At the time of the post, the most recent close on Euro futures was $1.2369 and over the course of the next 12 months, it staged an enormous 20%+ rally (with a very nice, easy-to-trade trend I might add) up to a interim high of $1.4925. Since then however, new worries regarding whether or not Greece would default (or if markdowns were accepted by bondholders, how much of a markdown) and rising yields on the sovereign debt the other PIIGS (Portugal, Ireland, Italy, Greece, Spain).

So now with the possibility of a Greek referendum on whether to stay in the Euro and the possibility that Prime Minister George Papandreou will be forced to resign, what are the charts saying about the direction of the Euro, and possibly the direction of markets in general? Let’s take a look below:

(Click here for a larger image)

This first chart is a basic long term trend line analysis reflecting the development of a VERY large wedge/pennant formation. Wedge patterns are indicative of uncertainty and a lack of conviction among investors and are not effective at predicting price movements (aside from trading the range) until they break up/down out of the pattern. The fact that the Euro has broken below and above the lines at certain points further illustrates the lack of conviction.

However, there is slightly more evidence indicating downward price pressure from where the Euro currently is for two reasons. 1.) The trend line from the June 2010 lows that had been acting as support was breached to the downside and the Euro has just finished retracing to touch it in what is possibly a “kiss of death”. 2.) As you can see on this zoomed in daily version of the same chart, there was strong resistance at the top of the wedge’s range so it would be completely normal for the Euro to retest the lows of the pattern again. The daily chart also shows that the Euro ran into resistance at the 150 and 200 day SMA lines (white).

Despite the bearish trend lines that I mentioned above, I currently have no position on the euro (I’ll explain why on the next chart). I would however become very bearish if it were to break down below $1.3020 because it would be a clear break of the wedge and would also be indicative of a head and shoulders pattern.

The reason I am not positioned short at the moment is shown on the next chart that uses Fibonacci retracement analysis.

(Click here for a larger image)

The graph shown above paints a slightly different picture. While it’s true that the 61.8% line was not penetrated in the short setup from the interim high at$1.4925 to the recent low at $1.3139, the long setup from the same recent low at $1.3139 to the recent high at $1.4243 also held. This situation mirrors the indecisiveness that was evident with the wedge pattern above. However, this chart leans more towards the bullish side because the two setups mentioned above in this paragraph are taking place within a much larger weekly long setup from the June 2010 lows to the interim high at $1.4925. The bigger the setup more more trustworthy it is and the trend is in place until it isn’t.

Based on the Fibonacci chart, my bias at the moment would be long but with a stop at $1.3560. If I got  stopped out, I would then wait for the next 50% retracement to get short. At that point, both the trend line and Fibonacci analysis would be pointing towards the bearish side so it would be more likely for the Euro to break through the weekly support. It’s also important to note that in the last six years, the Euro has never held a full half way back 50% long after breaking trend (as the Euro already did back in September).

In this case, we have the only area where the two indicators agree, is that the outlook is still mixed until the Euro breaks out of it’s current range so the best way to play this would probably just be being patient and waiting for the market to tell us the next move. I’ll try and give an update on this later when a trend materializes.

Disclosures:
No current Euro positions.

-MJB

While the situation is certainly bleak, a large majority of traders are currently short the Euro and you don’t want to sell lows. You can see from the chart below that we just hit a medium term short target and although its definitely possible that we could just keep going in an extension, it’s also very possible that we could see a near-term retracement to 1.26′s as shorts take profit in a crowded trade.

-MJB

(Click to Enlarge)

Overview & Outlook

Optimism abounded during the first quarter as corporate earnings continued to meet or beat expectations; auto sales maintained their upward trend and 4^th quarter U.S. Gross Domestic Product (GDP) registered growth at an annual rate of 5.6% (the strongest growth since 2004). The jobs picture also improved in the first quarter with a drop in the unemployment rate down to 9.7% from 10% in December.  March was especially strong as the economy added 162,000 jobs, the biggest monthly gain in over three years. Unfortunately, over 40,000 of those jobs were temporary Government hires for the Census and, after dropping to 9.7% in January, the unemployment rate has not fallen any further.

The signing of the health care reform bill by President Obama eliminated some uncertainty in the markets; influencing performance positively. Although the long term effects of this legislation are not yet clear, companies can now move forward with a solid understanding of what the rules of the game will be. Economists had been arguing that until the bill was either signed (or killed) it would be very difficult for companies to hire new employees because they wouldn’t know the true cost of employment.

