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 By Prieur du Plessis, on January 9th, 2008 posted in: Equities, Investment, Stocks, Wall Street  11 people had their say - chime in!
“Winter, spring, summer or fall, all you have to do is call, and I’ll be there, you’ve got a friend …” These are the lyrics of Carol King’s song. Yes, as life swings from boom to gloom it is the support of friends that often provide the necessary solace. It is unlikely that Mr Market will come patting you on the back when your investments go pear-shaped, but he does provide his own unique variety of comradeship. In an environment cluttered with noise, Mr Market offers us the very simple but true adage of “the trend is your friend”. This sounds comforting enough, but Mr Market still expects us to fulfill a task: to identify the direction of the trend. An important point to realize is that there are trends within trends, varying from ultra short (intra-daily) to short (daily) to intermediate (weekly) to long term (monthly). Although day traders play short-term trends from minute to minute, I believe that it is really the identification of the primary (multi-year) trends that holds the key to successful investing. One way of approaching this is to gauge the fundamental landscape – factors such as unfavorable valuations, stretched profit margins, mounting evidence of an imminent recession and increasing default risk. These paint a fairly bleak picture, but keep in mind the discounting nature of the stock market, having already factored in the gloomy news we are faced with 24/7. In order for the market to fall further the nature of the problems should turn out to be broader and deeper than currently discounted. As mentioned previously, I believe that the fallout of the housing and subprime situation has not been fully discounted. A more visual way of recognizing the primary trend is by means of analyzing the technical picture, especially using a longer-term perspective. The following graph indicates how the Dow Jones Industrial Index has been mapping out a series of lower lows and fallen below its 200-day moving average (often seen as an indicator of the primary trend). The shorter term 50-day moving average is trending down and provides an early indicator of what is in store for the longer-term average. The Index has just dropped below its November low on increased volume, serving as further confirmation of a downtrend.
Source: StockCharts.com The chart below shows the percentage of stocks on the NYSE that are trading above their 200-day moving averages. As of yesterday’s close the reading was 28.1%. This is the lowest reading in five years and indicates that more than seven out of every 10 stocks are in primary downtrends. Although the current level appears low, the number has fallen as low as 10% at previous bear market bottoms (such as 2002).
Source: StockCharts.com Next is the 10-year graph of the NYSE Composite Index (based on monthly data), indicating the price trend together with the MACD oscillator. The failed year-end rally in December witnessed the histograms falling below the zero line (see blue circle) for the first time since the start of the bull market in 2003. (The previous MACD sell signal was given eight-and-a-half years ago in July 1999.)
Source: StockCharts.com Turning to a monthly graph of the Dow Jones Industrial Index, a similar picture emerges when using the 14-month RSI oscillator. This indicator is overbought at levels above 70 and oversold below 30. The RSI’s trend is now falling for the first time since the bull market commenced in 2003.
Source: StockCharts.com My assessment of the above is that there is more weakness for the stock market ahead. Although the market is oversold on a short-term basis, I would be very reluctant to take long positions in the face what I believe is a market topping out and embarking on a primary downtrend. I therefore concur with Nouriel Roubini, professor of economics at New York University, when he says: “… a lousy stock market in 2007 will look good compared to an awful stock market in 2008.” I wrote a series of bearish articles on the stock market (and bullish on gold) during the latter months of 2007 of which the last one on December 17 was entitled “Is this the end of the stock market party?”. Mr Market has provided the answer and it is a rather discomforting one. Yes, “the trend is your friend”, but only if you heed Mr Market’s warnings and appreciate that the stock market is in a downtrend. Be inordinately cautious with your investment strategy.
Source: Unknown More on this topic (What's this?) Congressional Insider Trading… It’s Good to Be King (Investment U, 11/18/11) Martin Luther King Jr. Infograph: Little Known Facts (Value Investing, 1/16/12) Martin Luther King’s Most Inspirational Quotes (ValueWalk.com, 1/16/12) By Prieur du Plessis, on January 8th, 2008 posted in: Economy, Investment 4 people had their say - chime in!
