07/29/2010: We are all familiar with the common expression, markets do not like surprises. As it relates to the current state of the labor markets, the number of Americans filing first-time claims for unemployment insurance came in at 457,000 last week, which has again brought out comments from the media like "a figure that signals the labor market will be slow to improve even as the economy grows". Is slow employment growth a surprise to anyone? Expectations from almost all quarters call for slow improvement in the labor markets and persistently high unemployment. In fact, John C. Williams of the San Francisco Fed said yesterday:

Indeed, given the outlook for only modest growth through the end of the year, I expect unemployment to end 2010 at about its current level of 9 1/2 percent. Once growth picks up to a more robust pace, the unemployment rate should gradually decline, but only to about 8 1/2 percent by the end of next year. I expect it will take several years before it returns to more normal levels.

Not to discount the importance of job creation and the real hardships endured by thousands of American families, but financial markets have performed well in prior cycles despite "jobless recoveries". In the last recovery (early 2000s), job creation did not return for almost two years after the economy bottomed. However, asset markets performed quite well from October of 2002 to October of 2007, with the S&P 500 gaining 105% from the bear market lows to the bull market highs.

In the early 1990s, job creation was tepid as we emerged from a recession in March of 1991. From March of 1991 through year-end 1993, the S&P 500 gained 26% during a "jobless recovery". It is true markets do not like surprises, but weak job creation is a surprise to no one. In a similar vein, we noted recently in "Falling Consumer Confidence: Not a Death Knell for Stocks", it is important that we try to differentiate between economic concerns and economic concerns that historically have derailed bull markets.

Creating satisfying and rewarding jobs is extremely important to the happiness and well-being of Americans, but persistently high unemployment does not necessarily spell doom for the financial markets. Fortunately, rising asset prices can assist in rebuilding balance sheets at all levels of the global economy. Healthier balance sheets at the household, corporate, and government level can eventually lead to higher levels of confidence and job creation.

Concerns about the economy, markets, and job creation are all warranted, and the big picture needs to be monitored closely. However, it is important we understand how past economic concerns have impacted asset prices.

Some general comments about investing blogs can be found here.

07/26/2010: The most recent posts in Short Takes, can be found using the link below (please update your bookmarks reflecting the new home page for Short Takes:

Remaining patient and focused on the longer-term has paid some dividends in recent weeks. The S&P 500 is now over 8% above the intraday low set on July 1, 2010. We still have the 200-day to contend with at 1,113. If, emphasis on if, the market breaks through the 200-day in a convincing and sharp manner sometime in the next two weeks, it would fit well with the profile of the end of a stock market correction. For now, another close over the 50-day would be a welcome sign. We have taken a few more steps towards the edge of the bearish woods, but we are not out yet.

07/22/2010: On June 18, 2010, we presented the second chart below, which stated a move back toward 83 in the U.S. dollar was possible. This morning the U.S. dollar is trading at $82.82 (last night's close shown in first chart). Yesterday, Ben Bernanke told the Senate Banking Committee, "We remain prepared to take further policy actions as needed to foster a return to full utilization of our nation's productive potential in a context of price stability". This means the Fed stands ready to take further action to support the economy and asset prices. You may think there is nothing the Fed can do with interest rates already near zero, but with deflation a real threat, the Fed has a few tricks left up their sleeve. The dollar may end up being the sacrificial lamb.

U.S. Dollar as of July 21, 2010

The Fed is a wild card in making portfolio decisions in the coming weeks and months. Let's use an example to illustrate. Let's assume, hypothetically, the S&P 500 falls to somewhere between 945 and 1,000. As we approach these levels, the threat of deflation starts to become very real. The average investor, driven understandably by fear, sells their entire portfolio moving to 100% cash. The next day, the Fed announces they are no longer going to pay interest on bank reserves held at the Fed (to encourage lending). Stocks rally, but the incoming economic news continues to disappoint. Ten days later, the Fed announces a new asset purchase program to pump more money into the economy. Commodities rally strongly; stocks rally; gold and silver rally; the U.S. dollar tanks. Driven by the Fed's actions (right, wrong, or indifferent), the S&P 500 finishes the year between 1,200 and 1,325. Investors who sold out between 945 and 1,000 on the S&P can't sleep at night. Some investors, who knew the Fed would not remain on the sidelines as the threat of deflation rose, held their positions and breathed a sigh of relief as they began to wrap holiday gifts in December of 2010.

U.S. Dollar as of June 18, 2010

The above scenario is not a forecast, it is simply a scenario investors must understand and respect in the present day. We firmly believe the Fed will not remain on the sidelines if asset prices begin to fall rapidly again in the next few weeks. In the longer-term, we believe this "solution" will fail as inflation eventually will eat into corporate profit margins. However, a bigger than anticipated rally in risk assets could occur in the meantime. If you do not consider this hypothetical scenario to be a realistic possibility, we suggest you use the link below to Chairman Bernanke's remarks from November of 2002, "Deflation: Making Sure "It" Doesn't Happen Here". The following appears on our Inflation vs. Deflation page:

At a time when interest rates are near historic lows around the globe, it is important to understand possible nontraditional ways for policymakers to fight deflation. These 2002 comments made by then Fed Governor Ben Bernanke outline in detail Federal Reserve options in a low interest rate environment. It may help us better understand the possible range of Fed actions in the next 24 months.

After you read the paper above, you may want to consider how commodities, like gold, silver, oil, and copper, may fit into your future contingency plans (as hedges against a falling U.S. dollar). In our view, there is quite a bit of "Fed risk" to short positions in the current market. The Fed can announce anything at anytime; and they most likely would do so when the markets are closed, giving the shorts little or no time to prepare. The odds are probably greater than 50% we will see some type of non-standard move by the Fed in the next six to eight weeks. We have to build those odds into our portfolio management decisions. We are not making predictions; we are simply trying to understand all possible scenarios and outcomes.

MORE Short Takes - Previous Entries

Chris Ciovacco
Ciovacco Capital Management