We just published a new Economic Update titled Changing Seasons.  You can also retrieve the update by typing the following URL in your web browser: 

http://www.broadleafpartners.com/uploads/Changing_Seasons.pdf

Enjoy!

Today's New York Times had an interesting article on the declining costs associated with mapping a human genome.  This makes the age old, grade school ethics question a potential reality.   "If you could find out what disease you might have or die from in the future, would you want to know that today?

If someone gave you $50k with the condition that you have your genome mapped and that you study the results, would you do it?

I serve on an advisory board for my alma mater's business school, Miami University.  The finance department formed this board a couple of years ago to help guide the curriculum of its students, better prepare them for careers in the field of finance, and foster relationships between students and alumni.   

Given the financial meltdown of the past couple of years, the chairman sent us a series of questions ahead of a meeting we're having later this month soliciting our input on what we, as former students and current financial professionals learned from the ordeal and how professors might incorporate such thinking into a modern business school curriculum.  

I thought the questions were great and was encouraged to see academia seeking our input.  At the same time, I think the most valuable inputs from a course perspective might likely lie within the realm of humanities rather than business classes.  Below are some thoughts I shared with the department chair.  I think it will be an interesting discussion.

****

A greater emphasis on philosophy, religion, organizational behavior, and history might likely prove fertile educational grounds for:

1. Understanding that man is doomed to repeat the patterns of behavior surrounding fear and greed (if you are religiously bent as I am, this is our tendency to sin),
2. Gaining an understanding of what personal involvement in these two patterns of human behavior might entail (ie consequences), and
3. How an understanding of their inevitability might better prepare individuals for the future, whether it is on the trading floor, in the board room, or as a younger person planning their career options. 

As you would likely agree, experience is the best teacher because it is real and often involves pain.  There is nothing better than touching a hot stove to teach someone that touching hot stoves is not a good idea.  That type of experience is hard to incorporate into an academic situation, but my guess is an intense course on personal struggles of individuals across a spectrum of careers could be useful.  For instance, have a World War II vet talk to the class about dealing with Normandy, an astronaut about a faulty o ring, a catholic priest on dealing with their recent sex scandals, a politician on losing their recent race, or a Tiger Woods type on the cost of having an affair.  You could design a whole class on these things that I believe would enable students to find similarities on the human condition that might prove useful in discerning appropriate course of action.   

I would also note that one of the tell tale signs that an area of finance may be ripe for correction and/or comeuppance is when those types of jobs are the most coveted by undergraduate students seeking jobs.  My guess is that two years ago, the hot areas of private equity and fund of funds would have been highly sought after.  I don't know how this could be incorporated into a risk management discipline, but in my experience, bubbles are not identified by the characteristics most taught in finance classes like ratios etc, but in the flows of money to favored asset classes.  The more people are aware of how greed and fear manifest themselves, the better. 

****

What are your thoughts?  If you have anything unique to share, I will pass it along later this month. 
 

A friend and reader of yesterday's blog entry shares another funny kid story.  Keep 'em coming!

******

Two  little boys, ages 8 and 10, were excessively mischievous.  They were always  getting into trouble and their parents  knew all about it.   If any mischief occurred in their town, the two boys were probably  involved.

The  boys' mother heard that a preacher in town had been successful in disciplining  children, so she asked if he would speak with her  boys.  The  preacher agreed, but he asked to see them individually. So the mother sent  the 8 year old first, in the morning, with the older boy to see the  preacher in the afternoon.

The  preacher, a huge man with a booming voice, sat the younger boy down and  asked him sternly, 'Do you know where  God is, son?'   The  boy's mouth dropped open, but he made no response, sitting there wide-eyed  with his mouth hanging open.

So  the preacher repeated the question in an even sterner tone, 'Where is  God?  Again,  the boy made no attempt to answer.

The preacher raised his voice even more  and shook his finger in the boy's face and bellowed, 'Where is  God?'  The  boy screamed and bolted from the room, ran directly home and dove into his  closet, slamming the door behind him.

When  his older brother found him in the closet, he asked, 'What  happened?'

The  younger brother, gasping for breath, replied, 'We are in BIG trouble this  time,' 
(I LOVE reading  this next  line again and again

'GOD  is missing, and they think we did it!'

A little girl was talking to her teacher about whales.

The teacher said it was physically impossible for a whale to swallow a human because even though it was a very large mammal its throat was very small.

The little girl stated that Jonah was swallowed by a whale.

Irritated, the teacher reiterated that a whale could not swallow a human; it was physically impossible.

The little girl said, "When I get to heaven I will ask Jonah".

The teacher asked, "What if Jonah went to hell?"

The little girl replied, "Then you ask him".

****** 

A Kindergarten teacher was observing her classroom of children while they were drawing. She would occasionally walk around to see each child's work.

As she got to one little girl who was working diligently, she asked what the drawing was.

The girl replied, "I'm drawing God."

The teacher paused and said, "But no one knows what God looks like."

Without missing a beat, or looking up from her drawing, the girl replied, "They will in a minute."

****** 

A Sunday school teacher was discussing the Ten Commandments with her five and six year olds.

After explaining the commandment to "honour" thy Father and thy Mother, she asked, "Is there a commandment that teaches us how to treat our brothers and sisters?"

Without missing a beat one little boy (the oldest of a family) answered, "Thou shall not kill."

******

One day a little girl was sitting and watching her mother do the dishes at the kitchen sink. She suddenly noticed that her mother had several strands of white hair sticking out in contrast on her brunette head.

She looked at her mother and inquisitively asked, "Why are some of your hairs white, Mom?"

Her mother replied, "Well, every time that you do something wrong and make me cry or unhappy, one of my hairs turns white."

The little girl thought about this revelation for a while and then said, "Momma, how come ALL of grandma's hairs are white?"

******

The children had all been photographed, and the teacher was trying to persuade them each to buy a copy of the group picture.

"Just think how nice it will be to look at it when you are all grown up and say, 'There's Jennifer, she's a lawyer,' or 'That's Michael, He's a doctor.'

A small voice at the back of the room rang out, "And there's the teacher, she's dead."

****** 

The children were lined up in the cafeteria of a Catholic elementary school for lunch. At the head of the table was a large pile of apples. The nun made a note, and posted on the apple tray:

"Take only ONE . God is watching."

Moving further along the lunch line, at the other end of the table was a large pile of chocolate chip cookies.

A child had written a note, "Take all you want. God is watching the apples."

 

My Excel charting skills are indeed amateur, but I nevertheless wanted to get a feel for the historical relationship, if any, between changes in the Fed's discount rate and the stock market.  If you hadn't heard, the Fed raised the discount rate by 25 basis points after the close of the market last night to 75 basis points.  Changing the discount rate - the rate the Fed charges banks for loans - is one of the many monetary policy tools available to the Federal Reserve. 

CNBC is providing intense coverage of the Fed's moves this morning, basically asking professional investors if the Fed's moves signal anything about a change in policy that may usher in additional rate hikes and what that might mean for the markets.  Bulls might interpret the move as a sign that the Fed is more comfortable with the economic outlook and is therefore taking initial steps to remove temporary stimulus that may no longer be necessary.  On the other hand, bears might argue that the move may be the first in a series of many hikes in the Fed Funds rate, moves which may prove too little too late in fighting inflationary pressures brought about be easy money.  

The top chart shows the discount rate and associated changes since 2003.  In the chart, you can see two primary monetary policy campaigns.  The first is the period from 2004 to mid 2006 when the Fed raised rates as the economy recovered from the tech wreck earlier in the decade.  The second period was from 2007 to just before last night, when the Fed reduced the discount rate to nearly zero to combat what nearly became a second Great Depression.  The bottom chart shows the S&P 500 over the same time period, with the blue dots representing dates when the Fed changed the discount rate.

To me, a couple of observations and conclusions might be made from these charts.  First of all, it is likely that yesterday's increase in the discount rate may indeed represent a change in Fed policy and that barring a double dip in the economy, will prove to be the first of many such rate hikes.  However, what is also interesting is that the last time the Fed started to raise rates, the S&P 500 climbed higher from roughly the 1100 level in mid 2004 to the high of nearly 1500 three years later, when the Fed first started to cut rates once again.

To me, the data suggests that investors need not panic.  The time to worry about Fed policy may not be for a few years, or at least until the Fed ends its rate hike campaign and begins cutting them once again.  If history is a guide, rate cuts won't likely occur until a period of economic expansion is over and the Fed begins to worry once again about signs of visible economic weakness.  Economic growth and even some inflation will likely be interpreted by the stock market in a positive fashion. 

Over five thousand years ago,
Moses said to the children of Israel
"pick up your shovel,
mount your asses and camels,
and I will lead you to the promised land".
 
Nearly 75 years ago,
Roosevelt said, "Lay down your shovels,
sit on your asses,
and light up a camel,
this is the promised land" ...
 
Now Obama has stolen your shovel,
taxed your asses,
raised the price of camels,
and mortgaged the promised land!
 
Furthermore, I was so depressed last night thinking about health care
plans, the economy, the wars, lost jobs, savings, Social Security,
retirement funds, etc...

I called Lifeline, the suicide help line.
Got a freakin' call center in Pakistan.
I told them I was suicidal.
 
They all got excited and
asked if I could drive a truck....

Men at Work stole Down Under 

Australian band Men at Work copied a well-known children's campfire song for the flute melody in its 1980s hit Down Under and owes the owner years of royalties, a court ruled today (The Guardian).  I'm going to have that song in my head for the rest of the day.  My guess is their i-Tunes sales of the song get a spike.

                                                                             **********

Good Humor/To Do List from our summer intern, Kevin Arbogast. 

1.) At lunch time, sit in your parked car with sunglasses on and point a hair dryer at passing cars. See if they slow down.                   

2.) Page yourself over the intercom.  Don't disguise your voice!
                                                                              
3.) Everytime someone asks you to do something, ask if they want fries with that.   
                                                
4.) Put decaf in the coffee maker for three weeks.  Once everyone has gotten over their caffeine addictions, switch to espresso.  
                                                                                        
5.) In the memo field of all your checks, write "For Marijuana."    
                                                                             
6.) Skip down the hall rather than walk.  See how many looks you get.   
                                         
7.)  Order a diet water whenever you go out to eat, with a serious face.                                                                          

8.)  Specify that your drive through order is "To go."                        
                                                                  
9.)  Sing along at the Opera.  
                                                                                                                   
10.)  Five days in advance, tell your friends you can't attend their party because you have a headache.  
                                      
11.)  When the money comes out of the ATM, scream "I won, I won!
                                                                                  
12.)  When leaving the Zoo, start running towards the parking lot, yelling "run for your lives, they're loose!"

13.)  Tell your children over dinner, "Due to the economy, we are going to have to let one of you go."


                                                                               *********** 
                                                                
Cisco Systems reported stronger earnings relative to expectations than I've seen since they were a emerging growth story in the early 90's.  Earnings came in five cents better than expected revenues driven by a broad based improvement across all product lines and market geographies.  For most of that last ten years, Cisco has religiously come in a penny above expectations. 

The breadth of what they are seeing in terms of results should at the very least provide some support on the downside and hopefully reduce worries that remain over the prospects of a double dip.  Visa and Starwood Hotels had similarly strong comments and results. 

Broadleaf Partner's was quoted in CNN Moneyline this morning on our 2010 outlook for the markets.  For the full story, click here.

On another note, there has been a great deal of talk on new banking regulations and in particular the proposed Volcker rule.  Paul Volcker was a former Fed chairman during the Carter and Reagan presidencies and now serves as chairman of the newly formed Economic Recovery Advisory Board under President Barack Obama.  

I am personally in favor of re-separating commercial banking and investment banking activities.  If banks are going to be deemed too big to fail because they are fiduciaries of average Joe savings account deposits that must be protected at all costs, then perhaps these entities should not be permitted to participate in more speculative endeavors.  If, after all, these banks can't be trusted to make good mortgage loans - a bread and butter banking business - they probably should steer WAY clear of things like private equity, hedge funds and proprietary trading.  While these activities may be a small portion of bank revenues today, there is no doubting the fact that these activities will expand as the economy recovers if rules aren't put into place.. 

I also agree with Volcker's comments to the Senate banking committee yesterday, especially the idea that some entities will try to get around the spirit of any new regulations.   In particular, something may also have to be done to limit bank lending to the institutions that do participate in these activities, otherwise banks may end up holding the bag anyway the next time a speculative bubble bursts and equity holders are wiped out.

There is nothing wrong at all with speculative business activities.  What is wrong is exposing low risk capital (bank deposits) to the loss of high risk activities.  Banks should also, perhaps have to hold more of what they generate on the loan front, so they don't get as sloppy with their underwriting activities.  Warren Buffett, I know, has been a big proponent of that idea.  
 
For the full transcript of Volcker's comments, see below.

