The Markets – Unplugged

Conference Call Transcript ,  April 29, 2009 – 7:00 PM

Let’s begin our discussion with the events that took place in the summer of 2007. In July of that year, the major equity indexes displayed their anxiety over the news that two Bear Stearns Mortgage Hedge Funds were in trouble and would be closed down. After initially falling in July, the markets rallied to higher highs in October 2007 and then promptly started their long slide on more news that Bear Stearns, itself, was in trouble. This event precipitated the bust in the mortgage bubble that had been building since the early 2000’s and initiated the credit crisis – proclaiming what most people knew all along—that it is difficult to keep making payments on large purchases, especially homes, when a majority of the new purchasers were already strapped for cash and should never have qualified for their mortgage in the first place. What we found out soon enough was that the revenue stream of these purchasers here in the U.S. were packaged, given investment grade credit ratings and marketed around the world to most of our trading partners. That is why we saw a lag in the global downturn which reared its ugly head in July 2008, eight months after the U.S. stock markets started their slide in October 2007. Foreign investors realized our “toxic” mortgage assets had been exported to them. They, in turn, suffered along with us. The markets have been down since that time until March 9, 2009 when they hit a 12-year low. Price action in the major equity indexes have been characterized during this time by lower lows and lower highs; a downtrend. All of you are reminded of this in the newspapers when you read the word “bear market.”

Since March 9, however, the equity markets have rallied and the question on everyone’s lips “Is the bear market over?” The answer from an absolute price standpoint is “no,” but, based on our indicators over the move from the March lows to our current levels, we can observe the first signs of a market bottom. We are monitoring this process.

Market bottoms are always a “process.” It is not a date or a price because no one has a crystal ball to know when the exact date and low price will occur. Rather, as your investment advisors we use fundamental, economic and price indicators while we monitor the direction of the market, to fit the pieces of the puzzle together over time. This makes up a part of our investment discipline. Based on the preponderance of evidence, over time; information that is dynamic and changing daily, we put together plans, based on your particular goals and decide where in the market your money should be allocated. The first piece of the puzzle is MARKET DIRECTION which is the topic for this evening’s discussion.

A few of the indicators giving us cause to feel the market is beginning to put in a bottoming process are:

1. The price and strength of leading growth inputs like copper are rising faster than the overall market on a relative basis. Since this input is literally a building block for power plants, infrastructure and buildings, it is a good sign for a growing global economy.

2. A $586 B stimulus package from China to develop its internal economy, coupled with a similar U.S. Government stimulus package should allow for the flow of money to start up again here in the U.S. and around the world. The lack of money flow is what has caused a crisis in credit and confidence globally since last September. These are positive events that will give support to the market in its bottoming process.

3. Since the March low the Volatility Index ($VIX) has mitigated. A less volatile VIX in light of horrible economic news sets up a bullish divergence. In other words, prices are going down much slower in the face of harsh economic headwinds like higher unemployment, more bankruptcies, tight consumer spending and lower manufacturing output. This positive is a sign and is the first sign of how most bear markets end…poor economic news that is NOT followed by a huge move down in price.

4. The U.S. Government and Global Central Banks are working in a coordinated effort to set forth similar goals for stimulus in an effort to boost economies and GDP’s around the world. This working in tandem effort is somewhat new and should be positive for all global markets going forward. These actions are put forth during Central Bank meetings when one country follows another in, for example, the lowering of interest rates.

This is a general overview of some of the key fundamental, economic and technical indicators that are driving the beginnings of the bottoming process.

Let’s examine the sector specific reasons for being a bit more positive since the most recent March low:

1.                          The sectors which lead markets out of a bear environment and into a bull environment are the financial, technology and consumer discretionary sectors. Since the March low, these sectors have been among the leaders for the nine sectors we follow. This is a positive. These sectors reflect a loosening of credit, a forward look ahead in developing the technology driver; always a cornerstone for new bull markets and the consumer’s willingness to go out and shop more than they did last quarter. Consumer spending makes up over 70% of our nation’s GDP. A stronger consumer is a huge positive for our domestic markets.

2.                          Secondly, but very important are the high performance returns from those U.S. sectors that reflect the current global economic environment: energy, materials and metals and industrials. There is a direct correlation between energy consumption and growth in developing countries. Is it no wonder then that the top in the price of oil last summer occurred concurrently with the top in the global markets? We expect these markets to pick up again once the recession dissipates. Rising metals prices, which we have seen, presage economic upturns.

