Commentary for the week ending 10-8-10

It was a solid showing for the markets this week. At the Friday close, the Dow rose 1.6%, the S&P 500 climbed 1.7%, and the Nasdaq had a more rocky road, but was still higher by 1.3%. The weak dollar continues to fuel the commodity rally, with oil up 1.3% and gold up 2.14% notching further records along the way.

Source: MSN Moneycentral

A large loss on Monday was followed by a pop higher Tuesday when it became increasingly evident that the Federal Reserve will step in with a second round of quantitative easing. That means purchasing even more Treasury bonds in order to keep yields low, which keeps borrowing rates for consumers low. They will also continue with their POMO operations which is essentially them pumping money into the stock market to push stocks prices higher. This method has been largely responsible for the most recent rise in the market. At any rate, this quantitative easing will only happen if the economic outlook worsens, which is why the markets have been cheering bad news.

We received the monthly unemployment report on Friday, which showed a loss of 95,000 jobs. So we are back to the bad-news-is-good-news scenario, where the markets rallied and investors became even more confident in further stimulus. On the plus side, the report did show a gain of 64,000 private sector jobs, but this was lower than the 75,000 that was estimated. A broader measure of unemployment, the U-6 report, showed even greater job losses and the unemployment number rose to 17.1%.

Third quarter earnings began rolling in this week and were not that bad. The Dow component, Alcoa, is one of the key early releases and analysts like to look at their numbers to get a sense of what the remaining earnings reports will look like. The results out of Alcoa were mixed, with profit falling, but the volume of sales rose. Their shares were higher on the day, though, as their numbers were better than expected. We believe this will be the theme for earnings season - decent growth and solid earnings - and the markets will respond higher.

A troubling report caught our eye again this week. After last weeks report that 1,400 insiders were selling for every one buying, this week that number increased to 2,300-1. Again, this is not always the best strategy to follow, but it is hard to argue against numbers that daunting. It certainly makes us cautious when considering investment opportunities.

Even though the markets are looking stronger, it really feels like we are living in bizarre times. The reliable, free market, capitalist system we have had in the past is becoming just that, a thing of the past. The fact that a bank won’t foreclose on a home that is months and even years behind in payments - and is congratulated for it - is troubling. When the government floods the economy with trillions of dollars in stimulus, it is troubling. When the Fed becomes the second largest holder of US debt behind China (essentially just printing money), it is troubling. And when bad economic news and a cloudy future sends the markets higher, it is troubling.

A stable, reliable economy with a strong currency and established rule of law were ingredients to America’s greatness. Businesses were created and drawn here due to this favorable climate. As uncertainty creeps in, businesses and investors are fleeing the US economy and establishing operations abroad, where stable, fiscally-responsible countries are capitalizing. This phenomenon is clearly evident as merging markets have been booming largely due to this fact. We hate to sound apocalyptic, but currently, better investment opportunities can be found overseas.

Next Week

Activity will begin picking up next week as earnings season kicks into gear. Similar to last quarter, we want to see revenues rise, not just earnings (cutting expenses can boost earnings, but means little. Increased revenue means increasing sales).

For economic data, we will be receiving the CPI and PPI, as well as the trade balance and retail sales.

Where are we investing now?

It has been a good run for the markets and we do believe it will be higher through the end of the year. Not because the economy is stronger, but because of another round of stimulus and investment managers trying to make some gains before the year ends. There is still a considerable weakness in the economy, though, and we would wait for a pullback before making any considerable positions. There are many headwinds, too, like higher future taxes, increasing government involvement in the private sector, and a still-high unemployment rate, which continues to worry us.

In equities, we are focused on higher-quality and multi-national stocks, but some smaller stocks look promising, as well. A weak dollar would be a plus for export-oriented companies. We continue to avoid banking and insurance sector stocks. TIPs are important as we expect inflation to increase in the future, while U.S. treasuries are a sector we are very bearish (pessimistic) on as yields will increase over time.

Commodities remain a longer term favorite, as mentioned above, as inflation will also impact prices to the upside along with the weak dollar. Municipal bonds will play a more important role in our portfolios over the coming months and years as higher tax rates take effect. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.