*************************************************************************

STATEMENT OF PAUL A. VOLCKER

BEFORE THE

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

OF THE

UNITED STATES SENATE

WASHINGTON, DC

FEBRUARY 2, 2010

Mr. Chairman, Members of the Banking Committee:

You have an important responsibility in considering and acting upon a range of issues relevant to needed reform of the financial system. That system, as you well know, broke down under pressure, posing unacceptable risks for an economy already in recession. I appreciate the opportunity today to discuss with you one key element in the reform effort that President Obama set out so forcibly a few days ago.

That proposal, if enacted, would restrict commercial banking organizations from certain proprietary and more speculative activities. In itself, that would be a significant measure to reduce risk. However, the first point I want to emphasize is that the proposed restrictions should be understood as a part of the broader effort for structural reform. It is particularly designed to help deal with the problem of “too big to fail” and the related moral hazard that looms so large as an aftermath of the emergency rescues of financial institutions, bank and non-bank, in the midst of crises.

            I have attached to this statement a short essay of mine outlining that larger perspective.

The basic point is that there has been, and remains, a strong public interest in providing a “safety net” –in particular, deposit insurance and the provision of liquidity in emergencies – for commercial banks carrying out essential services. There is not, however, a similar rationale for public funds - taxpayer funds - protecting and supporting essentially proprietary and speculative activities. Hedge funds, private equity funds, and trading activities unrelated to customer needs and continuing banking relationships should stand on their own, without the subsidies implied by public support for depository institutions.

Those quintessential capital market activities have become part of the natural realm of investment banks. A number of the most prominent of those firms, each heavily engaged in trading and other proprietary activity, failed or were forced into publicly-assisted mergers under the pressure of the crisis. It also became necessary to provide public support via the Federal Reserve, The Federal Deposit Insurance Corporation, or the Treasury to the largest remaining American investment banks, both of which assumed the cloak of a banking license to facilitate the assistance. The world’s largest insurance company, caught up in a huge portfolio of credit default swaps quite apart from its basic business, was rescued only by the injection of many tens of billions of dollars of public loans and equity capital. Not so incidentally, the huge financial affiliate of one of our largest industrial companies was also extended the privilege of a banking license and granted large assistance contrary to long-standing public policy against combinations of banking and commerce.  

What we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets. The first line of defense, along the lines of Administration proposals and the provisions in the Bill passed by the House last year, must be authority to regulate certain characteristics of systemically important non-bank financial institutions.  The essential need is to guard against excessive leverage and to insist upon adequate capital and liquidity.

It is critically important that those institutions, its managers and its creditors, do not assume a public rescue will be forthcoming in time of pressure. To make that credible, there is a clear need for a new “resolution authority”, an approach recommended by the Administration last year and included in the House bill. The concept is  widely supported internationally.  The idea is that, with procedural safeguards, a designated agency be provided authority to intervene and take control of a major financial institution on the brink of failure. The mandate is to arrange an orderly liquidation or merger. In other words, euthanasia not a rescue.

Apart from the very limited number of such “systemically significant” non-bank institutions, there are literally thousands of hedge funds, private equity funds, and other private financial institutions actively competing in the capital markets. They are typically financed with substantial equity provided by their partners or by other sophisticated investors. They are, and should be, free to trade, to innovate, to invest – and to fail. Managements, stockholders or partners would be at risk, able to profit handsomely or to fail entirely, as appropriate in a competitive free enterprise system.

Now, I want to deal as specifically as I can with questions that have arisen about the President’s recent proposal.

First, surely a strong international consensus on the proposed approach would be appropriate, particularly across those few nations hosting large multi-national banks and active financial markets. The needed consensus remains to be tested. However, judging from what we know and read about the attitude of a number of responsible officials and commentators, I believe there are substantial grounds to anticipate success as the approach is fully understood.

Second, the functional definition of hedge funds and private equity funds that commercial banks would be forbidden to own or sponsor is not difficult. As with any new regulatory approach, authority provided to the appropriate supervisory agency should be carefully specified. It also needs to be broad enough to encompass efforts sure to come to circumvent the intent of the law. We do not need or want a new breed of bank-based funds that in all but name would function as hedge or equity funds.

Similarly, every banker I speak with knows very well what “proprietary trading” means and implies. My understanding is that only a handful of large commercial banks – maybe four or five in the United States and perhaps a couple of dozen worldwide – are now engaged in this activity in volume. In the past, they have sometimes explicitly labeled a trading affiliate or division as “proprietary”, with the connotation that the activity is, or should be, insulated from customer relations.

Most of those institutions and many others are engaged in meeting customer needs to buy or sell securities: stocks or bonds, derivatives, various commodities or other investments.  Those activities may involve taking temporary positions. In the process, there will be temptations to speculate by aggressive, highly remunerated traders. 

Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses.  An analysis of volume relative to customer relationships and of the relative volatility of gains and losses would go a long way toward informing such judgments. For instance, patterns of exceptionally large gains and losses over a period of time in the “trading book” should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.  

Third, I want to note the strong conflicts of interest inherent in the participation of commercial banking organizations in proprietary or private investment activity. That is especially evident for banks conducting substantial investment management activities, in which they are acting explicitly or implicitly in a fiduciary capacity. When the bank itself is a “customer”, i.e., it is trading for its own account, it will almost inevitably find itself, consciously or inadvertently, acting at cross purposes to the interests of an unrelated commercial customer of a bank. “Inside” hedge funds and equity funds with outside partners may generate generous fees for the bank without the test of market pricing, and those same “inside” funds may be favored over outside competition in placing funds for clients. More generally, proprietary trading activity should not be able to profit from knowledge of customer trades.

I am not so naive as to think that all potential conflicts can or should be expunged from banking or other businesses. But neither am I so naïve as to think that, even with the best efforts of boards and management, so-called Chinese Walls can remain impermeable against the pressures to seek maximum profit and personal remuneration.

In concluding, it may be useful to remind you of the wide range of potentially profitable services that are within the province of commercial banks.

•           First of all, basic payments services, local, national and worldwide, ranging from the now ubiquitous automatic teller machines to highly sophisticated cash balance management;

•           Safe and liquid depository facilities, including especially deposits contractually payable on demand;

•           Credit for individuals, governments and businesses, large and small, including credit guarantees and originating and securitizing mortgages or other credits under appropriate conditions;

•           Analogous to commercial lending, underwriting of corporate and government securities, with related market making;

•           Brokerage accounts for individuals and businesses, including “prime brokerage” for independent hedge and equity funds;

•           Investment management and investment advisory services, including “Funds of Funds” providing customers with access to independent hedge or equity funds;

•           Trust and estate planning and administration;

•           Custody and safekeeping arrangements for securities and valuables.

Quite a list. More than enough, I submit to you, to provide the base for strong, competitive – and profitable  - commercial banking organizations, able to stand on their own feet domestically and internationally in fair times and foul.

What we can do, what we should do, is recognize that curbing the proprietary interests of commercial banks is in the interest of fair and open competition as well as protecting the provision of essential financial services. Recurrent pressures, volatility and uncertainties are inherent in our market-oriented, profit-seeking financial system. By appropriately defining the business of commercial banks, and by providing for the complementary resolution authority to deal with an impending failure of very large capital market institutions, we can go a long way toward promoting the combination of competition, innovation, and underlying stability that we seek

I’ve taken great interest in the masculine characters of several Clint Eastwood films recently, including Unforgiven’s William Munny and Gran Torino’s Walt Kowalski.  This past weekend, I was also introduced to Robert Redford’s Jeremiah Johnson, a movie by the same name.  These films elevate the state of manliness – even with its flaws - to a level worthy of respect rather than scorn as is often the case in today’s culture.   Courage is displayed in a noble light, but is neither easy nor free.    

Throughout much of January, I heard the phrase “easy money” to describe the gains of 2009.  With the “easy gains” now behind us, the implication is that further progress for the markets will be more difficult.  While I agree with the idea that future gains may be measured, I disagree with the notion that the gains of the last ten months were somehow “easy”.   Employers, employees and investors alike have suffered greatly over the last eighteen months and in some cases, the pain remains severe. 

In spite of January’s market decline, we believe the economic recovery remains intact.  Jason Trennert of Strategas Research Partners points out that of the 45% of S&P 500 companies that have reported earnings results, 78% have beaten bottom line estimates, while a whopping 70% beat top line revenue estimates.  This latter figure is a tremendous improvement from year ago levels when only 30% of companies exceeded their goals.  Revenue growth is important as it is a useful indicator of a healthy recovery and future employment gains.       

ISI Group takes the argument a little further, suggesting that at current rates of improvement, S&P 500 profits could be back to the peak levels achieved in 2006 by the second quarter of this year.   It is worth noting that the last time profit levels were that high, the S&P 500, in spite of 2009’s gains, was nearly thirty percent higher than it is today.  The rate of decline in unemployment claims has also been surprising, exceeding the average declines of the prior two slow/jobless recoveries in 1991 and 2002 by almost three fold.  

On an individual stock basis, the prices of a few companies are already back to or near their former all time highs.  In general terms, these companies seem to be from one of two camps, each on opposite sides of the capitalist spectrum.  On the one side are companies that have been the beneficiaries of rare levels of sustained innovation and new highs in profits (Apple Computer) and on the other are those that have been beneficiaries of “too big to fail” government policy  (A few banks).   It will be interesting to see in the months and quarters ahead if the “too big to fail” premium reflects hoped for market share gains at the expense of the weak or out of business or simply the government’s implicit guarantee of equity shares.  

As we look forward, we see a recovery based on the strength of corporate profits and business spending rather than the consumer as has often been the case in recent history.  For all the bashing of the U.S. that goes on these days, our companies are able to change directions relatively quickly on a global scale, as market pressures dictate. 

Today, U.S. companies are generating significant cash flow and like it or not, have leverage over the labor force.  With aging corporate infrastructures, we would look to the capex cycle and improved exports to take the traditional place of the consumer in recent recoveries and eventually, as stimulus is curtailed, government spending as well. 

The economy, as the recent GDP report suggests, may be stronger than most expect, but this won’t necessarily translate into another outsized year of stock market gains.   Earnings will play a more dominant role in valuations as reality catches up with already expected improvements.  This is likely one reason that the response of recent stock prices to earnings reports has been underwhelming. 

We are firmly in the camp that the recovery is intact, but fully expect some backing and filling along the way.  As the year progresses, it may behoove investors to look at companies with stable growth prospects that are less dependent on the economic cycle for outperformance in addition to those cyclical companies that have not yet fully participated in the expectation of  recovery.

Gains won’t be easy, but in spite of the rhetoric, they rarely are.  Buying stocks last March wasn’t a very “easy” thing to do for anyone being honest with themselves.  Only in hindsight do the rewards of success appear “easy”.  Unfortunately, such views are most often shared by Monday morning quarterbacks and perhaps politicians lacking a majority.   

William Munny, Walt Kowalski and Jeremiah Johnson would not approve. 

We are in the thick of earnings season and so far, the reaction of most stock prices has been disappointing relative to the great numbers most companies have been reporting.  This may be another way of saying that a great deal of improvement in the economy was priced in with the gains investors experienced in 2009, at least in the short run. 

In general, I subscribe to the baseline view that while the economy may do great in 2010, stock market returns may be average.  What could cause the stock market to exceed this expectation?  In my opinion, the single greatest source of upside would be the employment outlook.  Right now, sentiment remains very negative, adhering to the notion that this recovery will be of the jobless variety.   Another alternative might be a sustained improvement in productivity, leading to a permanent step up in corporate profitability, beyond that which might be explained by inventory rebuilds, human or otherwise.  While not as politically desirable, it is a vision worth exploring.  Historically speaking, downturns have almost always given birth to technology transitions, perhaps because the costs of change are slight relative to the pressures of doing nothing.       

Last week, the markets took a five percent hit as several political concerns rose to the forefront of investors' minds.  Democrats will tell you that the swoon started when Brown won Kennedy's senate seat and plans for nationalized health care died, while Republicans might blame it on the proposed new banking regulations.  Those of both persuasions might lay the blame on Bernanke's prospects for reappointment.  As always, there are many explanations to go around.

Personally, I think Brown's election was a positive for the markets and that some of the banking regulations make a lot of sense, even though they won't, of course, prevent the next downturn.  Politics have rarely played a significant role for me on the list of stock market risks simply because the government is such a well oiled bureaucracy, cable of much talk but little change.  Brown's improbable win represents a fascinating case study in the perseverance of bureaucracy.  If you want to have faith in government, that's a type you can take to the bank!

As for Bernanke?   I'm so tired of the debates, I've kept CNBC on mute for most of the past two days.  While I'd never want his job, I'm certainly glad he had it over the past two years.  I'm with Buffet.  I'd keep him.

Our fourth quarter performance and market commentary is now available.  Please click here for our thoughts on what contributed to this year's 44% gain for the portfolio, lessons learned from 2009, and what may lie ahead for investors in 2010.

