The Week in Review And a Look Forward

This has been an amusing week.

The "big number" Friday was of course the PPI, and the headline came in hot. The bad news there was in food and energy, and bad it was - confirming a multi-year trend with both running at double-digit inflation rates. Year-over-year PPI came in at 4.4%, up from 2.1% in August. That's a nice trend isn't it?

Of course "core" was cool, with most of the "coolness" coming from a drop in auto prices. Huh? As in "trucks bought" or somesuch? Well if you buy a cheaper truck, I guess that would generate a lower price, right? This is good? If you say so....

Retail sales came in allegedly +0.6% from expectations of 0.4%. Of course this is retrospective (September) but it still surprises. What's interesting is that the forward data keeps cooling though, which isn't good. The retail sales data from Thursday was absolutely horrifyingly bad no matter how you slice it.

Centex said it was taking a nearly $1 billion impairment charge. Is that "all there is"? Oh hell no. But we shall see what the market thinks of it. Homebuilder stocks have been on fire the last couple of weeks, but for what reason? Let's be straight here - if you really believe that there is any possibility of a housing market bottom before 2009 you're delusional. My personal projection is that we're looking at 2010 before the bottom is hit and 2011 or 2012 before a real upswing is seen - and this assumes that the games are halted in attempting to manipulate the decline.

My expectations are that we will see multiple bankruptcies in the homebuilding sector and it will start before the middle of next year. Right now there are several builders hanging by a thread on their debt covenants and the recent "batch downgrade" of several to junk status is likely to trigger default conditions. How long the lenders will let this crap sit out there before attempting to call these lines becomes the real question - they know that a call puts these firms out of business instantly, so there is some reluctance to do it - recovery won't be good.

Petition work is coming along; I expect to have the database online and ready to rock and roll before the end of the weekend.

On politics there is real reason to be concerned. Hitlery is nearly certain to be the Democratic nominee and while she clearly will be bad for the nation and its economy I give her 90% odds of being elected. She keeps proposing more and more tax increases and spending - an interesting way to try to get elected given that the premise right now is that "the economy is ok because the Dow is at 14,000." Hmmmm.....

Thursday we saw a preview of what happens when 10,000 people try to fit through a 3' wide door all at once. Those of you who have been buying the big-cap techs on this run of late need to be extremely careful. Those gap downs you saw in those stocks? That was a warning and happened on just an itty bitty whiff of smoke. When the auditorium starts to fill and the drapes are on fire, you'll see the "real deal".

Today the buyers are back out in the morning playing the old "buy the dips" game. IMHO that's absolutely asinine and likely to lead to a huge loss in the very near future - but that's me. If you think you can call the turn - well - how many of you called it yesterday before it happened? Zero, right? If something like that happens overnight you're going to get destroyed.

Consumer sentiment came in at 82 .vs. 83.4 last month, while people expected a big rise, and expectations came in horribly at 71.6. Oops. The market reacted mildly downward - but not by much and certainly not for long. Is Chuckie smarter than Wall Street? I think so. Of course when you see your house declining in value, "Foreclosure" signs sprout like mushrooms on a soggy lawn and your food bill goes up by $25 a week over the space of a couple of months.... well..... what do you expect to happen to consumer confidence?

Put all that together and do you go to the mall and blacken the credit card - given that this is all you have left to spend with? Hmmmm......

We have NEGATIVE S&P profit growth predicted now (revised down from 8% a couple of months ago!), earnings warnings coming from all corners, including places that weren't supposed to have them (big overseas exposure firms such as IP) earnings misses coming from big industrials (AA) with overseas exposure, anemic US sales (if they're even positive) and yet the market is sitting at all-time highs.

Why?

The Bull Argument is that "it'll be better in the 4th quarter; we'll see 11% profit growth."

But... wasn't that the argument in the 2nd quarter? Indeed it was... we were "below trend" last quarter and everyone said we'd be over 10% this time.

What actually happened?

Hmmmm....

So we had a shock to "sentiment" in August, then BenDover's "shock and fraud".

