Wholesale inflation numbers reported this morning also jumped. January’s number was up 1.4% but core inflation which excludes food and energy was up only .3%. The problem is that both numbers were above expectations.

We will see retail inflation numbers tomorrow. I have a feeling that the producers might be experiencing inflation but they are going to have a hard time passing it along to the consumers. The economy is just too weak at this point to absorb price increases.

It may not feel like it but the economy is gaining strength and will likely continue to do so throughout most of this year. The stock market will realize this and will rise, just do not expect it to be in a straight line or expect it to be like last year’s rally. The rally is going to be much more muted this year.

Good Trading
Steve Peasley

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The market struggled this week but was resilient. In the first part of the week fear about the ‘stress test’ hovered over the traders. The unknown result will not be known to the public until next week or the week after. On Tuesday there were hints that Bank of America and Citicorp were being pressured to increase their capital structure though the CEOs didn’t agree. That pressure was a direct result of the stress test- at least that is the assumption.

Consumer confidence increased sharply in April. The Conference Board’s reading went from 26.9 to 39.2. That reading is still low but the degree of increase was unexpected. Later in the week a Consumer Sentiment report was released and it too was higher. I would not read too much into these numbers. You can look at actual retail sales each week which will give you more information than a monthly confidence report. Much of the confidence (or lack of confidence) by consumers may mean very little to us as investors. The swine flu for instance may affect consumer confidence but will that mean consumers will stop spending? They might spend differently. Any recent event will affect how people ‘feel’ about things, good or bad, but will it actually spur them to spend or stop spending? The evidence is unclear.

Also out this week was the Case-Shiller 20 city home index report. The problem with this report is it was for February. That is ancient history to the stock market. It showed a fall of 2.2% adding to January’s fall of 2.8%. Prices year over year were down 18.6% from 19% in January. This report is virtually useless. It tells us what happened two months ago. Who cares! I will not be writing about this report in the future. We know from more recent data that sales in homes are increasing and inventory looks to be flattening. It’s still too early to come to any conclusion. Housing will be weak but evidence suggests a bottom is on the horizon.

Also out this week was the first quarter GDP number which was down 6.1%, a bigger drop than expected. The market rallied strongly when this number came out. Welcome to the psychology of the stock market. So why would it move up? First, this number is also backward looking, but looking closer you will see that there was a large drop in inventory and exports. Managing inventory is something that traders watch closely. Inventory has fallen to a point that requires a build up over the next few months. At the same time consumer spending has gone up putting more pressure to increase inventory. Inventory building will mean a better GDP number in the future. All that is in the future and of course that is exactly what stock investors and traders react to.

On Thursday Chrysler’s bankruptcy was announced by President Obama. This is a good thing. We need to let the bankruptcy laws work. It would probably be better to let other companies file for bankruptcy as well. Did we need to save the banking system? The answer is yes. Do we need to save any other industry? The answer is no. Even in the banking system those responsible for the failed banks need to be punished, but the system needs to be supported for the short term. The real question is how long and how intrusive will the government be in private industry? One of the biggest U.S. criticisms in recent years has been foreign government involvement in foreign companies. Those companies with government backing were seen as unfairly competing with private industry. Now we, in the U.S. are doing the same thing. It damages the U.S. argument that we let free enterprise pick the winners and losers and not support otherwise failing companies with government dollars. That seems a bit hypocritical.

This morning, Friday, a stronger ISM (Institute of Supply Management) indicated that the industrial sector is picking itself up. It is still shrinking but improving. This was the fourth month in a row of an improving ISM report.

No matter what spin you put on it, the stock market is telling us that things are going to get better for the economy. History tells us that over the next year or two there will be a rally of over 50% in the stock market. This will not be a march straight up in prices. Expect pullbacks and use them to buy. Do not let fear control your decisions.

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On the economic front, retail sales reported this week fell 11% from February to March, Industrial production fell to 69.3% down 1% from February, and new construction fell 10%. All bad news, so why didn’t the market fall this week? Obviously, this kind of news was expected. Fear is subsiding. We saw good news this week in the earnings reports for the banks, in inflation which is dead, in mortgage applications for homes which are up 45% for the week compared to a year ago and in mortgage interest rates which are down to 4.8% for a 30 year fixed.

The numbers are still very ugly but the stock market has been so beaten up that it is reacting to news that shows some hints that the worst is over. The stock market is still down for the year even with the strong up move in the last month. There was a stronger move downward for the first two months of the year and so far all the market has done is return to early February levels. Except for the NASDAQ.

