Financial Sense   Home  l  Market Monitor  l  Market WrapUp  l  Storm Watch  l  About Us  l  Contact Us

Today's Market WrapUp  07.02.2003  Mon  Tue  Wed  Thu  Fri  Puplava Archive

What’s Next?
BY JAMES J. PUPLAVA, CFP

The sentiment indicators are at a record. Optimism has never been higher. The investment public is coming back into the market, day trading is on the rise again and stock prices are up. What’s not to like about this picture?

It appears to many that the good times are back—at least in the stock market. I would follow this up with, “Why” are stock prices up? and "Why" is optimism so high?

Ask an investor this question (or a professional for that matter) and chances are you’ll get a standard reply. It is confidence in the Fed and the government to resurrect a recovery. It is absolute faith in Mr. G’s green thumb to work his monetary magic. There is also the added confidence that is coming from a major fiscal stimulus from the government. The government is spending big money and the Fed is printing big money. So with this much stimulus, there is bound to be a big comeback in the economy. That is why the stock market is going up. It is discounting a future economic recovery.

Let's Look A Little Deeper

This argument holds up until you examine its logic. Put another way, if there is so much confidence in Mr. G’s power to resurrect a moribund economy, then why has it taken 13 rate cuts to do so? The economy has not responded to the major monetary stimulus outside a new housing bubble. The technology sector is still in the doldrums, manufacturing is still suffering and laying-off more workers, and capacity utilization rates remain anemic with one out of four factories idle. Simply put, there is no evidence of a strong economic recovery despite massive amounts of new debt added to the financial system and within the economy. Yes, people are still buying real estate, they are still extracting equity out of their homes, and they are still maintaining their spending habits. However, as Kurt Richebächer points out in his recent newsletter, a good majority of this equity extraction and refinancing savings is going to pay for expenditures on basic goods and services. It is costing more money to live these days from higher medical costs, insurance premiums, and food to energy and utility bills. Inflation is becoming more evident in the daily cost of living. We don’t measure this inflation. If we did, the picture would not be encouraging.

Because the costs of goods are going up far more than the government reports, (only idiots believe the government’s inflation numbers) more and more Americans have to borrow money to pay their monthly bills. This is not a good sign. What happens when interest rates stop going down or when housing prices stop rising in value? Will the Fed then pay us money? Unless Mr. G can inflate and monetize another bubble, the consumer consumption binge is about to hit a brick wall. Borrowing money to pay your monthly bills is a not a healthy economic sign. A burgeoning debt burden is what is going to keep the economy moribund and prevent the economy from accelerating as so many are forecasting for the second half of this year. Consumers are spending money all right, and they are using debt to finance all of their purchases. However, the majority of this money—over 60%—is going to pay for normal and ordinary living expenses, not luxuries, not new technology, nor other big consumer durable goods that would give us a robust recovery. There is no pent up demand. Most people are just trying to get by and it is taking more and more and more debt to do just that.

As for business, it's in the same boat. There is no pricing power so the only way to increase profits is to cut costs and lay off more workers. Top line growth is what drives business profits and top line growth has been dismal. Profits are up year-over-year, but this has come mainly from cost cutting. You can cut your costs forever or continue to fire workers continuously to return to profitability. Restructuring charges produce only temporary benefits. Eventually you have to figure a way to increase your top line growth or else your business atrophies and eventually dies.

There will be no discernable pick up in capex spending this fall because the economy is still plagued with excess capacity and malinvestments, which have yet to be liquidated. The revival of the junk bond market and the narrowing of credit spreads have done nothing more than put more companies on temporary life support.

Meanwhile the stock market, especially the NASDAQ, has been on a terror lately all based on optimistic forecasts for earnings and predictions for another second half recovery. The fact that there is very little evidence to support this is what is missing from most analysis that I read. A lot of assumptions are made, but very little evidence or proof is given to support these assumptions. All you hear is the constant mantra of easy monetary conditions and renewed physical stimulus. It is never mentioned that it now takes almost $5 of debt to produce $1 of GDP. That nobody questions this is what surprises me.

