That Dog Won't Hunt - 11/19/09

That Dog Won't Hunt
11/19/2009 9:07 AM EST


		Bullish HD BAC CB JPM LM PNC STT Bearish BEN TROW Update GS

I did my best to construct a logical and well-reasoned argument on last night's episode of 'Fast Money.'

Well, it's been open season on your double-dealing
And it's so wrong.
I guess I've been a fool, playing by the rules
For too long.
Well, I've been sitting here at home with the porchlight on
While you've been chasing everything that runs.
Let me put this in your ear and make it be so clear:
Baby, that dog won't hunt.
-- Waylon Jennings, "That Dog Won't Hunt"

Last night, I rejoined joined Melissa Lee and CNBC's "Fast Moolah" team. I did my best to construct a logical and well-reasoned argument given the quick, staccato pace of the show!

Let's go to the tapes.

Melissa asked me to response to Raymond James' Jeff Saut's bullish comments from the previous evening. Jeff, a buddy/friend/pal, has been correctly bullish and publicly so -- for that, he deserves all of our praise and kudos. On Tuesday evening, he posited that, with credit spreads back to pre-Lehman bankruptcy levels and with a greater clarity to solid first-half 2010 earnings, the S&P 500, too, could march back to the 1,200 level that stood in place before Lehman failed.

I admire Jeff a lot and welcomed the opportunity to debate him, even in his absence.

Here are my comments (and more) from Wednesday night's show.

I started by respectfully disagreeing with Jeff. His argument, I objected, was too linear as his principal focus was on improving credit spreads, which basically reference the relative health of large businesses. We all already appreciate that those large businesses have benefited from cost-cutting, productivity gains and are flush with cash. I felt that Jeff was missing the bigger part of the story. Jeff's bullish case omits the small business and consumer sectors, which account for a much more meaningful part of the economy than the large business sector he highlighted in his credit spread argument.

Indeed, the conditions in small businesses and in the consumer sectors have deteriorated markedly since the Lehman bankruptcy; they are in a sorry state now, and the outlook is not encouraging. I reminded the "Fast Moolah" crew that the National Federation of Independent Business Index, which surveys small business confidence, now stands at more than two standard deviations below its long-term average, as noted by a Goldman Sachs (GS) economist about 10 days ago. (This statistic was at the core to Goldman's view that third-quarter 2009 GDP would ultimately be revised lower.) Also, unemployment is now at 10.2% (vs. 7% to 8% before Lehman's failure) and probably going to 10.5% to 11% in early 2010; when you couple those figures with underemployment at 17.6% (vs. under 15% in mid-2008) and likely approaching 19% shortly, the consumer's condition is worse than 12 months ago. (Remember the so-called "Blue Chip" economists told us at the beginning of 2008 that unemployment would peak out at 6%, and remember that in 2007 Bernanke was firm in his belief that subprime lending was good for America and that the housing recovery would be sustained for years in light of low unemployment and even lower interest rates.)

Other differences between the pre-Lehman bankruptcy period and now have surfaced, arguing against Jeff's ambitious S&P target. For example, the banking industry no longer is as expansive in lending, and the shadow-banking industry, which fueled much of the economic growth before Lehman's failure, is adrift (as is the shattered securitized lending market). Housing is no longer a driver to the economy, and I can't find a sector that will replace it. Finally, we are only 12 months from a large hike in marginal tax rates and even closer to taking on the burden of expensive health-care legislation.

Moreover, I would remind Jeff that a trillion dollars of stimulus and a zero-interest-rate policy were needed to produce a 3.5% third-quarter 2009 GDP print, which is likely going to be revised lower. What happens in 2010 when that stimulus is withdrawn?

I suggested that the second difference I have with Jeff was that I was not as optimistic and certain that the path of corporate profits in early 2010 would be as smooth and as strong as he contended. I countered by saying that we are more likely experiencing a slow start to a bad recovery and that he (and others) have dismissed signs that the short-term fundamentals are deteriorating.

Let's examine what has happened since my last appearance on "Fast Moolah" a week ago. Since then, the economy has whiffed six or seven times -- this dog (the 2010 domestic economy) won't hunt -- raising concerns about the self-sustaining economic recovery thesis that is at the epicenter of the bull argument. Importantly, those whiffs over the last week were broad-based and include industrial production, jobless claims, consumer confidence, housing, retail and inflation.

