Market Watch - August 28, 2009

If Not for Debt, 'Bull' Would be Back

Technical Analysis

The market is currently hovering around 9500 points, 4700 points below its high in October 2007 of 14,165 points. The market hit 6,542 on March 9th which, so far, has signaled the low for the bear market. The first important positive technical hurdle occurred on August 7th when the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA) simultaneously reached new highs in the current market upswing. Dow Theory is very explicit in that “no significant movement up or down in the market may occur without the Transportation Average confirming new highs or lows in the Dow Industrial Average”.

The next big step in this market would be witnessing the Dow Industrials reaching 10,354 points, 850 points higher than current levels. If the Industrials reach 10,354 points, the halfway mark between the high of 14,165 points and the March low of 6,542 points (14,165 – 6542 = 7623 x 50% = 3812 + 6542 = 10,354), a huge technical milestone would be reached. If the Dow Transports confirm the resurgent Dow Industrials after they have reached 10,354 points, there is a good bet that the bear market is over and we really are in a new bull market.

But a brand new, full blown bull market will certainly encounter many, and extreme, difficulties.

Problems in the Economy

At this point, U. S. private savings is way up, now confirmed to be at least 7% and thought to be 9%. That is huge, and it has accounted for trillions of dollars in savings being accumulated over the last few years. To improve the economy, there must be an increase in consumer demand that will entice savers to part with some of their savings and spend their money. The whole idea of a “stimulus program” is to encourage the public at large to spend their money. Prudent businessmen and families, however, are not spending on anything but necessities. The fear of further economic collapse encourages people to build savings and discourages people from spending those savings. An increase in demand can not be created by government, or Federal Reserve System, policy.

Unemployment now exceeds 10% and is approaching 12%. It is estimated by the Bureau of Labor Statistics that we will lose 8 million jobs in this economic downturn. Additionally, we need to develop 150,000 jobs a month in this country just to absorb labor entering the employment market. For us to be “whole” again, we need to return the 8 million jobs plus 150,000 jobs a month; which will be tough and take time, particularly if people choose to continue to save rather than spend part of their savings. Not included in these figures are six million people who are working part-time that are looking for full-time jobs. These statistics dampen the probability for rapid economic expansion. To get back to where we were in jobs a year ago, 23,000,000 jobs need to be created in five years. That would mean adding 15%, annually, to the employment base. Unlikely!

The housing market, a significant part of our economy, has been picking up. In the month of July, of the houses that were sold, about 30% of them were “short=2 0sales” from banks (who lost money on each sale) and another 30% of homes sold were foreclosures. So 60% of houses sold recently are houses that are moving because they are troubled assets. When this inventory is depleted, and newly built houses are being absorbed by demand, the housing market will be on the way to being whole again. But it is certainly not well yet.

Estimates of the government’s bailout funds range all the way up to $12.9 trillion, and nobody can check the sources of these estimates because the Federal Reserve System has never been audited. There is an attempt in Congress to have the Fed audited so that we can measure the real obligations of our financial system. The resistance to auditing the Fed is so great one can only surmise that there are things in that audit the public cannot see, because it would make them furious if they did. Continued government dishonesty and lack of disclosure will not help in rebuilding any kind of economic resurgence.

Seventy-seven banks have closed so far this year. Many other banks are insolvent. Nobody in the private sector really knows the magnitude of the problems with these other banks which is another reason for auditing the Fed. The new rule to “mark to the market” assets held by lending institutions, is creating a furor among bankers. They know that marking most of their troubled assets “to current value” means marking them down substantially from where they are currently carried on the books. That means banks would report large losses of capital. Further, many other banks would be insolvent. Until we get beyond bank foreclosures, which may last another 18 to 24 months, economic recovery will remain frustrated.