3.                          Thirdly, although last year’s strongest performing sectors; utilities, health care and consumer staples have lagged the other sectors since the March low, we still see them as part of the growth engine going forward, especially in the developing world. These sectors are considered defensive since most customers need their goods and services regardless of the economic environment. Nevertheless, these sectors are poised for growth globally. For example, the utility industry is one of the faster growing sectors in the developing world. What we take for granted, like electricity, potable water and natural gas is a luxury for most of the developing world. Another defensive sector, health care, is also poised for growth globally. Medicine and vaccine needs must be addressed here and abroad. In the United States, people are living longer and creating a demand for health care services and products. The consumer staples sector, boring for most, will be the key behind the newly developing global consumer economies of China, India and central Europe. We see investments in U.S. multinationals as a way to participate in the rise of the global middle class. So, you see, even defensive sectors will contribute to the growth of your portfolios as world economies develop.


Going forward we are keeping a sharp eye on China, India, and commodities. As a group, they represent growth in infrastructure. India and China were among the fastest growing economies in the first quarter of 2009. They are not stopping for anything. Both countries have adopted huge infrastructure programs. We mentioned China’s $586 Billion stimulus program at the outset. India has one of its own. As a developing nation, India is in the early stages of building paved roads, developing utilities and other building projects. From an historical perspective, India is actually playing “catch-up” with China. The Chinese started their capital projects around 1980. India’s infrastructure projects have only been around since 1993. Think how far China has come? India is 13 years behind them; that is potentially a lot of growth to come. And, India is the largest democracy in the world. On a micro level, to give you an economic comparison between newly developing world countries like India and China, compared to the developed world economies like the United States we see something like this: India has 10 cars per 1,000 residents, vs. 600 per 1,000 in the U.S. With incomes rising and more affordable cars hitting their markets, won’t that drive metals like steel and aluminum? How about energy sources to fuel these vehicles? * These countries are on the move, much like the United States was on the move in the 1950’s. In just these small areas of roads and cars, the implications are clear; these countries will need basic inputs from the commodity arena. A developing, hungry world will drive up demand for food, as well. Therefore, we will continue to look to India, China and the commodities they will need going forward. We will focus on those investments that will take advantage in this area of the globe.

On the domestic front, going forward, there is a confluence of three events that lead us to believe our domestic recession may end by the middle of next year.

  1. The Obama stimulus program, similar to the FDR stimulus/infrastructure programs in the 1930’s, should take hold by mid-year 2010. The FDR stimulus programs took 12-18 months to gain traction. Should this be the case for the current program coinciding with Obama’s inauguration in January 2009, 18 months later for the program to gain traction will put us into mid-year 2010.
  2. Secondly, most real estate economic models, based on past real estate collapses, project the U.S. excess housing inventory to be worked off by Q2, 2010. Housing got us into this mess and a stronger housing market will be needed to get us out of it. Again, supply should be worked off by mid-year 2010, according to economic forecasts.
  3. Our last bear market (2000-03) lasted 31 months. The current bear market began in October 2007. If this bear market ends in mid-year 2010, coinciding with the work-off of the housing inventory over-hang and the beginning of Obama’s stimulus program gaining traction, then the bear market we are experiencing now will have lasted exactly 32 months; one month longer than the 2000-2003 bear which was the longest recession since WWII.

To summarize this evening’s discussion: Thus far, in the short-term, for the next few quarters, we see the mitigation of falling price action on a relative basis. Although a bear market still exists, the force behind the market rally from March and more importantly, the participation of leading sectors like financials and technology, coupled with aforementioned commodities like copper, lead us to believe we are finally starting to dig ourselves out of this hole. As a caution, we must also be realistic. Because this is a process and we have been experiencing a long period of down trending price action, we must realize that the coinciding sideways move will not be brief before price rises again. A base-building process means the initial rally we are currently experiencing will be followed by a retracement in price; a set back. This is the natural backing and filling process that markets go through after long periods of decline. Once price stalls after this rally, it will gravitate back to its point of origin, the March low. What happens from there will help determine if the recent rally is the first part of the bottoming process or just another bear market rally. Either way, in the short term, the uptrend should be in its final 2-4 weeks and will be subject to profit taking.

Over the longer term, the fundamental drivers to higher prices will be the directors of the global money supply, central bankers and the Federal Reserve, working together in a coordinated effort to free up the speed of money in the global credit markets, resulting in money moving through the system to accomplish various goals.

Those goals are putting people back to work by creating demand for goods and services across a host of industries as the entire world moves out of uncertainty and stagnation to a track where we left off prior to the current recession and crisis.  Given time, we expect the markets and the global consumer to pick up where they left off; a world where most countries are trading among one another, a growing demand for resources, businesses willing to work together to finance and profit while assisting their partners; all of this which will contribute to rising prices in quality financial instruments. The U.S. and the world will continue to grow and develop its skills and technologies. Accordingly, markets will rise as the United States and its global partners continue to do business with one another.


* Footnote: The Complete Investor, Stephen Leeb, Editor; Volume 7, Number 4,

April, 2009 p. 11

Carl Perthel