Valentine Capital IPC Notes
by Valentine Capital's Investment Policy Committee

Valentine Capital Asset Management
Investment Policy Committee

WEEKLY MARKET and ECONOMIC OUTLOOK
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October 28, 2010

After November 2nd

With Midterm elections next Tuesday, the stock market has had much to anticipate.  History offers a lot of insight relating midterms and the market. Based on 30 years of data and 15 federal elections, the market is significantly stronger after the midterm election results. Remarkably, investing in the S & P 500 on midterm election days and selling on the day of the next presidential ballot, resulted in  returns of 23.6% for each two-year period and median returns of 26.4% compared to a median 12.9% return from investing on the day of the presidential vote to the midterm vote.  Stretched further and measuring market reaction just following the elections, from 1922 to 2006, the average gain of the Dow Jones Industrial Average over the 90 trading days following midterms (roughly November until mid-March) was 8.5%, according to a recent research. That's almost 5% higher than the Dow's gains in non-election years. The Dow has risen following 19 of the last 22 midterm elections. Since the midterms tend to be an equalizing force on Capitol Hill, many experts have said in the past that this proves the markets like gridlock in Congress.  This, though, is not the case for the S & P 500.  Since 1945 when there’s been total gridlock — the President's party controls the House or the Senate but not both — the S & P  gained only 3.5% per year, compared to nearly 8% the midterm election years resulting in partial gridlock in D.C. (the President’s party doesn’t control the Senate or the House of Representatives). What will make this November 2nd even more interesting is what happens after on November 3rd.  The Federal Reserve’s Federal Open Market Committee is expected to announce more on “QEII”, a Treasury-bond purchase program intended to provide additional economic stimulus.

GLOBAL THEMATIC OBSERVATIONS  

     ECONOMIC UPDATES

          MARKET ANALYSIS

               EARNINGS DEVELOPMENTS

Japan said its central bank decided to leave its key overnight call rate unchanged, as widely expected, offered details of its asset-buying program and cut its growth outlooks.  Key interest rates remain near 0%. The bank cut its economic growth forecast for the current fiscal year through March 2011 to 2.1% from the 2.6% forecast it issued three months ago.

UK economy grew by 0.8% in the third quarter, data showed, defying forecasts for a sharper slowdown from the previous quarter’s surge and dampening expectations that the Bank of England would resort to a further round of monetary easing. The Office for National Statistics said third-quarter gross domestic product expanded by 0.8% compared to the second quarter. Compared to the third quarter of last year, GDP grew 2.8%.

U.S. Economic Events & Analysis: 

POSITIVE INDICATORS:

Jobless claims down:  The number of people who filed new claims for unemployment benefits fell 21,000 to 434,000 in the latest week, marking the third straight decline and the lowest level since early July, the U.S. Labor Department reported today.  Economists expected initial claims to rise to a seasonally adjusted 450,000 in the week ended Oct. 23. Claims for last week were revised up by 10,000 to 455,000. The four-week average decreased by 5,500 to 453,350. Altogether, 8.46 million people were getting some kind of government benefit in the week ended Oct. 9, the latest data available. That was down from 8.85 million the prior week. The four-week average of these ongoing claims fell 23,250 to 4.48 million, marking the lowest level since December 2008.

Consumer confidence up slightly:  The Conference Board reported that consumer confidence improved slightly this month but remained near the lowest level since February. The index of overall confidence rose 3.3% to 50.2 from a little-changed 48.6 in September. Nevertheless, the October level remained 20% below the May high. Consensus expectations had been for slightly less of a month-over-month increase. During the last ten years there has been an 82% correlation between the level of consumer confidence and the year-over-year change in real consumer spending.

            Details:  The October improvement reflected a 3.5% gain in the expectations component but it still was 19.9% below the April high. However, the index remained more-than-double the recession low. Business conditions in six months were expected to be better by just 16.0% of respondents while more jobs were expected by a reduced 14.1%. Consumers expect the inflation rate in twelve months to be 5.0%, a material decline from recent months' expectations and down from the 2008 high of 7.7%. Interest rates in twelve months were expected to be higher by 43.3% of respondents; down from the April high of 56.1%, and 16.4% expected rates to fall. An improved 27.7% of respondents expected stock prices to rise and 30.5% expected prices to fall. Finally, consumers' assessment of the present situation remained depressed. It rose just 2.6% from last month and remained 19.8% below the April high.

New home sales up:  Sales of new homes climbed 6.6% in September, figures released by the federal government showed, representing the second straight month of gains. Sales of new single-family homes rose 6.6% to a seasonally-adjusted annualized rate of 307,000, which is stronger than the 300,000 that economists expected.  Still, the pace of new-home sales is 21.5% below the same level of last year.

