timely and least important of all economic data. It is a measure of how you feel today and would produce a different reading if measured in two days or even if measured in the evening as opposed to the morning. So why was there a 2%+ rally in the major indices yesterday on this report, particularly as it came on the heels of an awful housing report? Frustration. Investors are frustrated with this downturn and want it to be over with. Wishfulness and hope have investors clinging to the smallest upbeat crumbs. We suggest that wishfulness and hope are insufficient elements for sound investing.
Things are getting better. The rate of economic decline appears to be slowing. We have said for well over a year that recovery will hinge on housing prices and credit market improvement. From an article this week in the Washington Post, “But the glut of foreclosed homes is pushing down prices, according to the National Association of Realtors, noting that 45 percent of the market is made up of distressed properties. That is expected to get worse as more homeowners fall into foreclosure after losing their jobs and banks restart the foreclosure process after implementing moratoriums late last year.” The Post covered both our concerns: falling housing prices and soaring bank loan losses translate into a cautious consumer and contracting credit.
The bond market isn’t helping. Yields on 10-year Treasury Notes have risen from 2.5% in mid March to 3.7% yesterday. That means bond prices have fallen as investors have increased their appetite for risk and in the face of increased Treasury purchase commitments by the Federal Reserve. This is a problem in several ways: mortgage rates will move higher, making houses less affordable and decreasing already weak demand; consumers will be less likely to use credit to purchase large-ticket items such as cars; and the increasing cost of capital will constrain companies inclined to finance growth through borrowing. We expect the government to take all necessary steps to keep rates down. Watch for more government intervention!
At the same time, oil prices are spiking again. Oil is up over 100% from the lows posted at the end of 2008. Given the precarious state of the US consumer, we wonder how well received higher gas prices will be at this stage in our “recovery”. Recall that $150-per-barrel oil was likely the straw that broke the camel’s back in late 2007 and early 2008. Consumers simply cannot afford this tax right now.
My esteemed friend Doug Kass and I were talking about the expanding jubilance this morning. I described myself as “a sentiment-contrarian, data dependent, bull/bear schizoid.” Right now the popular sentiment is too rosy, and the data are too dour. I am being very careful.
Calls from clients question our defensive position. They question defense because the market’s gone up. They feel good and they want in! My oldest rule for investing is “if it feels bad, do it!” If selling feels bad: sell, and conversely, if buying feels bad: buy. Emotion is the greatest foe of the long-term investor.
As you think about what makes sense to you in today’s market, ask if you can support your “sense” of things empirically. Frequently, investors approach me with an investment thesis built on their magazine and newspaper reading. They form thoughtful and reasonable investment strategies based on the collective current headlines. By the way, I find that headlines follow a sort of herd consensus: The Post writes about a topic and therefore legitimizes it for The Times. My challenge is: do numbers support the reasonable strategy? It may sound intellectually fascinating, but will the numbers hold water? (I love mixing metaphors.)
The recent dramatic increase in share prices against a backdrop of declining economic indicators, albeit slowing declines, doesn’t add up.
Keep your powder dry and exercise extreme caution when committing new investment dollars. This recession and Bear Market will end but probably not on your schedule nor on mine no matter how badly we may want it.
Hang in there!