The NASDAQ index, which is full of large tech companies, is flat for the year. Past bull markets have been led by tech and this one is no different. Banking stocks are coming off severe bottoms and no bull market in history has occurred without a rally in banking stocks. It appears that though the economy is still in a severe slump that the stock market, which is itself a leading economic indicator, is telling us that the fix is in. That ‘fix’ may be some months away as we deal with backward looking statistics but it certainly seems that the mood has changed.

As we at KPP Financial have been heavy in cash. We did not pick the bottom of this stock market, nor did anyone else. Because we were heavy in cash we did not go down with the market in January, February and the first part of March. What that means is that we are late in catching the rally as well. As our clients have seen we have been moving into the market for the last six weeks. We are now heavily invested but with some cash on the sidelines that we plan to put to work on any weakness in the market. This is a bear market rally so far, albeit a sharp one, forming a ‘V’ bottom which was unexpected. Any pullback will be an opportunity to buy.

Finally, history tells us that this is the first leg of a rally. If the ultimate bottom is in, which we have stated in previous newsletters that we think it is, then the rally should continue. It should rise at least 50% from the bottom. After the 1973-74 recession, which so far looks very similar to the current recession, the S&P 500 rallied 73% and the DOW 75.7% over 19 months. This kind of rally from a recession low is normal. Don’t think that this is uncommon. Therefore, missing part of the first leg because you were protecting your nest egg, as we were doing, is not a bad thing.

However, it is now time to invest. Do it carefully and in fact hope for some weakness so that you can take advantage of lower prices. Do not fear any correction. Fear is hovering over everything. To the degree it is keeping people out of the market it is a good thing. Stock market rallies climb a wall of worry. Be cautious but be buying.

We will continue to buy slowly. The plan is to take advantage of any weakness to buy more. That doesn’t mean we won’t sell if something is not working but overall we are on the buy side of the market not the sell side. That time is over.

Good Trading,

Steve Peasley

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The market appears to be giving back some of the recent gains but with reluctance. Most traders and investors expect a pullback from the recent steep rise and because they expect it they will likely make it happen.

However, earnings season is starting in earnest and it is getting in the way. Built in to stock prices is an expectation of very poor earnings so any outlook of future earnings that are reported as less draconian might push the market higher. On the flip side any reports that point to worse numbers may or may not affect the market because expectations are very low. This is going to be a confusing time.

This morning there was a very large merger in the home building industry and Alcoa reported bad numbers for the first quarter but the stock is up on expectations of better times ahead. The market was up this morning but weakly after being down strongly yesterday on the fear of bad earnings.

As I said, this earnings season is going to be confusing.

Good Trading
Steve Peasley

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The news of the fate of GM and this week’s G20 meeting is putting a crimp on the bull move in the market. In GM’s case it was the President’s rejection of their restructuring plan and the President’s speculation on a bankruptcy filing that spooked the market, though that might be the best solution for the car company. Of course that might have been best a couple months ago as well before billions of tax payers’ dollars were given to them. The G20 meeting in London has the market focused on what they might or might not do once the meeting is over. There is little faith in what will come out of the meeting.

Here at home it’s the unemployment numbers that come out on Friday that will garner attention by the traders. It is expected that many jobs will be lost. ADP’s survey this morning said that it will be around 742,000. That survey has been wrong in the past but a little more accurate in recent months. The official number will tell us what March really looked like. On the brighter side, the announcement of layoffs, though still high, have actually fallen for the last two months in a row. That is a leading economic indicator and just might signal less dire times ahead.

It’s time to be buying not selling. Just be very particular what you buy. Companies with low debt, high cash balances and clear earnings picture look very attractive.

Good Trading
Steve Peasley

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Today we learned that the fourth quarter GDP numbers were indeed one of the worst ever recorded. Only in the Great Depression can we find a more severe three months of a collapsing economy. Add to that the record income and wealth destruction and you have a free fall in our economy.

So why has the market rallied for three weeks in a row? It is simple. Economic numbers are reported from past events and the stock market looks forward to future events. The market is telling us the worst is over. As one of the most reliable economic indicators you can be confident that the economy, though still weak, will have bouts of further weakness, that over all it is likely going to be better six to twelve months down the road.

