Stuff Happens, but Price still Matters
Comment of the Day

August 23 2011

Commentary by David Fuller

Stuff Happens, but Price still Matters

My thanks to Michael Jones and Rod Smyth of RiverFront Investment Group for this special report: A Strategic Weekly View. Here is the opening:
Policy mistakes have caused us to reassess 2012 earnings, economic growth, and asset price ranges. Short-term risks have risen, so have longer-term return prospects, in our view.

Our Mid Year Outlook of just a month ago was based on the economic framework of "muddle through" and gave policymakers some credit for, at the very least, not making major mistakes. We therefore expected stock markets to hold their March lows, but they have not. In our view, the reason for the breakdown in stocks and the spike in bond prices is that US and European policymakers have recently made significant blunders and, as a result, have lost credibility with investors, consumers, and business leaders.

"Dogmatic ECB policy and the political paralysis among European governments are the biggest threats to the global financial system" writes BCA this week, and we agree. We think US politicians have added to the problems by taking entrenched positions, thus signaling to investors that they are unlikely to address US fiscal problems until after the 2012 elections. With the elections set to be a referendum on two very different views of fiscal policy, business decision makers will be making hiring and investment decisions without clear policy direction, likely making them more cautious.

David Fuller's view Governments may not have distinguished themselves in their handling of various crises large and small, but they seldom do, in my opinion. In the west, I look to governments to promote a healthy democracy in which we the people can feel sufficiently safe so that we can get on with our lives, pursuing our ambitions within both the letter and spirit of just laws.

I realised and accepted long ago that governments would not preserve the purchasing power of our fiat currencies. I live in hope, sometimes naively, that they will use the powers to tax and regulate wisely, favouring an enterprise society based on communitarian values, individual responsibility and equality of opportunity.

As an investor, I hope for and seek evidence of good corporate governance, which is often reflected in the share price and relative valuations provided by markets. Among leading multinational companies which Fullermoney often favours, I think standards of governance have improved considerably in recent years, and not least because of the financial crisis in which the west is still mired.

In many respects, the balance sheets of successful companies today are the antithesis of their home country governments in the west. Prospering multinational firms have reduced debt and waste, while increasing productivity and cash reserves. I have described them as autonomies and investors need not despair in their corporate world.

At Fullermoney, we maintain that the main cause of this year's downturn in stock markets was the spike in commodity prices, not least with crude oil for which Brent is the most relevant benchmark. Debt problems among governments, banks and consumers certainly have not helped, but they are a known known, as Donald Rumsfeld said in another context.

In this year's earlier and ranging corrective phase for stock markets, during a standoff between accommodative monetary policies and commodity price inflation, the latter was always likely to win (see 5th July's summary and earlier comments on this subject). I do not underestimate the west's enormous debt problems, but they did not cause the world's growth economies to tighten monetary policies.

Commodity prices are still too high in our opinion. Against this background, Brazil, China, India and the other growth economies will be reluctant to reverse their monetary tightening bias, although there is cause for them to declare a neutral stance before long, given that GDP growth is weakening.

I maintain that the US economy needs Asian-led GDP growth to avoid a slide into recession. Europe's economies are even weaker, and Germany's recent slowdown is a further blow to confidence.

Until we see some stimulus measures from growth economies, the Fed and the ECB - which may or may not be imminent - this is not a comfortable environment for equities, even though we see improving value in Eoin's share reviews. This month's earlier downdraught, exacerbated by high-frequency trading, has obviously not helped investor confidence, and more importantly, corporate sentiment.

Today's Wall Street-led rally reflects investor hopes (or concerns among short sellers) that Mr Bernanke will announce a new stimulus package at Jackson Hole this weekend. That would be controversial but if he did, it would make more sense for him to target the stock market if he wishes to boost confidence. Lower Treasury bond yields would only increase concerns that the US was following Japan's deflationary path.

Meanwhile, charts for many stock market indices show a low on 8th or 9th August, followed by churning, a brief rally, and a retest of the lower region. The big question: Are these patterns the first distribution beneath top formations or a support building process similar to this time last year?

Fullermoney was more optimistic a year ago, but the charts will show us. For the bullish case, we need to see sustained rallies above last week's highs for share indices which show quite similar short-term patterns as you can see from these daily charts for UKX, DAX, SMI, SPX, NDX, SPTSX, IBOV, SHASHR, HSI and AS51. Some form of monetary stimulus would help investor confidence. Conversely, absence of a stimulus and new closing lows for more than a day or two would reaffirm the bear trends. A significant rally in Treasury bond yields, which seems overdue, would help to mitigate recession and deflation concerns.

The sell-off has resulted in improved valuations, particularly regarding yields. We maintain that earnings estimates, on average, are too high. Tactically, Fullermoney always favours buying on weakness and selling on overextended rallies relative to trend means approximated by 200-day MAs. Until stock market lows are confirmed, we would not pay up for anything.

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