By Louis Navellier
RENO, Nev. (Marketmail) -- The overall stock market rallied for 14 straight weeks since the March 9th lows, but has since started to consolidate a bit. One reason the stock market rallied so steadily was that the mutual fund industry has enjoyed 12 consecutive weeks of positive inflows. If these inflows continue, any consolidation in the stock market will likely be short-lived, so I recommend that you buy on dips and take profits on stocks that outpace other stocks. Naturally, small capitalization stocks remain hypersensitive to rising trading volume, so steadily improving investor optimism bodes especially well for our small-to-mid cap stocks, and it’s good news for our large cap stocks as well.
The upcoming round of second-quarter earnings announcements that will be announced between mid-July and mid-August could be a great time for fundamentally superior stocks. The second-quarter earnings for the S&P 500 are suppose to be down as much as 20% compared to the same quarter a year ago, but due to a weaker U.S. dollar for much of the second quarter, the S&P 500’s earnings may be down only 12% after windfall profits from commodity-related companies and multinational companies being paid in appreciating foreign currencies.
Naturally, since my models focus on fundamentally superior companies, I’m optimistic that many of these stocks will perform well during earnings season. If you’re curious about our fundamentals, take a look at how they stack against our benchmarks.
Navellier Fundamentals
The unemployment conundrum
The real problem with the U.S. economy is that unemployment is showing no signs of abating anytime soon, so consumer spending, which represents approximately 70% of GDP growth, will continue to be impaired and could prevent a sustained economic recovery from occurring anytime soon. Moreover, consumers are saving, not splurging. The savings rate jumped to 6.9% in May, the highest level since December 1993, according to the Commerce Department. Read more
Unemployment remains one of the Obama Administration’s biggest concerns, especially after predicting early this year that unemployment would peak at 8%. It’s already at 9.4% and expected to rise to 10%, maybe even 11%. In fact, Christina Romer, chairwoman of the President’s Council of Economic Advisers, said even if the economy starts to grow again, she wouldn’t consider the recession over until employment starts to pick up, which could take a while. In a speech to the Commonwealth Club of California, Romer said the recession “won’t be over until actually we have the unemployment rate back down to a more normal level, like 5% rather than 9.4%” and added, “We’re a long way from it being over.”
The Labor Department announced that the unemployment rate in Western states jumped to 10.1% in May, the highest in the region in about 25 years. Additionally, 48 states and the District of Columbia saw employment conditions deteriorate in May. Only Nebraska and Vermont did not report unemployment increases. Michigan remains the unemployment leader with a shocking 14.1% rate, but Oregon is routinely the second worst state and now has a 12.4% rate. Other western states that are suffering are California at 11.5% and Nevada at 11.3%, which are all time highs. In the south, Florida, Georgia, North Carolina and South Carolina also set records. Factories, construction companies, retailers and financial companies are among the industries that have slashed the most jobs.
According to the Nelson A. Rockefeller Institute of Government, state income tax revenue declined 26% in the first four months of 2009 compared to the same period a year ago. Since most states are required by law to balance their budgets, these lower tax revenues will undoubtedly result in service cuts. For most states, their fiscal year starts on July 1, so many states are struggling with imposing tax increases, service cuts, or both. Some of the federal stimulus money will help some states, but plunging income tax revenue is expected to compound many states’ budget woes well into 2011 and possibly beyond.
Deficit Spending has reached its limit
The fiscal irresponsibility of the federal government and worldwide concerns about the deterioration of the U.S. dollar became increasingly evident. First, Treasury Secretary Tim Geithner spoke at China’s Peking University (the most prestigious college in China) and said that he favored a strong U.S. dollar, but the normally polite Chinese broke out in laughter. Second, Fed Chairman Ben Bernanke told Congress that they were spending too much and approaching the end of their borrowing limit. Finally, German Chancellor Angela Merkel, in a rare public rebuke of central banks, suggested the European Central Bank (ECB) and its counterparts in the U.S. and Britain have gone too far fighting the financial crisis and may be laying the groundwork for another financial blowup. In other words, Chancellor Merkel does not believe that the world economy is on the road to a sustainable economic recovery. “I view with great skepticism the powers of the Fed, for example, and also how, within Europe, the Bank of England has carved out its own small line,” she said. Merkel stressed that “We must return together to an independent central-bank policy and to a policy of reason, otherwise we will be in exactly the same situation in 10 years’ time.”
When Treasury Secretary Geithner was in China, Chinese officials continued to question whether the U.S. stimulus policies risk unleashing inflation. Geithner said, “In the United States, we are putting in place the foundations for restoring fiscal sustainability,” which was received skeptically at Peking University, where he studied Chinese as an exchange student in the summer of 1981. Obviously, Geithner’s comments admitted that the U.S. was not yet fiscally responsible. Ooops! At least Geithner was courteous to his hosts by crediting signs of improvement in the global economy to the early measures taken by China. Specifically, Geithner argued that what is needed now are more fundamental changes to both the Chinese and U.S. economies to ensure a “more balanced and sustainable global recovery.”
