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More Reasons the Bulls are Back


News on the economy continues to support the bulls’ case. Here are some data points assembled by analysts at ISI Group this week:

Unemployment Improving: Increases by both the Philadelphia Fed and the NY Empire Manufacturing Index suggest that payroll employment will post a rise of as much as 200,000 in March. That would be a huge number; the reporting date is Friday after next, on April 2. And another jobs bill has just been passed by Congress and signed by the president.

Spending Improving: Consumer related companies are showing stronger results in weekly surveys, with most notable results at retailers, restaurants, airlines, mail-order companies and auto dealers. Speaking of the latter, ISI sees March vehicle sales coming in at a annualized run rate of 10.7 million, while J.D. Power is estimating 12 million and Ward’s Automotive is estimating 12.2 million.

Net Worth Improving: A $5.9 trillion increase in consumer net worth due to the rise in home values and stock prices from the March 2009 low through the end of this quarter is helping consumer spending. ISI estimates that real consumer spending is rising at a 3.5% annualized rate (vs. negative last year.)

Manufacturing Improving: Manufacturing related data in the last week has been uniformly stronger; notables are steel production, semiconductor equipment orders (+9.8% month over month!), rail car loadings, the oil & gas rig count, and industrial production. Truckers’ business optimism is now at a 19-month high. From the low last year, industrial production is up at an 8.3% annualized rate, which ISI says is twice the pace at the start of the last two slow recoveries and equal to the pace of the strong recovery in 1983 that led ultimately to a 17-year bull market.

Meanwhile, overseas growth has been, if anything, too strong. ISI reports that FedEx (FDX) and Boeing (BA) results last week showed that their remarkably robust sales there are really helping to lift global growth rates. Notable strength was shown last week in Taiwan and Hong Kong exports as well as Thailand vehicle sales and Chinese retail sales. This is potentially getting to be a problem because it is leading governments to want to apply the brakes by tightening interest rates before wages and prices start to spiral higher.

The European Central Bank actually still has room and reason to ease rates at a time when Asian banks are tightening. We’re starting to see a real split around the world in terms of central bank policy — a huge difference from what we saw in the amazingly coordinated global effort last year — and that will have important implications in the paths that regions’ equity and debt markets take going forward.

Bottom line: Stay focused on U.S. equities, with an emphasis on the banks and insurance companies that are likely to do best in the next phase of the cycle.

Emerging markets go dark 

Except for a couple of special cases like Indonesia (IDX), stocks in emerging markets are on the skids. This is a rather unusual development, and demands some of our attention. 

While the long-term investment case for the emerging markets remains solid, this year most of them can’t seem to get out their own way. iShares Emerging Markets (EEM) remains well below its January high and is carrying a year-to-date loss of 0.4% compared to the 9.2% gain in the S&P Midcap 400 and the 16% gain of one of the red-hot U.S. retail sector.

What gives?

After spending all of January and February on the road meeting with institutional investors, Credit Suisse analyst Alexander Redman might have a clue. In a note to clients, he said he found a “distinct mood of despondency from clients surrounding the emerging markets investment case for this year.” While he found a “great deal of evidence to structurally support the asset class longer-term, he said he also found “significant shorter term constraints.” 

He then listed the following constraints that will likely weigh on emerging market stocks this year:

The strong momentum in leading global economic indicators has stalled. 

  • The performance of cyclical sectors vs. defensives will be vulnerable to rising short-term interest rates as central bankers around the world tighten policy. We saw an example of this in India a few days ago after a surprise 0.25% interest rate hike. 
  • Any continued dollar strength will provide a strong headwind to emerging market equities, since it decreases the dollar-denominated return of foreign holdings. 
  • A number of foreign banking sectors have more deleveraging to do through 2010. Notable examples include Russia, Kazakhstan, Poland, Hungary, and the United Arab Emirates.
  • Global excess liquidity is contracting, and investable emerging market funds appear fully deployed. 
  • There is the potential for a big increase in the supply of emerging market equities as foreign firms tap lofty valuations to raise capital. 
  • Fund flow momentum has slowed and is unlikely to match the record set in 2009. 
  • Investors are increasingly concerned over reduced investment in factories and infrastructure in China. Rising inflation is also a worry. 
  • Earnings revision momentum has turned lower for emerging market stocks.
  • The relative valuation of emerging market equities to developed world equities is not as extremely compelling as they were a few years ago. 

For the past few months, I’ve been discussing the sea change that was underway as American stocks were poised to enter a period of relative outperformance compared to foreign stocks. That was the right call to make, and my recommended portfolio profited by selling and taking profits on our heavy foreign allocation late last year.

Since then, we’ve been increasingly focused on U.S.-based investments to benefit from the strengthening U.S. dollar, retaining only one fund for exposure to the group, which is Indonesia (IDX).

Over the long-term, there is still plenty of potential in the emerging market countries. Once the dollar’s climb stalls, in fact, there will likely be very large resurgence by foreign stocks. By then, of course, they will be out of favor and we’ll have a great chance to pick up some real values.

For more ideas along these lines, check out my Trader’s Advantage newsletter.

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