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The following is an excerpt from our GMR #3 of 15
April.
US Big Picture Walkabout - Stagflationary
Tendencies?
Here's a few things on my mind, albeit just a few,
but enough to keep me busy while I lay in bed with eyes wide open...
geopolitical concerns in the Middle East (Iraq mess, Iran saber
rattling, Natural Gas Cartel), the US administration in a mess and an angry
Congress and seemingly a lot of dirt under the carpets in Washington, the Fed
obviously is not sure what the hell is about to happen in the subprime / housing sector and spillover
into the larger economy, US earnings dropping lower, US savings rate
continues to sink below 0, US and Eurozone trade
protectionism on the rise against China, big concerns about global warming,
Russia is in political turmoil as pro-democratic parties are
"threatening" Putin and the oligarchs, US
missile shield planned for Europe is provoking Putin,
on and on and the VIX shows no signs of worry. In fact, the markets seem
impervious to it all - the sun is shining and life is good, until it's not.
What will the trigger(s) be to bring it all down? Or will we all continue to
hope for the best and simply float along?
Yes, I am being facetious, of sorts, yet the markets
continue their grind higher. Have you noticed gold ?
It and silver have been stealthily also climbing higher and in fact, the
market credo "the bigger the base, the better the case"
comes to mind. Gold has recently been testing the $690 level; silver has now
crossed over $14 - more on that below.
Currently I find the following picture most
informative despite what all the "experts" say about it. Sure, the
yield curve can be wrong in predicting forthcoming recessions but I believe we
must seriously consider the possibility of the US rate yield curve, in
conjunction with a number of other factors as being a powerful reminder
of where we currently are. When the ratio of this curve goes above 1 then
this indicates that the long-dated treasuries are yielding less than the
short treasuries which in turn has often signalled the onset of a protracted
slowdown in the economy.
This, combined with the housing graphic in GMR #2
where I show the US
housing starts dropping significantly lower, implies to me a larger risk of US
economic contraction. Yet the Fed has kept us all in a sort of "greenspan-ish" limbo by leaving the door open to
multiple scenarios:
Not necessarily an unintelligent move, yet one which
takes a step back from previous hyper-hawkishness
on the part of inflation and now leaves the door open to potential easing in
the wake of a geopolitical crisis and/or financial crisis from subprime mortgage sector spillover.
So, even while the Fed has a verbal cushion to fall back on either way, we
could see more signs of dovishness in the future.
The most recent market data is implying a steady
rate posture coming from the Fed yet we remain, still, at this point, with
our forecast of 4.75% by end of year. This may fly in the face of consensus
yet I feel there are stiffer headwinds facing the US economy and that the Fed will
be forced to at least make a concessionary cut for the markets and to
maintain psychological bullishness within the financial markets. Despite the
history of the Fed being mostly behind the curve when it comes to taking
action, I feel that by Q3 the Fed will have significantly softened its
stance.
 The biggest
variable I currently have on my radar is that of oil and gas prices. If for
unforeseen reasons the geopolitical landscape would increase in risk
dramatically, then energy prices may force the Fed to hold rates in order to
battle any inflationary prices in the commodity sector - this certainly remains
a valid concern.
Despite the case I have outlined above, the case is
certainly not clear cut for a US
recession - in fact most of the corporate research I go through points to a
benign or soft-landing for the US economy. Here from SG,
Ample liquidity in many markets, a recovering
"carry-trade" and healthy economic evidence remains supportive. Our
view, and the one that is currently priced into the market, is of a healthy US economy
that is weathering the headwinds of the housing and auto slowdowns. These
headwinds are contained and will fade as the year progresses.
Yet the US
consumer is certainly not convinced of that viewpoint as surveys indicate
many citizens feel the US
economy is on shaky ground :
April 11 (Bloomberg) -- Most Americans expect a
recession within a year and disapprove of President George W. Bush's handling
of the economy even though the unemployment rate is at a five-year low, a new
Bloomberg/Los Angeles
Times poll found.
Six in 10 who were surveyed predicted a recession,
similar to the 64 percent who anticipated the economy would contract in a
December 2000 poll by the Los
Angeles Times three months before the last decline.
In the current survey, 71 percent of those earning less than $40,000 said
they expect a recession compared with about half for those making more than
$100,000.
"We're living on borrowed time," said
Andrew Herring, 43, a
chemical engineering professor at the Colorado School of Mines in Golden,
Colorado, who took part in the survey. "We spend ridiculous amounts of
money on the war and now we have issues with the subprime
housing market," said Herring, a Democrat.