The other fascinating aspect of Treasury Secretary Geithner’s China visit is that he sought to reassure Chinese officials of the Obama Administration’s commitment to reduce the budget deficit to a “sustainable” level once the U.S. economy begins to recover. Specifically, Geithner implied that narrowing the U.S. budget deficit to “roughly 3%” of GDP from its official forecast level of 12.9% in fiscal 2008 is the Obama Administration’s medium-term target. The U.S. budget deficit is officially forecast to hit a record $1.84 trillion in fiscal 2009, but it might easily hit $2 trillion and between $2.5 trillion and $2.7 trillion in fiscal 2010.
According to Treasury Secretary Geithner, Chinese officials expressed “justifiable confidence in the strength and resilience and dynamism of the American economy” in an interview with China’s media. Then Geithner proclaimed that there would be enough demand for record sales of U.S. debt, implying that China would continue to buy U.S. Treasury debt. This last statement was highly questionable, since he was publicly mocked at Peking University. Additionally, Bloomberg recently announced that China reduced its holdings on U.S. Treasury securities by $4.4 billion from $763.5 billion in April, down from $767.9 billion in March. Although China’s $4.4 billion drop may not seem like much, considering that the U.S. Treasury has to auction at least $2 trillion in the next year, any loss from the biggest investor in Treasury securities and government agency debt is worthy of noting, especially if it’s the beginning of a trend. The bottom line is long-term bond yields are likely going higher and/or the U.S. dollar will weaken. You can’t continue to print gobs of money and buy your own debt without undermining the value of your currency. However, the Fed has done a good job thus far in managing this task. This week’s record Treasury auctions were surprisingly successful. Read more
These growing budget deficit concerns caused Fed Chairman Ben Bernanke to recently tell Congress to reduce their nearly $2 trillion budget deficit, warning that the U.S. government cannot borrow “indefinitely” to meet the growing demand on its resources. Specifically, Bernanke said “Unless we demonstrate a strong commitment to fiscal sustainability in the longer run, we will have neither financial stability nor healthy economic growth.” The Fed Chairman also said the recent sharp rise in Treasury bond yields “appear to reflect concern about large federal deficits.” Bernanke stressed that “near-term challenges must not be allowed to hinder timely consideration of the steps needed to address fiscal imbalances.” Finally, warning of the risk of a future debt trap, Fed Chairman Bernanke said “We cannot allow ourselves to be in a situation where the debt continues to rise. That means more and more interest payments, which swell the deficit, which leads to an unsustainable situation.”
By the way, Bernanke was on the hot seat this week in front of members of Congress. Your can watch the grilling here (make sure you scroll down the page to see all of the clips; there are 11).
Based on the White House’s overly optimistic estimates of a $1.84 trillion budget deficit in fiscal 2009 and $900 billion in fiscal 2010, which is highly questionable, Bernanke pointed out to Congress that these looming deficits would push the U.S. debt-to-GDP ratio from 40% before the financial crisis began to 70% by 2011. Bernanke stressed that Congress should try to stabilize the debt-to-GDP ratio at its post-crisis level of about 70% and seek “over time to try to reduce it.” This would essentially be the highest debt-to-GDP ratio since World War II, but since the White House’s fiscal 2010 budget deficit is overly optimistic and the deficit could easily approach $2.5 trillion when the bulk of the $787 billion in stimulus spending comes in fiscal 2010. As such, it is very possible that the debt-to-GDP ratio could soon hit 100% of GDP. Overall, Fed Chairman Bernanke put the responsibility for dealing with debt concerns in the hands of Congress and the Obama Administration and then boldly proclaimed that “The Federal Reserve will not monetize the debt.”
The week, the FOMC held interest rates near zero and finally saw some “green shoots,” but plans to continue its quantitative easing. Policymakers will buy up to $300 billion of Treasuries by autumn. If the government’s estimated $1.84 trillion deficit is accurate, the planned Treasury purchases means the Fed will buy approximately 16% of the government’s deficit with funny money, or money created ex nihilo, within the next few months.
The Fed also plans to purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year, again using money created out of thin air.
Wisely, the Fed avoided mentioning anything about an eventual exit strategy, which is something that should never have come up at the G8 meeting in Italy. Widespread inflation concerns at this point of the recovery are nonsense, despite rising commodity prices. The Fed acknowledged this:
“The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”
In a nutshell, the Fed’s continued quantitative easing will pressure the dollar lower and push commodity prices higher. This will benefit our commodity-related stocks, export stocks, and U.S.-based multinational stocks. International stocks will have an advantage as well. The market is narrow, so go where the strength is.