The following is a guest contribution from our friends at Comstock Partners:

Recent events are reinforcing our long-held concerns about the stock market and the economy.  Negative reports over the past week indicate weakness in consumer spending, declining confidence among small businesses, continued concerns about residential foreclosures and serious problems with sovereign debt.

According to RealityTrac residential foreclosures will reach a record high 3.9 million this year, compared to the previous record of 3.2 million in 2008.  November was the ninth consecutive month in which foreclosures exceeded 300,000.  Although the November number was down 15% from the July peak, the number of filings was held back by work on mortgage modifications and a temporary lull in the number of adjustable rate resets.  Once the work on modifications is finished the remaining homes will be thrown into foreclosure.  Note that Federal programs to modify loans have met with little success so far and that of those that have been modified, a large percentage have already fallen behind in monthly payments.  In addition to the potential foreclosures already in the pipeline, a new wave of resets is about to begin and extend into early 2011.  This will result in further foreclosures, increased inventories and downward pressure on home prices.

Adding to the potential economic problems, the National Federation of Independent Businesses Survey Index (NFIB) fell to a 4-month low.  Among the sub-sectors in the survey, plans to increase employment and capital spending both declined.  The survey also indicated continued weak revenues and tight credit conditions.  Since small business accounts for half of all employment in the nation and almost all of its growth, the drop in the index is an ominous sign as we prepare to go into 2010.

Continued weakness in consumer spending was reaffirmed by the latest ICSC Weekly Chain Store Sales Index, which dropped 1.3% in the week ended December 5^th.  The index has now declined 1.8% since October 31^st and hints at sub-par sales going into the Christmas holiday season.  This is to be expected as a result of continuing high unemployment, absence of new hiring, tight credit, household debt deleveraging and lower wages.

Another ominous development is the recent emergence of sovereign debt problems.  The revelation of Dubai World’s inability to pay its debts on time resulted in a one-day market drop that was soon easily dismissed as one-off event.  After the initial blithe dismissal of the emergence of subprime mortgage problems, the world should have learned that such events never occur in a vacuum.  After a world-wide debt binge based on the theory that assets can only rise in value, an unexpected severe decline in asset values leaves debtors with too little cash flow to service their debts.  It was therefore naïve to think that Dubai would be the only nation impacted, and, sure enough, the other shoes have started to fall.  Fitch lowered their rating on Greece to BBB and S&P followed with a change in Spain’s outlook to negative on its current AA+ rating.  The firm had already downgraded Portuguese bonds a few days earlier.  The distress in Greece, Portugal and Spain place the ECB in a tough position.  The central bank has to do what is best for all 16 member nations as a whole, and when they tighten monetary policy the stresses on the weak members gets even worse.  We would not be surprised to see other nations in debt trouble as well, both in the ECB and any where else on the globe.

It appears the continuing slew of problems may finally be registering with investors.  The S&P 500 has hit at least temporary resistance in the 1080-1120 zone where it has spent the last five weeks.  Furthermore, new highs in the major averages have not been confirmed by the Russell 2000, breadth, volume, new 52-week highs or momentum.  As for sentiment, the Investors Intelligence Index shows that only 16.4% of market letter writers are bearish, a percentage usually typical of market peaks.  In our view the market, both fundamentally and technically, is setting up for a major decline.

Source: Comstock

Cullen Roche

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