8/16/07

Economics

fiscal profligacy (Government spending as a percent of GDP is too high and the looming explosion in entitlement expenditures will make it worse. There is no good solution save spending discipline.).

http://www.realclearpolitics.com/articles/2007/08/dead_men_farming.html

Adding to the near panic in the Market, today’s economic data are dismal:

July housing starts fell 6.1% versus expectations of a decline of 4.5%.

July building permits dropped 2.2% versus expectations of a decrease of .5%

Both terrible, we will have to revise our expectations for 2007 economic growth down.

Weekly jobless claims rose 6,000 versus expectations of an increase of 2,000--this is the second disappointing report in a row.

Politics

Domestic

International War Against Radical Islam

News from Iraq you won’t see or hear in the main stream media:

http://gatewaypundit.blogspot.com/2007/08/al-qaeda-in-iraq-has-lost-75-of.html

The Market

Technical

DJIA 12855 is now the level to watch; and it closed right on that number. In our mind, it is more important for the DJIA to hold 12855 than 13200 because it is the lower boundary of the current medium term up trend. If stock prices continue below 12855 not only does that mean that DJIA is back in a 5-7 year trading range but also all that is really left is lower boundary of the long term up trend (11757). For the S&P, watch 1330, that is the lower boundary of the medium term up trend.

Fundamental

As bad as the technical outlook is right now, fundamentals are still on track. Today’s poor housing numbers notwithstanding, yesterday’s (1) CPI report was in line with expectations--importantly the declining likelihood of an inflation threat gives the Fed more flexibility, (2) July industrial production--up .3% versus expectations of up .2%, (3) July capacity utilization at 81.9 versus expectations of 81.7. Further, a lot of very smart investors have been buying stocks over the last week, Warren Buffett, Carl Icahn, Eddie Lampert and Hank Greenberg to name a few.

The problems are that (1) because the financial institutions that own the lower quality credit instruments are still not being forthcoming about the depth of their problem, investors are increasingly unwilling to risk capital in ANY market segment; and, therefore, there are mounting remain liquidity problems throughout the credit markets, (2) over the last 5-6 years a whole slew of new financial instruments have been developed which were supposed in theory to increase financial leverage but mitigate the associated risk; well that ain’t working and it is causing liquidation of even high quality securities [high quality securities can be over leveraged more easily than low quality securities], (3) the yen is strengthening against the dollar and that is causing the liquidation of the so called ‘yen carry trade’ [borrowing yen cheap {1% interest rate and less} and investing that money elsewhere {if yen is rising versus the dollar, the yen carry trade is losing money on the currency translation}; that means that US stocks and bonds are being sold to pay off those yen loans.

Notice that these problems have less to do with anything fundamentally wrong with the asset value and earnings generating capacity of most of corporate America and much to do with fancy financial instruments and their accompanying investment banking fees. As justifiable as the painful consequences for this risky behavior may be to those who participated, as we noted above, whole sectors of the financial markets that are only tangentially connected to sub prime loans are increasingly unable to fund their normal credit operations (which means that what we all consider typical everyday sources of credit are close to shutting down); in our opinion, if it gets much worse, aggressive Fed action will almost certainly be needed.

Our bottom line is that (1) the US economy is in good shape, (2) Wall Street, on the other hand, is suffering mightily the consequences of inappropriate risk taking--there are even early signs of capitulation, (3) so we need to continue to avoid those financial institutions that participated in the risk taking and to build the list of stocks of those high quality companies that are being unfairly penalized, (4) but to act we need either more information on sub prime loans from financial institutions, a resumption of normalized transactions from the non-sub prime financial sector, assistance from the Fed to effect those normalized transactions or an exhausted Market that has discounted the worst case (capitulation).

News on Stocks in Our Portfolios

More Cash in Investors’ Hands