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Market Comment

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Stay The Course

Fri, Aug 15 2008, 06:29 GMT
by Comstock Partners Team

Comstock Partners Inc.

This market has held up very well in the face of all of the "headwinds" we discussed in past reports. And these headwinds continue to get worse. The predictions we made in early July remain right on target. We essentially predicted that the U.S. consumer has "hit a wall" with the housing price bubble bursting (and that is only half-way finished).

This scenario will drive the U.S. economy into a severe recession that will spread abroad due to the end of the insatiable appetite consumers have had for foreign goods and services. We also predicted that commodities would break due to the demand destruction caused by the global slowdown. We also predicted that the stock market would not rally even as commodities fall-even though most investors believe that the stock market decline from October to present was due to commodities (especially energy) rising. The market hasn't declined recently but we believe that the latest market rally is just a reprieve from the ending of the "concern" stage of the bear market and soon will enter the last stage of "fear and capitulation". This is by far the worst stage and should drive the S&P 500 to triple digits from the current level of about 1300. We doubt this relief rally will take the market above 1360-5.

July retail sales dropped 0.1% in July as auto purchases sank for the 6th straight month and the impact of tax rebates faded. Ex-autos sales rose 0.4%, but that was below consensus estimates and doesn't account for inflation (headline CPI was up at a 3.5% year/year rate reported today-double the estimate). We expect the retail sales to only get worse as the stimulus package is ending and a new Federal Reserve survey shows about two thirds of the country's loan officers reported tightening standards for credit-card and other consumer loans in the past three months. This is the highest in the 12 years since the Fed has kept track, and far higher than in the 2001 recession. This will mean a lot less spending by consumers. Even if congress and/or the administration creates another stimulus package it will only soften and may make worse the inevitable recession caused by the bursting of the housing bubble and excess consumer debt driving a consumption boom. You can't solve a debt and consumption frenzy with more Federal debt used to encourage consumption.

The spreading of the weakness abroad has surprised even us. The Euro-zone GDP fell 0.8% qtr/qtr in the second quarter. This is the first quarter-to-quarter contraction since records began in 1995. After posting a very strong first quarter, Germany's real GDP in the second quarter declined -2.0%. The Euro-zone retail sales index has plunged and now banks in the euro-zone have tightened lending again. Japan's economy contracted in the April to June quarter by -2.4% as softer consumer spending and weak capital investment threaten to bring its current expansion to an end.

There are also weak reports for emerging economies as consumer confidence in Korea and Mexico dropped sharply. For Korea it was the lowest since 2000 and for Mexico it was the lowest since the country began measuring the index in 2001. Although still strong, even China's industrial output growth at 14.7% slowed to a 17 month low in July, as weakening exports hit factory production across the nation. This is down from 16% in June and 18% in July of last year. The deceleration of export growth was the main reason for the slowdown as well as the strengthening of the Chinese Renminbi. As we have indicated in prior reports, this will be the biggest problem for all of our trading partners as "competitive devaluations" will be prevalent as the global recession accelerates. Our U.S. dollar has strengthened recently and many pundits have predicted that this is the best thing that could happen to the U.S. economy and stock market. Actually, the only source of strength in our economy has been exports which were driven by the weak dollar. We doubt that the stronger dollar will be helpful to our economy and as our trading partners inevitably lower their rates the dollar will only continue to rise and be a drag on our economy.

Our prediction of a decline of commodities in early July due to the global recession was pretty much right on target. The Goldman Sachs Commodity Index plunged a record -20.9% over the past 35 days as of Monday. The commodities have rallied since then but we expect the decline to continue into next year due to demand destruction. We also expect the stock market to enter the last stage of the bear market soon and do not think the S&P 500 will exceed its 200 day moving average at around 1360-1365 before it resumes.

Published on  Fri, Aug 15 2008, 06:41 GMT