SET Monthly Issue August 2009

| August 18, 2009

August 2009


Just the other day, I was taking a trip to the mall.  My Gold Toes were looking like Swiss-cheese… I needed new socks.

After grabbing a few new pairs of socks, I walked to the sales counter.

I’m never one to pass up an opportunity to get some front line economic news.  So I asked the sales guy, Dave, “How’s business?”

Not surprisingly, he gave me a one-word answer… “Slow.”

After a little while, Dave went on to tell me he’s been in retail for most of the last twenty years.  He did spend a few years working as a mortgage broker.  Not a big surprise in Arizona.

Right now it’s the worst he’s ever seen.  Mall traffic is slow, people spend less (when they buy at all), and most pay with cash.  Nobody is interested in a store credit card, and everyone is looking for a sale or discount.

This trip to the mall left me wondering if this is the ‘new normal’ for the American consumer.  I decided to take a closer look at the statistics.  What I found was shocking.

The savings rate for the American consumers is now around 5%.  That’s a huge jump after being near zero (or negative) the last few years.  Surprisingly, the amount of personal credit has been declining for five straight months.  It is clear consumers are attempting to repair their overleveraged balance sheet.

So the real question is, will personal savings rates continue to grow and will credit use continue to fall?

The answer to the question likely holds the key to how economic recovery takes shape.  Will it be the fast paced “V” recovery?  Or will we plod along the bottom in an “L” shaped recovery?

I came across a Gallup poll that sheds some light on the subject.  Take a look at this chart.


According to Gallup, the number of people increasing their debt recently is rising.  And the number of people decreasing their debt is falling.

This is an important shift in consumer behavior.  And it bodes well for the entire economy.

It is clear consumers are saving more and spending less than they were a few years ago.  But it’s also clear the savings rate isn’t going to continue climbing higher and higher.

In my opinion, we’ve seen the consumer shift from a buy now pay later mentality to asave now buy later mindset.  And it’s hurt the economy in the short term.  But it doesn’t mean the consumer is done spending.

One other factor will encourage consumer spending in the next few months… the unemployment rate.  Last month was the first report of unemployment falling.  More people working who feel secure in their jobs mean more consumer spending.

The holiday season isn’t too far off.  I’m expecting a lot of people who haven’t lost their job to start spending some of their savings soon.

I know I’ve started spending… Gold Toe is a great sock but they don’t last forever.


Industrials have been on a roll since the stock market began to recover in March.  And they’ve been picking up steam lately.  The industrials are up 72% from the lows.

It’s no surprise the highly cyclical industry is chalking up big gains.  All signs are pointing toward a swift economic recovery.  This industry provides ample growth opportunity when the economy is good.  It means they’ll be a big part of the recovery.

It’s clear the economy is bottoming.  Now is the time to move into the industrials… They have plenty of room to run.

Macro/Economic Trend:

Right now I see an important gauge of future sales indicating better times are just around the corner for the industrials… Wholesale inventories of unsold goods are dropping.

Here’s the deal, when the recession hit, retail sales tanked.  Just like a row of dominoes, once the retail sales tipped over, the rest of the supply chain fell.

As retail sales fell, companies didn’t need to restock their shelves.  This caused wholesale inventories to skyrocket.  So wholesalers cut back their purchases from the manufacturers.  But not before they had a glut of product on their hands to sell.

And finally, the manufacturers cut production as their orders fell.

Retailers and wholesalers had to work off excess inventory.  It hasn’t been a pleasant experience.  All along the line people lost jobs.  And overleveraged companies unable to weather the storm shuttered their doors.  (A few were lucky enough to get a bailout from Uncle Sam.)

Inventories have now fallen for ten months in a row.

In August of ’08, inventories peaked at $443 billion.  By June of ‘09 (the most recent data available), they had fallen to $393 billion.

We’re finally reaching a point where wholesalers are comfortable with inventory levels. In order to keep adequate inventory, they’ve started to increase orders from manufacturers.

Manufacturers are ramping up production.  Good things are beginning to happen. They’re bringing back laid off employees.  Those employees now have money to spend.  The money they spend drives retail sales… and the whole cycle repeats.

It’s a classic recovery story.  And it’s looking more likely every day.  One ETF I like to profit from this cycle is the Vanguard Industrials ETF (VIS).

Fundamentals:  A closer look at VIS

VIS holds 374 industrial company stocks.  The broad sector is composed of 17 different industries.  They represent everything from huge conglomerates, to railroads, to defense contractors.

The expense ratio is small at 0.25%.

The top five holdings and percentage weight for VIS are –

Company Name Ticker % Weight
General Electric GE 12%
United Technologies UTX 4.5%
3M MMM 3.8%
United Parcel Service UPS 3.3%
The Boeing Co BA 2.8%

One thing pushing stock prices higher is earnings growth, or the forecast of future earnings growth.

