Outlook - June 2010
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Overview:
The markets ended May with a loud THUD. The U. S. Markets just experienced the worst monthly performance of any May on record dating back to the 1940s. We are headed into the summer months with investor nervousness at extremely high levels. Investors have once again been reminded that their risk tolerance is high in good times and low when things are bad. If you have not reviewed your personal situation and discussed your risk tolerance with your advisor in the past 12 months the recent market fluctuations should have served notice that this is an important topic and should be discussed regularly. Generally people are nervous about Europe. A lot is this nervousness is because there is fear that the euro zone is going to break apart and everything in Europe is going to have bigger issues. However, in every dark cloud there is a silver lining. Countries like Germany that does not have fiscal issues and outrageous debt should benefit directly from the Euro-crisis. As we saw in the U. S. in over the past few years a weaker currency will benefit exporters. European companies that export to other European countries may not benefit. But companies that export to China and U.S. should do quite well. As we saw here in the U.S. there are sectors, and companies that will do well in challenging environments. You’ve got to know a lot of elements of how the companies do business, because it’s not just, are they exporters, it’s have they hedged their currency, what is their balance sheet exposure to currency, etc. We’re finding that companies are really discounting a pretty tough scenario. Yields on stocks in Europe, on average, are now twice that in the United States, and the price/earnings multiples are trading at a 20% discount on average. So, there are some companies that are quite depressed in valuation that are pretty well-positioned, with good managements that have dealt with tough situations before, and a lot of them do a majority of their business outside of the region. Some companies, the Euro telephone companies for instance, are under stress but get a majority of their earnings from Latin America. These types of situations are exciting to us. There has been much speculation that Greece and other countries will leave the European Union. The trillion dollar support program put in place, in my mind, dispelled this rumor. The best case scenario is that they find a way to quite the public rhetoric (difficult for the French and Germans), convince folks that they don’t have to move their money from Greece Spain, and Portugal, get their banking/lending system back on its feet, and then the inventory and investment cycle will begin again much like it did here in the U.S. The longer this takes the more likely we are to see governmental contraction, lay-offs, and a plethora of other moves that are bad for the economies as a group. In my mind the European crisis is an extension of what began here with Lehman Brothers. This all began with organizations that were highly leveraged then moved to consumer credit area through the banks and the likes of Fannie Mae. These organizations and countries that are highly leveraged run into the same issue: the markets wake up and say “we won’t give you money anymore” which leads to the same problem – how do I get the money I need to repay the portion of the debt that I’m able to? Here in the U.S. I believe that most of the bad debt has been identified and is in the process of being purged out of the system. My view is supported by the last round of earnings at the money center banks; Citigroup and Bank of America with both reporting an easing of loan losses and delinquencies and a dramatic improvement in earnings. Simply put, financials are becoming less risky.

My broader concern is the notion that the U.S. could become the next Greece if we don't grow our way out of debt. But, to the extent that scenario could occur to some degree, it likely would be a few years away. After all, economic momentum seems to be quite strong in the U.S., plus the latest de-risking attack actually bid up Treasuries as a safe haven. If it were our turn for the bond market vigilantes to drive up long-term interest rates, then certainly Treasuries would have been the first line of attack. I would be remiss here if I didn’t take a moment to mention the recent congressional grilling of Goldman Sachs. While I’m an advocate of holding folks accountable I, once again, became thoroughly convinced that the hearings broadcast on television were largely for show and provided certain congressmen and women their 15 minutes of fame. It was painfully obvious that these folks are ill equipped to ask relevant questions. I was first convinced of this when congress decided to spend my hard earned money asking baseball players if they have ever taken drugs. My sentiment was reinforced at the grilling of the Enron folks, again at the grilling of the CEO’s of banks, again at the grilling of CEOs of the auto industry, and soon the CEOs of off-shore drilling companies, and so forth. My contention is not that someone should or should not hold these folks accountable. I simply believe that congressional folks are not masters of all trades and therefore don’t know enough about all these industry specific details to dig into the heart of whatever the issue is. If congress wants to dig into such matters that relate specifically to various industries I much prefer they recruit unbiased experts within that industry that understand that industry to ask the hard questions. To that end; the scariest thing to me about the proposed financial reform regulations that are to be handed down by congress is that these rules and regulations were crafted by people that really don’t understand the industry they are trying to regulate. Enough about congress and Europe……………..let's discuss the markets.

Markets:

Investors are not only concerned about Europe but also tensions in the Korean Peninsula and the rift between Turkey and Israel. So what are the odds that a meaningful low has been set? First of all, my disclaimer here, I am not a technical analyst. I watch chart patterns for signals and I scour periodicals for macro trends. I treat investing much like I do my spiritual life. I seek knowledge and wisdom from many sources in an attempt to stock the tool box with as many tools as possible. Then, when presented a dilemma, I reach into that tool box and find what I believe to be the most appropriate tool for the situations. Having said that; here is my best shot at technical analysis……. Many technical conditions are now extremely oversold. Some technical indicators are as oversold now as they were in March of 2009. The difference is that in March 2009 we were coming off a 57% correction and now we are at a 14% correction. We are also sitting on a major support area around 1050 in DOW. This support area has been tested several times now. Investor sentiment has turned has also turned bearish, which is a bullish sign. The VIX which is a New York Stock Exchange measure of volatility recently spiked from the low 20s to the upper 40s. This is an indication of extreme fear, again a bullish sign. Why? We now have an economic situation that could cause the Fed to become even looser than it has been. What made 2009 so positive was the combination of improving economy and easy monetary policy. The Fed may now feel the need to put more punch in the punch bowl. This could mean renewed asset purchase and liquidity to prop up the funding markets. This could be a new lease on life for the U.S economy.
Let me put my technician's hat on again. Given the oversold condition of this market, my best guess is that we could rally from here. I suspect the market may be volatile all summer long, before possibly heading higher later this year.

(Federal Reserve - http://en.wikipedia.org/wiki/Federal_Reserve_System)
(FOMC - http://en.wikipedia.org/wiki/Federal_Open_Market_Committee )
(What is money supply? - http://www.econlib.org/library/Enc/MoneySupply.html )
(Fed Funds rate - http://en.wikipedia.org/wiki/Federal_funds_rate )
Technical Source Data: Haver Analytics, Factset, CQG Inc., and FMRCo

Alamo Asset Advisors is the operating name for E&C Private Wealth Management, an independently owned Registered Investment Advisor. Securities offered through WFG Investments, Inc. WFG member FINRA and SIPC