Alcoa's results last night represented the start to fourth quarter earnings reports which should shed some light on business intentions and plans as we begin 2010.  As always, it will be a volatile few weeks for the markets, with its own fair share of surprises.  Stay tuned!

I  found this beautiful winter poem and thought it might be a comfort to you.   It was to me and it's very well written.  I hope that you enjoy it too .

                  ' WINTER ' 
 
                                    by Abigail Elizabeth McIntyre
 

 
                                       Shit....It's Cold
 
                                                              The End
 

We were on CNBC this morning.  At the end of the interview, Mark Haines wished me a Happy Birthday, commenting that I didn't look a day over 50.  At just 42, I should hope not!

Joking aside, here is a link to this morning's interview along with the comments I provided to the show's producers ahead of time.  

***

A. Are you more bullish or bearish on the markets and why?
 
We are more BULLISH than most.  Why?
 
1.)  We see employment gains as 2010 progresses, removing a key case for the bears.

2.)  Companies will begin spending again, not on just hires and working capital, but on longer term projects.  A corporate capex cycle should commence as 2010 progresses.  We are seeing some of this already in renewed M&A activities.

3.)  Historically speaking, the deeper the recession (and this one was long and deep), the bigger the rebound.  Normally, an 8% type GDP number might be expected considering the recent downturn, but most economists expect 4% at most.  Expectations appear conservative, with the potential surprise therefore, to the upside.
 

B.  Where are we investing now?  Favorite stocks and/or sectors and why we like them.
 
1.)  We still favor CYCLICALS over DEFENSIVES given the fact that we still see the economy in recovery mode and not likely to double dip. 

2.)  Favor LATER STAGE CYCLICALS like Energy, Industrials and Materials over EARLY STAGE CYCLICALS like Consumer Discretionary at the margin.  (Many consumer discretionary stocks have had very large rebounds and
as the recovery matures, money will likely rotate to areas with even greater leverage still ahead of them.)

3.)  Focus on INNOVATORS, companies whose success is tied more to their own unique offerings rather than the stage of the economic cycle.  
 

C.  What would we be avoiding right now?
 
1.)  We would generally still underweight DEFENSIVE sectors like Staples, Utilities and Telecom.  I would put HEALTH CARE in this basket as well, but it may enjoy a continued rebound now that the light at the end of the Health Care Reform tunnel can be seen.

2.)  We're still not making a big bet on FINANCIALS.  I think they've had a nice recovery but from current levels may now lag for awhile as TECHNOLOGY did following its bubble earlier in the decade.
 

D.  Topic We'd Like to Discuss?
 
1.)  It's my birthday today! 

2.)  HOUSING stocks could be a really interesting play in 2010 on the long side.  Unlike financials and many other areas of the market, these stocks really haven't done a thing.  So, they are still priced as junk and as a result, could enjoy the greatest gains from here as the economic recovery matures.

Each year at this time, I like to reflect on the year that was with the hope of gleaning a few nuggets of wisdom.  With the caveat that the last two years have been anything but ordinary, these are our observations on 2009: 

1.)  Investment decisions made on the notion that “it’s different this time” usually end up in the bucket of dumb investment ideas.   When fear ran rampant last March, it was easy to expect the worst.  Very few – including ourselves - would have guessed that the stock market would prove capable of climbing 70% off those lows, but that is exactly what happened.  For our portfolio, the most difficult investment decisions also proved the most profitable.

2.)  I don’t remember a year when so many folks were so distraught by the change in Washington and what it might mean for their investment portfolios.  As is so often the case, reality rarely ends up the way right wing or left wing extremists paint it to be, whether we’re talking global warming or the end of capitalism.  This year once again reminded me that politics and investment policy make for very poor bedfellows.  

3.)  Selling anything in 2009 was a mistake, just as buying about anything proved to be in 2008.  Good results are easier to come by when the markets are strong like they were this year.   

4.)  Hiring and training new employees is alot of work but it sure beats the alternative.  Installing new, firm wide software isn’t for the faint of heart either, especially if you lack an IT staff. 

5.)  The S&P 500 has been moving sideways at the 1100 level for most of the last six weeks, roughly the level it traded when Lehman Brothers went under fifteen months ago, ushering in a recession that far exceeded garden variety expectations.  Breaking above this level in 2010 could symbolize a similarly important healing point for the economy, the stock market and investors at large. 

Warmest Wishes for a Prosperous 2010!

It has been quite a yawner for the markets since we published our last Economic Update, Painting the House, in mid November.  The S&P 500, our proxy for the stock market, has moved in an uncharacteristically narrow channel since then, with 1090 as the low and 1110 as the high, a whopping 1.8% in heart pounding variability.

In our view, this sideways move is a natural one, as the market digests its significant gains coming off the nearly fatal March lows and as the economy prepares to shift gears as it enters the 2010 straightaway.  We believe there is a higher probability of above average gains for the coming year than most folks expect. 

Why do we believe in an upside bias?  Three reasons.   

First, employment should not only stabilize in 2010, but should begin to increase, perhaps as early as next month.  According to work done by ISI Group and thoughts echoed by former Fed Chairman Alan Greenspan this weekend, corporate managements likely cut employment too far as they prepared for Economic Armageddon over the past year.  Historically speaking, a GDP decline of the recent magnitude would have resulted in a 3% cut in payrolls as opposed to the much more significant 6% decline that actually occurred. 

Employment is, of course, a lagging indicator and as a result, improvements may not necessarily signal higher stock prices from here.  Nevertheless, they should provide the basis for improved sentiment and clearly remove a key thesis for the market’s bearishly inclined.  

In addition to an improvement in employment, we also believe we are on the cusp of what will prove to be a significant increase in capital spending, particularly among cash rich, downsized and restructured corporations.  As company executives become more comfortable with the sustainability of the recovery, they will likely move beyond simply replenishing inventories and hiring more folks and restart longer term investment projects that have been on hold.    

As we’ve pointed out from recent earnings results, most companies have generated significant improvements in free cash flow as they’ve downsized, freed up working capital and curtailed longer term investments.   But in addition to the improvement in internal cash flows, the credit markets have also thawed considerably, providing a refreshed source of external cash flow.  

Recent mergers and acquisitions activity – Buffett’s purchase of Burlington Northern and Exxon’s purchase this week of XTO – are evidence of both improving corporate sentiment and the ability of the capital markets to finance future strategies.   Increased M&A activity is a noteworthy and bullish leading indicator. 
  
Finally and perhaps most importantly, is the relationship between the depth of economic downturns and the strength of subsequent recoveries in the past.  History suggests that deep downturns have almost always been accompanied by stronger than average recoveries.   Again, according to work from ISI Group, the depth and duration of the recent recession would normally suggest a GDP rebound of eight percent.  With many economists forecasting more tepid GDP growth of just four percent in the coming year, expectations appear conservative and the variation could prove to be on the upside. 

While no downturn is ever fun, I find myself increasingly more comfortable with experiencing the reality of asset bubbles and economic recessions.   Economic cycles are an inevitable trait of the capitalistic lifestyle.  As long as humans are inclined to believe in money in an unhealthy fashion, we will not only succumb to the allure of greed, but also fall prey to fear.  In harnessing the relative calm afforded by the reality of past experience, I’m hoping we can all improve our investment returns during future calamity.        

Over ten years ago, I bought a new Dodge Viper.  While I no longer own it, I loved nothing more than the rush I could get from shifting gears as I accelerated down a highway entrance ramp.  On many occasions, I’d drive from my home to downtown Akron on State Route Eight, entering and exiting the freeway far more times than was truly necessary.  While the car always got its share of admiring looks and could certainly have pushed the threshold of a prudent speed, it was the shifting of the low gears, the sound of the engine, and the feeling of torque that I will always remember the most.

As 2009 comes to a close and 2010 begins, I can’t help but anticipate the excitement of shifting economic gears. 

As gold hit new highs last week, I remembered a gift my father in law had given Lisa and I on our wedding day a little more than 18 years ago.  It took me sometime to find it, but I eventually did, buried under eighteen years of accumulated family video tapes located in one of my fireproof safes.

Ralph, Lisa's dad, had given us us a one ounce pure gold Krugerrand minted in 1979 as a wedding gift.  On our wedding day - according to the internet - gold was worth $356 an ounce, a substantial discount to the price Ralph and many folks like him had paid for the precious metal when it hit $800 an ounce in the early eighties.  I suppose Ralph had likely given up on the "investment", and advised us to keep it for a rainy day or a time when we could use it, perhaps to buy some "groceries".    

While it wasn't raining out and our fridge was reasonably stocked with food, when gold hit record highs near $1300 an ounce last week, I figured it was as good a time to sell as any.  

I checked out the prices for recent Krugerrand sales on eBay and decided to list ours in a no reserve, 3 day auction with a starting price of $50 and a Buy it Now price of $1350.  Of course, gold had its largest single day price decline in over a year the very next day (humor me), but I still managed to sell it for $1220 to a Virginian who, from the looks of his recent purchase activity, has been a large buyer of coins in recent months.  My listing had 150 views and 18 bidders over three days. 

It was also interesting to note the large number of Krugerrands listed on the site, almost all of which were coined in the late 70's and early 80's and then in 2008 and 2009.  There were very few coins for sale from the years in between.  According to the web, the export of African Krugerrands to the United States was banned due to Apartheid in the late eighties and early nineties, which perhaps limited the supply of coins available here.  Nevertheless, I can't help but think that the high prices of the late eighties, as now, pushed production levels up considerably.  

Historically, gold has done well during periods of high inflation or deflation.  While we do not have either of these scenarios today, the metal's rise suggests that a change may be coming.  Then again, the price rise may simply be another asset bubble, something we've seen a great deal of in recent years.  

Ralph's coin earned Lisa and I a four fold return in roughly twenty years, which as far as gold is concerned, is about as good as it gets.  Historically, returns on the metal have averaged 2-3% over long periods of time. 

Reversion to the mean, anyone?

It has been quite sometime since I last published a blog entry.  The good news is that I've been quite busy, the bad news is that this trend may continue.  As a result, I will likely publish less frequently, perhaps just sharing my thoughts in the form of our periodic Economic Updates.  If you would like to receive those, please visit our website and subscribe at www.broadleafpartners.com.

Over the next few days, I hope to synthesize my thoughts on the year ahead and what it might mean for investors.  I may put the update in a Q&A format, which worked well on an occasion earlier in the year.  To that end, if you have any questions you would like me to consider, please feel free to send them via comment on this blog or directly by email to dmackay@broadleafpartners.com.  

I also plan to provide my closing thoughts on the year that was as I do each and every year, critiquing what went well, what didn't, and what we might be able to improve in the future.

Until then, enjoy the holiday season!

It has been awhile since we published our last Economic Update and now that earnings season is largely over, the time is right for one.  
 
At the end of October, the markets began to weaken with many stocks - outside of Amazon - responding poorly to their earnings releases.   In a blog entry at that time, we made the following now paraphrased comments:  
 
"The double dip drum has been beating once again given the recent pullback in the markets.  While any pullback is worth monitoring, corrections are actually quite common.  In fact, we've had several 5% plus peak to trough corrections since the recovery began in March.
 
During June:  The S&P 500 "corrects" from 948 to 870, an 8% decline.
During August:  The S&P 500 "corrects" from 1035 to 990, a 4 decline.
During September:  The S&P 500 "corrects" from 1070 to 1020, a 5% decline.
During October: The S&P 500 "corrects" from 1100 to 1040, a 5% decline.

As the data suggests, each correction has been followed by higher subsequent highs.  Alot of money is still on the sidelines and these corrections have provided opportunities to buy rather than sell.  I believe the pattern will hold." 
 
Now, two weeks later, the S&P 500 has reversed course and is resting at 1100 once again, pondering its next move.  We believe the markets will resume their upward march over the next two to three quarters, but also recognize that some positive news may be necessary to catalyze a sustained breakout above current levels. 
 
So, the logical question is what might be the source of a positive surprise?
 
With earnings now behind us, the likely source of positive news may come on the macroeconomic front.   And since the greatest concern over this recovery's sustainability seems to rest on the outlook for employment, it stands to reason that a recovery in employment could be and perhaps should be the source of that very surprise.      
 
Before we discuss our thoughts on the employment outlook, however, it probably makes sense to provide a quick summary of our thoughts from the third quarter's earnings season just ended, thoughts which we've collected from reviewing forty or so earnings call transcripts as well as summaries of many more. 
 
Earlier this week, JP Morgan provided a top down analysis of earnings results.  Of the 440 companies in the S&P 500 that had reported their results as of Monday, 80% posted earnings that were ahead of expectations, the largest figure on record.   In addition, 60% of these companies also reported revenues ahead of expectations, which may help offset concerns that recent gains have been solely a function of cost cutting. 
 
From our own bottoms up perspective, technology companies have been the most bullish in their outlooks.   Cisco Systems, in particular, declared the first quarter as the trough for results, the second as the tipping point, and the third just ended as the start of a worldwide economic recovery.  
 
