Market Review for Week Ending 4-24-09

Last week the market declined .50%. Helping the markets last week was the large amount of companies that reported better than anticipated earnings. Unfortunately the improvement in earnings is coming from aggressive cost reductions rather than growth in revenues.

Getting a lot of attention last week was the “stress test” that was performed by the government on banks. This test is flawed in my opinion because they are using an unemployment rate of 10% and calling it a stress. In my mind 10% unemployment should now be considered a level of average unemployment that is here to stay for some time. When we first heard about the stimulus there was promises that it would create millions of new jobs. Over time this statement has been watered down to state that the stimulus will create or save millions of jobs. Some day I expect them to say that the stimulus did not create any new jobs but prevented unemployment from increasing further. Millions of jobs have been lost and many from industries that were built for an economy that no longer exists. As I pointed out last week much of our countries gross domestic product was spending of home values. That spending is gone for good.

This week we will here from the Federal Reserve. Last statement was a huge surprise so who knows what we will here next. I am guessing the Federal Reserve is disappointed that mortgage rates have not declined significantly since their last shock and awe statement. From the very beginning I have said that you cannot save housing so just let it go. There are much larger forces that will drive down the value of real estate over time.

The first obstacle to rising home values is the escalating associated expenses. Only a certain percentage of your income should be consumed by your home and that includes all the bills not just the mortgage. Utilities, home insurance, taxes, repairs, the list is endless…and all are rising fast. The mortgage is no longer the “big expense” when it comes to owning a home and that will serve to depress prices.

The second obstacle is the basic law of supply and demand. The baby boom generation has always been a demographic bulge that altered society as it passed through it. Every day in this country hundreds of people turn the age of 60. This also means the day will come when hundreds of people will be dying daily and all of their real estate will be coming on to the market. There will be a tsunami of homes for sale and this will last for many years. My best guess is real estate will decline at least another 15%, once it is done declining; it will hover at those prices for a long time.

The head of the Federal Reserve, Ben Bernanke, has his work cut out for him but his biggest job is going to be in selling the public on all of this spending. When interviewed on 60 minutes he said that his biggest worry is that our country will not have the will to do what is required to right our economic ship. This is a crafty way of saying that taxpayers have to become comfortable with spending trillions of dollars with no immediate measurable result. We are already starting to see taxpayer resistance to this spending spree. Most people cannot even fathom what a trillion dollars is but the masses are figuring out it is a BIG number. A trillion is a million million dollars ($1,000,000,000,000). I don’t know if it is true but today I read that it would take a military jet flying at the speed of sound, reeling out a roll of dollar bills behind it, 14 years before it reeled out one trillion dollar bills.

Speaking of big numbers it is going to be very interesting to see what is going to happen with state pension funds. Pension plans are woefully underfunded but the states lack the revenues to properly fund them. Illinois pension fund is underfunded by 42 BILLION dollars. Last year the average pension fund lost 27% of its value. Many pension funds, after suffering major losses in the 2000 bear market, turned to hedge funds for a solution. It is a shame to see that the managers of pension funds acted so human. It is human instinct, after a major financial loss, to become more risky to make it up but professional money managers are suppose to be trained to reject these human instincts. This is something to watch closely because if pension funds start defaulting we got ourselves a whole new ball game.

Last week brought welcome news for us as another company in the dependable rising income portfolio increased the income they pay us by 6.5%. News like this doesn’t cause a company to escalate in value immediately but income has value and as it increases so should the asset producing the income. Given the depth of decline in all stock prices there are many great companies that have become “accidental high yielders”. As tempting as these companies may be I am not in buy mode yet. No matter how good a company may look the direction of its stock price will be largely determined by the general direction of the stock market. For now I am not convinced the trend has turned up. With that in mind I will continue to watch the markets closely so you don’t have to.