Credit markets also continued to improve with the spread between corporate and government bond yields falling back to historically normal levels. Inflation was beginning to be a concern for investors towards the end of 2009 but the Consumer Price Index (CPI) data from the first quarter of 2010 allayed those fears by showing very muted gains. This maintains the foundation that the Federal Reserve needs to maintain its “exceptionally low levels of the federal funds rate for an extended period” while also providing financially strapped consumers with lower prices for their everyday items.

Despite the good news, there continue to be significant caveats and reasons for caution:

• Unsustainable GDP Growth
  The blistering 5.6% GDP growth rate from the fourth quarter is not likely to be repeated because it was primarily driven by companies stocking up their inventories for the holiday season. Inventory stocking is typical in the fourth quarter but its effects were magnified in this case because companies were being cautious last year and maintained especially low inventories during 2009. To provide some context, we would need three more quarters of 5%+ GDP growth to drive unemployment down just 1%.

• Weak Jobs Market
  Although the unemployment rate has fallen from its peak, it is still at historically elevated levels. U-6 Unemployment (a broader and more complete picture of unemployment) had been slowly declining but has now been ticking upward since February and registered at 16.9% in March. The picture gets even worse when you look at the details. Out of all the unemployed Americans, 44.1% have been unemployed for more than six months (almost double the worst level seen in our last recession). Also, many people who have been unemployed for more than a year are no longer being counted in the official statistics. This trend has only been getting worse and could mean that a lot of the jobs that have been lost are not coming back (particularly in construction, manufacturing and financial services). Unemployment rose in 24 states, while California, Florida, Nevada and Georgia all set new records for joblessness in March.

• Rising Oil and Commodities Prices
  Over the past couple of years, oil companies have drastically cut their capital expenditure budgets for building new capacity because global demand had significantly slowed. Following strong stimulus programs from around the world – most notably China’s – demand for commodities and oil has been rising and global demand for oil is expected to set all time records in 2011. This strong demand combined with a diminished supply of oil could cause another sustained run-up in oil prices, which would severely dampen the economic recovery taking place.

• Interest Rate Policy and Bank Lending
  A key driver of this recovery has been the strength of banks and their ability to keep credit flowing throughout the economy so that consumers can spend (even when they shouldn’t) and companies can expand. The more money banks make, the more credit they can provide. With the Federal Reserve holding their overnight lending rate at effectively zero, it has been extremely easy for banks to make money by borrowing from the Fed (AKA U.S. taxpayers) at a rate of 0% and then lending it out to companies at a rate of 5% or more; essentially providing the banks with windfall profits. Eventually the Fed will need to raise rates to stave off inflation, which will severely crimp the margins of banks, limiting their ability to continue contributing to growth.

• Continued Uncertainty Around Financial Regulation
  Now that health care legislation has been passed, the administration and congress can turn their attention toward regulating of the financial services industry There is strong political and popular will to ensure that a financial crises of the magnitude that we saw in 2008 does not repeat but it is still unclear whether it will be done in a way that would impair the ability of banks to provide credit. Major banks made themselves easy targets by taking taxpayer money (whether they claimed to need it or not) and then spent lavishly on employee compensation stoking outrage that continues to smolder.

• The U.S. Budget Deficit and Tax Increases
  In combating the recession and reforming the healthcare industry, the U.S. budget deficit has grown to unprecedented levels. This has been exacerbated by falling tax revenues due to lower corporate profits and consumer income. President Obama has already said that taxes will need to be raised for upper class Americans but it is not unreasonable to assume that lower income levels could also see higher taxes. Of particular concern for the stock market is that taxes on capital gains and dividends may also be raised, which would most likely be perceived negatively by the market.The elephant in the room however is looming social security and Medicare expenses that will continue to balloon as the baby boomers retire. Any reform will most likely require a mixture or higher taxes, reduced benefits and tougher eligibility requirements. Faced with the prospect of higher tax rates and decreased social benefits, investor sentiment is likely to wane.

Despite my caution, I am hopeful and optimistic that economic data will continue to improve. I would like to believe the market cheerleaders on CNBC who say that we are in a new long-term bull market but unfortunately, the facts of the situation do not yet support that assertion. After selling off a large portion of my portfolio in December and early January, I have been gradually increasing my exposure to certain areas of the market with a defensive posturing.