Here is the evidence I have to support my case:

October industrial production rose by only 0.1% -- consensus was a 0.4% increase -- and the Empire State Manufacturing survey was weaker than consensus, indicating that fourth-quarter manufacturing and output is moderating from the third quarter and has started on a disappointing note.
Claims remain elevated, and it is increasingly apparent that the unemployment rate is moving toward 10.5% to 11%. Remember, industrial production and employment are the two leading factors in the National Bureau of Economic Research's methodology of determining recession or growth.
Consumer confidence has also weakened.
The National Association of Home Builders (NAHB) confidence survey was horrible, confirming the homebuilders' conference calls that I referred to on last week's show, which indicated that since Labor Day the housing recovery was growing tentative in terms of traffic, activity and contracts closed. Wednesday morning's housing starts came in at the lowest level since April, it's the third straight monthly decline, and permits have declined in three of the last four months. Clearly, the housing recovery is weak and remains dependent on government subsidies. This means that a job recovery is essential for the industry to stand on its own, especially as the home tax credit and the mortgage-backed securites purchases (designed to keep mortgage rates low) are scheduled to expire early in the first half of 2010. If employment fails to recover, the nascent housing recovery will be in jeopardy and so might a housing-dependent economy.
Retail companies have signaled a difficult holiday season, including Saks (SKS), which predicted near double-digit comp declines, Home Depot (HD), Target (TGT) and Wal-Mart (WMT). Target's management was especially blunt, stating that "sell-side analysts are somewhat more optimistic across most of our industry than we believe is warranted in light of the harsh realities of the current environment.... Again, we are very early in the month, but we have seen slightly softer sales in the first two weeks of the month and a little bit of give-back in the discretionary categories." Saks in their call with investors and analysts said, "It's a fragile period for everyone in this industry."
Meanwhile, on the inflation front, pipeline inflation is rising. I noted that in Wednesday's PPI report, finished goods prices were up by over 6% in the last three months. It is important to consider some of the adverse consequences of a zero-interest-rate policy. For example, between Monday and Wednesday, lumber futures prices have been limit up despite the six-week drop in mortgage applications, weak NAHB confidence and the other economic whiffs I mentioned; this will hurt the consumer as well as industrial margins and profits. Inflation must be contained in order to support the current levels of stock prices.

There are two possible interpretations to the markets rising in front of these crappy data points: Either it's testimony that the stock market is so strong and impervious to current data points because the economy will emerge even stronger than consensus and will morph into a self-sustaining cycle, or there is a growing disconnect between reality and perception. I hold to the latter view, as I believe that the strength in the market is further reinforced by the invisible hand of momentum-based quant funds that worship at the altar of momentum and by other institutional investors and individual investors that have momentum-based strategies.

The momentum in stock prices and bullish votes (and participation) have been impressive, but as Warren Buffett remarked, over the short term the market is a voting machine, over the long term it is a weighing machine. Nevertheless, both in the short and intermediate term, it remains my view that there is a vacuum being created underneath today's stock price levels. Cheerlead if you will, but understand that the risks are rising rapidly (maybe exponentially) and that the reward in stock ownership is now greatly diminished from the generational low that I called for in March.

Melissa Lee asked me where I would be looking in the markets now. I responded that housing and retail are in the eye of the storm and that selected stocks in these areas were now very vulnerable.

Guy Adami mentioned Meredith Whitney's negative tone of late, and he asked me about the outlook for financial stocks. I told him that I have only one meaningful long in the sector, Bank of America (BAC). Actually, I blew that answer because I still have tag ends in longs of Chubb (CB), JPMorgan Chase (JPM), Legg Mason (LM), PNC Financial (PNC) and State Street (STT).

On the short side, I specifically highlighted that I had begun to expand my shorts in Franklin Resources (BEN) and T. Rowe Price (TROW), two asset managers that are levered to the capital markets and have as a headwind diminished 401(k) contributions from corporations that remain in a cost-cutting mode. Franklin Resources is my favorite short; the stock has tripled from its lows, and the company missed on the operating line in third quarter 2009.

As I said, I love being on the show, and I look forward to returning!