Right now, research analysts are adjusting earnings outlook higher.  This will keep VIS moving higher until we get a look at the Q3 earnings (in late October or early November).

Technicals:  The charts lead the way

VIS has been trending higher since March.  And it’s made a big move since mid-July.  In fact, it’s jumped 25% in the last month.

Now take a look at the chart.  You’ll see it’s pulled back to support at its 20-day moving average (the blue line).


When an ETF pulls back to support while in a strong uptrend, it’s often a great low risk entry point.

If that’s not enough, the 20-day MA is at the previous high set back in June.  When multiple indicators converge at a support level, it becomes even stronger.

It all adds up to a great time to buy.

Trade Alert

Buy:  Vanguard Industrials ETF (VIS) up to $46.50
Recent Price:  $44.61
Price Target:  $59.00
Stop Loss:  $39.00

Remember:  The economic data is telling us now is the time to buy the industrials. But there are still plenty of skeptics.  Many think this rally is nothing more than a bear market rally.  They’re taking every opportunity to poke holes in the bull’s argument. We could see some erratic trading as we head into late August.  But in the end, the data should prove us correct.  Take advantage of the pullback to buy this ETF at a great price.


Consumer Discretionary (8.87%)

What does the future hold for the American consumer?  It’s hard to say.  On a day to day basis, the economic data is sending mixed messages.  One day we’re riding a wave of better than expected numbers.  The next we’re treading water as they come in worse than expected.

Overall conditions are improving.  And expectations are heating up.  However, if companies aren’t able to live up to the new higher expectations, we could see investors head for the doors quickly.

Consumer Staples (1.96%)

The staples held true to form this month.  They’re a slow and steady defensive sector… not exactly what we’re looking for in a sector rotation strategy.

This sector’s not going to participate in the big moves higher the way cyclical companies do.  They’re just not sensitive enough to the economy.  I expect they’ll continue to climb higher with the rest of the market.  But the gains will be much smaller.

Energy (4.66%)

The price for a barrel of crude oil and S&P 500 are riding the same roller coaster. However, it hasn’t always been this way.  There have been periods of time where they go in opposite directions or don’t have any relationship whatsoever.  So what’s got these two moving in lockstep together?  It’s all about investors’ expectations.

When investors feel optimistic about economic recovery, everything goes up.  Then bad news pokes holes in the bull’s argument and everything goes down.

Right now, oil is riding back up toward resistance at the highs for ’09, around $73 per barrel.  It’s going to take better than expected news to keep it going higher from here.

Financials (17.30%)

The banks shook off worries about ‘toxic assets’ and rocketed higher this month.  We said “the financials are due for another rally” last month when we recommended theSPDR KBW Banking ETF (KBE).  We were right!  We’re up almost 25% in less than a month.

Here’s what’s going on.  The earnings season painted a much more positive picture than analysts were expecting.  And economic improvement makes it easier for borrowers to repay their loans.  I think the financials will continue to lead the markets higher as long as conditions continue to improve.

Healthcare (5.28%)

The political “give and take” continues as the White House seeks enough votes to get its healthcare reform bill through Congress.  What the final bill will look like is still anybody’s guess.  However, a public option, which could spell disaster for the private insurers, is becoming less likely every day.

As long as the debate continues in Washington, I’m staying away from healthcare stocks on Wall Street.

Industrials (10.50%)

Despite an already impressive run from the March lows, I think this sector has plenty of room for improvement.  We’re recommending the Vanguard Industrials ETF (VIS)… see Trade Alert 1 for more details.

Technology (3.74%)

The tech rally is cooling off a bit this month.  But technology is still one of the best performing sectors this year… for good reason.  Most companies are navigating the recession well.  And they’re positioning themselves to profit from an economic recovery.

It looks like the sector could be a victim of its own success.  The positive outlook for the tech companies has spurred a big rally.  But it’s also set them up for a big fall if they come up short of expectations.  This is leading to companies trying to cool investors’ expectations.  They’re taking the under-promise and over-deliver route.

In my opinion, this bodes well for their stock price once Q3 earnings season rolls around.  But in the meantime, we could see some weakness in the industry.

Materials (11.95%)

The correction for the materials sector is now squarely in our rearview mirror.  They’re riding the wave of the global growth story.

Right now it’s all about China.  The Chinese government is dedicated to keeping their economy growing.  The money supply and new lending is exploding in China.  This should keep demand for raw materials growing for some time.

Utilities (3.64%)

The utilities registered a modest gain compared to the more cyclical sectors this month.  A trend I expect to continue going forward.

Utilities will benefit from economic growth, just not on the same scale more economically sensitive sectors will.

In my opinion, this sector will continue to lag the cyclical industries as investors look for growth opportunities.

Portfolio Changes

  • This month we’re buying VIS…
  • Move KBE and IGV to ‘Hold’


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