Existing home sales up:  Sales of existing homes climbed 10% in September, with a drop in prices helping transactions increase for a second straight month.  The National Association of Realtors said sales rose 10% to a seasonally adjusted annual rate of 4.53 million, from a downwardly revised 4.12 million in August. Economists expected a smaller gain of 4.39 million. Still, sales are 19% below the 5.6 million unit pace in September 2009. Distressed sales accounted for 35% of all sales, compared to 34% in August and 29% in Sept. 2009.

Durable-goods orders up:  Orders rose 3.3% in September, the Commerce Department.  This exceeded economists’ expectations of 2.5%.  Civilian aircraft accounted for most of the increase in September. Aircraft orders rose 105% in September after a 30% decline in the prior month.  Excluding the 15.7% rise in transportation orders, durable-goods orders were down 0.8% in September, the second decline in the past three months. In less positive view, orders for core capital equipment goods fell 0.6% in September after a 4.8% rise in August, a signal that the manufacturing sector is cooling off.

Oil down: Crude for December delivery was down 61 cents, or 0.7%, to $81.94 a barrel yesterday. Oil is down from $82.54 last week.  The Energy Information Administration reported an inventory increase of 5 million barrels for the week ended Oct. 22.

Sources: Economy.com, Bloomberg, MarketWatch, IBD, First Call:   October 21 – October 28.

WEAK INDICATORS:

Home prices drop:  Home price gains lost forward momentum this summer. During August, the seasonally adjusted Case-Shiller 20-City Home Price Index fell 0.3%. It was the second month of decline and pulled the y/y gain down to 1.7% from 4.7% this past May. Consensus expectations had been for a 2.2% y/y rise. For the narrower 10 City Composite Home Price Index, August prices declined 0.2% which pulled the y/y gain to 2.5% from its peak of 5.5%. Not seasonally adjusted August prices fell 0.2%, the first decline following four months of increase.

CRB Index up:   The Reuters-Jefferies Commodity Research Bureau is up 5.56% year-to-date.   This is about the same as 5.51% last week.

Benchmark interest rate up: Yesterday’s closing yield on the benchmark 10-year Treasury was 2.73%, about the same as 2.48% last week.

Sources: Economy.com, Bloomberg, MarketWatch, Haver Analytics, IBD week of:  October 21 – October 28.

·          The Market:  

The stock market remains in a confirmed rally that was sparked by a positive reversal September 1. The S & P 500 has jumped nearly 14% since then.  The Dow booked its best September in 70 years. As we note above, October has been the month of market “crashes”, yet current market indicators remain bullish. So far, the S&P 500 is up 4% in October.  As we note above, the market may be discounting further stimulus from Fed action.  Low interest rates and continued strength in earnings, on top of record cash hoards on corporate balance sheets has provided a lift to the stock market.  Since the market bottom on March 6,’09  the S&P 500 is up over 77%.     Year-to-date major index performance:   S & P 500 6%,  DJIA 6.7%,   NASDAQ   10.3%, and the S & P 600 12.3%.     Here are the past week’s results:  October 21:  357 new highs & 22 new lows,   October 22:  309 new highs & 20  new lows,  October 25: 473 new highs & 21 new lows, October 26: 233 new highs &  27 new lows, and October 27: 159 new highs & 31 new lows. Industry Group analysis:  year-to-date, 164 out of 197 groups we monitor are positive.  

Source: Investors Business Daily.   October 21 – October 28.

**The Standard & Poor’s 500 (S&P500) is unmanaged group of securities considered to be representative of the stock market in general.

**The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.

 **NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.

 **The Standard & Poor’s 600 (S&P600) is an unmanaged group of securities, relating to the small cap segment of the U.S. equities market, covering approximately 3% of the U.S. equities market.

 ***Indexes are unmanaged and cannot be invested into directly. Investing in limited sectors may increase the overall volatility of a portfolio.

Bull/Bear Barometer: 

Market in confirmed uptrend:   BULLISH

Industry group strength broad :  BULLISH.  164 of the 197 industry groups we monitor are up year-to-date, down slightly from 168 last week.

Dow dividend yield: BULLISH. The current yield for the Dow Jones Industrial Average is 2.61%, down slightly from 2.62% last week and down from 4.45% March 9, ‘09, which was a 5-year high.