But is this optimism shift over the last month justified? If you ask CEOs, they say "no." Their sentiment has been deteriorating for the last several months and still is. This is bad news because what do CEOs do with their companies when they sense potential trouble? They pull back on CapEx - one of the potential "saving graces" for the economy. They also tend to pull back on hiring, but that usually comes second, and only after a recession is evident.

Why?

Well, talk to Pepsico. They're not happy with the supply-side inflation pressures, and with good reason. They can try to pass it through in higher prices, but that's inflation the consumer feels. The only other option is to take a hit on earnings by absorbing the increase on their input costs. This same corundum has been playing out in every board room in the nation.

Now add to this one more piece of data and things get far more murky - profit margins are at post-war highs. How do you drive them higher when your input costs are rising and you've already taken the big gains from mechanization and computerization of your internal processes?

Remember, the Bull argument is that profit growth will go back to 11% in the 4th Quarter.

But for that to happen you have to either radically increase sales or you must increase operating margins. Margin expansion is incompatible with input cost pressure and a slowing consumer and sales gains in the US are likely to be non-existent - there's no economist on the planet forecasting 10%+ sales growth in the 4th Quarter in the US.

That could be a problem - potentially a very serious problem. Should margins shrink to any material degree multiple contraction would set in with a vengeance and could easily take 30% off the major indices - even without a recession! If we get a recession on top of it, well, 2003's lows on the SPX are not out the question over the next year or so.

In the "bubble" names its even worse. Apple, Amazon, Google and RIMM are all trading at P/Es that are in the stratosphere. AMZN in particular is trading at over 100 on a P/E basis, and yet the truth is that it is simply a retailer. Can they really grow operating profits at 50% annually for the next five years? That'd put the P/E/G ratio on a forward basis at 2, which is the upper end of "acceptable". I don't see how, and a miss anywhere along the line could easily whack 50% off their stock price instantly. RIMM is in even worse trouble on a potential basis - they've been hitting their numbers now for three quarters sequentially by channel-stuffing, and the pace has escalated precipitously the last two quarters in a row. That can only continue until the channel revolts, and eventually it will. This is the nature of such a "trick"; you have to continue to stuff harder and harder because what you "pushed forward" then has to be sold down in the following quarter! Ultimately this pyramid scheme fails and you wind up fessing up to a huge miss.

The NDX is trading at a P/E North of 50. Does anyone remember when that last happened - or what came next?

In short we have enjoyed a "sweet spot" the last few years - input disinflation due to Chinese influence and profit cycle expansion - that is, expanding gross operating margins.

But these are cyclical - that is, they oscillate. Since May the Chinese "disinflation" has turned to "inflation" - and the rate of change is still increasing. This is likely to continue for the foreseeable future. Commodity price inflation hits the PPI side as well on the "inputs" end of the pipe which, as noted above, has to come out the other end one way or another, and both are bad for equity prices.

The bond market has figured most of this, along with the dollar weakness caused by an intentionally-too-loose monetary policy, out already. It has responded by ratcheting up rates to levels that are now nearly a full quarter-point above where they were on the day of the Fed Rate Cuts.

In other words, what The Fed tried to giveth, the Bond Market tooketh away and then some.

Had Bernanke left rates alone the long end would have likely remained where it was and the paradox would be that real interest rates would be lower today than they are - even though "his" rate would be higher!

But you (personally) can't borrow at FedFunds; your mortgage rate is set by the bond market, not BenDover. That's a problem and one that The Fed hasn't dealt with. Paradoxically, if they were to raise rates by a quarter point this month long rates would probably subside a bit!

Going forward The Market is at a crossroads. Yesterday the market broke down hard as a rising bearish wedge closed off to a point, forcing a decision by the market. It decided - South. Today we have a valiant attempt to rally but we are not headed back towards the highs of yesterday, and as the market has risen volume has fallen off once again. So long as the market remains below those levels, it is vulnerable to another individual hollering "FIRE!" and starting a new stampede.

