The Window Of Uncertainty
Core fundamentals remain positive but do not exhibit the strength
seen throughout 2009. This indicator has only two settings --
positive and negative. When the core is positive, monetary policy
is relaxed, confidence is high or improving and interest rates, both
short and long are in cyclical low zones. The signal goes negative
when the Fed actively tightens credit via raising short rates and
draining reserves and bond yields begin to rise on a cyclical basis.
Negative core fundamentals do not imply an end to a cyclical bull
market, as credit growth usually supports rising output and profits.
But a negative signal suggests investors should either raise some
cash and/or trade in the shorter run, as the "easy money" has been
The window of uncertainty we are now encountering involves an
interval of unknown duration in which reliance of the economy
switches from monetary liquidity growth to private sector credit
to sustain recovery / expansion. Usually, this transition is seamless
and occurs early in the recovery cycle. It has not happened yet,
and the uncertainty is poignant because the Fed, having loaded the
system with monetary liquidity in 2009, has stopped adding on the
assumption private sector credit demand would grow and take up
the slack. The latter has yet to occur. The Fed is jawboning banks to
lend and Bernanke has promised to take steps to add liquidity in
the interim if the recovery falters. But, if this interim period is
mishandled, we could have a situation wherein the recovery fails
and a cyclical bear market develops even though core fundamentals
Such a failure would be unprecedented and, I suspect, it is still too
early to tell if a failure is other than a remote possibility. But, my
indicators show that a seamless transition from monetary to credit
driven growth has yet to occur, so the unpleasant possibility of a
serious screw-up needs to be flagged.
Investors are aware of this particular uncertainty issue. And, over
May and June, when my weekly cyclical pressure gauge took a
tumble, the market reacted in a strongly negative way. The
weekly pressure gauge has leveled off, and investors no doubt are
heartened by strong Q 2 '10 profits results and the Fed's pledge to
address the liquidity issue as needed (See the 6/15 post for more on
the pressure gauge).
Indications that economic and profits growth are going to be easing
along with the uncertainty inherent in present monetary / credit
policy have led the market to trade at a significant discount to fair
value despite the recent strong advance off the 07/02 low. My
Market Tracker has fair value for the SP 500 at 1215 based on
estimated 12 mos. net per share through July. The discount stands
at 8.2% now, and was even an even larger 15.8% in early July. The
Tracker is a cyclical measure. On my long term model, the market is
now well priced under 1155 for holding periods beyond three years.
If you are kind enough to be reading along still, I can tell you the US
has not seen a situation quite like this for a good 100 years, if not
longer. It could all be wrapped up tidily and positively in a month or
so, or it could drag on, in which case the best and time honored
indicators would fail to signal correctly what to do and would leave
us to fly by the seats of our pants. I remain positive but watchful.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!