Volatility index down: NEUTRAL.  Also known as the ‘Fear index’, the VIX (volatility index)           is 22.5, up just slightly from 20.5 last week, and still down significantly from the last bear market highs. The VIX has dropped from over 50 near the market bottom in March ’09.   According to FactSet Research, the VIX spiked to record highs of between 81 and 96 in late October ‘08, and then peaked at 103.4, as panic gripped markets worldwide.  Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.

Investors Intelligence survey shows increasing optimism: BEARISH.  The Investors Intelligence Advisors Sentiment index, which gauges the stock advice of about 150 newsletters and other paid market-advice outlets, now shows the bulls taking the lead.  “Bullish” professional sentiment is 45.6%, up from 45.1 last week (and down from 56% at end of April, near the previous market top).    The “Bearish” sentiment is 24.4%, up from 22% last week.    The 5-year high is 62.9.  The index is considered normal at a measure of 45% bulls, 35% bears and 20% neutral.

Bear Perspective:  Bull market or Bear market rally?? Both provide impressive gains, especially over the short-term.  During the October of 1929 to July 1932 bear market the Dow lost 89% of its value.  During that time there were 7 large rallies exceeding 27%.  For example, the bear market rally that began in October 1931 lasted 35 calendar days and resulted in a gain of 35%. The Dow gained 15% in one day!  Additionally, a more powerful bear market rally ensued in 1932 when an early August to late September advance exceeded 100% before another leg down, losing over 30%.  Japan’s Nikkei showed 4 huge up moves of 50% or more during its prolonged bear market, losing 74% of its value. Japan’s stock market is still a fraction of its September 1989 peak near 40,000, as it is now about 10,000.

Sources: Wall St. Journal, IBD, Thompson First Call, Zacks, Stock Traders Almanac, AlphaTrends. October 21 – October 28.

● Earnings & Company Developments:         

Another impressive start to another strong earnings season.   According to Zacks Investment Research, 159, or 31.8%, of S&P 500 firms have reported.  There have been a total of 128 positive surprises and just 17 disappointments.  With positive year-over-year growth for 130, falling EPS for 28 firms, the positive-to-negative ratio is 3.64. Total net income reported is up 33.8%. Year-over-year growth is expected to slow to a growth rate of 16.36% from the 37.54% reported in the Second quarter, which was in turn down from 47.61% growth in the first quarter, according to Zacks Investment Research.  That is still a very healthy level of earnings growth.  Thomson Reuters’ earnings growth estimate for the S & P 500 in Q3’10 is 31.1%.  Top-line growth is also expected to slow in Q3 from Q2.  Total revenue for the S&P 500 expected to grow 3.9% from a year ago, a sharp slowdown from the 10.8% year over year growth posted in the second quarter.  Total revenues for the S&P 500 expected to rise 4.65% in 2010, 5.90% in 2011.  According to Zacks Investment Research, total earnings for the S&P 500 expected to jump 41.4% in 2010, 12.7% further in 2011.    S&P 500 firms earned a total of $548.5 billion in 2009, and are expected to earn $776.8 billion in 2010.   Companies of interest:  A T & T reported that its third-quarter profit surged to $12.3 billion, or $2.08 a share, from $3.19 billion, or 54 cents, a year earlier. Total operating revenue rose to $31.6 billion from $30.7 billion. Excluding items, the company said it would have earned 55 cents a share. Analysts, on average, estimated profit of 55 cents a share on revenue of $31.2 billion, according to FactSet.  The company, which is the exclusive U.S. carrier for the Apple Inc. phone, said Thursday it activated 5.2 million iPhones in the quarter, 62% more than the record set earlier this year.

Sources: Zacks Investment Research, Thompson Reuters, Earnings.com, TheStreet.com, FactSet.  October 21 – October 28

On This Day:

October 28, 1962 -- Soviet leader Nikita Khrushchev informed the United States that he had ordered the dismantling of Soviet missile bases in Cuba.

Source: history; about.com

Valentine Capital Asset Management, Inc.   

6111 Bollinger Canyon Rd. Ste 100, SAN RAMON, CA  94583

925.275.0200

Published by Valentine Capital Asset Management
Copyright © 2010 Genevieve Valentine Enterprises. All rights reserved.
All rights reserved. Valentine Capital Asset Management 6111 Bollinger Canyon Road #100 San Ramon, CA 94583 (925) 275-0200 Valentine Capital Asset Management is an SEC Registered Investment Advisory firm doing business in the State of California. John Valentine, Founder & President. Securities offered through Purshe Kaplan Sterling Investments, member FINRA/SIPC, Headquartered at 18 Corporate Woods Blvd, Albany, NY 12211 NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE, INCLUDING LOSS OF PRINCIPAL. NOT INSURED BY ANY STATE OR FEDERAL AGENCY.