During times like this when hope and optimism outweigh the raw data, it’s important to maintain perspective and discipline. Warren Buffett said it best in a letter he wrote to his investors during the stock market frenzy of 1969:

It is possible for and old, overweight ball player, whose legs and batting eye are gone, to tag a fast ball on the nose for a pinch-hit home run, but you don’t change your line-up because of it.

Market Summary
Although very volatile, the S&P 500 continued its upward march, gaining 5.39% in the first quarter of 2010 and bringing its return for the trailing twelve months to 49.76%. However, it is still down more almost 19% from the October 2007 market highs.

The MSCI EAFE (European, Asian & Far East) index continued to underperform U.S. equity markets with a gain of only 0.94% in the first quarter, bringing its’ total return for the past year to 55.19%, slightly above the S&P 500. We feel that the MSCI EAFE is still being held back by a strengthening U.S. Dollar as well as concerns over sovereign debt in countries such as Greece, Ireland and Portugal. Despite these concerns, we maintain a favorable view on foreign/emerging markets as a whole because of their stronger fundamental growth prospects and lower consumer debt to income ratios.

The Barclays Capital U.S. Aggregate Bond Index underperformed equities during the first quarter of 2010 with a gain of 1.78%. The index is now up 7.70% over the past year and yields approximately 3.8% as of the close on March 31. The recent underperformance of bonds is likely due to investors shifting money from bonds (which are relatively safe) into riskier assets such as stocks (which offer greater returns). Another downward force on the price of bonds is speculation regarding when the Federal Reserve will begin to raise interest rates (higher rates tend to depress the price of bonds) and by how much.

Final Thoughts
We are either at the end of a Great Depression style “fools” rally or entering the second stage of a longer term bull market but it is very difficult to tell which it will be. The market is longer “cheap” by almost any definition with the P/S ratio now solidly over 1.0 and the dividend yield of the S&P 500 back to normal levels below 2%. However, with a forward P/E ratio of  16.95 (as of market close on 4/23/10) the market is not exactly overpriced either. We are now in a valuation limbo of sorts.

The main reason for this is that there is currently an unprecedentedly large divergence in the corporate earnings estimates of top down macroeconomic analysts and bottom up security analysts. Historically, bottom up security analysts have predicted operating earnings 19.25% higher than those predicted by top down macroeconomic analysts. For 2010 and 2011, the difference has widened to over 28%.

It the optimistic bottom up analysts are correct and the S&P 500 has operating earnings of ~$95 in 2011 (up from ~$57 in 2009), then the market is certainly undervalued and could easily run up into the 1,400′s assuming a modest P/E ratio of 16. However, if the top down analysts are closer to the mark and the S&P 500 earns only $70, then using the same P/E of 16 would imply a market correction down into the low 1,100′s.

This being said, I remain long the market and do not see any strong technical resistance other than 1,229 (the 61.8% Fibonacci retracement from 2007 highs to 2009 lows). However, until we break above that line, I am keeping my mind very open to the idea of a deep decline for two reasons. 1.) Selloffs bring lower prices and opportunities to buy great companies that might have been missed earlier during the rally and 2.) The public and political will for strong financial reform (which I feel is absolutely necessary in some areas) has been dwindling with each new month that the market continues to rally. The impetus for reform would be greatly strengthened if the market begins another dramatic selloff and stories continue coming out about issues similar to what went on between Goldman Sachs & Co. (GS) and Paulson & Co.

Bottom Line: Don’t short a market that wants to rally. I’m staying net long until technical long setups start breaking down and if short setups start working before we break above 1,229 then I’ll have to reevaluate and strongly consider going short.

-MJB

Case-Shiller Percentage Year over Year Price Change Index

Unfortunately, the above chart gives a very skewed picture of what is actually happening to U.S. home prices because we are coming off of such a low base. To account for this statistical anomaly, I prefer to look at what actual prices are doing with the chart below.

Case-Shiller Home Price Index

Looking at the first chart would leave you to believe that you’re about to “miss” the next boom in real estate but using the second chart for added context will surely give you pause. The U.S. Government began inflating the housing bubble all the way back in the 1980′s with aggressive home-ownership policies spearheaded by Fannie Mae, Ginnie Mae and Freddie Mac. Wall St. helped the bubble along with financial “engineering” and then the Federal Reserve even stepped in to do its’ part after the dot-com crash by lowering rates dramatically for an unprecedentedly long period of time.