The hot financial topic of discussion at the moment is the likelihood of a US economic recession. Against the background of a deteriorating economic landscape, it is not surprising that more and more commentators have started declaring that a recession was either already underway or just around the corner. A noteworthy contribution to this debate has just been offered by Asha Bangalore, economist of Northern Trust. Her analysis deals specifically with the movements of the S&P 500 Index just prior to and during a recession. The leading/lagging properties of the Index, and by how much it changes during a recession, are summarized in the table below. S&P 500 Index – peaks and troughs
Two major conclusions follow from Bangalore’s research:
By the close of the market yesterday the S&P 500 Index was down by 9.5% from its peak in October 2007. Although the expectation of a recession has been gaining support, it does not represent a consensus view by a long shot. Using Bangalore’s analysis of the historical relationship between the stock market and economic cycle as a guide, a rough ride could be in store in the months ahead. More on this topic (What's this?) U.S. Economy 2012 Forecast: Where to Find the Biggest Gainers and Avoid the Biggest Losers in Thi... (Money Morning, 12/23/11) Portfolio Update: Value Stock Guide Portfolio Up 12.90% vs 4.41% for S&P500 in January 2012 (Value Stock Guide, 2/4/12) Poll Misses Point: Washington and Wall Street Partners in Blame for Bad U.S. Economy (Money Morning, 10/19/11) By Prieur du Plessis, on January 6th, 2008 posted in: Economy, Investment, Markets 6 people had their say - chime in!
A trading week made up of a bit of the old year and a bit of the new caused some anxiety in financial markets as economic woes escalated and weighed on investor sentiment. The problems related to the housing market and the subprime implosion seemed to be coming to a head. After all, the Dow Jones Industrial Index recorded its worst three-day start to a New Year year since the depths of depression in 1932, according to Barron’s. Stock markets were left in the shade as both gold and oil hit all-time highs. Nouriel Roubini, professor of economics at New York University, wrote on his blog: “… the stock market started the year with another bearish fall … a lousy stock market in 2007 will look good compared to an awful stock market in 2008.” Santa Claus failed to call upon the traders on Wall Street. The “Santa Claus Rally”, as defined in the Stock Trader’s Almanac, is the propensity for the S&P 500 Index to rally during the last five trading days of December and the first two of January. This year’s Rally saw the S&P 500 Index down 2.5% and the Dow Jones Industrial Index (-2.9%) and the Nasdaq Composite Index (-3.3%) were not spared either. It is pointed out by the Stock Trader’s Almanac that the lack of a rally had often been “a harbinger of a sizable correction or a bear market in the coming year.” Hence the saying: “If Santa Claus should fail to call; bears may come to Broad & Wall.” John Mauldin, author of the Thoughts from the Frontline newsletter, is also of the opinion that the equities bull market may finally succumb in 2008, and said in his 2008 forecast: “I think that we are in a recession for most of the first half of this year, and that we begin a slow recovery in the second half. It will be a Muddle Through Economy for at least another year after that. That would suggest that most companies will come under serious earnings pressure. If history is any indicator, that means we should see a bear market in the first half of this year. How deep will depend on how fast the Fed cuts, but I don’t think we are looking at anything close to the bear market of 2000-2001. Still, I wouldn’t want to stand in front of a bear market train.” Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance chart. Economy The much anticipated US employment report on Friday, which showed weaker-than-expected job growth and a rise in the unemployment rate, compounded investors’ worries. According to the Institute for Supply Management, national manufacturing activity shrank unexpectedly in December. Specifically, the ISM Index fell to 47.7 from 50.8 in November – a reading below 50 indicates a contraction in manufacturing activity. These reports provide strong support for further Fed easing. An interest rate cut of 25 basis points at the FOMC’s next meeting on January 30 seems a foregone conclusion, but the Fed Fund futures now also indicate a 46% chance of a 50 basis point reduction. “There are those who hope that the Fed will ride to the rescue with more rate cuts. I believe they will, but it is a case of ‘too little, too late’,” remarked John Mauldin. WEEK’S ECONOMIC REPORTS
Source: Yahoo Finance, January 4, 2007. The next week’s economic highlights, courtesy of Northern Trust, include the following:
Markets
Source: Wall Street Journal Online, January 6, 2007. As this article deals only with the past week’s performance, a separate performance review of 2007’s market movements was posted on the blog last week. This round-up makes for interesting reading and also provides pointers of what to expect in the year ahead. Please click here for full the article. Global stock markets began the year on shaky ground, trading lower during the past week amid escalating concerns about the fallout in the housing and credit markets. The MSCI World Index lost 3.2% during the course of the week, but a number of emerging markets helped to stem the overall losses. The US markets were at the forefront of the sell-off with the blue-chip Dow Jones Industrial Index losing 4.2%, the broader S&P 500 Index 4.5% and the technology-heavy Nasdaq Composite Index 6.3%. Small caps and the sectors for REITS, financials, housing and consumer discretionary spending, in particular, were not spared the selling pressure. Government bond yields declined in both developed and emerging markets as the global economic outlook worsened and investors switched stocks to what is perceived to be a safe-haven asset class. On the currency front, the US dollar came under renewed pressure as markets started pricing in the possibility of the Fed reducing interest rates by 50 basis points at the end of January. Concerns about the deteriorating prospects for the UK economy resulted in the British pound recording a four-year low against the euro. The star performers among the major currencies were the Japanese yen (+4.1%) and Swiss Franc (+2.0%) as increased risk aversion resulted in unwinding of carry trades. The Chinese yuan also caught the limelight on the back of its uptrend (as reported in the “quotes section” below). Commodities were the big winners during the past week as investors piled into oil and precious metals. Crude oil hit a record level of $100 a barrel early in the New Year, but subsequently eased back somewhat. Factors driving the oil price included a weaker dollar, geo-political tensions over the Middle East and supply concerns. The gold price also reached a record high during the past week, soaring above the $850 an ounce level last achieved in January 1980. In addition to the factors driving the oil price, gold benefited strongly from mounting inflation jitters. Agricultural commodities again put in a strong performance and gained 3.6% during the week. This week promises to be a key week for the direction of financial markets. Hopefully the words (and graphs) from the investment wise below will assist in guiding us through the stormy waters and making the correct investment decisions. But firstly, to cheer you up, here is nature’s way of saying “have a nice day!”.
