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Slowdown or Meltdown?

05/24/2011
May is happily approaching the end. Appreciation in the S&P 500® has stalled, spring has been absent in New York, and the Yankees have struggled all month.
 
Bring on June, a month that will provide further evidence of whether what the capital markets are experiencing is a slowdown or a meltdown.
 
Let's look at some evidence that I expect will prove it's a SLOWDOWN:
  • The early May sharp sell-off in commodities was largely driven by speculative excess that has since normalized. From the stratosphere, commodity prices have normalized back toward secular support (Figure 1.1). Fundamentally, 'Dr. Copper" suggests emerging world demand is returning. The International Copper Study Group reported this week that supplies trailed demand by 17,000 tons in the most recent month (February) -- the second consecutive monthly deficit.
Private sector borrowing costs remain historically low and corporations are accessing the credit markets to fund M&A, pay dividends, and buy back shares. Watching the HBO docudrama "Too Big to Fail" the other evening, I was eerily reminded about the frozen credit markets in 2008, a condition that exists in a capital markets' meltdown, not a slowdown.  The current credit markets are fluid, not frozen.
  •  This week, Caterpillar (CAT) announced it will fund its $8.6 billion acquisition of Bucyrus International (BUCY) by scrapping its previous equity offering plan in favor of $4.9 billion in bond sales. Caterpillar's stock has appreciated 50% since September 2010.  If management didn't believe in the global growth story and further equity appreciation, they would have issued equity.  A meltdown is not feared in the executive offices of Caterpillar.        
  •  More evidence of a slowdown comes from the high yield debt market. Last week  EchoStar (SATS) sold $2 billion worth of bonds to fund its Hughes Communications (HUGH) purchase.  Alpha Natural Resources (ANR) sold $1.5 billion to fund its Massey Energy (MEE) purchase.
 The cyclical strategy remains:  Be defensive, emphasize diversification, and wait out the current SLOWDOWN. 
  
Figure 1.1 XLE (Energy ETF)

Source:  Bloomberg

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