Most markets finished down on the week, but the trendless trend of the last two months continues. The economic news was dominated by the worse than expected employment report Thursday, but overall the data continues to indicate a bottoming process in the economy. Employment is generally the last data point to improve coming out of recession (which is why it is classified as a lagging indicator) so while the report was disconcerting it isn’t all that surprising.

Like most weeks recently, we got several economic reports that point to recovery and several that didn’t. On the positive side, factory orders, pending home sales and the ISM manufacturing index improved. On the negative side, mortgage applications, construction spending and employment didn’t. The stock market’s reaction was generally negative but the averages continued to trade in the previous range:

This sideways action will eventually be resolved and while I’d love to say that it will be resolved to the upside, that is far from certain. What’s gotten us this far is monetary policy and I am becoming increasingly concerned that current Fed policy will not be sufficient to offset the uncertainty surrounding fiscal policy. The Fed’s balance sheet expansion, despite all the quantitative easing talk, has come to a screeching halt over the last couple of months:

Meanwhile, fiscal policy is creating the same kind of regime uncertainty as Roosevelt’s policies of the early 30s. Climate change legislation was passed in the House, but the horse trading it took to get it passed means that if anything is passed in the Senate it will have only a passing resemblance to the House version. Healthcare reform is, if anything, more muddled. With no clear picture of how these and other issues will be resolved, it is very difficult for business to make long term decisions. With consumers likely to continue their frugal ways, business spending is the last best hope for a private sector led recovery. Until there is more certainty in the policy arena, businesses are unlikely to make any big decisions. That leaves monetary policy to do the heavy lifting and Bernanke and his fellow FOMC members are walking a tight rope of inflation expectations that limits their options.  

Credit spreads and CDS prices seem to indicate that the improvement in the credit markets may have reached a peak. It seems increasingly likely that the Fed will have to expand their excursion into quantitative easing or their efforts to date may come to naught. Unfortunately, they risk damaging their credibility on inflation if they are seen as merely monetizing the deficit, so this will not be an easy decision.

Spending from the stimulus package passed earlier this year will start to ramp up over the next few months, so it is possible that the Fed can delay any further monetary expansion for a while, but since the stimulus is seen as temporary, it is unlikely to have much effect on the private sector. Businesses will not hire new workers to fulfill demand derived from temporary measures. Consumers also will not expand their spending if they believe the new income derived from the stimulus spending is temporary. All of the rise in last month’s income numbers was stimulus provided and almost all of it was saved. That seem unlikely to change.

For now, there isn’t sufficient reason to make any big changes in our portfolios, but I am increasingly concerned about the uncertainty of both monetary and fiscal policy. Unless there is a change in one or the other soon, the path of least resistance would seem to be for further weakness and a more conservative investment stance. I’ll keep you updated.

Back in the fall when ±5% moves in the stock market meant only that another day had passed, I longed for calmer times. I wanted more than anything to just have a day or a week when nothing much happened. Well, it has taken 9 months but I’ve finally gotten my wish. The market spent another week in the same range in which it has resided for almost two months now. The week did include a couple of days with 100+ point Dow moves (one down, one up), but by the end of the week, we were basically back where we started. The S&P 500 ended the week a whopping 0.25% from its starting point:

S&P 500

The spate of economic data and events I highlighted last week as potentially resolving the range were mixed enough to instead reinforce investors lack of conviction. Durable goods orders were higher for the third time in four months and the capital goods orders portion of the report showed a rise of 10%. On the other hand, shipments of said goods fell for the 10th straight month. Existing home sales continued their slow march higher, but the median price fell again while inventories remained in the too darn high category at 9.6 months. Mortgage applications broke a losing streak though and rose as mortgage rates fell back a bit. New home sales fell a bit, but the median sales price, while down from last year, actually rose month-to month. Personal income rose a robust 1.4%, but the robustness turned out to be due to various stimulus programs that are obviously not permanent (or at least one hopes). Spending was also up but less than income so the savings rate jumped again as Americans socked away the extra government largess to the tune of $768.8 billion, a 6.9% rate the likes of which hasn’t been seen since the early 90s. All in all the economic data continues to act like a compass needle near a magnet.

