Bored with the Bearish Arguments? Try these . . .

Last week was the market’s first losing week in six. As the economic numbers improve, the real action is in corporate profitability: It’s skyrocketing off of low baseline numbers. High productivity, relentless cost cutting, just-in-time inventory controls combine to allow lean companies to maintain high profit growth – despite the lack of either end user demand improvements, or top line revenue growth.

For traders, the guessing game has been in trying to determine when the indices finally get so far ahead of themselves – when a robust economic recovery becomes fully discounted by Mr. Market – that the indices will finally crack. This has been a losing strategy so far this year.

So what could go wrong? A well-known pundit stated he’s “bored with the bearish arguments:” insiders are selling, valuations are stretched, budget deficit is too big, and a strong economy would lift bond yields to 5%. In response to his ennui, here’s a short list of issues worth watching. Any one of them might eventually contribute to a correction.

Federal Budget: Federal nondefense, noninterest spending has soared to a record high 14.3% of GDP. It’s merely that the deficit is too big (most economists are not opposed to short term, Keynesian spending boost); Rather, the deficit has become a permanent structural part of the U.S. budget. “The days of smaller government are over,” said Ned Davis.

Consumer is extremely extended, at least when measured quantitatively. Household liquidity (cash divided by liability) is at 82.2%, a record low. These are way below historical norms of 133.6%, according to Ned Davis Research. Low interest rates explain some of the debt, but not the four million bankruptcies over the last ten quarters. Further, homeowner equity has now dropped to 54.3%, also a record low. Mortgage debt growing twice as fast as household real estate is simply not sustainable.

States: It’s not just the consumer who’s extended, the States are also. Lacking the Fed’s ability to print money or run deficits, the States have had to raise taxes, cut services and reduce spending. At this stage of the recovery, increased taxes or reduced State spending is not helpful; This is happening not just in California, but nationwide.

Trade and Account Balance Deficits: The concern is not just the near record U.S. trade deficit; Rather, it’s foreign ownership of U.S. Treasuries hitting a record 46% (as of Q2 ’03). China has been a big buyer, as has Japan. That gives huge negotiating leverage to countries whose interests are not the same as those of the U.S, and often are opposite.

These are a partial list of lower profile issues, all of which have potential negative connotations for the economy. . .

Chart of the Day
As long as the Nasdaq maintains its action within the up channel, demand is in control – not supply. Technimental’s strategist Kevin Lane notes “this market has been very resilient, bouncing back after sell-offs.”
Nasdaq Composite up channel
nasdaq channel.gif
Source: Technimentals

Trimming under performing positions is not a bad strategy, as somewhere soon eventually we will hit an inflection point. “If you own ’em, hold ’em, until a real crack in the tape occurs,” wrote Lane; That’s good advice I agree with.

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The Post-Modern President

Quote of the Day
“There is only one side of the market, and it is not the Bull side or the Bear side, but the right side.” –Jesse Livermore

Thanks to for the Forbes pointer.

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