Finding Value --- AND --- An Economic Update...

Professionally, I see the world from the top down. I pay attention to sectors and regions, as opposed to individual securities. This approach virtually eliminates the business (or managerial) risks associated with investing in a small number of individual stocks. As I've reported of late, I presently see the U.S. equity market as a mix consisting of overvalued and fairly valued sectors, with just a couple, in my view, remaining undervalued (and not by a lot). Fortunately, most of the fairly valued, and both of the undervalued, sectors possess cyclical appeal. Of course when I'm talking cyclicality, I'm talking about the economy.

Last week's smorgasbord of (U.S.) indicators, when taken in the aggregate, came in warm enough, but a little cooler, in my view, than the immediately preceding weeks. Here's a brief summary of last week's log followed by message for the day:

Monday:
THE EMPIRE STATE MANUFACTURING SURVEY came in well above expectations. However, an under the surface look shows key data, such as employment, not as robust as the headline result suggest.

U.S. INDUSTRIAL PRODUCTION surprisingly declined last month (-1% vs +.3% estimate, and +.2% in July). However, automobile production led the decline which is probably due to retooling that looks to have occurred later this year than usual.

U.S. CAPACITY UTILIZATION RATE declined to 78.8%. That's an interesting development. One would expect that based on recent indications---that the U.S. manufacturing sector is gaining momentum---that capacity utilization would begin stretching, not contracting. This will be one to watch going forward. Certainly good news for folks worried about sooner than previously expected Fed tightening...

Tuesday:
THE ICSC WEEKLY RETAIL REPORT dipped noticeably. And surprisingly, given what I've noted in recent retail numbers and consumer sentiment. Likely a lull after back to school...

THE JOHNSON REDBOOK weekly reading on retail confirms the ICSC results.

THE PRODUCER PRICE INDEX FOR FINAL DEMAND (PPI-FD) came in flat; weighed down by the recent plunge in oil prices.

Wednesday:
MBA PURCHASE APPS surprisingly (in light of rising mortgage rates) bounced back.... go figure! Perhaps home buying isn't all about mortgage rates... or, perhaps folks get busy and buy when they fear rates are rising...

U.S. CPI came in low... Shouldn't be a huge surprise considering the recent plunge in energy prices.

THE FED INTEREST RATE ANNOUNCEMENT TODAY maintained the "considerable period" language, QE ending next month and continuing to reinvest principal payments in its portfolio. When they finally tighten, they'll start with the Fed funds rate, then raise the interest on excess reserves, then go to reverse repos, etc...

Thursday:
In contrast to the last homebuilder sentiment survey and last week's jump in new purchase mortgage apps, AUGUST HOUSING STARTS disappointed.

This week's big drop in WEEKLY UNEMPLOYMENT CLAIMS was almost too good (too big) to take seriously (down 36,000 to 280,000). Ongoing claims dropped noticeably as well... Promising news for the labor market...

The data within the PHILADELPHIA FED SURVEY tell a pretty strong economic story (strong move in the employment components) .

Friday:
THE U.S. INDEX OF LEADING ECONOMIC INDICATORS ROSE .2% IN AUGUST. Missing the estimate of .4%... This reading is consistent with a slight softening in the data over the past week.

An economy running not too hot and not too cold is heaven for the bulls who are ultimately concerned with when the Fed will begin raising interest rates. Fears that might be sparked by the improving employment picture are effectively offset by readings such as the low CPI and the decline in capacity utilization. Another thing those bulls have going for them is the present economic state of much of the rest of the world. With a few exceptions (such as Brazil, Mexico and India), the rest of the world is experiencing either very little by way of inflation pressure or fear over outright deflation (keeping foreign interest rates remarkably low). I don't suspect that the Fed is interested in putting more upward pressure on the dollar (it's been on quite the run of late) by getting aggressive with interest rates.

And speaking of the rest of the world, while on balance it struggles economically, that's where I'm finding attractive valuations (worries over the economy can make for attractively valued stocks). The question is, does one wade into those cheaper markets now, or wait for signs of sustainable recovery? The thing about asset allocation is that if you forever wait for the sun to shine before adding a position or two, the fact that markets anticipate means that you forever miss the opportunity to pick up undervalued assets. Of course the flip side is that, generally, assets are cheap because they deserve to be cheap, and they can remain cheap---or get cheaper---long after you add them to your portfolio.

So then---acknowledging that cheap assets may remain cheap or get cheaper---we must ask ourselves: What's more likely to get cheaper (lose value) going forward, already cheap stuff or expensive stuff? And/or, what's more likely to rise in price going forward, already expensive stuff or cheap stuff?

While I believe value remains in certain sectors within the U.S. economy (particularly if present economic trends hold)---and that bear markets (not necessarily corrections) are recession-born phenomena (and there's no U.S. recession in sight)---I say, within reason, that we begin migrating a bit of our portfolios toward the cheaper stuff abroad. Which, if you're our client, and you're light on international exposure, is what I'll be saying to you during our next review meeting (if not sooner)...