Tuesday, April 14, 2009

The worst is not yet over

The stock market has had a great rally since March 9. As someone who has a large pile of cash, I’ve was wondering if I missed a buying opportunity, but OTOH my large pile of mutual funds (such as my VFIAX) has come back to levels of early February — only 15% below Election Day and 33% below the end of August.

Still, I’ve stayed out because this felt like a sucker rally. (Peter Cooper of Seeking Alpha agrees). Perhaps the market was oversold: I’m not a technician, nor do I play one on TV. The rally could also be due to a change in sentiment, and I’m no expert on mass market psychology.

But as a young investor, I recall Charles Schwab’s advice to look for economic signs in your daily live to guide your investment decisions. (iPhones among Silicon Valley housewives might seem like such an indicator, but first I’d like to see their counterparts in Des Moines and Birmingham).

The indicators that I’m seeing suggest that firms have lost their pricing power, and are scrambling to cut prices (or pretend to cut prices) to gain sales, sometimes at any cost. This will depress the bottom line and probably the top line as well.

Of course, everyone knows auto sales are down and bankruptcy-prone GM and Chrysler are doing anything they can to attract sales. Here in California, car sales (and other big ticket items) will be down for months, because legislators raised the sales tax this month by 1% as part of an ugly end to an uglier budget mess. Buyers will also be postponing purchase of other big ticket items, whether HDTVs or Caterpillar earthmovers.

Beyond this, home improvement stores are also aggressively trying to attract business. Conventional wisdom is that in a down economy (or when financing is tight), homeowners remodel in place rather than buy a new McMansion, but that doesn’t seem to be happening right now.

Here we have three main stores — Home Depot, Lowe’s and OSH — and all three are promoting more aggressively than any time in the 6.5 years I’ve lived in the Bay Area. Perhaps they are quietly cutting corners on the quality, such as by pressuring suppliers to ship shoddier Chinese-made tools, or lowering the grade of building materials — but it still seems as though their earnings will be depressed for the rest of 2009.

The NYT wrote Monday about how the home improvement and other retailers are aggressively repositioning themselves as value havens during the down economy.

Another area that’s supposed to do well in downturn is fast food, and indeed McDonald’s has held its market value compared to the broader market. However, in the overall fast food/quick serve market, the last 3 months has seen a dramatic increase in the emphasis on bargain menus — items in the $1-1.50 range. Locally, it started with our sub shops (Subway, Togo’s, Quizno’s) which are at the high end of the fast food/quick serve price bracket, but now it's hit all of the FF/QS market. (Some of these are phony price cuts based on reduced portion sizes).

All of these depressed profits will not help stocks. Falling revenues and profits (into losses) would also bring more layoffs, and layoffs will reducing pruchasing power and consumer confience.

This morning, the Merc published a SVLG survey of SV CEOs about their expectations for the economy, which are expecting more job cuts this year.

Finally, economists at UCLA’s Anderson Graduate School of Management are predicting real GDP declines through September, and unemployment peaking in 2010 — at above 10% for the US and nearly 12% for California. Even ignoring Anderson’s good forecasting record, I don’t see how a recession this strong will turn around substantially in 2009.

So my expectation is for ugly corporate earnings for several quarters. Banks may be off their firesale prices, but it’s hard to see much upside for the overall economy for the next 6-9 months.

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