A Foul Weather Fall?

Digressing here for a moment, I would like to return to my favorite pastime, which is sailing. I use weather analogies a lot, because I find they are helpful. If you live on the East Coast you know the old saying that the Grand Banks are no picnic in the fall. Some of the toughest weather is found on these waters in the fall. Likewise, the stock market is no picnic either in the fall. I suspect that when the economy doesn’t recover as forecasted for the fourth year, or if company earnings don’t improve, or if more companies issue warnings, we could be in for some rough weather this fall. Everything that has occurred in the stock market so far this year is all riding on hope, a lot of hype and near religious optimism. Wall Street is expecting miracles this fall and economic apparitions by December. The question is: What happens if these miracles and apparitions don’t take place? The stock market has discounted some pretty hefty earnings to materialize in the second-half of this year. It doesn’t matter that most of these earnings are of the pro forma variety; it is still going to be a big mountain to climb. Unless Mr. G can start producing miracles, pull a rabbit out of his hat, or produce some sort of illusion, we should be experiencing a full gale by October or even as soon as September.

Here's Something to Think About

While there has been great excitement by professionals and the public these days over the recent levitation of stocks, in particular technology, I would like to point out two contrary indicators that investors should pay attention to. The degree of insider selling has not been this high since the heady days of late 1999 and the spring of 2000. In addition to some of the largest insider selling we have seen since the bubble burst, smart money commercials have gone considerably short again on the S&P 500; while the public has gone long. Commercials have been net short this market until March 24^th when they went long to ride out this rally. As of June 26^th they have now increased their short positions to 42,144 contracts. Commercials have been gradually increasing their short positions in June and are now accelerating that increase as of last week. The individual investor who went short in March has now gone long to the tune of 74,223 contracts. The smart money has been right in this market and now that money is going short. It is one reason I keep emphasizing that unless you are a professional trader, and thoroughly familiar and a master of technical analysis, you don’t belong in this market. This is a bear market rally and as such it is a trading rally. Unless you have considerable trading skills and are master of your emotions, you are in treacherous waters.

Although the stock market has done well recently, there is another bull market that is ongoing that few on Wall Street are talking about. It is the rally taking place in precious metals, foreign currencies, select commodities (energy being one of them), and especially in junior mining stocks. Euro-denominated debt, especially government bonds, are up between 10-15%. The HUI is up over 35% from its March low. Natural gas stocks are up between 20-30%. Small cap natural gas stocks and junior mining stocks are up even more. Several small cap juniors are up over 50-60% this year. The bull market in “things” still continues to roll on; it is just that nobody is talking about it. As far as which asset is in a bull market, paper or “things,” I think the two charts below of the S&P 500 and gold showing 20 and 40-month moving averages tells the whole story:

... and here's an interesting table to complete the picture:

Today's Market

Wall Street issued a plethora of upgrades today in the tech sector, upgrading Microsoft and Cisco to a strong buy. That helped to rally the NASDAQ to its best close of the year. The Dow rallied as did all the major indexes with only three of the Dow’s components, Coke, GE, and Kodak, finishing on a negative note. Technology, biotech, and brokerage shares led the advance.

Volume hit 1.44 billion on the NYSE and 1.85 on the Nasdaq, which was pretty strong for a short holiday week. Breadth was positive by 25-7 on the NYSE and by 23-8 on the Nasdaq. The VIX continues to fall slipping .15 to 21.14 while the VXN went in the reverse direction edging up.83 to 31.05 but still in highly complacent territory.

Copyright © 2003 Jim Puplava
July 2, 2003

Graphic source: www.StockCharts.com

Financial Sense   Home  l  Market Monitor  l  Market WrapUp  l  Storm Watch  l  About Us  l  Contact Us