Derek And The Dominoes

Ok I must confess I don’t have a tie in for “Derek” other than being a great fan of Eric Clapton, so I’m thinking of Dominoes today with the effect of GDP to Corporate Earnings to Stock Valuations.   So much for the Gloom and Deflation from this past Summer.

The U.S. economy is clearly accelerating regardless of the weakness in Europe so the recent rise in equity prices is justified IMO.  In fact, I do believe that 1200 on the SPX will be surpassed and will become the next support level by this December.   While I’m gratified for having nailed the recent market stop with our sales in ETF’s, that top may prove to be a momentary top along the road higher.

RMHI model portfolios have actually exceeded the peak from a month ago and are on their way to an above average year.   Since the model is about being “above average” I’m not surprised just gratified.  Taking a look at the fund performance list on the top of the heap appears to be the Calvert Capital Accumulation fund which was up approximately 15% at the end of October.   Our portfolios have moved almost in sync for the past 3 months and I hope this will rank RMHI as close to the top of the heap as 2007.


This morning Goldman Sachs raised estimates for real U.S. GDP:
2011 GDP goes from 2.0% to 2.7% and 2012 goes to an estimate of 3.6%.

With that kind of growth, where’s the love for bonds now?  If investors want to recoup losses from past years they must adjust for the resurgence of growth in the U.S. and dispense with the “fear trade” of bonds over equities.  Bond investors, especially those owning Treasuries will find that there is a very high price for the concept of “safety” and that the perception of safety is a myth to begin with when you find that your pursuit is enjoined with the masses.  Safety can most often be found with high investor negativity when the urge to sell is at its peak, no when its the overwhelming trend.

On the Green Investment / Socially Responsible Investment ledger our models are identifying a class of equities that appear to have our favored combination of Value plus Momentum: In particular are Battery Manufacturers and China based waste to energy plays.

Be careful out there


No Positions

China slowdown worries

Stock futures are signaling weakness in US markets this morning with the catalyst being China.    The Conference Board revised its leading indicators lower for the month of April to the lowest rate of growth in 5 months.  The Shanghai Composite is down 4.3%.   We keep in mind that the China GDP grew at an annualized 11.9% in the 1q which is a risk to overheating, a more moderate GDP growth in the 7-8% range would be welcome longer term.

In addition the highly anticipated offering of the Agricultural Bank of China has been pared back which has not helped investor sentiment.

One note we’d like to express in our view of socially responsible investing and China.  In our view investing in China is split between state owned businesses like the Agricultural Bank of China and those owned independent entrepreneurs and businessmen free of state ownership.  We have no interest in owning state owned companies where the proximity to the Chinese government is too close for comfort.   We only consider companies free of state control.

Market Commentary:  Pessimism in US markets is quite high now and cycle projections indicate a rally in US shares could commence very soon.   However, I believe this is a rally that should be used to lighten equity holdings as September is generally the worst performing month of the year.   Market action in the September/October time frame will be very important going forward.   Should the market stage a significant sell off in September/October it may create the combination of very attractive valuations and high degree of pessimism (a market positive) that could propel stocks higher into 2011.    Should the September/October weakness be shallow or non existent it will likely be borrowing from 2011 upside potential which will increase the odds of a bear market in 2011.

The 10-year Treasury bond is gaining a great deal of attention this week as it approaches the prices of early 2009 when our economic outlook was in question.    There are other possible reasons for this move which include the US being a haven of security from European sovereign bonds.   Regardless this move higher bears watching:

Thursday malaise

“Malaise” seems to be the word of the day as markets cope with incompetence in both business and political realms.

Will the leak caused by BP in the Gulf ever end?

Will the war in Afghanistan as highlighted by Rolling Stone ever end or remain in FUBAR?

Will the Obama administration ever make job creation are real priority rather than lip service?

Will China (which is much more important than Europe) achieve the soft landing in its economy?

Despite the chatter about “double dip recessions” economic data just doesn’t support the dd premise. Growth isn’t robust but it moderate and lumpy and expectations have pulled back sharply in expectations since the start of the year……..a good thing.

Capital Goods orders were up 2.1%.
Durable goods orders were up 0.9% and now have been up in 5 out of the last 7 months and up to 20% ytd.