All these factors make it very hard to get a real idea of what housing prices should be because the markets have been manipulated so completely. For a best guess, we can look back to where prices bottomed in the 1990′s or we can look at metrics such as income to home price ratios. Unfortunately, no matter what you look at (aside from the housing bulls’ percentage price change chart), things do not look pretty. The 1990′s levels leave us with a long way to fall and inflation-adjusted median income has fallen.

Let’s just hope that I’m wrong and the housing bulls are right…

-MJB

Adding to the woes are increasing inventories at the carriers.  This is an issue because Palm records sales when the products are shipped to the carriers, not when they are actually sold to consumers.  Thus, large stocks of unsold inventory will prevent Palm from recording much in the way of sales until that backlog is cleared.  Thus, Palm issued revenue guidance for the upcoming quarter that is half of the $305.77 mm that analysts were expecting.

My Palm article in September hypothesized that the stock (then at 17.40) would drop as consumer adoption of the new operating system would lag.  Back then, Palm was shipping over 800,000 units per quarter, that number has since increased to over 900,000 but sell through to customers has decreased to 400,000 units.    The stock in after hours dropped to below $5 as the long term survivability of Palm remains in doubt while they try to compete against the mighty Apple, Google and RIMM.

-AH

Disclosure: Long GOOG, no position in any other stock mentioned

Many of China’s trading partners (including the US) have been upset with China’s handling of their currency during one of the most devastating economic period in recent history (China had been gradually appreciating the yuan but stopped in 2008). Adding to protectionist issues, Google said over the weekend that is 99.9% sure it will be closing it’s China.cn web portal and China made a warning to Google’s Chinese partners that they will be responsible for any search related problems on their own website.

Despite all this negative news flow, investors has been hanging on to hope with the tired lines of “things are getting less worse”. Bulls are still reciting facts about recoveries in past recessions as if the more they repeat them, the more they will apply to the current crises. Unfortunately they do not.

It would seem that people are ignoring fundamentals and the more the stock market rises, the more bullish they will become. The downside to this strategy is that most people who are bullish are already invested. It is almost always short sellers covering their positions that launch the market into it’s final peaks before coming down and this is certainly how it feels to me.

The chart above from Bloomberg gives some good color to the situation. There is no “clear” indication that we are topping out right now but there are definitely more (and better) reasons to be cautious than to be optimistic. The rally over the last month has been strongly moved by short sellers having their stops hit (trust me, I’ve been trying), and I fear that a few months from now we will be looking back at this point in the stock market as a double top and possibly the highs for the year. Be careful everybody.

-MJB

Disclosure: Net-long the stock market with over 35% assets in cash

Very often, the people who utter those words end up feeling quite stupid and having less money in their brokerage/IRA accounts than before. Usually it is because that when you go along with conventional wisdom and group think, you wind up in a very crowded trade with little room left to run. Today however, the conventional wisdom is that this time it’s not different and that we will proceed to have a strong jobless recovery. The jobless recovery phenomena may have worked in past recessions but A.) There are only so many times you can have a “jobless recovery” before it’s not an actual recovery as evidenced by the continued drop in real productivity and income per capita and B.) This is by no means a normal recession.

Take a look at the chart below, I hope it offers some valuable perspective and context (note that the data doesn’t even include numbers from 2008 and 2009) . This time, things may very well be different…

-MJB

]]> http://lucidinvesting.wordpress.com/2010/02/13/where-are-we-in-the-unemployment-trend-historical-perspective/feed/ 0 Michael J Burns Historical Unemployment Trends http://lucidinvesting.wordpress.com/2010/02/10/google-looking-to-revamp-another-industry-goog-aapl-t-cmcsa-msft-adbe-twx-sne-via-cbs/ http://lucidinvesting.wordpress.com/2010/02/10/google-looking-to-revamp-another-industry-goog-aapl-t-cmcsa-msft-adbe-twx-sne-via-cbs/#comments Wed, 10 Feb 2010 18:05:51 +0000 andrewhhale http://lucidinvesting.wordpress.com/?p=764 ]]> MarketWatch is reporting that Google will be testing a new direct-to-home fiber-optic internet connection service that will reach speeds of up to 1 gigabit per second.  The company is currently looking for interested communities, and hopes to test their new system with up to 500,000 people.

