WAVETECH ENTERPRISES, LLC
Private Account Wealth Management Services
Newsletter Issued 10-31-10:
By: John T. Moir
Position overview . . .
Our previous newsletter, dated July 31st, stated that the weaker US could produce a counter trend bear market advance within the stock market, with the projected DOW trading range for the month between 9,700 and 10,800. The actual result saw the DOW in deed rally, but with a slightly narrower trading range than forecasted, between 9,614 and 10,585.
The US dollar, at least for the near-term, was projected to remain under price-pressure, with a euro fx equivalent trading range for the month between $1.24 and $1.34. This proved to be fairly accurate, but with a narrower trading range than anticipated, between euro fx equivalent $1.2350 and $1.3063.
The US treasury 10-year Note was anticipated to hover around the 3% rate, and the long bond around the 4% level, since the Fed had no logical reason to start tightening, as long as credit growth remains flaccid, hiring stays weak, with inflation non-existent. We forecasted, at least for the near-term, that the US 10-year Note could come under slight price-pressure, causing yields to inversely rise, with a projected base-yield of 2.90% or higher. This proved to be accurate, as the actual US 10-year Note yield range for the month was between 2.88% and 3.12%.
Looking forward . . .
The Chairman of the Federal Reserve, Ben Bernanke, recently described four tools that the Federal Open Market Committee (FOMC) have at its disposal to strengthen the US economy: (1) purchasing additional long-term securities, (2) changing its communications strategy, (3) reducing the rate paid on excess reserves, and (4) as suggested by some outside economists, increasing its inflation goals. He has outlined the limitation of these strategies and further rejects changing the FOMC’s inflation objectives.
What seems to have been lost in the Chairman’s attempt to be forthright is the limitations of these policy options. In normal times, the FOMC adjusts the funds-rate target, discount rate, and rate paid on excess reserves — to achieve a balance between inflation and growth. However, these are not normal times, and now the Federal Reserve is focused simply on stability for the financial system and getting the economy growing again.
The implication for investors and markets should be that the FOMC will be cautious in taking actions and will likely do so in a deliberate and measured way. This means that rates will continue to be low for a while, and any policy actions, either to reverse course or to respond to unwanted realization of downside risks, will be incremental rather than dramatic.
It appears that the Fed’s efforts to expand liquidity have been far more successful in producing asset inflation than jobs, as the recent employment report reminded us. Non-farm payrolls fell by 95,000 in September instead of coming in flat or just slightly negative, as the consensus forecasted. The private sector showed a gain of 64,000, while downplaying the 82,000 plunge among state and local governments, collectively the nation’s single biggest employers.
The official unemployment rate held steady at 9.6%, but the so-called underemployment rate, which includes labor-force dropouts and part-timers who would rather have a full-time job, surged to 17.1% from 16.7%. The true unemployment rate hit 22.5% in September up from 22% in August, if the underemployment rate were to count folks who have been out of the labor force a year, and do not get counted among “discouraged workers” by the US Government.
There have been some recent warning signs within the credit quality of non-financial companies, and we fear that Corporate America is ready to go on a borrowing tear and burn up all of that cash it has accumulated since the depth of the Great Recession, which would in turn endanger its more elegant credit status overnight.
Companies have handsomely spruced up their balance sheets in the past several years, and defaults have taken a nosedive. Now, this may not change in a flash, but there are signs that the improvement may be nearing a peak. Companies are becoming more venturesome by launching share repurchase plans, pursuing mergers and acquisitions, as well as scrambling to take advantage of bottom-scraping interest rates by issuing debt — all happening as the fears of a double-dip recession have faded.
Junk bonds have been all of the rage in the quest for yield in a zero-interest environment, due to the decline in the default rate of these speculative instruments, which could change, as a large wall of debt maturities are coming due in the next five years — suggesting a substantial turn for the worst in the coming months and years. Hence, any extended loss of market access for high-yield issuers is likely to accelerate a rise in defaults of these instruments.