The bullish outlook from technology companies can also be supported by the large number of M&A deals in the space, including last night's announced acquisition of 3Com by Hewlett Packard.  We would also add that technology tends to be a sector with early cyclical characteristics as many companies try to delay the need for new hires by transitioning to next generations of productivity enhancing technologies first.   
 
While the outlook from technology companies has taken the next step forward, I would characterize the outlook from other sectors of the economy as remaining "cautiously optimistic".   In spite of their more tentative outlook, free cash flow generation is reaching historical highs for many sectors of the economy.  In fact, it remains well above reported earnings, as a function of reduced production, leaner inventories, falling receivable balances, and lower employment levels.    
 
A Rockwell Collins executive may have summed up the outlook best by saying "you can delay painting your house, but you can't not paint your house forever."   Double negatives aside, spending may remain restrained for a time, but it can't be restrained forever. 
 
In simple terms, our macroeconomic playbook reads something like this.  Almost all economic recoveries begin with cost cutting.   After the cost cutting, revenues eventually stabilize and pick back up as a function of overshooting production on the downside and a more stable demand environment.  The final step in the recovery begins when companies start the process of "painting their houses" once again.  As confidence returns, corporate spending will pick back up and along with it, employment. 
 
Of course, this takes money, but on this front there is good news, given high rates of corporate profitability and cash flow generation, as discussed earlier.  It is also worth nothing that while bank lending standards may still be tight, corporate debt issuance has been at record highs and spreads remain constructive.   
 
Already, there are twelve countries outside the United States experiencing improving employment, including Australia, as reported by ISI Group.   Within the United States, continuing claims have stopped increasing and in spite of a record unemployment level not seen since the early 80's, the four week moving average of weekly unemployment claims just declined for the tenth consecutive week.
 
The unemployment rate is generally viewed as lagging indicator since it has historically peaked well into the earlier months of an economic recovery.  As we look to the winter and spring months ahead, we believe the biggest surprise will therefore be the employment outlook.   (Note that the unusually high worker productivity level just announced - 9% - is likely unsustainable and may be a function of cutting payrolls too much.)   

Of course, an improving employment outlook would be a major surprise in an investment environment that remains so skeptical of that very thing.  But in spite of such skepticism, the recovery to date, has been far more textbook that most would care to admit.  While there are always those who would say "this time it's different", in my experience, these words have invariably accompanied very poor investment decisions. 
 
Tactically, we have been paring our significant gains in early cyclicals, particularly consumer discretionary stocks purchased a year ago when the death of the consumer was loudly proclaimed.  We've been redeploying these gains into later stage cyclical stocks more recently - areas that should outperform as the recovery matures; primarily energy, industrials and materials. 
 
If time proves our forecast correct, an improvement in employment should be on the macroeconomic agenda at some point in the next two or three quarters, setting the stage for continued outperformance as we enter 2010. 
 
That's the picture we've painted.  Now it's time to sit back and watch the paint dry.

The double dip drum has been beating once again given the recent pullback in the markets.  While any pullback is worth monitoring, it is instructive to consider that corrections are actually quite commonplace.  In fact, we've had several 5% plus peak to trough corrections since the recovery began in March!  Did you even notice?  

Here's my chicken scratch math:  

During June:  The S&P 500 "corrects" from 948 to 870, an 8% decline.
During August:  The S&P 500 "corrects" from 1035 to 990, a 4 decline.
During September:  The S&P 500 "corrects" from 1070 to 1020, a 5% decline.
During October: The S&P 500 "corrects" so far from 1100 to 1040, a 5% decline.

Please keep in mind that these are intra month corrections rather than the declines the market posted for each of the months in question.  Corrections are commonplace during economic recoveries, and as the data suggests, each correction has been followed by higher subsequent highs.  Alot of money is still on the sidelines and these corrections have provided opportunities to buy rather than sell.  I believe the pattern will hold. 

Of the earnings I follow, results have generally been ahead of expectations on the bottom line and inline on the top line.  Stock prices, however, have often come under pressure on the results, even when guidance has been increased, at least on the initial report.  Fast money and whisper numbers may be to blame for the fast trading reactions, but with fundamentals improving rather than deteriorating, the upward bias should remain intact.  

Q3 GDP just came in at up 3.5%, the fastest rate since 2007.  Additionally, continuing claims came down, a positive sign and new unemployment claims came in at the low 500's.  Admittedly, these releases are all backward looking, but should set the tone for a basing process and an end to October's mini correction.

Once the earnings deluge is over, I hope to provide some additional insights, but for now, I'm knee deep in the earnings data and conference call transcripts.

The markets pulled back aggressively at 11:30am EST and are now down about a percent or so.  According to some, the reason for the pullback was because of a reversal in the dollar and the fact that the markets hit upside resistance and couldn't break through.  In short, I think this latter comment implies that the markets have pulled back because they couldn't go up anymore.  How is that for simple brilliance!

For more outstanding examples of reasoning and a good chuckle,  check out these children's answers to a recent science exam.   

Q:  Name the four seasons.
A:  Salt, pepper, mustard and vinegar.

Q:  Explain one of the processes by which water can be made safe to drink .   
 A:  Flirtation makes water safe to drink because it removes large pollutants like grit, sand, dead sheep and canoeists.

Q:  How is dew formed?
A:  The sun shines down on the leaves and makes them perspire.

Q:  How can you delay milk turning sour? (brilliant, love this!)
A: Keep it in the cow.

Q:  What causes the tides in the oceans?
A:  The tides are a fight between the Earth and the Moon. All water tends to flow towards the moon, because there is no water on the moon, and nature hates a vacuum. I forget where the sun joins   in this fight.

Q:  What are steroids?
A:  Things for keeping carpets still on the stairs.

Q:  What happens to your body as you age?
A:  When you get old, so do your bowels and you get intercontinental. .

Q:  What happens to a boy when he reaches puberty?
A:  He says good-bye to his boyhood and looks forward to his adultery.

Q:  Name a major disease associated with cigarettes.
A:  Premature death.

Q:  How are the main parts of the body categorized? (e.g., abdomen)
A:  The body is consisted into three parts - the brainium, the borax and the abdominal cavity.     The brainium contains the brain; the borax contains the heart and lungs, and the abdominal cavity contains the five bowels A, E, I, O, and U.

Q:  What is the fibula?
A:  A small lie
Q:  What does "varicose" mean? (I do love this one...)
A:  Nearby.

Q:  Give the meaning of the term "Caesarean Section."
A:  The Caesarean Section is a district in Rome .

Q:  What does the word "benign" mean?'
A:  Benign is what you will be after you be eight.

 

If you own Amazon, you're one happy camper.  Unfortunately, I'm not one of them.

The stock is up a whopping 25% after announcing great earnings, which included news that the Kindle (a product that they own and manufacture) was their biggest selling product in both units and dollars.  This news gives the company a new Apple-like angle to it, as a manufacturer rather than just a low cost retailer that is giving the mighty Wal Mart a run for its money.  

Aside from Amazon, it has been a big week for other earnings as well.  But as a general observation, I would say the reaction of stocks like Amazon and Apple has been atypical.  Many companies that we actively follow have demonstrated strong results relative to expectations both as a function of leaner operations and - unlike previous quarters - some areas of revenue improvement.  In most cases, analysts estimates have increased based on improved guidance.  In spite of this generally positive fundamental news, more stocks seemed to have responded negatively the first day following their earnings releases.   For investors, does this mean anything?

The quick answer is that I don't know.  I've long resisted making changes to the portfolio during earnings season as it tends to be a very emotional time driven by technical trading considerations that often don't sustain themselves longer term.  One stock I'm thinking of in particular traded down ten percent the first day after their earnings release.  Today, three days later, it is trading back above its pre earnings price level.  I'm not sure why this is the case, but it is an example of why I'm careful around earnings season.      

Consistent with this pattern on an individual stock basis is the observation that the S&P 500 has hit 1100 on several occasions in the past few weeks but has each time failed to break convincingly above this important level of resistance.  My best guess is that the index will break through sometime before year end as earnings season winds down and folks conclude that the economic recovery remains intact.  (The 1200 level would seem reasonable to me as an end of year resting point, or about where the markets were before Lehman Brothers went under roughly one year ago.) 

A few other tidbits from the week that was:  

1.)  Brazil's leaders proposed a 2% tax on foreign investments into stocks and bonds in its country to slow down the speculative mass of money flowing its way.  

2.)  The decline in the dollar hasn't been kind to Brazil's residents and many others around the world.  In terms of the Brazilian Real, the 25% gain in the S&P 500 this year would actually translate into an an eight percent loss for Brazilian investors in the index because of Real strength/dollar weakness.        

3.)  About mid week, I noticed that the S&P 500 was up nearly 65% from its lows last March.  My guess is very few people would have guessed they could make sixty five percent on their money six months ago, but that is exactly what has happened.  What an important lesson!

4.)  Starwood Hotels indicated that revenues per available room continued to decline at a significant pace, but at a declining rate this quarter, which is expected to slow still further in the future.  While 2010 is still up in the air, they are seeing improved bookings in China and big markets like New York city.  As business profits improve, companies will likely feel more comfortable booking events once again.  

Stay tuned, even more earnings next week.

    

While the markets are pulling back a tad today, earnings results so far - from the likes of Intel, JP Morgan, and Goldman - have been encouraging.  Of particular note was a quote from Goldman this morning, which characterized the global economy as having continued challenges, but that "we are seeing signs of improvement and stabilization - even growth - in some areas."  This latter comment regarding "growth in some areas" is what I expect to see from more companies in the coming two quarters.  First, cost cuts, then improving revenues and even more leveraged earnings gains.

On an altogether different note, I'm taking my 13 year old son to his first rock concert tonight, as recently inducted Rock Hall of Fame members Metallica thrash Cleveland with their particularly loud and driving brand of heavy metal.  Somehow I didn't quite think my son's first concert would be with a group that was around when I was young, but in a way, it's cool.  Way cooler, in fact, than if it were someone like the Jonas Brothers.  I think Guitar Hero has done a lot to introduce classic rock to today's youth, which can't be a bad thing, can it?   

Although I'm not a metal afficianado, I like Metallica, particularly after having watched a recent rockumentary about the group.  I admire them for surviving rock n roll's ever present dark side, which seems to feast on the souls of everyone in the business, regardless of style or genre.  Surely, heavy metal fits the stereotype more than most, but few musicians prove immune to the temptations that accompany extreme levels of fame and fortune.  Founders Lars Ulrich and James Hetfield strike me as two highly creative, intelligent and enterprising musicians.  They are likable not because they are rock gods, but because they have experienced what it means to be human, face one's demons, and survive.  

At 7am this morning, I purchased several sets of earplugs, thinking that the one's I use with my chainsaw might be a bit much and perhaps a tad embarrasing, at least for my 13 year old.    

Bring it on Metallica...I'm ready.
  

It is hard to believe, but it's that time of year again.  The earnings parade commences in earnest this week, with heavyweights Google and Goldman Sachs both set to report on Thursday. 

As we have said before, we believe that earnings reports will be particularly crucial both this quarter and next.  It is true that a great deal of earnings surprises over the summer months came predominantly from the cost side of the equation.  Now, six months after the market lows, we should begin to see some faint signs of revenue improvements as well.  If so, the earnings gains may be even more leveraged as margins expand.

We continue to believe that the economy is in recovery mode and that a focus on the more cyclical sectors of the economy will likely generate the greatest relative gains for portfolios over the next six to twelve months.  The Fed will likely remain on hold, but be biased towards tightening at the first signs of improving unemployment.

What could lead to an improvement in the unemployment rate?  Aside from time, increased production levels and continued, strong free cash flow generation should give companies the confidence to start hiring again.  We suspect that this phenomenon will become more evident by the spring of 2010.

Aside from these macro comments, a couple of other items caught our eye this morning.  First of all, Meredith Whitney downgraded Goldman Sachs to neutral from buy.  She has been very good with her calls and it will be interesting to see how the call ends up looking when Goldman reports on Thursday.  Second, TIPS (Treasury Inflation Protected Securities) have gained 8% this year while Treasuries themselves have declined 3%. This divergence in performance is one of the largest on record.  Bond powerhouses PIMCO, BlackRock and Vanguard have been big buyers of TIPS lately, suggesting that "smart money" is positioning for resurging inflation.

Finally, I have been watching the prices of many bank stocks in recent weeks.  This morning, I was amazed to see that the stocks of several higher quality banks like JP Morgan and Wells Fargo are only 10% or so off their all time highs.  Really?  Perhaps that is what a government guarantee can do for you.  But perhaps I ought not to be so quick.  There also appears to be a group of lower quality bank stocks like Bank of America that remain 50% off their highs.  

With a great deal of our quarter end activities now behind us, we hope to be blogging more regularly.  If you have thoughts or ideas that you'd like us to discuss, please throw them our way.