There are many people who have taken cheap shots about the lack of an explicit "call" on my part in The Ticker over the last couple of months. I don't know why, bluntly. Cash is an asset class and so are short-term Treasuries. What's wrong with them? Or with Municipal Bonds?

Sitting out periods of indecision may look foolish now with the market crawling higher, but if you look at the fundamentals can you justify being long as an investment here?

The problem with "buy and go for the ride" is that the sort of thing that happened yesterday is a prelude of what can come. Who here remembers 2000-2003? The Nasdaq Composite had several 200-400 point losing days during that period of time, and most of them came with absolutely no warning.

Most of those days gave you absolutely no real way to get out either, as the futures were down hard in the morning so by the time you tried to sell - too late, you took the loss. Then you got whipsawed as the market bounced, you bought back in (having taken the difference right out of your pocket) and then it plunged again, hitting you a second time.

Many people didn't take a 30 or 40% loss this way, they took an 80% one by thinking they were "buying back in just off the bottom" only to find out that yet another leg down was right around the corner.

Anyway, this is why my view is that outside of "lottery tickets" (whichever way you wish to play it - short or long, call or put) that you expect to write off as 100% losses, you're nuts to do anything other than daytrade the market here. If that's either something you're uncomfortable doing, you lack the capital to do it, or you lack the ability to put the time into it, my view is that the right place for your capital now is in cash equivalents - short-term Treasuries or outright cash.

Might you miss "the start of the next Big Bull Run"? Sure. Does it matter? Not if this really is the start of the Next Big Bull Run.

Look at this rationally. We're in the 16th year of a consumer expansion that was fed by home equity withdrawals, with the "crescendo" coming in the last three years. Now that window is closed and spending has shifted to credit cards.

Reality is that The Market is trading on the view that "The credit crunch" was a one-shot deal and is over. BenDover fixed it and we're back to normal.

But guys - this has never happened before. Every time there has been a credit problem of real substance - not the little blips like LTCM and Amaranth - it has not been over with one shot in the arm. Never. Nor has a housing downturn ever occurred without a recession and higher unemployment. The "Globalization" siren song has been heard before - we heard this back in 2000, and it didn't work that way. Yes, there are tremendous foreign reserves and wealth, but do you really think that Chindia is going to come here and buy houses at 2005 valuations? Of course not - they are going to invest that money in their own infrastructure and improve their competitiveness, develop their internal consumption so as to become independent of us over time, and expand their trade blanket to cover more and more nations. That's what intelligent nations do. To believe that they will just come buy everything in the United States is to call them stupid - and they didn't get where they are today by being stupid.

At the end of every Bull Market, when P/E/Gs get out of control and spiral materially north of 2 everyone looks for something they can claim is "different" to justify the valuations. There are always claims of a "New Paradigm" in the markets.

Each and every time they are ultimately proven wrong.

It's possible that this time they're right, but history says no and thus if you're handicapping the end of this you have to go with what has worked in the past, and that's not being exposed in a position you can't get out of fast if and when the worm turns.

This is about risk management guys. Right now we have a market that is pricing itself in the opposite direction of the macro economic picture and the cyclical forces behind profit growth.

It is very easy to think you've got a tiger by the tail and are slaying him in markets like this. You buy Google and watch it go up $10 a day for a couple of weeks. That's good, right? But are you going to sell? And if so - when? Because if Google misses earnings, it could be a $300 stock in an afternoon.

Then what?

One anecdotal thought that I haven't mentioned before - ever notice how "The Street" only has "buy, sell and hold" ratings? Uh, guys - what's what about? You do realize that "Hold" and "Sell" are neutral ratings (on either side of neutral), right? What's the missing rating? "Short!"

Hmmmm.....

Oh, remember our friend in the ABX? One of those things that has blown the shit out of the markets before...... How's this look?


Thirty-four? THIRTY FOUR CENTS ON THE DOLLAR?!

And "A" credit?

FIFTY FIVE CENTS? Remember, this recovered big on the rate cuts..... that didn't last long did it?

Something to think about....

Here's your week-long technical... lots of cross-currents in here.....