Most of the excitement last week involved job applications. Ben Bernanke got a grilling over the Bank of America deal from politicians expressing outrage over the bullying of CEO Ken Lewis. Of course, if Bernanke and Paulson hadn’t played bad cop, bad cop on Lewis and instead allowed Merrill Lynch to fail, they would have held hearings on that too; politicians exercising 20/20 hindsight isn’t exactly news. Anyhoo, this was seen by some as a job interview for Bernanke whose term expires at the end of the year. I doubt seriously whether a more flexible Fed chairman can be found, but I’ve heard rumors that Larry Summers has been spotted taking yoga lessons. My Lord, isn’t that a vivid image?

The other job applicant was Mark Sanford, the governor of South Carolina, who has been mentioned recently as a potential 2012 Republican presidential candidate. He has apparently been attempting to fill the foreign affairs hole in his resume for several months now by engaging in some “hiking” along the Buenos Aires trail and got caught. With the Fed engaged in a monetary policy last practiced in the pampas, maybe Sanford was just brushing up on how to deal with inflation.  As to whether he is able to recover before the 2012 campaign, well let’s just say that if philandering were an Olympic sport, politicians would occupy the gold, silver and bronze positions every four years, so who knows. Heck, he might even try switching places with his wife who seems quite a bit smarter and a hell of a lot more stable.

The FOMC also met last week and produced about as much excitement as all the rest of the economic news. There was a minor change in the language of the statement indicating that the Fed believes it has vanquished the horror of falling prices, but other than that everything remains on hold. They also announced that the majority of their liquidity enhancing programs, otherwise known as Ben’s pawn shop, would be extended to February of 2010. Not exactly an exit strategy.

Digging a little deeper into the markets, defensive sectors have been making a comeback during the recent malaise. Pharmaceuticals, Biotech and utilities are all enjoying a decent bid these days:

I Shares Pharmaceuticals

I Shares Biotech

Utilities SPDR

We’ve got a smattering of exposure to these sectors but they aren’t a large part of our portfolios right now. All these sectors are subject to a considerable degree of uncertainty right now due to pending political action. Healthcare reform, where odds of serious change seem longer every day, would be a mixed blessing for the pharma and biotech sectors. They might see increased volumes as more people are covered but they would also enjoy less pricing power if a public option is adopted. I actually don’t think most of the plans being offered right now have much chance of being passed nor should they. I would prefer that we try reforming medicare and medicaid first to see what might actually work rather than adopting something only to find it has made things worse which is more likely than most suppose.

The utilities are facing uncertainty over the cap and trade legislation which managed to pass the House on Friday by a slim margin. The outlook in the Senate is somewhere between slim and none though so that might explain why these stocks have caught a bid over the last two weeks. One beneficiary of cap and trade that we have in some of our portfolios is FPL Group, the largest producer of renewable power in the US:

FPL Group

I continue to favor foreign bourses to the US market. China, Brazil, Australia, Chile, South Korea, South Africa and Taiwan are among the favorites:

China

Brazil

 

Australia

Chile

South Korea

South Africa

Taiwan

Commodity markets were as quiet as the stock markets last week as traders seem to be waiting to see whether the green shoots will wilt. I suspect that for the short term, the green shoots may turn out to be more tenacious than the consensus believes. There are, I believe, good reasons to believe the cyclical stars are aligning although the longer term outlook remains pretty darn poor. As it happens, I just completed an economic outlook yesterday for your perusal.

One last note before closing for the week. While the US REIT market remains in the doldrums, international real estate ETFs are performing quite well. A few weeks back I highlighted the Asian real estate ETF. Here’s a look at a broader international real estate play:

SPDR DJ Wilshire Int’l Real Estate Index

While there is quite a debate about the potential for US inflation, not many seem to be concentrating on the prospects for it outside the US. If the Fed continues to act like a central bank floozy, inflation will likely not be contained in the US. If the dollar falls, that means that capital is flowing out and it has to go somewhere. When it fell last time, inflation in Asia was a multiple of the US. That either means they are more honest about reporting it or US policy had more of an effect there than here. I suspect there is truth in both those statements, but one thing seems certain. If we get inflation, real estate will be affected positively and the early momentum is in foreign markets.