Wednesday, June 8, 2011


The 10-year U.S. note auction went well (2.967%) -- which is not surprising considering rising economic concerns and sovereign debt issues.

The bid to cover was better than the last several auctions and the percentage of indirect bidders (strong holders) was basically in line with the averages over the previous auctions.

Gartner has reduced its PC growth numbers for this year, now looking for an increase of 9.3%, to 385 million units. The firm's prior forecast was for 10.5% growth.

The housing market is drowning in debt and that while residential real estate markets are now a small percentage of GDP, the weight of the markets will continue to be a headwind to domestic economic growth.

I still believe this to be the case, as the shock of a 30% drop in home prices will weigh on consumers' balance sheets, confidence and spending patterns.

Regarding Whitney Meredith's expectation that 2011 will bring a 10%-plus drop in home prices, however, the housing market has become bifurcated, so aggregate numbers lose some of their meaning.

This was brought home by the TOL conference call. Home price weakness continues to be in regions exposed to the shadow inventory overhang. But there are emerging areas of strength where that challenge doesn't exist -- for example, the Northeast corridor is experiencing price increases, reduced incentives and near-record-low cancelations.

This distinction must be made, as this signals the beginning of stabilization, not a material leg down in the U.S. housing market.

The near-universal investment optimism of April has now been replaced by growing investment concerns, as weakening economic data call into question growth assumptions.

As share prices move ever lower, we have finally begun to discount the increased possibility of a self-sustaining soft patch as opposed to the consensus forecast of smooth and self-sustaining growth, which vaulted stock prices to two-year highs only seven short weeks ago.

There are offsets to my economic concerns; ignoring the positives would be foolhardy and inflexible (as arguably was the case when the bulls dismissed economic and market risks when the S&P 500 was at 1360).

Too many investors bathe in the water and find comfort in the momentum of rising stock prices, and too many investors are frightened by the value that is created as an outgrowth to market drops.

"In the twentieth century, the United States endured two World Wars and other traumatic and expensive military conflicts, the Depression, a dozen or so recessions and financial panics, oil shocks, a flu epidemic, and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497."

-- Warren Buffett

Here are some of the reasons why I believe that the downside to stocks is limited:

1. The strength in corporate balance sheets and income statements. While I see some vulnerability to corporate profits, my estimates are only a few dollars per share below consensus.

2. Valuations are not stretched, especially relative to inflation and interest rates. At 1250, the S&P 500 will be priced at a reasonable 13.5x my 2011 S&P forecast of $93 a share. (Price is what you pay; value is what you get.)

3. Uneven and more volatile economic and profit growth are my baseline expectations. But an extended (yet lumpy) economic up-cycle still appears the most likely outcome. More effective and productive public policy could extend the recovery further.

4. At 1250, the market will be sufficiently oversold technically, and sentiment will have moved to a more negative extreme. Always remember that a public opinion poll is no substitute for thought.

5. Individual investors are relatively uninvolved and hedge funds are conservatively positioned.