This year has continued to be a strong one for the stock market and for Broadleaf Partner's Growth Equity Portfolio, which is up 35% on a year to date basis.
 
For details on our performance, related disclosures, and insights on our current market outlook and strategy, please read the attached Third Quarter Market Commentary.

As a quick aside, there is considerable discussion over the last two trading days over speculation that oil exporting countries may abandon the dollar pricing of crude in favor of a basket of alternative currencies.  
With gold hitting new highs (one of the few asset classes doing so) at the same time, the interpretation is that inflation expectations could be on the rise.

At this point, we believe it is easy to make the case for a declining dollar, but what that might mean for the stock market remains unclear.  If the source of the dollar's decline is primarily a retreat from its role as a safe haven in difficult times and a resumption in the risk trade, it might be less worrisome.  If it's decline, however, reflects a change in purchasing power/pricing pressure dynamics (ie inflation), it could be more worrisome.  And yet, even with all that, a declining dollar can also benefit exports, which might be a benefit to earnings and perhaps the stock market.  Confused?

The issue makes for great financial headlines, but both the impact and implications appear less clear.  There are many moving pieces.

Stay tuned, it will be an interesting issue to monitor.

Well, already it looks like the Browns are going to be in a world of hurt this season.  After Brady Quinn had a dismal showing during the first half of their rout by the Ravens this week, my wife joined me outside to help cut down and prepare our gardens for the approaching winter.  As we chopped, piled and moved the garden waste to our backwoods brush pile, we heard Anderson enter the second half of the game from our outdoor speakers ( Nasdaq 5000consumption)and proceed to throw three interceptions in relatively quick order.

Browns fans, like my wife, are undoubtedly wondering what's going on and are probably already thinking what prospects might look like for the draft this spring.  The only redeeming thought is that the Steelers aren't fairing much better at 1-2, even though the records are hardly worth comparing.

As for the market?  All hope is not lost.  Yes, we have pulled back a tad, but six months hence as I sit on my porch watching the draft, I suspect that the action in the markets and economy will look far better than this year's Browns season. 

Why am I so bullish?  Three reasons.

First I believe that earnings will be substantially higher in the coming two quarters as gains on the cost front are matched by improvements in revenue and the dramatic, dual natured impact that might have on profit margins.  If we are correct, employment levels, while not outstanding, should improve measurably.  Profits generated in this dual natured manner should lead companies to start hiring again.  We are already seeing improvements on the temporary hire front today, as manufacturing production ramps up to offset abnormally low inventory levels.

So, the second reason to be bullish is on the economics front.  Another way to frame this debate is took look at it from the bear's perspective.  Bears repeatedly state their case on the notion that employment looks so bad.  But, if this measure does begin to improve over the next six months for reasons that I outlined above, the thesis behind the bear case may very well go into hibernation. Six months hence, we suspect that the view from the macro lens may be far less cloudy!!

Finally, there remains Fed policy.  It would be very unusual for the Fed to raise rates and take back stimulus in the face of high or rising unemployment.  Nearly unprecedented, in fact, from my understanding of history.  But, if my scenario pans out, the Fed may be, six months out, ready to pull back at least marginally so.  The greater the confidence in the employment outlook, the more confident the Fed may be in taking back what they so quickly provided.  Bears, no doubt, may double down on their bets with Fed policy as their new stake in the ground.  I would only point out, however, that the Fed's moves often lead their economic impact by twelve to eighteen months.  (It took that long for their stimulus to point us in the right direction finally last March.)  A change in official policy stance could in fact be viewed favorably, as a sign of "official" economic stability.  Twelve or eighteen months hence on my porch? I'm willing to wait and see what the weather will bring. (Right now it's raining.)

As a final note, sentiment measures of both investors and chief financial officers continues to be guarded and cautious.  I don't view this negatively at all.  It means both investors and corporate officers alike will more likely base their investments decisions from the realm of prudence rather than the go-go invest in anything now mentality that accompanied Nasdaq 5000, housing 2004, and private equity extravaganza 2007.  Prudent planning 101 is the philosophy that drives a market in recovery and allows bull markets to climb the wall of worry.

So, while my wife and the legions of Browns fans across the country may already be throwing in the towel on this year's season, I believe the excitement may just keep rolling for the economy and stock market at large. 

Six months out, there may be a tear in my beer for the Browns, but a little bubbly in my glass for the economy. (For the record, I still prefer beer - especially Cleveland's Great Lakes Dortmunder Gold.)  Blackberry out, from my porch, in the here and now.

Sent via BlackBerry by AT&T

If you didn't get a chance to catch the live broadcast this morning, please click here to see the replay. 

Today's appearance was pretty short, but still worth the free PR it provides once every quarter or so.  The Broadleaf background is new and must have helped as I had several emails from strangers on my Blackberry afterwards.  I'd guess our website hits went up as well.  

When preparing for these, we usually submit "talking points" ahead of time that the anchors can use, but you really never know what will transpire, so you have to be quick on your feet and always ready to run with whatever they throw your way.   

For interest's sake, these are the "talking points" I submitted ahead of today's appearance.  (Please keep in mind that these are our best investment opinions and are published for educational purposes.   Any investor who acts on these thoughts does so purely of their own accord.  We also have no obligation to update our thoughts and opinions as they change.)

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1.) What are you telling clients right now? 

In a recent update, we encouraged contacts to "GET IN THE GAME".   

The tone of THIRD QUARTER EARNINGS CALL which will begin in another month or so SHOULD MOVE BEYOND THE "LESS BAD" CATEGORIZATION AND INTO THE "BETTER" CATEGORY. 

While we have had a strong run off the lows in the market, THE YEAR TO DATE GAIN OF 20% FOR THE S&P 500 IS STILL SUBPAR BY HISTORICAL STANDARDS OF RECOVERY.   An additional 10% upside to 1150-1200 by year end would still only make this year's stock market recovery an average one for a recovery year.  Given that the decline was of an historical magnitude, the surprise could be to the upside.  

THE RALLY OFF THE LOWS HAS BEEN TEXTBOOK so far, with cyclicals leading the way over defensives. 

2.) What sectors or stocks do we like?

We still have a PREFERENCE FOR CYCLICALS OVER DEFENSIVES.  BUT we are now beginning to fade early cyclicals like the consumer discretionary sector in favor of later stage cyclicals like the industrials. 

INNOVATION PLAYS ARE WORTH INVESTING IN PARTICULARLY AT THIS STAGE IN THE CYCLE.  Why?  Companies aren't just investing in new technologies because it's cool, but because productivity gains are paramount and corporate cultures are much more accepting of necessary change.  Think TECHNOLOGY and certain areas of HEALTH CARE.   

3.) What sectors or stocks we would avoid?

I still believe DEFENSIVE SECTORS of the market will likely continue to lag, WHICH LEADS US TO BE UNDERWEIGHT UTILITIES, TRADITIONAL HEALTH CARE AND STAPLES.    At the same time, these areas have woefully underfperformed and MAY REPRESENT GOOD VALUE FOR MORE PATIENT INVESTORS. 

I am SKEPTICAL OF GOLD EVEN THOUGH IT IS ALL THE RAGE RIGHT NOW.  At a recent lunch of institutional investors, gold was by far the favored asset class for outperformance this year.  Contrarians beware...many of these same folks were extraordinarily bearish on stocks six months ago, particularly the consumer discretionary sector, which has been among this year's top performing areas.  When fund flows go gaga over an asset class, it is often time to lighten up even if the fundamentals look great.  And in this case, I'M NOT SO SURE THE FUNDAMENTAL CASE FOR GOLD IS ALL THAT COMPELLING.   (Typically gold does well in inflationary and deflationary environments, but has little intrinsic value other than for jewelers and to an increasingly less extent dentists.  In the see saw debate between extreme inflation and deflation, reality may lie somewhere in the middle.) 

4.) Other thoughts worth addressing? 

EVERYONE IS BEARISH ON THE DOLLAR given its recent underperformance.   MY INTERPRETATION IS DIFFERENT AND PERHAPS WORTH AIRING.  THE DOLLAR IS NOT WEAK BECAUSE THE U.S. IS IN SECULAR DECLINE, BUT SIMPLY BECAUSE MANY FOREIGN ECONOMIES ARE GROWING FASTER - AT LEAST FOR THE MOMENT.

Tune into CNBC's Squawk on the Street show with hosts Mark Haines and Erin Burnett tomorrow morning at 9:35am to hear our latest thoughts and opinions on the economy, the stock market and your investments. 

We will post the video clip and our thoughts for those that may miss the live appearance tomorrow afternoon.

Thanks for watching!

Converting a traditional IRA to a ROTH IRA and paying taxes on the converted amount today may save you significant taxes down the road.  Up until 2010, the ability to convert has been limited to those with no more than $100,000 in annual income.  But in 2010, all IRA holders will be able to not only convert regardless of income, but also elect to spread the tax payments due over two years, 2011 and 2012, easing the cash flow restraints that may have kept some from converting up until now.

The appeal of a ROTH conversion may be even greater among owners of small business start ups.  When I started Broadleaf, I incurred start up losses that I was able to fully offset with income from converting a portion of my IRA rollover.  As my income has slowly grown, I have converted additional amounts to make sure I make full use of my annual income deductions like mortgage interest etc.  In essence, I have been able to convert over $200,000 in IRA assets to a Roth tax free over the last four years, a rare opportunity indeed.  As my income grows, I have converted less but now with the income limit going away, I will still be able to do more if I believe it would benefit me economically. 

Given the direction of the economy, the fact that many might have lost their jobs and have lower incomes this year, it likely makes a great deal of sense for almost anyone to touch base with their accountant and see if a ROTH conversion could work to their benefit.  And again, the good news for 2010 is that any tax bill doesn't have to be paid all at once as has been the case up until now. 

For those that converted IRA assets earlier this year, the conversion may have worked out even better as the values of those converted assets has likely appreciated following this year's stock market gains.  You can also always re characterize a converted ROTH back to an IRA if, for instance, the value of the assets converted has plunged making the timing of a conversion today financially more appealing.  While I doubt we'll double dip with the economy, if we do, a re characterization might be something to consider. 

And again, for those who may have started a business following the worst recession since the Great Depression, the prospect of a tax free ROTH conversion might be just the silver lining you're looking for as you are faced, no doubt, with the inevitable year or two of small business losses.   (According to Fortune Small Business, the average small business wage was lesss than $30,000, the lowest since 2006.  So really, a ROTH conversion could be unique to you.)

For more thoughts on conversion, check out the following link.  

Disclaimer: I am not accountant.  Anyone interested in converting an IRA to a ROTH IRA should consult their accountant before doing so. 

We originally published this entry two years ago after hearing a speech from 9/11 survivor George Sleigh.   We've decided to republish it once again this year in memory of all those affected by the tragedy.  

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George Sleigh, the 9/11 survivor shown on the right in this widely distributed picture, spoke to our church at our Saturday morning Men's Breakfast this week.  George was on the 91st floor of the North Tower, the highest floor with any survivors, when he saw the underbelly of the plane approaching from only a few hundred feet away.  Now retired and living back in Hudson, Ohio, George provided a first hand look of the attack, from his experience that day.  

"No one inside the buildings expected that they would fall," George told us.   He related some of the strange things that he and some of his coworkers did that day.  George, himself, went back to his office to retrieve the briefcase he is carrying in the picture.  Another guy went back to shut down his PC and a third watered his plants, remembering that they had died after the 1993 bombing.  The two other men in the picture with George were Port Authority employees from the lower 40th floor, who had waited to begin their exit from the building, after reasoning that the hallways might be crowded and it might be better to wait. 

When asked a few years ago whether or not his faith saved him that day, George told us, "No.  There were others who shared my faith who died that day.  My faith did not save me, but it has sustained me."   My faith did not save me, but it has sustained me.

I keep Proverbs 23:4-5 taped to the top of the computer monitor which spews forth the day's financial quotes.  It reminds me, "Do not wear yourself out to get rich: have the wisdom to show restraint.  Cast but a glance at riches, and they are gone, for they will surely sprout wings and fly off to the sky like an eagle."   

Financial wealth is one of life's many false idols, perhaps even the greatest one.   I try to remind myself of that as I remember the events of 9/11 and as I watch each stock tick, ticker away... 

Now that Labor Day has come and gone, most of Wall Street has returned to work and trading volumes are picking back up.  After moving sideways through the Dog Days of August, September has so far resumed the Up, Up and Away Trend established since March.  The following news items from just this morning are driving out sized daily gains in some atypical names and supports our call for remaining bullish.

1.)  United Parcel Services (UPS) stock broke out yesterday.  This is important in that the company's stock is the most highly correlated with future GDP of any S&P 500 company. (Stock up 8% in last two trading days.)

2.)  Procter & Gamble (PG) reaffirmed guidance this morning, with a slight upward bias to sales and earnings projections.  They also indicated that lower commodity costs going forward should help them, a major part of their cost of goods.  (Stock is up 4% today, a very large and atypical percentage move for a company that has woefully lagged the market this year.)

