Noise,
Noise, Noise, Noise....
John Riley, Chief Strategist
12/03/07
Our world is
full of noise. Kids, traffic, TV and whatever else drives you crazy.
We have to keep focused on what we are doing and put the noise behind
us. The noise can’t distract us from our objectives.
The market is
more full of noise than usual these days. And just like the rest
of our lives, we have to stay focused on what is important and ignore
much of the noise. Sometimes, like a parent that can determine the
difference between a pain scream and a playful scream from their
kids, you have to learn to decipher the noise.
For instance,
the recent $7.5 billion investment from Arab investors into Citi
was received by the market as a signal that the worst of the sub-prime
mess was behind us and that much better days were ahead.
We didn’t
view it quite the same. The first thing we questioned was why go
overseas for a bailout? Were there no sources domestically? The
next thing was that Citi is paying 11%, a rate double what they
normally pay on debt. Why? Why would they give any investor a rate
double their normal rate? And last was the size of the investment,
7.5 billion sounds like a lot, but in terms of the sub-prime mortgage
mess and the broader mortgage mess and the derivatives mess (don’t
get me started there…) this is not even a drop in the bucket.
So what is really
going on at Citibank? How bad are things there? And if they are
this bad at Citi, how bad is it at JP Morgan, BankAmerica and the
rest? The only conclusion we can come to is that Citibank was desperate
for a cash infusion (Why else would they pay double their normal
rate?) and that this will not likely be their last desperate grab
for cash.
Putting it in
perspective, the mortgage mess took 10 to 12 years to develop, it
isn’t going to be resolved in three months. The fallout is
only beginning.
We anticipate
there will be a failure (or two) of a major financial institution(s),
a significant decrease in available mortgage financing, (and re-financing),
continued falling home prices and rising unemployment. The cycle
will continue to feed into itself. The bottom won’t be hit
until home prices have given back much of their gains of the past
five to ten years, and debt ratios are back to historic norms. Because
of the decreasing home prices, debt ratios are not likely to return
to norms for years. A three month solution? Forgetaboutit!
The sub-prime
mess is only one of the loudest noises to distract investors. Other
noises include 200 and 300 point daily swings in the stock market,
commodity prices spiking up and retreating, politics and most of
all - self-serving pronouncements and reports from Wall Street and
the Federal Reserve, who’s goals and strategies of self-preservation
have never been so united.
Below are the
recent charts and some interesting perspectives.
The big moves
recently have not been enough to send the Dow Jones above the 13500
resistance level. This may happen soon, but until it does, the downside
is more likely. Holding support at 13000 is important to prevent
further declines.
One of the benefits
of Point & Figure charting is how it eliminates a lot of the
daily noise. You can clearly see that 13500 is the next resistance
area within a down trend. Rallies within a down trend are selling
opportunities, not buys.
The S&P
500 is mirroring the Dow in that it has hit and held support and
is just under an important resistance level.
Until the S&P
breaks above the 1490/1500 area, it is in a downtrend and should
be expected to continue lower, despite the recent noise.
The Dow Jones
World Index looks like its domestic counterparts, until you look
at the P&F chart below.
It is still
trading well above its bullish trend line. This puts the potential
for correction extremely high with possibility of a 50% decline.
Or… the World markets could trade sideways for a while, months,
maybe a year or so. If the world markets were to have enough volatility
but still do nothing more than “run in place”, the bullish
trendline could catch up to the index and the size of any decline
could be mitigated.
Our position
on the international stock markets is much more positive than on
US stock markets. A decline, a major decline, in the international
markets would be a buying opportunity, while a decline in the US
markets will likely be followed by more declines, since the market
support from the past few years (Consumers and real estate) are
tapped out, dried up, or gone.
This is a major
reason for the potential for a long term US stock market decline.
Long term interest rates have likely bottomed years ago.
Don’t
be fooled by the recent noise of lower long term rates. The overhang
of unhappy foreign bond holders, inflation and the domestic mortgage
mess have not gone away. The recent rally in the long bond is a
selling opportunity.
Short term rates,
the most easily manipulated, show just how noise can get in the
way. The long term trend has been down, but several times, rates
dropped quickly, only to be followed by increases, up to the trendline.
Unfortunately, the interest rates drops corresponded with huge increases
in debt. While rates went back to trendline, we were left with huge
piles of debt.
The US Dollar
has recently had an uptick, sending gold and oil lower. But the
uptick has been within the down trend. Again, the fundamentals should
control the long term and the fundamentals for the Dollar are poor.
The steepest
decline in the Dollar, from 2002 to 2005, was followed by a rally
for all of 2005. But in 2006, traders came back to their senses
and return the greenback to its fundamental trendline, downwards.
The bull market
in “stuff”, represented by the CRB (I actually like
the Roger’s Index better) continues, even after a significant
correction in 2006, thanks to the relentless appetites of growing
global economies.
Gold is in a spike this year, but any decline should be considered
a buy. Why? Because inflation and global demand are both still strong.
The same goes
for oil, although it hit resistance at about 99/bbl, and it could
correct down to 80 or so, it is still in a long term fundamental
bull market that could last for years.
Oil stocks have
seen a bit more volatility than the commodity itself as investors,
we believe, have been worried about the legitimacy of oil’s
bull market run.
Oil Services
have taken off though as the utilization of capacity gets squeezed.
Once all the tankers are filled and rigs are drilling, there isn’t
any extra capacity.
Although the
linear chart looks like Oil Services is in a spike, the P&F
chart shows that the Oil Services Index is trading sideways enough
o catch up (sideways) with its bullish trendline (blue line).
Closer to my
heart, the Ag index is showing it is near the top end of its range.
If anybody thinks inflation is strictly a monetary phenomenon or
doesn’t exist, they should pay close attention to this chart
and the one below.
The Livestock
Index has shown a consistent bullish pattern for the past 10 years.
Although it has had a couple of down spikes (’98 and ’02;
I’m hoping another one comes along right before I buy my next
herd of Angus!) the trend has been stable to up.
The Iindustrial
Metals Index also shows how widespread inflation is. It is not just
a gold thing!
We still feel
like there is a large hole in front of the US markets, not just
a normal decline. The recent volatility is a bad sign. The tone
of the market seems to be very fragile, and emotional. Any major
bad news, especially in the geo-political arena could be the trigger.
Until then, we will sell rallies and not get caught up in the short
term noise, like a Fed rate cut or what kind of hairspray John Edwards
uses. (One is about as important as the other.)
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