Rally? What Rally?

The last quarter ended with a whimper. Stock indices had their worst quarter in four years and the worst August since 2001. Despite the rally last week where we saw the indices tack on 2.5% in one day, it’s been a miserable year for stocks. Gold on the other hand is approaching news lifetime highs despite the talk of deflation and a double-dip.

Gold is reacting to the fears of the future, not the doings of the present. Yet, in truth, if the fears of the future were so great, gold would be trading at twice the price of today, and interest rates as measured by the bond market should be double or triple where they are. Neither is happening and that should give even the most ardent bear some pause.

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Don’t Fight the Fed

That is an old axiom on Wall Street. When the Federal Reserve is loosening the spigots on cash, history has shown that the wrong move is to fight the ocean of liquidity. The thinking is quite simple. Americans just can’t resist spending money and getting in debt and the cheaper the cost of the money, the quicker they will resume their spending ways.

This time though, there might be a bigger fly in the ointment. Money is cheap…but unless you don’t need it, you can’t get it. And, if you do need it, the last thing you want is to actually borrow it and put you in more debt.

Pre-2008, the savings rate in the US was zero, maybe even negative. This compares to places like Singapore where they save more than 30 cents out of each dollar made. The negative savings rate implies that people spent more than they made. This is possible due to credit and it was one of the driving forces of consumption over the past three decades. Yes, my friends, this problem was not created by the housing boom, the Internet boom or any other recent boom. It was created in seventies and eighties when lending standards began to erode and the accessibility to credit by those who could understand it least was granted in full. Easy credit became an entitlement of sorts.

Today the savings rate in the US is approaching 6%. That is bad news for the economy. People don’t save, at least in the US, unless they are really, really scared of the future. And, people aren’t the only ones saving. So are businesses. Corporate coffers are filled with cash. This is where the Fed steps in. If you’ve got cash, you’re making nothing on your money. Add in inflation and taxes, and you are probably losing money everyday that it sits in your checking or savings account.

The Fed knows this. By adopting policies that stimulate money supply and keeping interest rates extremely low, they are banking on you getting tired of making nothing on your money and forcing your hand into the markets or into investments such as real estate or small business ventures. Yes, right now you are worried about return OF capital, but there will come a point where you start worrying about return ON capital again.

When you factor all of this in, you understand why the markets are acting in what appears to be extremely irrational fashion. In truth the market is trying to gauge who will win out in this argument. Will you be forced to spend or will you continue to save?

The Inside Track

I have written in the past about indicators that offer insight into where the markets might be tilting. One of the more predictable ones is insider buying of shares. Insiders are those executives and board members who are most knowledgeable about the future of their own companies. In the past, when insiders have bought shares in their respective companies, it signaled that better times lay ahead. I’m not talking about a little bit of stock here or there, but big chunks of stock relative to the wealth of the insider and to the market capitalization of the company.

In the weeks preceding the most recent meltdown from 11,000 on the Dow to 10,000 insider buying had all but dried up. I look at my insider buying screen daily and on some days there were fewer than 1 or 2 transactions of note. But, as share prices have declined, insider buying has picked up. In the past month there have been several significant insider buys at major companies like Akamai and Monsanto, trades that are valued in the millions.

Companies are also beginning to announce share buybacks. The biggest one was announced just a few days ago when Hewlett Packard disclosed that it will buy back more than $10 billion of its own stock…more than $3 billion in the upcoming quarter alone. For a company that’s been in the news for all the wrong reasons of late, that is quite a statement. It doesn’t hurt that the shares are trading at 8 times next years earnings or that they are at 52-week lows.

The market and the economy may be looking sick right now. But, there are indications that looks might be deceiving. It would seem ludicrous that we could actually have a market rally in the face of economic, political and social unrest. But, as the past has shown quite clearly time and again, times of crisis for some are viewed as times of opportunities by others.

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Best regards,

Kevin Raymond


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