Monday, July 6, 2009

Global Markets Rally: RIP, and How To Profit

Why the Non-Farms Payroll Data Disappointment May Be the Turning Point.


Markets were nervous on Thursday before the Non-Farms Payrolls report came out, with Asian, and European stocks already solidly down on Thursday before the report came out. The results confirmed the fear.

The U.S lost 467K jobs in May, about 29% more than the 363K forecasted and 45% above April’s surprisingly small (at least in today’s market) loss of only 322K jobs. This report, issued at the beginning of June, had fed hopes that the worst might be over. It helped keep world stock and commodity markets trading in a horizontal range near their 12 month highs, awaiting further news to justify the 20-30% gains in stocks since the beginning of March and nearly 100% gain in crude oil since 2009 began.

This report dashed those hopes, causing a predictable sell off in US trading on Thursday in “risk-appetite” assets that appreciate with optimism about the world economy. These include most markets, including stocks, commodities, and higher risk currencies (the AUD, NZD). Safe haven assets, particularly the JPY, USD, and CHF currencies rose against other currencies deemed riskier.

The Wrong Data at the Wrong Time

While the NFP data is important, it hit very hard on Thursday, and may well continue to weigh on the markets. To understand why, consider the context and its possible ramifications.

· Global Markets Look More Overvalued. Glance at a daily chart of any major global stock or commodity market for the 4-6 months. It's mostly up, typically well over 20%. Crude oil has climbed about 100% from its December lows to its mid June highs, and was still close As this author has repeatedly noted, we have yet to see evidence that jobs, earnings, GDP, or any other meaningful measure of recovery will see similar growth within the coming year While many believe markets anticipate actual growth by 9-12 months, traders have been getting impatient for some solid confirmation of a turnaround.

· Lack of News to Support Recent Global Stock and Commodity Rallies. over the past month had been at best mixed, and markets were waiting for an important indicator like the monthly US NFP results.

· The World Bank Forecast Looks Correct. The last time we saw this kind of drop was on June 22nd, when the World Bank announced downwardly revised estimates for even greater global economic contraction. Markets recovered from the drop, due to no small degree to a more optimistic picture from the OECD. However, the OECD forecast was based mostly on a more optimistic view of US growth, which it believed would outweigh a worsening situation in other regions. Thus the NFP report struck at the foundation of the OECD's view, possibly leading traders to conclude the World Bank was right and that real recovery is not coming soon, and that growth related assets were more likely to fall in value in the near term.

· US Financials Appear More Vulnerable. The source and likely resolution of the ongoing economic crisis is the US financial sector, especially the top 20 or so major banks and brokerages. A worst case unemployment level of 8.9% was a key criterion for the US banks' stress tests, and official unemployment is already at 9.5, a quarter century high, and building momentum towards 10%. That means less spending, and a lot more residential/commercial mortgage and credit card defaults.

· US Consumption to Drop Further? As bad as the figures were, the details were equally discouraging. Average hourly wages remained stagnant, and average hours dropped. Thus even those still employed are overall earning less, or may soon be earning less, and are in no position to ask for raises. Consumers are likely to be spending much less, if only out of fear driven need to save more.

· Bad News for Earnings. Because consumer spending accounts for 70% of US GDP, even if Q2 earnings don't disappoint, lower guidance for Q3 could also make Q2 earnings a very bad trip.

In sum, given the current mood, the NFP left markets with a greater sense that another dip to deep support could be coming, feeding a vicious cycle of declining employment, leading to declining spending, leading to declining earnings, leading to more declining employment, etc. Fun.

Friday’s trading was mixed as the markets stabilized to digest the news. As of mid-Monday GMT, Friday's digestion has become Monday's indigestion, as global stocks, commodities, and all but the safest currencies are moving down.

Global markets will need some very positive news and earnings to avoid a retest of March lows. Of course, when things get really gloomy, depend on Team Washington & Wall Street to devise a new song and dance, with America's creditors and importers singing backup, to give the markets at least another short term boost.

As noted on Friday, to regain their uptrend, stocks will need overall positive earnings surprises or other economic news to justify higher prices. Positive earnings will be especially needed from the financial sector, which has been the source of both major declines and rallies for the past two years.

Guidance on second quarter earnings should begin to come out next week, and may well bring markets the direction they seek.

Yet the question remains: How can a consumer based economy expect increased earnings when consumers are losing jobs and those working are earning less and fear losing their jobs? Moreover, even if Q2 earnings are good, what kind of guidance can we expect on Q3, given the present rising unemployment and stagnating average wages and hours worked? Even a good earnings announcement can be reversed if guidance for the future is downbeat.

Conclusion: So What do You Do?

Short Term Traders: Have your entry points or orders in to go short most global markets in some way, be it via Put Options, Ultra Short ETFs, short stock sales, or selling currency pairs in which the safer currency is the counter currency (i.e. denominator, right of the "/" line, etc. These include AUD/USD, USD/JPY, etc.

Long Term Investors: Wait for markets to approach March lows before taking new long positions in stocks we've recommended over the past months for reliable high yields and currency diversification. Need a reminder? Check back to the pre-May articles. Favorites to consider include:

Atlantic Power Corporation (ATPWF.PK)
Enterprise Products Partners (EPD)
Kinder Morgan Energy Partners (KMP)
TEPPCO Partners (TPP)

For those willing to take more risk with much more share price and dividend increase when energy prices firm and the global economy improves:

Vermilion Energy Trust (VETMF.PK)
Enerplus Resources Fund Trust (ERF)

Disclosure: The author may hold positions in the above instruments.

1 comment:

  1. Great blog, good information, Imagine a life where you don't have to wake up at seven o'clock in the morning to go to work and make money for somebody else. Imagine a life without any of the common financial worries
    Good luck !