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Tom
Crow Financial

SEPTEMBER MARKET COMMENTARY

By Tom Crow
October 8, 2012

 

 

Gain (Loss) by Period

Index

Month End

Month

Most Recent Quarter

Year-to-Date

Trailing Twelve Months

Dow Industrials

13,437

2.7%

4.3%

9.9%

23.1%

S&P 500

1,441

2.4%

5.8%

14.6%

27.3%

Nasdaq

3,116

1.6%

6.2%

19.6%

29.0%

 

The markets put together another strong month, making it four in a row for the S&P 500. Once again, the Dow has pushed past the 13,500 mark and is looking for a foothold. The trailing-twelve month numbers above are a better illustration of the trough we were in last fall than they are an indicator of how high things are, but we are indeed higher...than we were in December of 1999. Well, at least the Dow Industrials are. The S&P 500 and the Nasdaq still aren't there.

 

The volatility index (VIX) finished September above the mid-month lows, but the monthly average was still lower than the previous month's. Despite some good sized pullbacks, the S&P 500 has not dipped below any of its critical, trailing moving averages since June. The indices are holding well above their very-long-term moving averages (20 and 40-month) and look very strong from that perspective.

 

Alcoa will kick off third-quarter earnings reports on Tuesday (10/9.) If earnings reports are strong on average, it could almost override the economic and political uncertainty and drive markets higher. If companies take advantage of the uncertainty and continued economic weakness to air their dirty laundry, cut estimates, reduce projections and write down some losses because a little more bad news won't hurt, we could basically see the markets continue flat to down through mid next year at least.

 

Perhaps needless to say, but we'll be watching and listening closely to what companies are saying this earnings season and making adjustments to our clients' investments accordingly. At this point, congress' lame-duck session following the elections may have more impact on the markets than the elections themselves given all the continued speculation and hand-wringing over the looming fiscal cliff.

 

Most analysts think congress will reach some kind of deal before the end of the year, but you can be sure it won't be without plenty of threats, bickering and other nonsense. The cost of not doing it is too high and nobody from either party is going to want to explain why they let us slip into another recession. I believe they will reach a last-minute deal. In the words of Winston Churchill, "You can always count on the Americans to do the right thing...after they've tried everything else."

 

I read so many good articles this past month it has been difficult to decide which one(s) to highlight, but since it has been in the news so much lately, I'll spend a little time on QE3, the third round of quantitative easing by the Fed, why it's different than its predecessors and what it is intended to accomplish.

 

QE1 and 2 involved the purchase of US Treasuries. This time, the Fed is buying mortgage-backed securities. Also, the first two version of QE had specific time limits and amounts of money associated with them. QE3 is open ended as far as duration is concerned. The announcement of QE3 contained wording to the effect of $40 billion per month, ongoing until the economy and employment situation improve. Nobody knows how long that might take.

 

Another big difference is the Fed's current balance sheet. Since our elected and unelected officials seem to have an appetite for piling up debt wherever they can, this should come as no surprise, but prior to the financial crises in 2008, the Fed's balance sheet stood at $900 billion. As it rescued the financial system by gobbling up all the diseased mortgage assets it could, the balance sheet nearly tripled.

 

Now, the Fed's balance sheet sits at about $2.85 trillion, with its largest holdings in US Treasuries ($1.6 Trillion) and mortgage backed securities ($834 billion and growing.) At $40 billion per month, a balance sheet in excess of $3 Trillion sometime in 2013 is likely a foregone conclusion.

 

The Fed is willing to embark on these QE excursions because they maintain inflation is not a problem. The Fed projects inflation of between 1.2% and 1.7% this year, which is below the 2% target, at which point they'll intervene by tightening up their free-money at low-rates policies. But, an index that tracks a basket of 24 commodities has increased more than 15% this year, gold has more than doubled in the past five years, and gas prices have doubled in the past 4. I'll maintain that inflation is, without a doubt hurting consumers, in more ways than one.


The cash the Fed is using to purchase all these assets is just printed up as needed. It has no value other than what we all believe and trust it has. Flooding the market with cash simply devalues the dollars that are out there. Don't make me pull out my supply and demand charts. Wages have increased, but not as much as prices. When consumers are forced to pay twice as much for gas and groceries they do not have as much left over to buy other things. This is not economic expansion. It is contraction.

 

Second, the Fed's zero-interest-rate policy hurts savers and those on fixed incomes, and they have promised to maintain this easy-money policy through 2015 at least which will mean savers still won't earn anything on cash or CDs with banks and seniors relying on income from investment-grade bonds and CDs will be stuck with payouts at the low end of the scale. Again, people with less money to spend as prices rise...more contraction, not expansion.

 

Low mortgage rates are one positive consequence of QE and low-interest-rate policies, but banks are finding that with all the restrictions they've been saddled with since the meltdown, they can't lend because so few consumers qualify. Corporations with cash can borrow all they want, and they are to some extent, but they are not using that money to hire and expand because they don't have a backlog of consumers to buy their goods and services.

 

Do you follow this? The banks are making money by loaning money to corporations and investors who don't really need it but who turn around and invest the cash...gobbling up all the quality investments and profiting on the spread. Money is being made, but not spent which again is not expansion.

 

All three QE programs were supposed to improve the job market. Have they? In late 2008, unemployment was at 6.8% and the rate including those working part-time, as little as one hour per week who would rather be working full time, also known as U-6 was at 12.7%. September's rates, announced Friday, are at 7.8% and 14.7%. The raw numbers from the Bureau of Labor are as follows: USA Population Jan 2009: 305,529,237; number of people employed in January 2009: 142,099,000; USA Population April 2012: 313,176,891; Number of people employed in April 2012: 141,865,000. QE has been ineffective at lowering national unemployment.

 

The jobs report for September was not without controversy. The headline will be that the unemployment rate fell from 8.1% to 7.8%...the lowest since January 2009, when Obama took office. Maybe I'll be accused of piling on the conspiracy bandwagon (wouldn't be the first time) but I can't get the numbers to add up, or spin this as good news no matter how I try. The employment report for October will come out four days before the elections and given the likelihood of more wild revisions, could be equally controversial.

 

114,000 new jobs were added and the last two month's numbers were revised higher by a total of 86,000. Another surprise in the revisions was that federal, state and local governments added 63,000 jobs in July and August, compared with earlier estimates that showed losses.

 

Most of the buzz will be about the estimated 873,000 people who miraculously "found" jobs this month according to the household survey. This is the highest level for this number since 1983, and there are plenty of skeptics. This estimate comes from a government survey of 60,000 households. Survey respondents are asked: Do you own a business? Did you work for pay? If not, did you provide unpaid work for a family business or farm? Those who did are considered employed. Got that? Working for no pay for a family business or farm is considered a "job."

 

Some analysts have noted that the September numbers of the past few years have shown similar spikes in this number and are suspecting some seasonal bias (harvest, back to school, 3rd-quarter inventory) that is not being accounted for properly. The other number that calls the entire estimate into question is the U-6 rate, which did not change from the August level of 14.7%. The average, monthly job growth in 2011 was 151,000. So far in 2012, it is 146,000, and that has been heavily skewed by the first quarter's average of 226,000.

 

So...I've written a lot about numbers that are likely to be heavily revised over the next month or two. Unfortunately, these are numbers and revisions to which the markets often react violently. Since we are nearing historic high levels in the stock indices, we may be inclined to take some profits off the table and move to more-defensive investments until some clarity emerges.

 

Please call if you have any questions. The next time we do this we'll be days away from the election and things should be pretty exciting. Until then, enjoy the cooler, shorter days.