Hat tip: Jim Sinclair’s Mineset Financial Times (Alphaville): Marc Faber – when surrounded by rubbish and danger, buy gold “In the New Year issue of his Gloomboomdoom.com monthly market commentary for subscribers, Faber muses darkly on the direction of the US economy, markets, bond insurers and Wall Street banks, and concludes – as he has increasingly in the past months – that gold, among other commodities, is a very good place to put your money. In the US, the severity of the housing recession is evident from the record level of existing home inventories as a percentage of US households, he notes. ‘It should therefore, only be a matter of time until housing starts decline further and will also signal the onset of a recession.’ “He sets out three key observations:
“Emerging stock markets are definitely to be avoided, he adds, ‘following their significant out-performance over the last few years’. “So, where would Dr Doom put his money? He likes sugar, cotton and he still recommends accumulating gold, which he expects to continue to out-perform equities for several years. Still, nothing goes up in a straight line, notes Faber, and, therefore, investors need to be aware that gold could still correct to around $750 or so.’ “In Faber’s opinion, ‘the gold bull market will come to an end when Sovereign Wealth Funds – sick and tired of their investments in financial stocks – will finally purchase gold – probably at above $3,000 per ounce.’” Source: Gwen Robinson. Financial Times – Alphaville, January 3, 2008. Richard Russell (Dow Theory Letters): Stock market’s primary trend turning down “Answer – As you know, I’m guided at all times by the action of the stock market itself. When the market doesn’t agree with me, I stop, revise my thinking – and get in harmony with the market. Which is what I’ve been doing over recent weeks. “Something has interrupted the major rising trend of the market. It’s not a little thing, no, it’s something very big, very powerful, very basic. Frankly, I don’t know what it is. Could it be that the dollar is in serious trouble? Could it be that the US economy is in chronic trouble? Could it be that the US consumer is finally throwing in the towel on spending? Could it be that the real estate situation is a lot worse than we think? Could it be that the situation is so major that it is beyond the Fed’s ability to manipulate? I don’t know, I honestly don’t know. “But I do know one thing. The primary trend, the great tide of the stock market, appears to be in the process of turning down.” Source: Richard Russell, Dow Theory Letters, January 4, 2008. Asha Bangalore (Northern Trust): Weakness in US labor market points to recession Note: Shaded areas denote recessions. Unemployment Rate and Recessions “Payroll employment rose only 18 000 in December, the smallest gain since August 2003. Revisions to October and November payroll estimates show a net gain of 10,000 jobs. Private sector payroll employment fell 13 000 in December, the first monthly record of private sector job losses since July 2003. Total payroll employment increases averaged 111 000 per month in 2007 versus a 189 000 per month in 2006. On a year-to-year basis, total payroll employment slowed to a 0.9% gain, down from a peak growth rate of 2.14% in March 2006. Household survey data also show a similar decelerating trend in hiring.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 4, 2008. Continue reading Words from the wise for the week that was (Dec 31, 2007 – Jan 6, 2008)
Dead on target on the first day of the New Year, Byron Wien again published his annual list of surprises to expect in the coming year. Wien, chief investment strategist of Pequot Capital, has been publishing his list of economic, market and political surprises since 1986. Reviewing Wien’s 2007 list, he got about half of his predictions right. He foresaw the surge in agricultural prices, the Fed refraining from reducing interest rates in the spring, and Latin America putting in a good performance. He furthermore predicted gold bullion at $800 and oil at $80 – perhaps too conservative but nevertheless in the right ballpark. Wien was, however, quite wrong with his prediction of a year-end yield of 5.5% for the US 10-year Treasury Note, as the actual figure turned out to be significantly lower at 4.04%. Although Wien’s prediction of higher stock market volatility, expecting a year-end VIX Index of 20 (compared with the actual value of 22.5) was on target, his other stock market predictions were off the mark. He expected the S&P 500 Index to be 1 600 by the end of 2007 and the Japanese Nikkei 225 Average to gain 15% during the course of the year. Both turned out off the mark – the S&P 500 Index closed the year at 1 468 and the Nikkei declined by 11.1%. Wien also erred with his prediction of S&P 500 earnings growth of 10% – the final number was closer to zero. Wien believes his ten surprises have at least a 50% chance of occurring at some point during the year. Although this is not a very high probability, his predictions nevertheless make for interesting reading. His list for 2008 is as follows:
 By Prieur du Plessis, on January 3rd, 2008 posted in: Investment, Performance round-up 5 people had their say - chime in!
