Into September

Welcome back, ye tan and rested laborers! Let’s get to it.

Last month was a lot better than I expected it to be. The end of August saw a market rising, albeit on lower volumes, which makes the rally suspect. This abbreviated week will see the return of higher volume and, therefore, will provide a more meaningful look at where the market wants to go.

Some excerpts from the Sept. 4 issue of Barron’s:

The bullish case for the stock market is built on three arguments: that inflation has peaked, or soon will; that the economy, although softening, is resilient, and that investors will warm to stocks anew as concerns about both recede. Prudential Equity Group’s Ed Keon notes the U.S. economy has been in recession in just five of the past 94 quarters. “Some say a soft landing is tough to engineer,” he says. “The record says it’s been very tough to push this robust economy into recession.” [JK NOTE: Keon expects the S&P; 500 to end this year at 1410, a gain of 7.6% from Friday’s 1311 close.]

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More often than not, equity markets take a hit in the fall. Beyond this seasonal element, uncertainty over Federal Reserve policy and the economy, the weakening housing market and mid-term elections in November could challenge sentiment for equities before 2006 begins to wind down.

One habit taken up by tactical investors in recent years is selling into stock rallies as the indexes approach the upper part of their range.

Another habit, this one enduring across generations, is for stocks to struggle in September, which qualifies, on average, as the month with the poorest results.

Both these tendencies would argue against [last] week’s strength in the indexes continuing without some kind of setback.

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In mid-August Tom McManus, chief investment strategist at Banc of America Securities, trimmed the equity allocation in his recommended portfolio to 55% from 60%, joining others such as Charles Schwab’s Liz Ann Sonders and Merrill Lynch’s Richard Bernstein in seeing more virtue in cash. Interest rates aren’t yet restrictive enough to thwart inflation, McManus says, while stellar corporate-profit growth and record profit margins have raised investors’ hopes enough to make earnings disappointments likely. “There’s a good chance we’ll be able to buy stocks at lower prices,” he says.

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From ValueStockTips.com in The Villages, FL:

I became so concerned [about the lost wealth effect from real-estate deflation], I convinced my family to sell their real estate in Silicon Valley, Calif., in April this year and we moved to a more reasonably priced home in Central Florida. I knew all of this was coming in real estate and have been writing about it for a year, but it is happening faster than even I contemplated. The thing that is the most scary about the real-estate asset bubble is that while it didn’t occur in the entire country, it was its most intense in the regions where the nation’s wealth is most concentrated.

I found the ratio of bullish to bearish comments to be about 1:3 in Monday’s issue. Most pros on parade in those venerable pages expect to see lower prices before the market commences a rally. That’s also what I’ve been expecting for some time now, which is why I find it unsettling that so many others are in agreement. I prefer to be the odd man out (hence my preference for unfashionable clothing).

A guy who is decidedly an odd duck on today’s pond is none other than Jeremy Siegel, who wrote at Yahoo Finance yesterday that stocks may climb a wall of worry. His opening sentence is, “I believe that odds are about five to one against the U.S. falling into a recession over the next year.” He thinks both the high-oil-prices and bursting-housing-bubble fears are overblown. In regard to the former, he wrote, “Oil producing countries are as addicted to their revenue from oil as we are to using it. They also know if they set the price of oil too high, determined conservation will hurt their long term prospects.” Indeed, as the first real trading day of September dawns, NYMEX crude futures are trading just above $68.

Econoday is onboard with Mr. Siegel. Senior Economist Mark Rogers wrote last Friday that, “More recent economic data clearly show some slowing in the economy.” However:

Overall, the economy is in good shape. At this point, a soft landing appears to be more likely than not. Continuing that analogy, the only question is whether the pilot (the Fed) needs to adjust the wing flaps a little or not. But for now, the economy seems on the right glide path.

Realmoney.com’s Paul Kedrosky tossed his bull horn into the ring: “With oil prices sliding and recent better-than-expected economic news, the market could have another positive week.”

Yet, on the same page, Harry Schiller writes, “It’s never fun to miss a rise, but this one has precious little to recommend it.” Doug Kass writes, “The bulls are running and the indices rebounding, but economic signs point to future pain.” Adam Oliensis titles his column “Market Deck’s Stacked to the Downside” with the summary, “The internal metrics for the Nasdaq 100 and S&P; 500 aren’t encouraging for the next big move.”

Perhaps metrics aren’t your bag. You might be the type to worry about one of the wars in the news. Paul Farrell says you shouldn’t because war chatter has nothing to do with your investment strategy. Just remember back to the war drums of 2003 before the shock-and-awe invasion of Iraq. That was much worse than today, and the year turned out to be the best for stocks in 25 years.

If A.G. Edwards’ Al Goldman can be trusted, we’re in a modest up-trend that should continue this week.

Then again, Irwin Kellner reminds us that September stinks and writes that it’s a time for caution.

But perhaps the most aggravated guy is Donald Luskin at SmartMoney, whose rant last Friday against the Federal Reserve takes us through this serpentine logic:

  • Inflation is a real threat
  • Thank goodness oil prices are falling
  • No, wait, less money spent on oil and gas means that consumers will have more to spend on “core” items like cars, movies, and furniture
  • The Fed watches “core” prices for signs of inflation
  • They will rise as oil prices fall
  • That will drive the Fed to keep raising interest rates
  • That will spoil the growth we were about to see in the economy from lower oil prices

Note that he disagrees with Mr. Kellner about September being a problem. He thinks the short-term will be fine, but the medium-term will be bad. He wrote, “We’re now in the last few months of the good times. As the economy accelerates, stocks should continue to rise. Make hay while the sun shines. But be ready to bail out. Midnight will toll sooner than you think.”

I’m a tech investor, and tech’s been good to Kelly Letter
subscribers over the past six w
eeks. Our additional purchase of a major semiconductor company over the summer has already seen a 17% gain. Is it all up from here?

I don’t think so, as evidenced by my sale last week of one of our internet holdings at a 10% profit. I want back in — but at lower prices.

According to Michael R. Sesit at Bloomberg, I’ll be getting them. Yesterday, he wrote, “There’s little evidence that business is improving for technology companies, and the U.S. economy is slowing.” He quotes Janus Twenty Fund’s Scott Schoelzel, who said, “I don’t think it’s a trend yet. You have pockets of anecdotal strength that people are hanging on to. I’m not willing to jump in with both feet today.”

Few are, it would seem. A cautious stance looks like a good idea. As the above digest shows, little is clear. I remain net long, with a hedge against falling technology prices in place. That’s a middle-of-the-road approach. Meanwhile, I’m ready to pounce on cheap prices with a chest full of cash. No matter what happens, we’ll do pretty well here at The Kelly Letter. We always do.

Best of luck to you!

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