Monday, February 9, 2009
I remember having breakfast with one of our treasured clients on Thursday, September 18th. He asked me if I felt that the markets could repair themselves. I responded emphatically, “No.” The degradation of the financial system coupled with the collateral damage in the real economy would cause economic activity to halt. The only force powerful enough to kick-start a stalled economy would be the government, and we fully expected a governmental response of considerable magnitude would be announced within days. Friday morning, Treasury Secretary Paulson laid out the case and parameters for the TARP package that would provide $700 billion in rescue funds to be used as the Treasury saw fit. The S&P 500 rallied 11% from the low on the 18th to the close on the 19th. After a week of discussion and negotiations, with the market treading water, the House voted no on September 29th (a moment still unrivaled in its idiocy). The market fell nearly 10% on the next trading day and almost 30% over the next 10 trading days. The investment community went into that legislative discussion full of hope only to be aghast at the process that followed. Bad Surprise!
Now the situation may be reversed. Two enormous packages will reveal themselves this week as the fiscal stimulus package moves toward a vote and the new Treasury Secretary Tim Geithner unveils TARP II. The once bitten investment community has deeply discounted the potential effectiveness of these programs, driving stock prices down to the bottom end of the current trading range in anticipation. The risk from this position is not that the programs are flawed, that is what’s expected; the risk is that the programs might be effective. Good Surprise! It is to this end that the markets have been rallying into the weekend as traders recognize that if the legislation proves rational, logical and even mildly promising, they might once again be caught on the wrong side of the trade. Better to close out the short positions and see what unfolds. That is why the market completely blew off the announcement Friday morning that another 600,000 jobs were shed in January and that the unemployment rate has lurched from the cycle low of 4.4% to 7.6%.
In other words, we know things are bad, we have reflected that in asset prices. The market expects little from the Keystone Cops in Washington. With expectations low, any eclipsing reality will move markets. The risk is now to the upside. Tune in this week! It’s Showtime.
What in the World
Now that we have 10% of 2009 behind us let’s take a look at the planet and see where the money is flowing (priced in US dollars):
2009 YTD Returns Trailing Year Returns
Chile: +14% -50%
Brazil: +11% -50%
Norway: +3% -56%
While 2008 was certainly shocking and painful, the liquidation trades worldwide over-rode any fundamental differentiators, so let’s concentrate on the more rational 2009 results.
These top three markets have some common elements. Chile has a budget surplus, a strong banking sector, and an economy driven by commodity exports. Brazil has a slight budget deficit, has an ever improving credit rating, and has the most advanced balance between trade and domestic GDP generation in Latin America. Norway runs a large budget surplus and a large trade surplus. Their economy revolves around oil production, but they used the run-up in oil to hoard capital, effectively creating a self-insurance policy. An honorable mention must be made for Saudi Arabia, which is slightly negative this year, but also has a nice budget, a trade surplus and obvious natural resources. The bottom line is that although earnings and demand are falling worldwide, the countries that have stronger financial disciplines in place to weather the downturn, and an abundance of natural resources to participate in the upturn, seem to be attracting capital. To test a theory, one must consider the negative articulation as well. Here are the bottom performers:
2009 YTD Returns Trailing Year Returns
Romania: -50% -78%
Poland: -32% -65%
Nigeria: -32% -73%
Romania’s economic condition includes twin deficits, both budget and trade. Natural resources are pretty limited, so they rely on industrial output and a domestic consumer. Poland also suffers from twin deficits and few natural resources. Nigeria, rich in both natural resources and corruption, also suffers from budget deficits and an overall lack of credibility. So the inverse proves the rule. Global capital currently favors countries with deep pockets and natural resource reserves. This seems like a prudent litmus test at the moment and has led us to some portfolio manager discussions, as we consider our international exposure for the remaining 90% of 2009 and beyond.
The economic data released so far profiling January have actually surprised to the upside, if you can believe it. The ISM manufacturing index expressed that we are in a deep contraction, but registered a more moderate reading than expected. The same can be said of the services reading. Both ticked incrementally higher than December readings. Employment came in weaker, bad for consumers, but productivity came in higher, good for companies. Those who remain on the job actually saw incremental wage gains in January while the hours worked held steady. The economic weakness most clearly centers on the household indicators, such as employment, consumer borrowing, and household spending activity, which are all weak. Households tend to carry more votes than corporations, so the weight of the stimulus activity will naturally fall there. Corporate earnings for the 4th quarter have been ugly. 273 companies of the S&P 500 have reported earnings, with total net income figures 40% below year ago levels. Even ex-financial earnings have fallen 22%. 2009 earnings estimates continue to fall with an 8% net income decline expected for the year compared to a decline of 13% for 2008. Halfway through earnings season, even positive earnings surprises outnumber negative surprises by below average margins. So survey says: economic data weak but stabilizing, employment weakening at a consistently rapid pace, and earnings deteriorating, albeit at a less dramatic rate of change.
Remember this: Investment Returns = Reality – Expectations, and even in the face of grim political and economic realities, if the expectations fall even lower, it’s a recipe for gains. While that may seem twisted to some, it was beautiful to watch last week!
David S. Waddell
Senior Investment Strategist
David S. Waddell commentary, Washington Post, Tuesday, February 3, 2009.
David S. Waddell, biography.
Click here for more information on Waddell and Associates.
**This blog represents the opinion of W&A and is for informational purposes only. It is not intended to be construed as tax or legal advice by the recipient. Past returns of investment are no guarantee of future results.
***Any data reported in this blog has been compiled from the Wall Street Journal, Morningstar, Investors Business Daily, or various other informational internet sites.