Fifty-seven percent of those surveyed disapproved of
Bush's handling of the economy and 38 percent approved, his worst showing in
eight months. Nonetheless, 57 percent said the economy is doing well. That
was down 11 points from January.
The International Monetary Fund cut its estimate for
U.S. economic growth,
citing the impact of the downturn in housing, according to its semiannual outlook released in Washington today. The fund reduced its
2007 forecast to 2.2 percent from 2.9 percent in September.
Job Report : The Department
of Labor reported on April 6 that the economy added
180,000 new jobs in March and the unemployment rate fell to 4.4 percent,
matching October's five-year low. On the minus side, gasoline prices have
risen 29 percent since January and the housing market has cooled.
Sixty-four percent of those polled said their own
finances are very or fairly secure compared with 35 percent who described
them as shaky.
"People tend to be pretty optimistic about
their own situation, but when it comes to the larger economy they're much
more pessimistic," said Karlyn Bowman, a
polling expert at the American Enterprise Institute in Washington. "The public's
just in a very sour mood because Iraq continues to cast a pall
over everything."
In conclusion, I would like to float a few ideas
about the next 12 months because as a trained engineer I tend to think in
probabilities as opposed to givens, in fact, there are no market givens.
Let's indulge ourselves in the following scenario :
- US has a
larger slowdown than the Fed is currently admitting and that although maybe
not a full-blown recession neither is it a robust economy growth
scenario - a.k.a. muddle through
- Energy
prices continue steady with an upward bias both in oil and gas prices
- Global warming concerns increase
- Commodity prices continue higher
- Ergo,
inflationary tendencies remain in the "pipeline"
- Ergo, Fed
is torn between fighting inflation or fighting growth weakness
- US Dollar
weakens just as the ECB is tightening rates (as it has already indicated
it will ; foreseeably in June) - spread
decreases - Euro attractive
→ This is a TOUGH SCENARIO to call
IF the US can manage a soft(er) landing than many bears are predicting this would go
a long way to keep the imbalanced, highly integrated world economy from
unravelling. If it cannot, then the consequences of a US "cold"
causing "pneumonia" in other places remain at hand, despite the
better than expected robustness in Europe and a delicate Asian (China, Japan)
outlook.
As I said, this is tough and I certainly do not like
to see that yield curve remain longer-term inverted. I realize I am a
"lone wolf" at this point and have, based on the latest Fed
statements, re-adjusted my outlook of Fed rate cuts
from 75 bp to 50 bp
mostly on the back of anticipated commodity inflation as opposed to weaker
economic growth. Finally, here is a recent remark from BMO, not totally out
of line with my own scenario :
"This week's FOMC minutes revealed that the
phrase shift from "extent and timing of any additional firming" to
"future policy adjustments" did not reflect reduced
rate hike odds. Indeed, the Fed perceived even greater inflation risk than
before. It was the raised odds of rate cuts in response to greater economic
risk that caused the Fed to change its language. Although inflation risks
remained the predominant policy concern, "in light of the increased
uncertainty about the outlook for both growth and inflation, the
Committee...agreed that the statement should no longer cite only the
possibility of further firming." Given the Fed's unchanged outlook
for an inflation-dampening soft landing, many market participants
subsequently concluded that rate cut hopes had completely faded and that
rates would remain unchanged indefinitely. Time will tell, but it's important
to keep in mind that the now fatter tails around the Fed's outlook can
themselves trigger policy moves."
U.S.
Stock Market Overview
After meeting resistance at the chart gaps made by
the Feb. 27 sell-off (particularly in the NDX), most
of the major stock market indices have pulled back this week, taking a
well-earned breather following a sharp run-up last week.
The S&P 500 index (SPX) is still a good 50
points above its intraday low of 1365 from mid-March. The Dow 30 index is
about 400 points above its intraday low of 11,910 and the NASDAQ 100 index (NDX)
is some 65 points off its early March low of 1710.
Perhaps the most impressive of the broad market
indices has been the S&P 400 Mid-cap index (MID), probably the single
best index taking into consideration the current profile of the market. The
Mid-cap index is one of the few indices that was
able to get back above its 30/60/90-day moving average series and has so far
managed to stay above it despite this week's pullback. I view the MID as a
proxy for broad market strength or weakness and major near term support for
the MID lies between the 820 and 830 levels.
As of Tuesday, the 20-day price oscillators for the
S&P 500 and NASDAQ 100 indices have gone into "overbought" readings.
This means the market likely needs more time to work off the recent excesses
from last week's sharp rally. This could translate into a more or less
lateral trend in the next few days until the recent technical extremities are
worked off. I don't expect the market to fall below its correction low of two
weeks ago, however, as the dominant directional bias indicator is still
rising and the main market psychology indicators are still very much bearish
(which is positive from a contrarian standpoint).