2007 ended with a nasty hangover in the case of some asset classes and stock market sectors, but also with pockets of splendid performance. Reviewing the past year’s investment returns makes for interesting reading, but also provides guidelines in some instances of what to expect in the year ahead. In order to glean the macro view of what transpired last year, it is useful to consider the performance of the principal asset classes as a point of departure. I have deliberately kept the commentary rather brief as the detailed reasons for specific movements have already been covered in my weekly “Words from the Wise” article.
Source: Stockcharts.com Commodities (+16.7%), in general, were the top-performing asset class, followed by the US 10-Year Treasury Note (+4.9%) and the S&P 500 Index (+3.5%). A money market investment, based on the average US 3-Month T-Bill rate, would have yielded a return of 4.4% – somewhat better than the S&P 500 Index (but less than the Dow Jones Industrial Index and the Nasdaq Composite Index as shown later in the article). The other side of the coin saw the Dow Jones REIT Index declining by 19.2% and the US Dollar Index by 8.4%. The dollar weakness was naturally one of the factors contributing to the strength in commodities. Interestingly, the performance table changed around quite dramatically during July 2007 as the subprime problems started to surface, resulting in an acceleration of the US dollar’s downtrend and large-scale switching from stocks to bonds and commodities.
Source: Stockcharts.com Zooming in on stock markets, the chart below shows the Dow Jones World Index gaining 8.4% during 2007. Top-notch performance was achieved by emerging markets (+28.8%), and specifically by China (+110.1%), India (+69.4%) and Hong Kong (+39.4%). On the other end of the spectrum, Japanese stocks (-5.5%) were in the doldrums and experienced losses. As far as the major US stock markets are concerned, the blue-chip Dow Jones Industrial Index gained 6.4% – somewhat better than the S&P 500 Index’s 3.5%, but behind the technology-heavy Nasdaq Composite Index’s respectable 9.8%. US small caps, as represented by the Russell 2000 Index, fared poorly in the light of being more sensitive to an economic slowdown and depreciated by 2.8%.
Click here for the detailed performance figures, ranging from one month to three years, for 55 global stock markets. Looking in some more detail at the various US stock market sectors, seven out of the nine sector SPDRs recorded gains, whereas the Consumer Discretionary SPDR (-14.0%) and Financial SPDR (-20.0%) were the big losers. This weakness was offset by Energy (+36.1%), Materials (+21.5%), Utilities (+17.0%) and Technology (+15.4%), resulting in the major US indexes still ending the year in positive territory.
Source: Stockcharts.com The stark difference in performance between the diamonds and dogs are illustrated clearly by the graph below comparing two of the top-performing industries – Oil Services (+50.9%) and Gold & Silver (+21.8%) – with three of the worst casualties – Housing (-38.9%), Banks (-24.6%) and Retail (-17.9%). The subprime fallout, needless to say, stands largely to blame for this dismal performance.
Source: Stockcharts.com The credit crunch resulted in interest rates declining across the spectrum of the yield curve but to a larger extent on the short end, resulting in a steepening yield curve as shown in the diagram below. As the credit situation deteriorated, safe-haven buying resulted in yields of government bonds being pushed down across the globe.
Source: Stockcharts.com The US dollar’s downward trend intensified as the implications of the subprime debacle started to unfold, resulting in the US Dollar Index losing 8.4% during the course of 2007. The largest beneficiary of the dollar’s woes was the euro with a gain of 10.6%.
