Trickle Down Liquidity

Well, one day after my last post, consumers tried to prove me wrong and surprised everyone with their strength in the retail sales report. I am still not convinced that the market isn't a little ahead of itself. That said, I should make it clear that I recognize the difference between the economy and the "market". The economy is on the mend and who am I to argue with the Fed. The market on the other hand has lost communication with ground control and has gone right past mend to "plaid". The S&P is up 60% from March lows and is trading at over 19 times estimated 2009 earnings. I am still calling for a pull back before year's end.

In a more relevant note to potential clients, the spread on High Yield, Investment Grade and Libor over treasuries continues to shrink which signals improved liquidity in the debt markets. Corporate bond sales are at a 6-month high. These improvements in credit will trickle down to your local banks and then to small and medium sized businesses. Improved liquidity combined with SBA fee waivers through year end should have small businesses evaluating their capital structure and determining if they need more capital or should refinance existing loans. A wave of commercial real estate defaults, a shadow inventory of foreclosed homes, and a winding down of government liquidity programs could reverse recent credit improvements.

Old World Indicators

I wish I knew where markets were headed this fall. Doesn't everyone? For a clue, I consulted my favorite leading economic indicator, the Baltic Dry Index. I like it because it is global in nature and related to the demand for the raw materials that economies consume. Mostly, I like it because it is old, its roots trace back to the Virginia & Baltick Coffee House in London in 1744, and yet still very relevant (perhaps more so due to global markets being more interlinked). Old and getting better with age; some of life's better things share this trait. According to the BDI and recent correlation, the S&P 500 is due for a pull back.

The S&P 500 is itself a leading indicator of economic activity and is one of the ten components of the The Conference Board's Leading Economic Index but when it is the stock market that you wish to forecast, you need an indicator that is sans S&P500 and is out in front historically. For at least recent history, the BDI has been leading the S&P500 by about three months. This would have suggested a fall in the S&P500 at the beginning of September. Obviously, it hasn't happened. The cash for clunkers program and similar ones in European countries have been a temporary positive boost to economies and perhaps a reason for the sustained levels of the stock market, but with those programs done and the China stimulus effect fading, the markets will be looking for the next engine of growth to sustain valuations. I wouldn't bet on consumers to pick up the slack despite recent improvements in their expectations. It will be up to the US stimulus package to finally kick in but so far its impact seems to have saved jobs (i.e. maintain government payrolls) rather than drive growth. I think we'll see more of the latter this fall but I am not so sure it will be enough to support current levels.

There certainly are other positive indicators to cite but it is recent events like the FDIC closing of Corus Bank due to soured commercial real estate loans combined with the lack of a convincing driver of economic growth for the near term that has me bearish on the fourth quarter. I would not begin to make recommendations on what to do with your stock portfolio; I am no good at that. But, I would advise companies in need of capital to find it quickly. Liquidity has returned to debt markets and the spread of high yield bonds over Treasurys has returned to levels not seen since last year. For now, decent companies seem able to issue debt and equity at reasonable terms as investors began to get comfortable with risk again. Depending on the increasing rate of commercial real estate loan defaults and the FDIC's decisions to wind down certain credit support programs this fall, we could see credit tighten again in the near term. If that happens, we'll see the S&P 500 take a dip. Having the cash to bridge the gap and seize investment opportunities will be key to survival and growth for many small companies. With that in mind, I think the market risk is to the downside for this fall. I hope I am wrong.

Knowing Where to Look

Beating up on the inefficiencies of government has become sport these days but I am continually impressed with the amount and quality of free data and information available on city, county, state and federal web-sites. Judging by my clients response, they are no less pleased with what I have been able to find while researching government databases for the purposes of building business plans or just framing the size of opportunity for new markets. Through a combination of web and human interface, I have found most government institutions to be an excellent source of valuable information.

Most recently, I had a prospective client tell me they were looking to expand and had located a property suited to their needs. It was not listed for sale so I suggested they let me do some poking around. In no time, I had gathered the target property's current owner, contact information, when the property last sold and the price paid. I also provided the dollar amount of debt used to acquire the property and from which bank it was borrowed and if there had been any subsequent foreclosure filings made on the property or owner. The client was curious, "where do you find all this information?" It's just good government and knowing where to look for it.