Stocks finished the latest week on a positive note
on Friday, with virtually all the averages closing with gains for the week.
The Group Movement Index (GMI), which measures the extent of sector rotation
among the major market segments and thus of accumulation/distribution
pressures, made a new high on Friday. So did the China Shanghai index (SSE). This shows the broad market interim trend to still be
upward.
The market's main breadth measure also continues to
hold up extremely well in spite of the recent spate of bad news. The number
of stocks making new 52-week lows on the NYSE has consistently remained well
below 40 for the past two weeks. On Monday there were only 15 new lows compared
to 184 new highs. This is not meant to imply predictive value in and of itself, for just because sub-surface selling pressure
remains virtually non-existent doesn't mean it can't suddenly increase. But
the odds are against major selling pressure manifesting itself in the near
term based on the factors we've been discussing here.
The Dow Jones Utilities Average (DJUA) has been the
big winner of late as the index made a new all-time high on Monday, closing
at just over the 500 level for the day. We've noted in the past that the
Utilities have long been a leading indicator for the broad market and that a
rising trend punctuated by higher highs in the DJUA has eventually been
followed by higher highs in the other major indices. This is not an
immediate-term indicator, but just something to keep in mind in the
intermediate-term.
Market Philosophy
"But what if this time is different?" I
keep hearing this over and over it seems, wherever I turn. I hear it in the
pages of the financial press...I hear it from concerned investors and
subscribers...I even hear it sometimes inside my own head. So let's ask the
question, what if this time *is* different?
Well is it? I'll give you my straight and honest
answer: I don't know! But since you're not reading me to find out what I
*don't* know let me tell you what I do know: I'm going to follow the dictates
of the time-tested and battle-hardened investment disciplines that haven't
let me down in a major way yet. I'm going to stick to the philosophy that in
the investment markets you must not approach your trades/investments with the
thought that this time must be different...but instead you have to assume
this time *won't* be different. In other words, you must assume the laws of
probability will work in your favor whenever the
odds are in your favor. And the odds definitely favor a bullish investment posture.
I've given a lot of thought to this philosophy in
the past few days, namely, the "this time will be different"
approach to the markets. I conclude that for an investor to favor this approach is like reverse lottery playing.
Lottery players are those who are either stubborn enough (or stupid enough!)
to go against the odds and who like their chances of winning when the law of
probability is firmly against them. That doesn't seem to deter them in their
persistence at frittering away money on what usually amounts to a losing
game.
Yet the reverse of the lottery player's mindset is
to assume that when it comes to trading/investing, one should *not* engage
when the odds are firmly in the investor's favor
because, after all, "this time might be different despite the odds being
in my favor." Sound familiar? We've all heard
it, and let's be honest, most of us have succumbed
to this thinking at one time or another. If you read the financial press
you're being constantly subjected it to it today. But if you embrace the
"this time will be different" way of thinking then my question to
you is, "Why even bother trading or investing?"
If you have investments in the stock market it's presumably
because you believe in playing when the odds are in your favor.
I'm assuming that most of you make informed investment decisions through
careful analysis and consultation with one or more investment analysts or
stock market advisory services (including, perhaps, yours truly). So assuming
this describes you (and it certainly describes me), then why should we assume
that this time will somehow be different? Why go against the grain of the
fundamental/psychological/momentum indicators? Why assume that the bears will
win out this life-or-death struggle and that the bull market is finally over?
If we're going to make that assumption based on nothing more than gut feeling
or instinct or fear, then we might as well chuck the indicators right now and
retire from the investment markets because the whole point of having a
discipline (or "system" if you will) is to stick to it as long as
the signals are favorable. If you arbitrarily
decide to ignore your system then you've defeated the whole purpose of having
one.
But...and here's the clinker: what if this time
really does turn out to be the exception to the rule? After all, we live in a
dynamic world where strange things can and do sometimes happen to upset even
the "sure things," especially in the financial markets. I'll admit
that there's always the possibility that this time could prove to be
different (i.e., a bear market and recession that develops in the face of
bullish monetary, psychological and momentum factors). In that case we have
an exit strategy by cutting our losses when it becomes obvious that we're
just plain wrong in our assumptions. But unless and until it happens the
rational investor should stick with his or her disciplines as long as the
odds are favorable. Right now those odds are still
firmly in the investor's favor.
Come join us - we have an excellent track record of
calling the markets - private and institutional investors in 40+ countries.
Best regards from the GMR,
By : Randolph Buss
Editor, Der Invest Informant
Berlin, Germany
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