Source: Stockcharts.com On the commodities front, oil (+52.3%) was the star performer on the back of a tight demand/supply situation and omnipresent geopolitical tension. Agricultural commodities (+41.1%) also shined as producers battled to keep up with increasing demand. The precious metals complex benefited from the Fed’s easier money policy and mounting concerns about rising inflation. Industrial metals, however, were the odd one out and faced declining prices as investors started factoring in slower economic growth.
Source: Stockcharts.com The overriding message of the above analysis is the strong emphasis on defensive asset classes and sectors. There also does not seem to be any indication of last year’s primary trends reversing as we enter 2008, although some of 2007′s laggards may bottom out during the course of this year.
Waving the old year goodbye with a few new records under the belt is no mean feat, but the real glitter for gold bullion is that most indicators seem to point to more good news down the line. The first record is that the gold price recorded its first ever month-end close above $800 on Monday, December 31. As mentioned in my blog post “Gold bullion – a belated Christmas gift” (December 27, 2007), gold had only closed above this level on two days during its 1980 surge, namely: $830 on January 18 and $850 on January 21. However, the end of January 1980 saw the price significantly lower at $659. Looking at monthly averages, January 1980 was $675. This figure was equaled in May 2006 and exceeded for the first time in April 2007. A new record of $806 was established in November 2007, whereas December’s average was slightly lower at $802. It is, of course, true that in inflation-adjusted terms the gold price is still a long way off its euphoric days of 1980. If adjusted for movements in the US consumer price index, the $850 record would today be around $2 250 and the average for January 1980 around $1 790. Real gold price* (January 1971 to October 2007) *Monthly averages revalued to Q3 2007 prices. (Gold price deflated by seasonally adjusted US consumer price index.) More importantly, the gold price is not only making headway in US dollar terms, but also in most major (and minor) currencies. This is a manifestation of increased investment demand, whereas the initial rise in the gold price from its low in 2001 ($250) until the middle of 2005 was mostly a reflection of US dollar weakness. The World Gold Council reports that identifiable investment demand during the third quarter of 2007 was nearly double year-earlier levels in tonnage terms. Further to the table published in my previous article, gold has now entered record territory in terms of most currencies other than the US dollar. This includes the currencies of the two largest consumers of gold, namely the Indian rupee and the Chinese renminbi as illustrated below. (China has just overtaken the US as the second largest gold consumer after India, according to the World Gold Council.) Gold in Indian rupee
Source: Fullermoney.com Gold in Chinese renminbi
Source: Fullermoney.com Other central banks pursuing a policy of increasing their gold reserves relative to fiat currencies include Russia and Saudi Arabia. The following charts show the gold price in their respective currencies: Gold in Russian ruble
Source: Fullermoney.com Gold in Saudi riyal
Source: Fullermoney.com I have debated the fundamental case for investing in gold on a number of previous occasions, but let’s recap the implications of the inflation/deflation scenario by means of an excerpt from Richard Russell’s Dow Theory Letters. (I should add that he has been reading the gold cycle with painstaking accuracy.) Russell says: “… the Fed is fighting the potential forces of deflation. What deflation? Deflating home prices, a potential decline in consumer spending, plus the specter of rising unemployment. … let’s say that in 2008 the economy turns ‘bad’. In that case, the Fed will step on the accelerator and fight the downturn with everything at its command, which … means expanding liquidity and declining short rates. … the ideal atmosphere for a rising price of gold.” Examining the opposite side of the coin, he argues: “Let’s say that the US economy stabilizes. The housing situation hits bottom and begins to improve. Business realizes that the worst is over for banking and housing – the economy is starting to recover. In the face of this, all the Fed’s previous monetary machinations begin to ‘kick in’. Under those conditions, gold is again advancing. All the money that was created during 2007 to counteract recession now acts as an ‘overflowing punch bowl’. The global economy is ‘on fire’. Under these conditions, gold heads sharply higher.” The one situation that could be bad for gold is when deflation takes over and there is a panic for cash in order to stave off bankruptcy. A variety of assets, including gold, would then be sold in order to raise dollars. But this state of affairs is rather unlikely while central banks are at liberty to create money out of thin air. I cannot help but conclude that we have not yet seen the last of the yellow metal’s new records and that more excitement lies ahead. For starters, I will not be holding my breath for the all-time high of $850 to be breached. After all, platinum, which often leads gold higher, has already recently recorded an historic high in US dollar. More on this topic (What's this?) Scary: Why China is Buying Gold Like Mad (Learn Mining News, 1/30/12) Why the Gold Slump is Not Over (Investment U, 1/9/12) Gold and Silver Are Headed for Record Highs (Wealth Daily, 1/31/12) |
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