3.)  Qualcomm (QCOM) raised their shipment expectations among distributors. 

4.) Disney's Chief Financial Officer (DIS) comments at a conference that he sees positive signs in the advertising market, another highly sensitive economic indicator.  They also made a big acquisition of Marvel last week, a further sign of corporate confidence.  (Disney's shares are up 4% today as well and like, P&G, this is an unusual percentage move.)

5.) Indian off shore consulting company Cognizant Technology Solutions (CTSH) indicates at a conference that revenue growth trends have stabilized and that they continue to show signs of acceleration intra quarter.

6.) Texas Instruments (TXN) raised guidance again.  Many semiconductors have done this repeatedly in the last couple of months as inventory levels are in a rebuilding stage.  While increased guidance by semiconductor companies is often a lagging indicator - in other words by the time they guide up, the stocks are already up and often set for a fall - inventory levels are still short of where forward demand levels might likely go.   Over the summer months this area has generally moved sideways, so perhaps a breakout is possible.

7.) Our new Paychex salesperson indicated that business employment activity seemed to be loosening up a bit, at least in the territory she covers. 

Next week, we will here the first of third quarter earnings results, with Best Buy and Adobe Systems both reporting earnings.  As October rolls around, I fully expect we will hear more about current business trends directly from company managements, which is where the rubber meets the road of the macroeconomic data we're all hearing.  

"Less bad" was enough to really move stock prices coming off their depression lows, but "better" may be required to continue the move from here.  So far, the very recent commentary - like that of today - appears constructive.  If the tone continues to improve as I expect, a move to 1200 on the S&P 500 could be achievable and perhaps even conservative.  Remember the market was down 37% last year and is up only 15% year to date.  Historically, we've had much stronger than 15% gains in the market during economic rebounds.      

A guy from Cleveland dies and is sent to Hell. He had been a horrible man his entire life.

The devil puts him to work breaking up rocks with a sledgehammer. To make it worse, he  cranks up the temperature and the humidity.

After a couple  of days, the devil checks in on his victim to see if he is suffering adequately. The devil is baffled as the guy from Cleveland is  happily swinging his hammer and whistling a  happy tune.
 
The devil walks up to him and says, "I don't understand this.  I've turned the heat way up, it's humid,  you're crushing rocks; why are you so happy?"

The  guy from Cleveland , with a big smile, looks at the devil and replies,   "This is great!  It reminds me of August in Cleveland . Hot,
humid, a good place  to work. It reminds me of home. This is fantastic!"
 
The devil, extremely perplexed, walks  away to ponder the remarks of the guy from Cleveland. Then he decides to  drop the temperature, send down a driving rain and torrential wind. Soon, Hell is a wet, muddy mess.
 
Walking in mud up to his  knees with dust blowing into his eyes, the guy from Cleveland is  happily slogging through the mud pushing a wheelbarrow full of  crushed rocks.

Again, the devil asks how he can be  happy in such conditions.

The guy from Cleveland replies, "This is great! Just like April in Cleveland . It reminds me of working out in the yard with spring planting!"

The devil is now completely baffled but  more determined to make the guy from Cleveland suffer. He makes the  temperature plummet. Suddenly Hell is blanketed in snow  and ice. Confident that this will surely  make the guy from  Cleveland unhappy, the devil checks in on him.
 
He is again  shocked at what he sees. The guy from Cleveland is dancing, singing, and twirling his sledgehammer as he cavorts in glee.

"How can  you be so happy? Don't you know its 40 below zero!?" screams the devil.

Jumping up and down, the guy from Cleveland throws a  snowball at the devil and yells, "Hell's frozen over! This means the BROWNS won the Super Bowl."

The kids are in bed and it's halftime of the Browns final preseason game. For anyone who knows me, that means that my wife has been totally zoned out watching the game. Browns games are one of the very few times of the year where my wife is pretty much useless, a complete role reversal from the other thirty six or so weeks of the year.

Like the economy, no one, save "Mangenius" - our latest and hoped for saviour of the team - knows who will quarterback the team to an elusive yet perennially hoped for winning season. Will it be Quinn the boyish hearthrob, Anderson the experienced, or one of the third stringers duking it out tonight? Will we have a V, a W, or some other alphabet soup shaped economic recovery and what sectors will lead it?

The economy and the stock market have been alot like the Browns since they came back on the field ten or so years ago - there have been brief flashes of excitement, frenzied controversy, and signifant despair - even depression - along the way. The Steelers, like China, have been getting all the glory and all the press.

But the Browns, one of the most beloved teams in franchise history move forward anyway, trying to regain traction from the season two years ago that provided a faint glimpse of what a full fledged recovery might look like.

Recoveries are always tentative, frought with doubt, splashes of genius, and third string tries. But let's face it, short or long, you have to be in the game to get a chance at victory.

Yes, I've kept up with a lot of the economic stats of the week, the back and forth debates between bullish and bearish interpretations. I could hash over all the economic statistics of the week - I have a list with me right at this moment- but I won't. And it isn't simply because writing a blog entry from my blackberry on the porch during halftime of the Browns game is just a little more than my thumbs can muster.

At this point, only one thing really matters.

Are you in the game?
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Dave Rosenberg, former economist at Merrill and long time bear, points out that even after a five month 50 percent rally in the S&P 500, the index is still no higher today than it was on February 18, 1998. Including dividends, you'd have earned roughly nothing on your money in ten years.

Dave points to this stat as a reason to believe the bear market remains intact. An alternative view might be a more positive view towards forward ten year returns.  Same fact, different interpretation.  Which do you see?

Please join us in welcoming three new hires to Broadleaf Partner's professional staff.  Alyce Hoffman, Lisa MacKay and Kevin Arbogast will be serving the firm in various operating roles as we enter our fifth year of operations and grow our business.    

Alyce Hoffman, Operations Assistant, is a graduate of the University of Akron with a degree in business administration.  She has worked in the financial industry since 1994, as an investor relations and client services manager.  Alyce's primary role at our firm will be in the areas of client service and communications.  Alyce lives in Hudson, Ohio with her husband, Kevin, and their two boys, Jordan and Jared.  You can reach Alyce at 330.650.0921 or by email at ahoffman@broadleafpartners.com.

Lisa MacKay, Operations Assistant and wife of Doug, is a graduate of Miami University, with a marketing degree in business administration.  With our youngest child now back in school, Lisa has decided, with my nudging, to re-enter the workforce outside the home.  Lisa will be assisting us in the areas of accounting, payroll, and performance reporting and measurement.  Lisa and I live in Boston Heights, Ohio, with our three children, Pete, Molly and Johnny.  You can reach Lisa at 330.650.0921 or by email at lmackay@broadleafpartners.com. 

Kevin Arbogast, Broadleaf Intern, will be furthering his summer internship  through the fall and early winter months.  Kevin will be finishing his finance degree from the University of Akron this winter.  He will be assisting in the areas of IT support, investment research, and special projects.  Kevin lives in Stow, Ohio.  You can reach Kevin at 330.650.0921 or by email at karbogast@broadleafpartners.com. 

Again, welcome Alyce, Lisa and Kevin!

 

Yesterday was the first day of school in Hudson, Ohio.   Johnny, my youngest, enjoyed his first day of kindergarten.  When he came home, I asked how it went and, without missing a beat, he said "Very well, I didn't even have to go to the principal's office."  Nicely done, Johnny, way to keep the expectations low.  When my wife asked him what he learned about at Hudson's public schools, he said they talked about "Jesus".  Yeah, right.  I tend to doubt that one.  Something tells me I should worry a bit more about my youngest.  

Speaking of worry, market pessimists have been getting alot more press lately as stocks have moved sideways on little volume and have failed to break above recent resistance levels even on positive economic releases.   (Durable goods orders soared nearly 5% in July and temp firms said demand in August increased "markedly".)  I will readily admit that the action in the markets has been pretty uninspiring and listless in the last week or two, but after going through the events of the past year, I'd hardly classify "flat lining" as a top ten worry.

As workers return to their offices and children head back to school, trading volumes should pick back up and conviction levels will likely increase as we get hints and commentary about what third quarter earnings might bring.  When I'm tired, I usually go to sleep for awhile and then awaken refreshed.  As the slumber called August winds down to a close, I'm sure September will awaken alive and refreshed. 

     

I have been blogging a little less frequently in recent weeks.  Things have been busy (in a good way) and I simply haven't had the time to comment as often as I'd like or as I've done in the past.  If my blogs are a bit longer than usual, it's because I may be trying to digest and relay my thoughts on a weeks worth of news.   

Now that there is an absence of earnings announcements, macroeconomic data has come front and center as the driving short term influencer of stock markets around the world.  On this front, the news continues to be both good and not as good, but on balance, much better than it had been a year ago.  Shanghai's 20% stock price decline into bear market territory has increased everyone's anxiety levels this week, but perhaps it would also make sense to point out that their primary index had more than doubled off its November lows. 

Bears point to the death of the consumer and low quality earnings gains driven by unsustainable cost cutting as reasons to remain negative and to expect a double dip.  While both of these concerns are valid in the short run, I would also point out that most economic recoveries begin in this fashion.  In fact, a rebound in consumer spending often lags an uptick in corporate and government expenditures, which often recover first.  On the earnings comments, bears are also likely missing the point that the path of lower costs naturally precedes a turn in revenues and so far we've had just that, a superb job in expense management efforts.  Productivity growth has been stellar in recent government reports, suggesting that the cost cuts may prove more than temporary, providing greater operating leverage in the future even if there is only a small uptick in demand.  This pattern of improving productivity growth is, once again, common in recoveries.    

Most folks views of the world are colored by personal experience.  If you don't have health care and want it, you might like the idea of a government run plan.  If you do have a health plan and like it, you might look at a larger role for government with suspicious eyes.   A few business owners I talk to remain very bearish about trends in their own industries, while others are seeing signs of life.   I sense that their personal views of the economy at large are often colored by what they are seeing in their own businesses.  This is, no doubt, natural, but might not always provide a good picture of the broader investment environment.    
 
On balance, I'm still hearing more folks talk more optimistically about the future than they were in the recent past.  One business owner has been asked by his customers whether he will be capable of meeting a significant up tick in orders.  My neighbor who is a trucker of sorts (he drives large cargo vans) had no business six months ago, but now he and his coworkers are having a hard time keeping up with demand.   "If what we're seeing is an indication of the future, than maybe it's not so bad," he told my wife.  Another business owner is far less optimistic, having seen no change in demand, with no bottom in sight.   Again, there are stories on both sides, but as I balance them out personally, my bet is that the future for the economy as a whole gets brighter from here rather than worse.  

On the credit side, banks are still slow to extend new loans even though refinancings are up considerably.  On the other hand, the corporate debt market has been extraordinarily strong in recent months, both from an investor demand side and a corporate supply side.  As we know from most earnings reports, many companies are generating strong free cash flow - often greater than reported earnings - as they've reduced inventories and other working capital.  As these cash balances improve and as corporate debt offerings flourish, liquidity improves in the economy.  Eventually the banks will heal and make more loans, but in the meantime, alternative sources of debt financing appear to be picking up some of the slack.  

I haven't been quite as worried or alarmist about what is happening in Washington as many of my conservative friends have been, simply because history has taught me not to have too much faith in what government can do or hope to do, especially for controversial issues.  Our Constitution was superbly written with so many checks and balances that progress (or those who see the same issues as regress) rarely moves very fast.  I think it is far more important to watch what our leaders actually do rather than what they say.  Oddly enough, for all the talk about the stimulus plans of the last year, I've heard that perhaps as little as 10% of it has actually been spent.   

From my vantage point, there seems to be two kinds of investors these days.  One sees an S&P 500 that is up 50% from its March lows as a reason to be very concerned.  The other sees an S&P 500 that is up 10% year to date - an average year by historical standards - and thinks there could be more to come - especially in an economic recovery.  Like many things, both see the same truth, but through different colored lenses.  

Where do you stand? 

Earnings are for the most part now in the rear view mirror.  As a result, stocks may likely take their short term trading cues from macroeconomic factors in coming weeks.  On this front, retail sales were a mixed bag today, with results for July below expectations in spite of the successful Cash for Clunkers automobile program.  Wal Mart and Kohl's were also guarded in their outlooks.

For the most part, however, the readings have remained positive.  Yesterday, high end homebuilder Toll Brothers indicated that net contract signings were positive year over year for the first time since 2005, or sixteen quarters.  In addition, the Fed commented that the recession was likely nearer its end, while both France and Germany reported GDP statistics that were slightly positive, indicating that they have likely emerged from their recessions already.

The markets are consolidating their gains after being in an overbought territory, similar to what we experienced in June.  As we look to September, the focus will once again turn to earnings and whether or not improved production levels associated with inventory rebuilding will be sustained on the basis of increasing demand.  We believe it will, but time will tell. 