These are simply early warning signs, but it have been proven that excessive use of credit can ultimately spell doom for an economy, no matter how seemingly robust, and a market, no matter how seemingly buoyant on the surface. Such a warning is better to be too early rather than too late, when viewing the chronic complacency of investors. .
Long-term conclusions and current month expectations . . .
Quantitative easing (QE) is coming, and it is the equivalent of that proverbial “printing press,” which raises concerns for everyone. When the Japanese government tried QE, two things happened: First, it failed to re-ignite the economy: and, second, the value of the yen fell by more than 25%.
This month’s discussion, by Federal Reserve Chairman, Ben Bernanke, of QE became widespread, even though QE has not been officially adopted. It will likely be disguised with some other name, and it will not change the monetary world immediately — meaning, it is more like drip irrigation rather than flooding the field
The US dollar could remain in short supply, until the Federal Reserve fully adopts their version of QE. The US dollar could actually appreciate through such a dismal financial situation, because dollar denominated assets remain the largest liquid investment in the world, and also since a large eurobond market does not exist. One must buy individual national debt, to invest in euro, which limits the possibilities.
Furthermore, the US dollar, because of the anemic money supply growth, has been becoming rarer. The US dollar could remain relatively rare, at least until the Federal Reserve officially adopts QE. We would anticipate, at least for the near-term, that the US dollar to remain under pressure, with a projected euro fx equivalent trading range for the month between $1.36 and $1.40.
The only positive thing these merger and acquisition (M&A) deals do is boost short-term stock market prices of the companies being purchased. The thought that M&A activity is a signal that corporate managements are gaining confidence in the future is completely misplaced. Corporations seek out acquisitions when their existing markets run out of growth prospects.
Many studies have shown that the majority of mergers do not produce the results that are intended. The challenges involved in combining different companies and cultures are significant, and more often than not enormous resources are wasted in the process. One need not go no further than to study the huge write-offs that have followed so many mergers to see this point confirmed. Furthermore, mergers are the last thing needed by an economy with a structural unemployment problem. Virtually all mergers result in so-called redundancies, which is a polite word for layoffs. It will only make the unemployment situation worse, if there is a merger wave right now.
Temporary hiring has been on fire, but it may no longer be as strong a bullish signal for broad employment as it once was in the past. Employers are simply uncertain about too much, to create new full-time jobs.
Over the past four months, temp hiring has been running at a record level, gaining 19.5% year-over-year. This reliance on temps is simply not a great forward-looking barometer of rising labor demand ahead, but rather a deliberate just-in-time hiring strategy that helps contain costs with no commitment to the new recruits. In this period, with temp hiring on fire, employers have slashed one million full-time positions from the job rolls.
Executives continue to say that they plan to boost temporary and contract hiring to 25% from 17% prior to the recession. Hence, we may be witnessing a structural change in the American work force, which will be confirmed over time. The major concern is that this could be a replay of the 2001 recession, when manufacturers permanently killed full-time jobs in favor of temps.
We anticipate, at least for the near-term, that the stock market could continue this counter trend rally, with a projected DOW trading range for the month between 10,750 and 11,200. This advance could further encourage the pundits to increase their equity allocations, causing the various US treasuries instruments to come under price-pressure, inversely moving yields higher, with a projected base-yield of the US 10-year Note at 2.50% or higher.
FOOTNOTE: The August 2010 and September 2010 newsletters were not released, while the October 2010 newsletter postponed, all to the financial benefit of investors utilizing our Private Account Wealth Management Services.
PRIVATE ACCOUNT WEALTH MANAGEMENT SERVICES:
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John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
Acknowledgements: Federal Data, Ned W. Schmidt with Schmidt Management Company, Bob Eisenbeis with Cumberland Advisors, Michael E. Lewitt with Harch Capital Management, John Williams of Shadow Government Statistics, Moody’s, Greg Weldon, CEO of Weldon Financial, American Staffing Association, Susan Houseman, Economist with the Upjohn Institute, David Rosenberg, Chief Economist with Gluskin Sheff.
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