In the 1960s Hamilton Bolton, one of the founders of Bank Credit Analyst, and also a strong Dow Theory proponent, proved that every $3 of new debt produced $1 of new GDP. Mr. Bolton’s successor, Ian McAvit, writes in his latest report “Over the four years to September ’07 when the meltdown began, U. S. GDP rose to $2.86 trillion, or 25.8%. Total credit market debt increased by $14.85 trillion over those 4 years. This translated into $5.19 of new debt for every $1 of new GDP (14.85 ÷ 2.86 = 5.19). In the two years to September ’08, new debt required for each $1 of additional GPD had ballooned to $6.49. Increasing federal debt to recapitalize banks isn’t going to translate into resurgent growth and consumer spending”. Remember, each new dollar of debt, and we have at least $3 trillion this year, requires interest payments. Those interest payments take away from money that could be spent for something that is more productive in creating jobs than the payment of inte rest.

Here are some interesting numbers through July 31st that relate to our economy in this fiscal year:

Any reasonable human being that understands math can see these numbers cannot be sustained. Furthermore, there is no indication in government planning, or in economic activity, that this disastrous posture created by our government will be abated at all, let alone anytime soon! To further compound the problem, government revenues are down 33% this year and government transfer payments (stimulus funds) are up 33% this year. These are not good, or healthy, signs. In 1984, total U. S. debt was 1.25 x GDP. In 2009, our total debt is 3.1 x GDP. We are swimming in an ocean of debt, literally a tidal wave of debt.

We have run into the problem of trying to find buyers for the national debt. 70% of our national debt in the past is owned by Social Security and Medicare, the former program of which is using 100% of its annual donations, and the latter of which is already running deeply in the red. That eliminates them as further buyers of treasury funds. The two recent biggest buyers of U. S. treasury securities, China and Japan are not buying any more treasuries because with the value of the dollar going down, they lose money daily. The only thing left is a scam: the Fed creates the money with a printing press and turns around and uses that new money to purchase debt from the Treasury Department, which debt results from deficit spending. Since nothing of value was rendered for the new cash, there is now much more cash in the economy that is necessary for the goods and services that can be made available in the economy. The result is inflation . We may stave off inflation a little bit while unemployment remains high; however, we will get slammed down the road if and when full employment returns. The current decrease in the value of the dollar is a direct result of investor fears of future inflation. Walter Wriston, long-time chairman of Citibank, which was very successful in the 60s and 70s, says “Money goes where it is wanted and stays where it is well treated”. We may expect the irresponsible treatment of our money supply to chase investors away until the government makes some noise about, and some reasonable action is invested in, balancing the budget.

Outlook

The outlook is gloomy. We are not in a confirmed bull market, even though many economists say we are. We are not healthy, even though many economists say we are on the road to health again .

What to do?

There is nothing wrong with cash. It gives you time to think. There is a huge socialistic agenda being placed before the Congress. All of these agendas are to be paid from “increasing tax revenues”. That is government speak for “tax the rich” because there ain’t nobody else to tax. Margaret Thatcher said “The problem with socialism is that eventually you run out of other people’s money!”

It’s prudent to see what happens with some of these issues on the table that could have a dramatic effect on the direction of the stock market. There are some buys for investors who are interested in equities. All of the following are A-rated companies with long-term records of increasing both dividends and earnings. They all yield 3.4% or more, and they all sell at price earnings ratios far under their historical averages: Abbott Labs, Altria, Chevron, Clorox, Coca Cola, Emerson, Home Depot, Johnson & Johnson, McDonalds, Pepsico, Phillip Morris Int’l Inc., Proctor & Gamble, and Sysco. We have not seen a list of good values in so many A-rated companies in more than quarter of a century.

There is a bright spot. U. S. factory utilization is the lowest it’s been since WWII. Our factories are in good shape. When business improves, the private sector will be gushing cash. If the profits are not stolen by the government, and business is allowed to hire more people and produce more products, our economy could be cured more quickly than it appears.

Carpe Diem.
George Rauch
August 28, 2009