A few blog entries ago, I commented on Mark Buehrle's perfect game with the White Sox, noting that momentum plays an important role in many sports as it does in the stock market.  I also suggested that after a stellar 45 straight outs, Mark might expect a prolonged slump at some point down the road.  Sure enough, and perhaps quicker than I would have expected, Mark rang up an 8.35 ERA over his next three starts, easily his worst stretch of the year.

We've had a great run and I believe the future will continue to brighten.  But it is also important to recognize that there will be setbacks along the way.  Perfect game or perfect mess, it's often best to stay humble and not get caught up in the hype of success or the agony of defeat.   Easier said than done, of course, but it's likely an admirable goal for both pocketbook and psyche.   
  

 

Earnings season is winding down and now that Cisco's results are out of the way, only a few major companies have yet to report.  As is always the case, I've read through a boatload of earnings results and conference call transcripts and will pass along my generalizations shortly.  But before I go there, I thought I'd discuss the recent economic data, which continues to paint a picture of an economy on the mend, a recession nearer its end, and recovery that may be far more and powerfully V shaped than most expect.           

The most important leading indicator we follow is the ISM Manufacturing Index which continued to increase last week and is now very close to levels associated with an expansion in the manufacturing sector.   The stock market itself has also tended to be a decent leading economic indicator.  With the S&P 500 now up fifty percent from its lows, it is clearly signaling a shift in attitudes over economic prospects.  As this index has climbed to the 1000 mark, a distinguishing feature of pullbacks in recent days has been the fact that they have been met by new buyers.  Again, this suggests it isn't just purchasing managers (The ISM Index) that are becoming more confident about the future, but investors as well.  They aren't panicked by the dips but are starting to view them as buying opportunities.  New unemployment claims continue to move in the right direction as well, and although it tends to be a lagging rather than leading indicator, it can't hurt to have it moving in a more bullish fashion.  And finally, housing related data, be it starts, inventories or pricing, have all been interpreted in a more positive light in recent days.  

Now, let's move back to where the rubber meets the road, or where the reality of recent company earnings and management commentaries affirms the pulse of the macroeconomic data.  As I read through the earnings reports, the one key factor that sticks out the most is the strong cash flow - often record cash flow - that most companies are generating in spite of the very difficult top line environment.  Many companies have responded to the eighteen month downturn by cutting costs wherever possible and it shows up visibly in the earnings data. 

In addition to cutting costs, cash flow has surpassed reported net income levels as many companies have reduced inventories and other working capital to bare bones levels.  While no one wants to hear it, in past recessions, the more severe the downturn has been, the more powerful the upturns have been.  Bears are decrying a jobless recovery with very little demand growth.  While this may prove accurate for a time, it doesn't take much of an increase in demand to spark a powerful improvement in manufacturing and production when  inventory levels are so low.  I suspect bearish phrases like "jobless recovery" or "below trend growth going forward" have been common coming out of most recessions, particularly those as severe as the one we've just experienced.   Let's grant ourselves some leeway. 

Aside from the numbers, what have management teams been saying?  For the most part and across most industries, they are saying what we're all hearing in the media.  Results appear to be stabilizing at lower levels, with some faint signs of improvement in some areas.   The stock market could be represented as the collective picture of our very human attitudes towards the future.  Historically, a turn in the markets has preceded the end of recessions by about six months.  With the lows put in during March, six months would place us in the third quarter earnings season as a likely time for management teams to start using the word "improving" more often than merely "stabilizing".  Stay tuned this Fall.

Another clear element of the economic recovery has been the role that foreign countries have played in it.  Asia and China in particular are already back to production and market levels seen when Lehman went under about one year ago.  For all the talk about a dying U.S. consumer (I'm not so dire), the Chinese consumer is picking up a lot of the slack.  In it's earnings call, Goodyear mentioned that sales to the region had grown every year for the past few and that tire production that was once being exported from China to countries like ours was now staying there and being consumed internally.  China, as many know, recently surpassed Japan as the number two auto market in the world, behind only the United States.  It's importance cannot be denied.

Speaking of Goodyear, they noted a statistic in their call that I found interesting.  Domestic miles driven increased for the second consecutive month in May after a record sixteen months of decline.  Like other macroeconomic statistics, year over year figures like miles driven are still down, but are moving in the right direction on a month to month basis.  And how about this for a surprising statistic.  The scant .008% fewer miles driven year over year equates to a total reduction of ten BILLION miles.  I guess this might fit with the notion that when inventories are low, a slight uptick in demand can make a world of a difference, powerful enough to produce the V shaped recovery we all (although some secretly) desire.  

I asked myself two questions of every company I reviewed this earnings season.  One, is this company positioned to take advantage of faster growing, international economies?  And two, what kinds of secular growth dynamics - independent of geography - does this company have going for it?  In general, these questions have driven me to two areas of the market - industries with international, cyclical based characteristics and those with overwhelming and powerful levels of innovation-driven demand.  For this second type of company, it is worth noting that recessions often play a key role in transitioning change within working cultures, particularly those that can drive worker productivity.  Why?  I suppose it's because when times are fat and happy, incentives are few, but when they are lean and mean, hunger takes over.

So, what does the future look like? If the past two years has taught us anything, it's to expect surprises, especially the big ones.  And since the notion of a big, fat V shaped recovery seems laughable to most, we'll run with it.  

Don't be left out of this recovery.  While we're already 50% off the market's bottom, we're still 36% from its peak.  If we can lend a thought or hand, please give us a call.

I forgot to share a notable quote from this season's earnings calls.  In describing the likely shape of this economic recovery -- whether it would be strong and "V" shaped or double-dipping "W" shaped, Scott McGregor, President and CEO of Broadcom made the following quip.

"... since it's hard to tell the difference between a V and the first half of a W, we are planning on being fairly conservative."

Nice way to sum things up!

Earnings.  The flurry of earnings continues in earnest and so far, things have been decent but not outstanding.  I have been extremely impressed by corporate America's rapid cost cutting efforts which have boosted bottom lines and will hopefully provide leverage once revenue growth returns.  

Residential and Commercial Real Estate.  Several data points have come out recently which suggest that the housing market may be stabilizing.  In fact, several real estate professionals, including Sam Zell this morning, are suggesting that the bottom has been reached in residential real estate sales and pricing.  On the other hand, most folks I talk to continue to be concerned about the commercial real estate market, believing it will continue to get worse from current levels.  The debate rages on whether or not the same degree of speculation occurred in the commercial real estate market as the residential market and while I'm doubtful, time will tell.

Commodities.  Speaking of speculation, Wall Street was abuzz yesterday over a recent change in views from the CFTC over whether or not the rise in oil prices to $150 a couple of years ago was due to excessive speculation rather than the pure fundamentals.  They apparently have access to new data which suggests that speculation played the primary role.  Our view of course is that any time you have fund flows going gaga over a particular asset class, you are by definition going to attract speculators who invest, perhaps unknowingly, more on the allure of momentum than the presence of fundamental value. 

New Regulation?  The debate now rages on whether or not speculation in the commodities markets should be limited to those entities who take or deal in the actual physical deliveries of such goods.  The question here is a very difficult one to answer.  Speculation in housing has certainly hurt more than just the folks in housing (because of its affect on banks), but it isn't clear to me yet that the energy bubble did the same.  Should we protect ourselves from such things or let the players who reap the rewards face their own disasters?  For me, we would need to make sure that the banks aren't exposed to such speculation because if they are, then it will affect Main Street bank deposits and given recent history, bailouts would be deemed necessary.  

Durable Goods.  Durable goods orders, while notoriously volatile, were a little weaker for the month of June, down 2.6% compared to an expectation of a .6% decline.  Turning point or simply more noise from a noisy data series?

Major League Pitching.  In far more interesting news, White Sox pitching ace Mark Buerhle followed up last week's perfect game by retiring his first seventeen batters in yesterday's game.   His astonishing 45 outs in a row set a new record in the MLB, beating the prior record of 41 straight. 

Momentum in Stocks, Sports and Life.  The role that momentum plays in the stock market and almost every sport has always fascinated me.  Nice job Mark Buerhle, I hope you enjoy your recent string of successes.  If you really are a great pitcher, I'm sure you'll handle the inevitable slump down the road just fine.   

Last Sunday night, at 1am in the morning, my wife and I made the spontaneous decision to take the family on a last minute beach vacation to Avalon, New Jersey.  We decided to make the trip earlier that day after our son's final baseball game of the season, but waited to tell the kids until we woke them in the wee hours of the morning.  The weather was fantastic and the beach was great.  It was one of the best vacations we've taken in quite some time.  I guess you could say we needed the break.    

Signs of economic weakness on the Jersey shore were evident in the ease with which we booked our last minute accommodations and by the abundance of beach parking.  Gas and food prices for the most part were very fair, in line with what we pay back here in Ohio.  The price of real estate, however, was quite high, at least by my Midwest standards.  The cheapest home I saw was about a million dollars, with the average about $3 million.  Unless you're incredibly rich and don't care, it seems like renting would be the better choice.        

When one of us is out of the office on vacation, we like to encourage one another to stay longer especially if the markets are strong.  Well, with the markets up ten percent in as many trading days, my ten year old daughter Molly even got in on the action, suggesting I should leave work more often since it "seemed to do so well without me."  Nice!

So what's driving the markets, as far as I can tell?  In a nutshell, the strength has likely been influenced by continued positive earnings news, at least relative to expectations.  Last week's favorable unemployment claims data and leading economic indicators also helped, as did the increased likelihood of gridlock in Washington over health care reform.  Volumes have actually picked up a bit as the markets have moved past important technical levels, but may also ease back as investors flock to the beaches for a final break before school returns.    

This morning, new home sales came in at up 11% in June, the third monthly increase in a row.  While the sample set is a small one, my brother and my business partner both sold their homes in recent weeks at prices they had hoped for in a matter of days and weeks rather than months or quarters.

I don't know if it was the great vacation weather, the company we shared (thanks Lentz and French families!), or the good markets we enjoyed while I was out, but boy do I feel relaxed.  I think I'll even keep my beard for a few more days.    

Chalk one up for Avalon, the beach and the Jersey Shore.  Hadn't been before, but would gladly do it again.

Gains ahead for financials?  JP Morgan and Goldman Sachs both reported strong results, reflecting their success in taking significant market share from substantially weaker competitors.  Cisco Systems, along with other leading technology players, was similarly able to take share from weakened competitors following the tech wreck earlier in the decade.  Does this mean Goldman and JP Morgan are buys?   Perhaps, but I'm not so sure.  Cisco's stock remains substantially closer to its ten year lows than its all time highs, in spite of all the share gains and its even greater market position.  Valuations, of course, were much higher for technology companies at Nasdaq 5000 than financials were during the mortgage bubble, but the fact remains that both were at the center of their respective storms.    

We'll hear the word "jobless recovery" alot more in the months ahead, but don't let it get you down.  Noriel Roubini - Dr. Doom - and Merideth Whitney both made comments this week that strayed from their usually dour forecasts.  While saying that they made positive comments might be a relative call for these two influential bears, they may nevertheless be acknowledging some green shoots in their tone.  If bears are no longer able to use the words depression and recession to state their case, expect to hear the phrase "jobless recovery" in its place.  I'll bet the term has been used in the early stages of most economic recoveries, so don't necessarily let it get you down.  Shifts in sentiment take alot of time and almost always lag the market's performance.   

Unemployment and continuing claims point to an improving outlook.  New and continuing claims both declined this week, suggesting that the recession may be on its latter legs.  Some economists are forecasting positive GDP growth in the third quarter.  

China, China, China.  It's no secret that China has been a big driver of the world's recovery.  The country's citizens will likely purchase 11 million cars this year, more than U.S. citizens, and GM may get as much as a quarter of its sales their this year.  According to Francois Trahan at ISI Group, China's stock market recently surpassed Japan's as the world's second largest.  For those who are bearish on the U.S. consumer, perhaps the Chinese consumer will pick up some slack. 

Corporate travelers still staying home.  Intel and Goldman's earnings releases got all the press this week, while Marriott Hotel's was lost in the shuffle.  Marriott's revenue per available room rate (REVPAR) has stabilized, but corporate travel is still way down.  Deep discount, leisure travelers are one of the few bright spots, with higher weekend occupancy rates than weekday rates reflecting this trend.  Management still isn't seeing any green shoots, but believes "planting season" may be around the corner.  

What's on the docket for next week?  Lots and lots more corporate earnings.  So far, the markets have responded positively to the earnings news, confirming a more stable environment and perhaps providing some meaningful value to continued cost cutting efforts.      

Over the last few weeks, the market has dropped its hyperactive fear of inflation (a fear we did not share) and has recently been obsessing over deflation.  During the former period, we suggested that inflationary concerns weren't the reason for the backup in government bond yields as corporate bond yields hadn't experienced a similar backup.  After all, inflation would affect the value of any investment dollar, corporate or government in orientation.  Instead, our view was that yields had likely risen in government debt as a reflection of improving economic prospects and a resumption in risk taking in the face of minuscule risk free yields. 