This service has the potential to be a game changer.  Google is interested in much faster internet connections because of their belief in “cloud-computing,” where very little information is stored on a user’s local machine because the actual computing is done by a remote server.  They have pushed this technology into the mainstream with services like Docs, Picasa photo editing, Calendar, and hope to take the technology further with the Chrome OS.

The current issue concerns the speed of the user’s connection to these services.  Even with the fastest available connection speeds, which in my area is 50 mbps, these services are not as fast as a desktop client due to latency.  Picasa only offers minimal photo editing due to bandwidth limitations, and video manipulation is impossible.  Thus, desktop programs like Photoshop, Office, iPhoto and iMovie are still necessarily stored on a local machine.

Google knows that companies like Apple (AAPL), Microsoft (MSFT) and Adobe (ADBE) are too entrenched on the desktops of consumers, so they are not trying to fight the battle there.  Instead they are staying on the relatively uninhabited world of web-based applications.  And they are winning, chiefly because they are a high-profile company and that no one else does free, ad-supported products quite as well as Google.

If this service from Google becomes widely available, and at a reasonable cost (admittedly a big ask), it would destroy the business models of many companies.  Software providers like Apple, Microsoft and Adobe would find themselves competing against a free, cloud-based product that acts in the same way that their desktop software does but available anywhere.  Content providers like Time Warner (TWX), Sony (SNE),  Viacom (VIA), CBS (CBS) etc be selling their media via streaming services, as people move their entertainment libraries off their shelves and hard drives and onto remote servers.  And current internet providers like Comcast (CMCSA), AT&T (T) and Verizon (VZ) will be competing against a service which runs at 10x their current maximum bandwidth.  That is why this could very well be a game changing moment for Google.

-AH

Disclosure: Long GOOG, MSFT, T and the market in general.  No positions in any other stocks mentioned.

Toyota Prius Crash Test

The Wall Street Journal is reporting that today Honda (HMC) is widening its 2008 airbag recall to include over 826,000 Honda and Acura vehicles.  The vehicles affected are model years 2001-2002, and cross the broad spectrum of vehicles sold by the company.  Add this to the well publicised woes that are currently plaguing Toyota (TM), and one could easily ask the question: What has happened to legendary Japanese reliability?

In the eyes of the general public, the main selling point for both these manufacturers is their reliability.  Ask a Honda or Toyota owner about how long they expect their vehicle to remain on the road, and most likely their answer will run in the hundreds of thousands of miles. High profile recalls, especially involving a critical part of the car, can damage a carmakers reputation for years.  Ask any of the American automakers.  Just from looking at this timeline (from Time magazine), one can see that in the last decade the Big Three Detroiters accounted for 5 of 7 large recalls.  Their reputation for reliability took a hammering during this time, and their sales suffered greatly.  It would not be a stretch to say that this was one of the main reasons for the recently abysmal performance of Ford, GM, and Chrysler.

However, the Japanese recalls present a fantastic opportunity for these three companies to realign themselves with the idea of a quality product.  They have already been making massive strides.  GM brand Cadillac came third in the JD Power Initial Quality Study for 2009, Ford was 9th and Chrysler was 10th.  All companies handsomely beat the market average.  And from crisis comes opportunity. Chrysler has created offers and discounts for people who trade in Toyota vehicles.

So as an investor, is this “crisis” actionable? Long term Toyota shareholders should be furious at the company’s management. Their response to the recall was lackluster at best, damaging at worst, and the stock has lost about 23% of its value.  The drop seems to have stabilized as “knife-catchers” try to time the bottom, but more pain could be ahead during the Senate hearings.  Honda’s stock has held up well during the Toyotapocalypse, but the valuation is a bit high and this new news could set off a round of fear-induced selling.  Since Ford (F) is the only tradable component of the (Not-So) Big Three, we shall discuss them, and I think they present an interesting opportunity.  Certainly there is a lot of optimism built into the stock, but it holds a lower PE than Honda and Ford is absolutely the strongest of the Americans.

-AH

Disclosure: Long HMC, Proud owner of several (non-recalled!) Hondas, Long the market.

The interesting thing to note here is that it would appear the market is still pricing in a decent probability of some form of assistance coming in, possibly from another country.

-MJB