Title: LTSMTM
UPDATE July 1, 2007
Author: Steve Thompson (with editorial comments "EC" by Kirk Lindstrom)
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Introduction.
SteveT:
The U.S. stock market finished the second quarter with nice gains
despite the ups and downs of June. The much anticipated emergence of
large and mega cap leadership has yet to assert itself. Often
leadership by smaller cap stocks occurs as the economic pace improves
following a period of weakness. Over the past month bond ghouls have
done some of the heavy lifting for the Federal Reserve by increasing
the yield on the longer term Treasuries, erasing the inverted yield
curve. This gives those concerned about recession one less thing to
fret over. A period of summer consolidation is nothing new or a reason
to go into panic mode. Let’s take a peak at how Bob Brinker maybe
interpreting his model as we begin the second half of 2007.
SteveT: A while
back I got to wondering what causes Bob's model to change from bullish
to bearish or bearish to bullish. Is it simply his personal
expectation for future market returns? Does he really have a "model"
that he completely relies on? Over the years, certain things kept
coming up repeatedly that led to a hunch on my part about "the model."
I have looked back in time trying to identify what triggered a change
in Bob's model and I believe I am on to something.
EC:
Bob has been consistent in saying that his model is "either bullish or
bearish." In other words, there is no in between. But, Bob's own
"interpretation" of his timing model has suggested that he assigns
various degrees of the bearishness or bullishness of the model.
VALUATION INDICATOR:
The value of the S&P 500 dropped a couple percent in June but had
little effect on the P/E. Using Bob’s 2007 S&P 500 earnings
estimate of $92 and a level of 1503.35 we get a valuation of 16.34.
This is, as has been the case for months within the reasonable historic
range considering current rates and inflation. This key indicator
remains bullish.
EC: Bob Brinker tracks the P/E ratio of the S&P 500 when analyzing the valuation component of his timing model. In my July 2007 Newsletter I wrote, "Standard
and Poor’s estimates 2007 "Bottoms Up" operating earnings for
their S&P500 index will be $94.09, down from $94.11 last
month. At $1,533, this gives a price to earnings ratio (PE) of
16.3 on 7.3% earnings growth over 2006. The earnings yield,
inverse of the PE, is 6.1% for 2007. The PEG, PE over earnings
growth rate, is 2.2
The
10-year US Treasury bond yield jumped to 5.165 from only 4.70% last
month. This is well below the S&P500 earnings yield so the market is not over valued according to the “Fed Model.” In addition, the S&P500 has a dividend yield of 1.81%."
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(LTSMTM
UPDATE
Continued)
SteveT: Continues:
MONETARY POLICY:
The June FOMC meeting revealed no surprises. It seems those on both
sides of the debate to alter short-term rates have the burden of proof
squarely on their shoulders. The FED seems quite content to keep rates
where they are until we get a pronounced signal of future economic
activity. Real M-2 money supply growth has dipped into the high 3s the
past few weeks. Steady money supply along with a FED that seems to be
focused on restraint in selecting future rate direction warrant continued neutrality on the monetary indicator.
EC:
Bob follows the monetary supply to determine the necessary liquidity
for continued expansion in the United States economy. Bob
has referred to the M-2 money supply as "the fuel of our economic
growth" Bob has been on the Federal Reserves case for tightening
the money supply in their effort to tame core inflation which they say
(and I agree) was too high. Bob disagrees and said we did not see
inflation and that the higher priced energy was not inflationary.
I believe the Fed was 100% right and they have brought down core
inflation without causing a recession (so far). Bob may
have had this indicator as bearish in the past but now I think he would
have it as neutral given the data says core inflation has moderated and
we have not fallen into a recession.
ECONOMIC INDICATOR:
The July 6th jobs report is going to be closely watched as will the mid
month inflation releases. The final first quarter GDP report showed an
economy growing at .7%. Looking closer shows the GDP price index came
in at a year over year 4.2%, while the core PCE was revised upward to
2.4%. The other side of the coin is month over month increases have
been more subdued. I am greatly encouraged by ECRI’s view of
resilient economic growth prospects along with inflation pressure held
in check.
Consensus
estimates are the second quarter GDP will be in the 2% plus range. This
certainly sounds like we have turned the corner on sluggish growth and
beginning to over come some of the affects of the housing slump. The
concern is, will inflation proliferate? It seems the Federal Reserves
recent concerns over inflation are not unwarranted if you judge the
first quarter numbers. What is important is we are starting the third
quarter. The first quarter is water under the bridge. July 9th will
kick off earnings season with Alcoa reporting. This earnings season
will begin to give us some direction on economic activity in the second
quarter. I think earnings growth is going to show improvement and a
strengthening economy so I rate this as bullish.
SENTIMENT INDICATOR: The
sentiment indicators I track have changed little over the past several
months. Bob’s new favored sentiment indicator is the 60 day
Put/Call ratio. It is currently at .96, more than enough pessimism to
maintain a bullish stance. The ratio of bulls/(bulls+bears) four week
moving average from the Investors Intelligence survey is 72.19%. This
is at the upper end of the range since the market took off in
April. It is showing a good deal of optimism. I am also noticing
some increase in the VIX indicating a slight upturn in volatility. We
could be in for wider and longer corrections as many traders retreat to
the beach for summer vacations. These are frequently health restoring
and pave the way for future rallies. I feel this is bullish for Bob’s model.
EC: Sentiment Charts of :
CONCLUSION:
Even with a couple percent give back in June the second quarter was
still strong. It is not practical to expect returns of five or six
percent per quarter to continue. Still with three bullish and one
neutral indicator I predict Bob will remain bullish and fully invested
with a buy signal at S&P 500 under 1430.
EC:
I agree with Steve and would interpret Bob's timing model as bullish at
this juncture.
On the radio, Bob continues to recommend a dollar cost average approach
for new money while he recommends a fully invested position in his
newsletter model portfolios.
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