“Malaise” as been bantered about now on CNBC and Jim Cramer is not the type of attitude existent at market tops but more often at market bottoms when economic blemishes are visible to all and the bulls have turned to bears.

The soft patch we find ourselves in presently could change in quick order should something good happen.

Earnings have been growing nicely but have been largely ignored this year. We’re using an earnings estimate of $90 for the S&P 500 in 2011 which makes the market 12x times 2011 earnings. Historically the S&P has been nominally valued at 15.3x earnings with comparable interest rates and inflation, and up to 17x. There is significant upside potential looming and with negativity growing rapidly the bottom in the current correction may be soon. My best guess is the “real” rally would likely be in the 4th quarter but the risk at present is not great by my estimation.

“In speculation, interestingly enough, contrary-mindedness is often a virtue. A layman might suppose that profits lie with the majority. Because the mass of people have the weight of the money, he might imagine that the crowd would tend to be on the winning side of things. Not for long, in my experience. If the majority confidently knows something, that one thing is probably already reflected in the structure of prices, and the market is vulnerable to a surprise. Markets are moved by the unexpected and the unexpected is what the crowd isn’t anticipating. The financial future may be imagined, but it can never be positively known. What people know is the past and present, and they often project the familiar out into the unknown, with unsatisfying results”

— Jim Grant, Minding Mr. Market: Ten Years on Wall Street With Grant’s Interest Rate Observer

Wednesday drift

Interesting story on whats under the hood of SRI ETF’s:

Buyer Beware: What’s Really in Your Socially Responsible ETF?

Summer doldrums markets as participants are waiting for the FOMC message later today.  While few expect any real change, the tone reflected in the post meeting communique tends to move markets.

NDR continues to predict that no Double Dip recession is on the horizon.   Their Recession Probability Model remains at 0%.  Economic activity advanced in 47 states in May and over the past three months.

Industrial Goods manufacturer Hawk Corporation (which we have a position in for clients) makes fuel cell components has raised their 2010 guidance based on an improving economy.  The stock is responding nicely up $2 to $23.

Chinese Health Club owner Soko Fitness and Spa SOKF may be finally coming to life on news of two new facilities in the Harbin area.   Soko is an example of a company where the valuation is hard to ignore with earnings capable of .50 cents a share in 2010 and .80 or more for 2011.   While the stock has done little in light of the weakness in the Chinese stock market it has held up reasonably well.   Should present growth rates continue for another year the valuation would be very compressed.  Selling at just 2x book value and 7x present earnings with no long term debt, .70 in cash along with +50% revenue growth and 80% member retention rate this has some serious potential.   But beware SOKF can be volatile and isn’t heavily traded with a big spread between bid and offer.

From the Carbon Disclosure Project: Corporate Clean Energy Investment Trends in Brazil, China, India and South Africa  pdf

Long HWK, SOKF (client and personal accounts)

Chinese Bottle Rockets: Part Deux

In our most recent quarterly letter we mentioned the subpar revenue growth for US based companies.    This anemic revenue growth stood in stark contrast to many Emerging Market companies that have excellent top line growth.

One of our favorite purchases….the purchases that make you scratch your head as you just wonder how and why it became so cheap has been China Automotive Systes (CAAS).

CAAS just boosted revenue guidance to at least $195 million versus $163 million in 2008.  Second quarter earnings came in at 21 cents versus the estimate of 12 cents which obviously means estimates for 2009 and probably 2010 are too low.   The stock is now gapping higher to $9.45.

While we’ve pared off a small fraction of our shares into todays strength, the message to our clients has been that the gains to be made in Emerging Markets is substantial since many do not face the significant and non-traditional headwinds facing the US economy.

We’re not a buyer of CAAS at these levels but should the Chinese market pullback, possibly so.

RINO finally had some air taken out of its levitation yesterday, this is why we peel off shares into great strength from time to time.   When stocks become beloved and traded by the Momentum crowd the slightest negative news can bring a torrent of selling as the Mo-Mo’s sell as blindly as they buy.  The company missed its estimate (there was only a single analyst) by a couple of pennies but was otherwise a very solid quarter with substantial revenue growth.   The stock is tempting under $14 which would be at just under 8x 2009 estimates.

Be careful out there.