Expect another fall in stock prices. The move up is too fast. The market fell fifteen of seventeen days before this rally and now we have had three weeks of a strong bounce. There is an ebb and flow of prices. If indeed we get a pullback that will be the one to buy as long as the indexes hold above their old lows.

Good Trading
Steve Peasley

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On Friday I wrote about the fear of inflation but also stated that maybe a little inflation is not all bad, and indeed it is preferable to deflation.

Rising prices are always hard on us consumers as many times our incomes do not keep up. So why would inflation be preferable to the alternative which is deflation where prices fall? One very strong reason is that in a deflationary cycle, consumers stop spending. They postpone purchases in an effort to wait to buy lower priced items as they fall month after month. This happened in Japan in the lost decade from 1990 to 2000 where their entire economy shrank.

Also, and just as is important, is as the government takes on trillions of dollars in debt, and that is a lot of money that no one can really visualize, it is much easier to pay that debt off in inflated dollars down the road. With deflation it is much harder to pay off.

If dollars become less valuable, the cost of paying off debt is less. If you buy a house and make a $3,000 a month payment with a 30 year fixed mortgage, in 20 years with inflation that $3,000 dollars will feel much less burdensome. That is inflation at work. The government has the same issue except their mountain of debt is a much bigger problem.

A little inflation is a good thing. A lot of inflation destroys wealth.

Good Trading
Steve Peasley

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The big economic statistic of the week was today’s unemployment rate for February. The expectation was for a poor jobs report and an unemployment rate to exceed 8%. What we got was exactly what was expected. The market breathed a sigh of relief in the morning but it’s Friday and the day is early. Expect unemployment to reach about 10% nationwide before it starts to improve. It will continue to rise even when we see evidence that the recession is waning. There is no evidence of that yet, but it will end despite what many think. The Depression word should not be part of the discussion. Could we go into a depression? Yes, but the probability is slim. 

There was a plethora of economic statistics released this week and I don’t want to go over all of it, but it is prudent and enlightening to touch on a few data points. First, the ISM (Institute of Supply Management) report for February rose to 35.8% from January’s reading of 34%, a very slight improvement which may or may not be statistically important but any reading higher month over month is good though any reading below 50% is a shrinking economy. Construction spending fell 3.3% when expectations were for a fall of 1.6%. This report was for January. January factory orders were down 1.9%, much better than the expectation of a fall of 3.5%. Finally, retail sales in February rose. All these are backward looking numbers but they certainly paint a picture of a falling economy with hints of stabilization. The recent bad news is a direct result of the liquidity crunch that froze all economic activity in October and November before it started to loosen. Liquidity is still tight. We are far from being out of the woods but we can see the end of the forest as we slog our way forward. 

If we look for any sign or spark of hope, it is in the news that seems to becoming less Draconian. Less bad news means we are still falling in economic activity, but the pace of the fall is slowing. A recent news article spoke to announcement of layoffs in February that appeared to be less in number than in January, but that was after a 14 year high in layoff announcements in the first month of the year. The consumer seems to be spending a bit more. Housing and refinancing is still very weak, but there are small signs of improvement in California where sales of existing homes was flat last month but rose the month before and inventory actually fell. However, new home construction is in the basement and digging a deeper hole. Foreclosures are increasing, but there is a plan released by the White House to help. It will take time to see any impact but frankly, foreclosures will continue to rise. In past loan work outs we have seen half of them return to the foreclosure process. I think much of this effort is wasted. Affordability is very good and interest rates low. Buyers are starting to come back but very slowly. 

The market has fallen 25% since the first of the year. That 25% can be directly contributed to the lack of clarity and focus of the stimulus package. Despite the President’s smooth speeches, the constant drum beat of the evils of our system and actual policies that have been announced and passed have been just as toxic to the stock market as toxic mortgages are to the banks. 

The hope the market had for the ‘stimulus’ plan of $800 billion disappeared as the details showed it to be a multi year ‘spending’ package packed with pork barrel spending. The public and the market see it for what it is not for what politicians try to spin it to be. 

For our clients we have turned very defensive with high cash levels, larger short positions and equities that are anti or out of the market. We have a few long positions in the stock accounts but only in those companies that have a clear growth of earnings path and at the same time are extremely underpriced when compared to price to book, price to earnings and price to sales. In the mutual fund program we have very high cash levels, two bond funds, a double short mutual fund and very few long funds. These efforts have enabled us to far outperform the market though we still have loss value this year. 

There will be a turn but we will wait for the bottom to show itself before moving into the market in any significant way.

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