Greece is still a problem as the rest of the EU talks about a bailout without calling it a bailout. Greece itself seems to be walking around like a zombie telling anyone who will listen that they have no problem.

There are many issues that could upset the worldwide recovery as China deals with a budding inflation problem. So far they have tightened their money supply twice this year to hold down inflation.

Despite these headwinds there is a rather large tail wind for our economy. Only about a third of the stimulus package passed last year has been spent. As a result, this year and next will see massive spending in our country and at a time where economic stats are showing us the beginnings of a recovery already. That spending is a major push and should support continued growth.

Will that push stock prices higher? Earnings and growth are the key. The chances are good that both will do well this year.

Good Trading
Steve Peasley

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It doesn’t help that the massive snow storms on the east coast has drastically reduced the number of traders in New York. Light volume usually translates into more volatility.

The stock market does not like uncertainty and we have a lot of questions in our economy and the economies around the world that need to be clarified. In Europe it’s the weakness in the PIGS-  Portugal, Italy, Greece and Spain, all of which are having debt problems and in the U.S. its rule changes for the banking industry and Obamacare. Where are we going?

All these things relate to future corporate earnings. Clarity is often an illusion but investors and traders will react on what they believe will happen and at this point they are unsure.

Good Trading
Steve Peasley

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By mid week, after a couple good days, we had a sell off on Thursday which was broad based and painful. However, this morning with the bank stress test and an employment report for April behind us without any surprises the market decided to rally again, at least so far this morning. This is an obvious case of the market climbing a wall of worry.

The economic numbers actually were very encouraging this week. Retail sales were up for April by .3% and for last week up .7%, but what was more surprising was the first time jobless claims which fell by 34,000 this week and the four week average fell as well by 14,759. True jobless claims sit at over 600,000 which are very high but the stock market cares about the trend and is looking for the beginning of the change. That seems to be happening. Can this change turn into actual growth? At some point it will but not for a number of months, maybe by the fourth quarter this year or next. At some point the worry will turn to the strength of the recovery but so far no one is talking about that, yet!

We have had several weeks in which economic numbers, though still showing us that the U.S. economy is in a recession, seem to point to a turn from free falling to just falling or leveling off. The just ended earnings season came in better than expectations. Of course those expectations were severely downgraded at the beginning of the year therefore beating them is not all that difficult. The real test will be the sustainability of improving numbers. Can that happen?

I believe it will. The LIBOR rate is now below 1% when a few months ago it was as high at 5%. That is the rate banks lend to each other. The mortgage rates are at 5% or less and this week we saw productivity increase by .8%. Add these stats to all the others these last few weeks and we have strong evidence that things will get better. Finally, China, who embarked on their own stimulus plan, is already showing signs of strengthening growth despite the slow down in exports. The guidance, by independent firms, is calling for an increase in China’s GDP from 6% growth to 8% this year.

Does this mean the stock market is going to rally straight up from the March 9th low? Probably not. We will have corrections along the way. Any correction will be one to buy not sell. At the same time taking profits every so often is not a bad thing. Since China is already recovering and growing we have increased our exposure to the Asian market. You need to go where the growth is and since the stock markets of the Far East fell a lot harder than ours it has made all of Asia a good place to invest, despite the risks of lack of transparency and multiple books that their companies keep.

It is time to invest and has been for several weeks. No one knows when and where the bottom is but we can look back and clearly see a strong bottom of the various markets that took place on March 9th. Put fear aside and let’s make some money.

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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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Fear for the first two months of the year has gripped the stock market as almost universally investors and traders assume that none of the stimulus packages passed by Congress are going to work. That is probably not the case. Is there waste? Yes. Will most of the efforts put forth by both Obama and Bush not work? Yes. However, there is improvement in the banking sector. Slow and struggling, as it is, there is improvement. There is probably too much pessimism in the market, and certainly stock prices are at historic lows based on most normal methods of evaluation. The only way you can say that they are not undervalued, would be to suggest there will be a much further fall in earnings next year. The very lowest estimates put earnings for the S$P 500 for next year at around $53 per share. With a 10 P/E, which is very low, the S&P would trade at 530 and today it’s trading at 755 after a week of an explosive rally. So that is your possible ultimate low. If you give it a P/E of a normal low of the range which is about 15 then the S&P should be at around 795. Most experts are putting the earnings for the index at around $60 today. In a normal market the P/E range is usually at between 15 and 19. That means a high for the S&P using next year’s earnings estimate of $60 and the high range for the P/E is 1,140. So there’s your possible range. The market could fall another 25% or it could go up 40% from here. Obviously, that means the lower it goes the stronger the rally. 

There are two ways the market will tell us that is has stopped falling. Either it will make a ‘V’ or a ‘U’ shaped bottom. No one can predict which and the ‘U’ shape means that the market could trade sideways for a while at the bottom. It is hard to see anything that will cause a ‘V’ shape. What striking news can we foresee that would turn the market up on a dime? I don’t see it, but of course that is exactly why that kind of bottom can be made, an unknown and unknowable event to spark a rally. This week we saw a sharp spike up because of a very oversold situation. It certainly looks like a ‘V’ bottom in the making, but give it another week or so and we will see. 

On Monday there were major merger deals between Merck and Schering Plough, Pfizer and Wyeth, as well as talks between Roche and Genentech. The surprise in these major moves is that the market did not much care. In this environment everyone is cynical. At least it didn’t care initially but maybe it’s part of the reason for this week’s strong move. 

Later in the week the retail sales and industrial production numbers were reported and they came in line with projections. Retail sales appear to be improving ever so slightly. The consumer has begun to save money as seen over the last few months and of course that has made the slump deeper, but I believe the consumer will start spending again, probably not as recklessly as before, but more than recent numbers have suggested. That too may have given a reason for the up move this week. 

There is talk of changing the Mark to Market rule, to make it less onerous. I think it is just plain mindless to leave it as is. The value of illiquid assets, such as a mortgage loan, should not solely be based on today’s market price. First, banks hold on to many loans forever with no intention of selling them. Should they carry those loans on their books at market value? At times the value will be very low and at other times very high. Values can be unreasonable at both ends. There needs to be a way to smooth that out that makes sense. Let’s hope the powers that be will realize that. I would like to know whose idea it was to put this rule in just at the high of real estate values. That has done more to destroy banks’ balance sheets than the high rate of foreclosures. When value rises it will distort those same balance sheets on the high side just like it is doing on the low side. Banks will follow the rules but shouldn’t they make sense first? 

The market is trying to find another bottom. While it’s doing that it is time to be very careful, but buying. We have held onto our shorts this week because of the explosive nature of the up move. We will begin to exit them on a pullback of the market. Meanwhile we are gathering our buy list and will start to add positions carefully.

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