We’re All “Dogs of the Dow” Investors Now

Good Evening: Grappling with an already confusing investment climate, investors were treated today to a GM bankruptcy filing and a scorching stock market rally. To the list of firsts previously set during the 2007-2009 bear stock market, we can now add the Chapter 11 filing of a current Dow component, the steepest 2-10 year yield curve in history, and the largest monthly gain for commodities prices in a quarter century. In response to these tidings, the S&P 500 is now at a 7 month high, some 41% off its March low. Since many institutional investors have been caught underexposed to their benchmarks, and since the S&P looks like it has broken out of its May trading range to the upside, it is quite within the realm of possibility that the S&P makes a run at 1000 — a level fully 50% above its March nadir. If you are having trouble making sense of the current environment, you are not alone. As we shall see, some firms are posting widely divergent research as to where the U.S. economy is heading next.

Monday’s rally really started on Friday afternoon, when the tape hit a gusher during the final minutes of trading. I don’t hold with some of the conspiracy-minded theories on Friday’s late day ramp job; it could have been anything from an error to some clumsy trading by some of the infamous “ultra” ETFs. Whatever the reason, the late leap in prices left the S&P 500 charts looking poised to break out to the upside, and Friday’s rally continued early this morning. Another firm set of economic numbers in China bolstered equities across the globe, and our index futures were pointing to gains of between 1% and 2% prior to the opening bell. This morning’s release of a raft of better than expected economic releases only bolstered the case of those who firmly believe that China ‘s economy has recovered and that ours will soon follow. Worried that this perception of a return to growth would gain further currency, not-long-enough stock investors bought equities, while Treasury investors sold long dated issues with equal fervor (see below).

Other than some jokes (GM now stands for “Government Motors”, etc.), the sad and widely anticipated GM bankruptcy filing had little impact on the markets. The filing will further disrupt U.S. auto production and consumption during the weeks ahead, and it will also add another stock to our Government’s taxpayer-funded equity portfolio. The Feds now own chunks of 5 companies in the Dow Jones Industrial Average (at least for now — GM and C are to be replaced next week by CSCO and TRV). AXP, BAC, C, GM, and JPM may not pass Jim Cramer’s “Am I diversified?” test, but few will argue that this motley bunch could be called the new “Dogs of the Dow”. Toss in Chrysler, AIG, the GSEs, and all the TARP recipients, and we taxpayers are assembling quite an exposure to the automakers and financial companies. Even if the taxpayers that comprise the UAW are somehow more senior than either bondholders or non auto-assembling taxpayers, we’re all in this together now. Let’s hope divesting ourselves of these bow wows will be less painful than accumulating them. We’ll need every cent we can muster to help pay off our escalating budget deficit.

After this morning’s upward explosion in New York , the major averages settled into a trading range between 2% and 3% higher. The tape never did retreat much at all during the session and by day’s end the averages sported gains of between 2.6% (Dow) and 4.7% (Dow Transports). Small stocks did quite well, and it seemed the more speculative the name, the better it did today. With bullish sentiment on the rise (the CS equity risk appetite index is nearing the “euphoria zone”) and with measures of volatility ebbing (the VIX has often traded below 30 lately), it is of little wonder the technicians are saying this market has broken out to the upside. Treasurys were abandoned once again today, and yields climbed 20 bps on the long end. The dollar weakened again, and though the greenback made a bit of a comeback later in the day, commodities kept rising. After posting in May their best monthly gain since 1974, the commodities comprising the CRB index kicked off June with a rousing 3% gain.

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Rising equity and commodity prices, accompanied by diminishing bids for Treasurys and the dollar, mean economic growth will soon return to the U.S. , right? “Yes”, says the top-down looking, London-based fixed income team at Credit Suisse, while “no” is the reply from the same firm’s bottom-up looking, New York-based equity analysts (see attached PDFs). Credit Suisse argues, persuasively in each instance, that the “green shoots” everyone seems to have an opinion about will either soon be trampled or as high as an elephant’s eye by the fourth of July. The fixed income team’s case rests on a restocking of depleted inventories, which will lead to positive industrial production figures by this summer.

The equity analysts don’t see it that way. Both the homebuilding team and the folks who track rail car shipments say the very latest indications in those markets are still pointing south. Mr. Market has registered his vote, with each asset class indicating some form of growth and/or inflation is on the horizon. But he is a fickle gentleman, and even the CS fixed income team admits that their forecast will prove too optimistic if employment trends don’t improve later this year. I worry less about the monthly squiggles in the economy than I do about how we pay for everything in the out years. It may all be a bit confusing, but that’s what printing money tends to do. The excess liquidity tends to find a way into the asset markets, and it gives everyone an ersatz sense of confidence. Until the Fed can print jobs as easily as it prints currency, the other 25 names in the Dow are at risk of dogging it every bit as much as the five we all own together.

— Jack McHugh

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