worth a read

Keep your eye on leading - not lagging - indicators
Charlie Aitken | July 03, 2009
Article from: The Australian
WALL St couldn't cope with worse than expected June unemployment data that showed 467,000 Americans lost their jobs (consensus 365,000).

The May number was actually revised lower, but that didn’t matter as traders decided it was all too hard ahead of the Independence Day long weekend and cashed in bets in cyclical and risk stocks.
By the end of only a low volume session all 30 Dow components were lower, which added up to the Dow falling 223 points, or 2.67 per cent, to 8280.

So the battle between leading and lagging economic indicators continues. One the one hand US industry is still shedding jobs and unemployment is headed over the magical 10 per cent level, yet on the other hand every single global and US leading indicator I am looking at is pointing to some sort of economic recovery starting as the global stimulus packages kick in.

There was another positive leading indicator last night in the form of US factory orders for May which rose 1.2 per cent versus expectations of 0.9 per cent, but that was outweighed by the lagging indicator that is unemployment.

While it is easy to write scare stories about US unemployment, I am certain that the single best way to make sure you make no money in the recovery when it starts is via focusing on the most lagging of lagging economic indicators which is unemployment.

You, must, must, must focus on leading indicators and global trade flow indicators (shipping prices, commodity inventories, financing activity, port volumes etc) if you are going to be positioned correctly for the recovery when it comes.

You see, investors are a spoilt bunch. They want to see compelling evidence of US economic recovery, but they also want stocks to be cheap when that happens.

Unfortunately that won’t be the case. By the time it is obvious to all that US economic growth is returning the Dow will be 20 per cent higher than today and cyclical stocks will be up 30-40 per cent. There is no chance you will have stronger data and today’s cheap share prices, and the same can be said for Australian equities.

The very, very smartest money I saw in New York was using the northern summer holiday period to accumulate cyclical and financial risk. They told me ‘Charlie there will be weak days when the market worries about the past and that is when you must nibble away in risk’. They are right; this is about getting yourself set for the better data when it comes and I am convinced that data will come in the second half of this year.

To me this isn’t about earnings, valuations or anything. This is about sentiment and momentum of data. All we have seen so far in the bounce off the March lows is the world price out complete financial system armageddon. That has been avoided and the markets are acknowledging that.

However, there is simply no possibility that markets are currently discounting any form of sustained economic recovery. There is simply no way the S&P/ASX 200 around 3800 points (once 6800) and the Dow around 8000 points (once 13,600) are discounting economic recovery of any kind.

Even today I read all over the internet comments from bearish commentators about how the so called green shoots are weeds. That is absolute rubbish. The green shoots were never represented by unemployment data, they are represented by restocking, capacity utilisation increases, consumer confidence increases, shipping rates, shipping queues, commodity prices and the like.

The fact I saw so many people come out this morning and slam the green shoots theory on the back of the most backward of backward looking indicators suggests to me that very, very few people either are positioned for or believe in the chance of consistently better US economic data in the second half of this year.

What they forget is the comparisons versus this time a year ago start getting easier. The headlines on the data will read better because the previous corresponding period data was so weak. In a world that is totally about getting sentiment right that is the key variable.

Bull markets climb the walls of worry; that’s how it works. However, to genuinely make money we must be two or three steps ahead of the consensus pack. This is pretty simple now - you can only be in on one of two camps. You either believe in the certainty of economic recovery, or you don’t. You can’t fence sit.

The portfolios appropriate for the different views are the polar opposite. My view is very, very few people are truly in my camp of economic and market optimism. It’s a lonely place not being pessimistic. I know you are perceived as smarter if you are bearish, but being bearish since March has cost you anywhere between 30 per cent and 300 per cent, depending on what stock or commodity you weren’t exposed to.

If you were physically short it was worse. If I am right the punishment for bears will be just as large in the second half of the year as the data shows growth ahead of expectations.

So I will stay absolutely on target. That target is six months out in a brighter world. I will use days like today to accumulate cyclical and financial risk, and I will look for indicators from today’s world for guidance rather than looking backwards.

The market will give me those opportunities today, with stocks like BHP Billiton and Rio Tinto down 5 per cent in London. However, I note the resilience of the LME metals last night which is telling me to stay committed. Copper only lost 1 per cent, while nickel only lost 0.3 per cent. That is telling you something about the growing inventory tightness as the industrial world restocks.

That is my key point. The industrial world destocked inventory too aggressively. They are also destocking labour too aggressively. We are now seeing industry restock inventory and inputs and it won’t be long before they start restocking labour. But remember, labour is the last thing you restock.

This may seem too simplistic but the recovery, when it comes, will be led by the stocks that led the decline. It will be the Rio, News Corps, Fortescues, OZ Minerals, Brambles, Billabongs, National Australia Banks, Aristocrats and Macquarie Groups of this world. It certainly won’t be defensives that lead the recovery.

I have only been back a week from the US and it’s been a busy week. Domestic investors think I’m on drugs and can’t understand my bullishness. To me it seems they are all holding very similar low risk portfolios and on days like today they will feel good about themselves.

While markets will muddle their way through the northern summer we must stay on target and emerge into early August with portfolios set for better US economic data and a rally in cyclical and financial risk. Today we explore why National Australia Bank fits the criteria we are looking for.

Don’t look back in anger, people.

Charlie Aitken is Executive Director of Southern Cross Equities