Ever since new unemployment claims came out a couple of weeks ago and were higher than expected, the tone has changed.  The stock market has been weak and government bonds have rallied.  Now, the concern doesn't seem to be over inflation, but deflation.   Once again, we believe this concern is misplaced.  Near term economic prospects are far more important at his stage of the game, while inflationary and deflationary concerns may be more correlated to one's political views.  As we have said before, a little inflation might be a good thing as it would be a sign of an improved economy.  

The real reason for the pullback in the markets is likely that we are on the verge of earnings season, which started with Goldman this morning, continues with Intel tonight, and then Google on Thursday.  After such a huge run off the lows, trading volumes have dried up and the markets have pulled back as investors await this quarter's message from those in the trenches -- the management teams of corporate America.  Will the message remain status quo - that the environment has stabilized - or is the recent unemployment claim number a sign that a more sinister picture is about to emerge?  

I personally believe in the status quo view, consistent with what Goldman said today, what it appears that Intel is saying after the close, and a few other companies that have made comments at various conferences in the past week.  Things have likely stabilized, but aren't yet improving.  I think this simple acknowledgment will be powerful enough to push the markets back to their recent highs, giving those who remain under invested a unique opportunity to get board the equity train before it once again leaves the station.  

After such weak GDP numbers in recent quarters,  substantial draw downs in inventories across most industries, and unprecedented stimulus,  I don't see how production numbers could do anything but go up from here, if not this quarter then certainly the next.  

All aboard!!!

 

Do you remember Acid Rain and No More Nukes? 

When I was in high school a couple of decades ago, there was significant political and media attention paid to the potentially disastrous impacts that acid rain would have on the environment.  Acid rain, it was proposed, would cause untold damage to wildlife, vegetation and mankind if left unaddressed.  I remember seeing print ads promoting the issue by showing rusted out car hoods and dying wildlife.  When I was in grade school, I also remember fearful discussions of nuclear war and the potentially deadly effects of nuclear based energy programs.  Demonstrations abounded and as a youngster it was easy to get caught up in the fear of it all.

Now, twenty years later, I hear very little about acid rain or Russian nukes.  The only thing I hear about nuclear energy is actually a positive one.  I read about how forward thinking the French have been now that they get the majority of their domestic energy supplies from nuclear sources.   Whether or not these changes in focus are  related to effective policy or a simple shifting in populist winds I know not, but the fact remains that they no longer seem to be the issues of the day.  

Following the 1980's energy and inflation scare, my father, a now retired dentist, built an incredibly energy efficient stucco office building with few if any external windows.  He also purchased a diesel Volkswagen Rabbit which got over 50 mpg and could do zero to sixty in a blistering 43 seconds.  Later in the car's life, it was delegated to "kid car status" and became an incredible chick magnet, at least in my dreams.  Here's a picture of a couple of my buddies and I posing with our hot rods (now known as cash for clunkers) circa 1986. 



A year or so ago when gas prices hit nearly $4 per gallon, I heard alot about hybrid cars and even saw a few tiny Smart cars traveling the streets here in Hudson, Ohio.  Now, I hear of few car sales at all, let alone energy efficient ones, but cash for clunkers is all the rage.  Whether or not this change in attitudes is related to lower gas prices, a tougher economy or simply changing populist winds I know not, but the fact remains that it no longer seems to be the issue of the day.

Today, of course, there are new major concerns, including climate change, global warming, and the bankruptcy of GM.  The government is proposing a cap and trade based system for carbon emissions, one which would supposedly use market forces to curb carbon footprints and hopefully save the earth from spiraling global warming.  The system is an elaborate one, with both its supporters and its detractors.  As a related aside, if you missed the Rolling Stone article this month on Goldman Sach's, please check it out.   

At the beginning of the year, billions of dollars were spent bailing out GM because of the fears over what a bankruptcy might mean for the company, the industry and the economy.  Now, only a month into bankruptcy, CNBC is reporting that the company may be set to emerge from those proceedings and go public once again.  On another note, those attuned to global stock markets and the economy have seen the fear of hyper inflation be supplanted by fears of global deflation in a few short weeks.  

Maybe what I'm getting at here in a round about way are two basic observations.  First, rare events sometimes do occur, but it's rarely those that are wildly expected or politicized.  And two, when pressed by personal incentives or motivators, mankind is incredibly adaptable.    

Whether or not fear is a useful catalyst for change or simply wasted energy I know not, but history, at least to me, suggests that we should have a little more faith.       

  

This year has been a strong one for the stock market and for Broadleaf Partner's Growth Equity Portfolio.

For details on our performance and insights on our current market outlook and strategy, please read the attached Second Quarter Market Commentary.

Doug will also be sharing his thoughts on the market with CNBC's Squawk on the Street hosts Mark Haines and Erin Burnett this Monday, July 6th at 9:35am.  Please tune in if you can.

Enjoy the Fourth!

We'll be very busy for the next week or so as we complete our quarter end activities.  As a result, it will also be a little quieter on the blog front.  Please bare with us.

The good news is that it was a great quarter for the stock market and for the Broadleaf Growth Equity portfolio.  Subscribers to our economic newsletters will get a full performance report and commentary shortly.  If you'd like to sign up for those, please visit our website at www.broadleafpartners.com and enter your preferred email address in the yellow box in the upper right hand quarter.

Before signing off for the next few days, here are some basic thoughts on recent economic releases and the coming earnings season.  As a whole, we remain positive on the markets through year end, believing that the worst is behind us.  "Less bad" news got a lot of mileage for the markets when Great Depression scenarios were being priced in this winter.  Now that this possibility has diminished, some strong gains have been made, investors feel a little more comfortable, and mutual fund flows for many equity asset classes have finally turned positive.

A key economic statistic we will be watching is the ISM survey.  This morning, the numbers came in at 44.8, up from the prior month and basically inline with expectations.  This survey is as strong a leading indicator for the economy and the stock market as any we follow.  In general, a survey reading above 50 indicates the economy and production levels are expanding.  So, while the economy is likely still contracting, it is at a lower rate than it had been.  As long as the number stays below 57, we believe it makes sense to stay focused on the cyclical areas of the market that stand to benefit from the recovery tailwinds as opposed to defensive areas that may play catch up once we've fully recovered.   

Consumer confidence, on the other hand, ticked down yesterday to 49 from 55 in May and also was below expectations.  Higher gas prices and views on jobs being hard to get likely set the reading back a tad, even though it remains substantially above its all time low of 25 last fall.  Fortunately, this series hasn't been a very good leading indicator for the economy, so it doesn't concern us as much.   

Unemployment will likely continue to increase, but hopefully at a slower rate.  We expect, as we've long believed, that it will peak in the 10% range.  While this may be bad news for those that are unemployed, the indicator has usually been lagging in nature and is therefore not as much of a concern for the stock market itself.  In other words, in the past, stocks have usually performed well during recoveries even as the rate of unemployment increases.  

As you enjoy the 4th, take a minute to remember this country's revolutionary roots.  Thugs and despots always stand in the way of freedom the world over.  Unfortunately, it is almost a universal truth that the only way to gain freedom is to go through those that stand in its way, often at tremendous personal sacrifice.  

In spite of all the well intentioned efforts to spread democracy worldwide, it will only flourish if those who are poised to benefit the most from it also bear its costs and have a majority stake in the game.  In an odd sense, this may be one of the few areas where traditional conservatism seems to be more liberal in its orientation.  Welfare based independence simply doesn't and can't work over the long haul.   

This is still the best country in the world, bar none.  Sure, others are catching up, but I know of few Americans who are actually emigrating elsewhere.  As other countries open up, competition increases and consumers on a worldwide basis benefit from improved standards of living.  As China leads the worldwide economic recovery, perhaps we would be wise to recognize the role that broader based capitalism may have played in keeping a second Great Depression at bay.  

Enjoy your 4th of July, be thankful for your independence, and remember above all, it wasn't free.   Would you still fight for yours today?

Ben Bernanke got a major grilling from Congress yesterday over whether or not he had threatened to replace Ken Lewis and the entire board of Bank America if he didn't follow through with the acquisition of Merrill Lynch last fall.  While Ben denied making any such threats, Ken Lewis apparently still felt pressured, or at least several in Congress felt he might have been. 

Unfortunately, no one ever asked the right question.  If Ken Lewis didn't think the acquisition was the right thing to do for Bank of America shareholders, why would the prospect of losing his job over the matter have any effect on the decision he made?  Somehow, the Congressional silence on this angle implies that we can't and shouldn't expect leaders to do the right thing if the consequence of their decisions require sacrifice, particularly personal sacrifice. 

Ken Lewis made the decision to acquire Merrill and in my opinion, we must trust the notion that he believed it to be the best long term course of action for his shareholders at that time.  To do otherwise would be the real reason to fire him.   

With regards to health care reform, Jason Trennert makes the fascinating observation that the official actuarial estimate for the 1965 Medicare legislation forecasted total Medicare spending of $9 billion by 1990.  In the final analysis, however, it topped nearly $100 billion!  Lesson learned?  Discount to the extreme any projections provided by politicians, particularly for future social programs.  

                             

In the entertainment category, Michael Jackson and Farrah Fawcett both died yesterday.  Talk about a gut punch for a kid raised in the 80's.   My own children knew who Michael Jackson was, but they didn't know Farrah Fawcett, proof positive that I'm advancing in age.  Kids, here's the poster that was on every teenage boy's bedroom wall across America in 1976.  I think my brother even had a t shirt just like it.  As for Michael Jackson?  As of 8am this morning, 28 of the top 100 songs on I Tunes were by the King of Pop.  Like him, hate him or not understand him, the dude could dance. 

I like this chart from JP Morgan.  As many of you know, I strongly believe that fund flows into and out of equity funds are a huge and often overlooked determinant of stock market returns.  In particular, when fund flows go wild after certain sectors, those sectors tend to do well, but when they are in a funk they don't do so well.  

While the chart only goes back ten years, you can clearly see how excess fund inflows coincided with the tech and commodity bull markets while excess outflows coincided with their respective bear markets.  This, of course, should be entirely obvious and I may even seem silly to some for pointing it out.  So why do I do it?  Simply to suggest that all the fundamental and valuation based analysis in the world may mean very little if everyone on the block wants to sell their house but you.  

Even more interesting is the fact that it may not take very much in the way of fund flows in or out of the equity markets to make a very big impact on the level of many common stock market indices.  For instance, even though the stock market declined nearly 50% from its peak, losing I believe trillions in stock market wealth, only a cumulative $144 billion in equity funds were actually withdrawn over this period of time.  While these figures simplify fund outflows by not including entities like hedge funds, it probably still suggests that a large multiplier effect exists for the market when the anxiety and greed associated with fund flows takes over.  

As recently as February, fund flows into domestic equities were as depressed as they had been in the last ten years.  Not too surprisingly, as the market has gained nearly 40% from the bottoms, fund flows back into equities have also turned positive to the tune of $29 billion.  

In the past, periods of excess fund outflows persisted about a year while periods of fund inflows persisted for four years.  With fund inflows turning positive in April, let's all hope the historical pattern remains intact.  In the next few days, I hope to share some similar insights from a sector perspective.

The World Bank may be driving markets lower today on its disappointing outlook for worldwide economic growth this year - down 2.9% - and a tepid outlook for 2010.   The truth, of course, is that no one knows what's responsible for moving the markets on any single day. 

Here's my two cents.  I think we've had a tremendous run on "less bad" economic data.  With a torrent of earnings expected next month, investors are on pause, knowing that at some point "better" as opposed to simply "less bad" becomes necessary for the markets to make further progress.  We're at an important crossroads technically and long time bears like Nouriel Roubini are getting some press once again, knowing that the bulls will be forced to show their hand in the coming weeks when earnings season begins in earnest.  

Will we get the better news?  I suspect we will, but there is enough doubt that some churn and consolidation is likely in the meantime.  The reasons to be positive include unprecedented global easing, a rebound in industrial production following a significant draw down in inventories from many industries, declining corporate bond yields, and even evidence that the employment situation may be moderating.  Historically, it is also worth pointing out that the deepest recessions are typically followed by the greatest rebounds, which would also bode well for this recovery even though that prospect feels like a long shot. 

There are those, of course, who believe that the significant global stimulus is actually the market's greatest risk.  While I concur on the concern over inflation, I think it is an issue much farther down the road.  Right now, growth is the most pressing concern, which would be consistent with the argument that today's weakness reflects the World Bank's economic forecast.  One also wouldn't expect to see the commodity complex leading on the way down as it today if the inflation risk was the market's most pressing concern.

I still think we've seen the markets lows and won't revisit them anytime soon.  In the meantime, volumes are light, consistent with the arrival of summer, the U.S. Open, and a wait and see attitude.