The Challenge of Bear Markets
In my previous articles (“Equity Bear Markets in Progress… and Why” -July 5), and “The importance of holding cash” – March 22, I have been very bearish for the indices. Today is no exception.
Was the proof in the pudding?
Well, in April, the FTSE and Japan’s Nikkei 225 topped out, and most other equity markets around the world have been falling since May, so events showed my words to have been timely.
What came as a surprise to traders was the Fed’s statement on May 10 that economic growth and inflation risks were no longer in balance, and that growth would moderate due to higher energy costs and a slowdown in the housing sector.
International traders then became concerned about the plight of the American consumer, the lack of U.S. government fiscal restraint, and prospects for the $USD, and, for foreign companies, what that means for exports to America.
Global Market Summary
“For the most part, the equity markets of emerging economies and advanced economies peaked May 10, which I believe was the starting point of the 2006-xx Bear Market.” Yes, I have been writing those words here and in my blog since May 10. There is no change at this time except that I believe the Bear will pick up momentum within a month. I am still forecasting a Bear Market low of about Dow = 8800 in 2H06.
U.S. Sector ETFs:
Over the past three months, six of 10 U.S. sector ETF's I track were down and the losers have averaged a loss of -8.2 percent, whereas the winners averaged a gain of just +4.2 percent. But if you look at the winners carefully (consumer staples and healthcare, utilities and telcos), you will see they are the high-dividend, lower-beta, slower growing, defensive stocks.
U.S. Bonds and Interest-Sensitive Equities:
Over the past three months, bond yields in the U.S. started dropping for the first time in a couple years, which meant that bonds and interest- sensitive equities did relatively better than economy and commodity-price sensitive stocks. But the most remarkable change has been that mortgage lenders, which on the surface should be helped by this environment, were overwhelmed by the contraction in demand for mortgages. The three giants in the industry, Countrywide Financial (CFC), Freddie Mac (FRE) and Fannie Mae (FNM) dropped in share price this past 90 days by -21.6 percent, -6.7 percent and -6.0 percent. The explanation of course is that interest rates and bond yields fall when economic growth slows or contracts, but those are conditions that also depress corporate top-line and bottom-line growth, and worry the consumer.
Oil & Gas:
In two years from the 3Q03 low of 26.72 to a 3Q05 high of 70.85, the U.S. crude oil futures index ($WTIC) jumped +265 percent (a gain of $44.13). But in almost a year since then, $WTIC is up just $2.40 or +3.4 percent, and traders are now expecting that the global economic slowdown is causing oil prices to peak this quarter.
The gold futures index ($GOLD) usually lags the oil price cycle, and is typically the last of the commodity group to reach a peak. Over the past three years, $WTIC has clearly outperformed $GOLD, but that situation reversed in the past year. I hold the view that $GOLD (and to a lesser extent $WTIC), will trade close to an inversion of the $USD for the balance of this market cycle. I believe that before the next U.S. Presidential election (Nov-2008), the $USD will fall further, based on U.S. economic and fiscal problems, and that $GOLD will ultimately rise to a peak of over $850.
The goldminer shares I follow have performed quite poorly over the past three months. In fact a group of ten quality gold miners I track closely are down on average -14.5 percent. The reason is obvious: $GOLD peaked on May 14 at $730.40, dropping in a month -25.8 percent to a cycle low of $542.27 before recovering to a narrow trading range between $610 and $650, now at $625-$630. Presently, there is an interesting symmetrical triangle pattern (i.e., the slope of the price highs and lows are converging to a point) that has developed, with a breakout (up or down) expected within a month. I believe that, within a very choppy trading market, a new cycle high above $750 will be set within two months for $GOLD, which will drive the goldminer shares to a higher intermediate cycle peak of their long-running Bull market.
Trading in the $USD has been extremely volatile. After hitting an intermediate cycle peak of 92.63 (Nov-2005), the $USD reached a cycle low of 83.60 on May 15, which was reached again in early June at 83.72. Subsequently the $USD rallied to 87.05 in late June and 87.33 o July 19. So the $USD has been range-bound between 83.60 and 87.33 since late April this year. Given that the Fed has run out of policy tightening options, and that the Treasury must still print money to meet its fiscal obligations, I hold the view that the $USD is soon headed lower, which will become apparent if, as and when the 83-level support fails.
Trends and Cycles:
As my readers know, it is my belief that price motion in capital markets is caused by mostly natural phenomena that culminate in periods of rising and falling corporate fundamentals and quantitative results, and macro economic scenarios, all of which combine to impact market prices. While a matter of conjecture, how far prices rise and fall in cycles should not be our concern. Our focus should be entirely on the matter of trend, and with respect to equities, the selection of the shares of the best quality companies, with timely acquisition on the basis of technical indicators.
The Big Picture: I believe that the long-term bullish trend in equity prices existing since late in the 2Q02 has reversed. The big story now, in my view, is a state of the U.S. economy that I refer to as “stagflation” even though +3.5 pct GDP growth is not stagnant and +2.0 pct inflation may not appear all that serious.
But when traders look at the market internals, they see the stocks of both the big Nasdaq 100 companies and the Dow Transports have been falling hard, which is an indicator of economic problems. The Nasdaq 100 index is down -10.3 percent over three months. The Dow Transports are down -16.2 pct over three months and -9.8 pct in the past four weeks.
We also see problems in the health of the consumer, and the pricing power of the companies that serve us, which we can assess in the trading of the major retailers, auto manufacturers and hotels, restaurants, cruiseships and casinos, where people spend the bulk of their disposable income. For the two big American retailers – Wal-Mart and Home Depot – with a combined market cap of $261 billion, the loss in cap was a company average -11.9 pct over the past 90 days.
But the problems are not just with consumers, techs and transportation. If you look at the three-month stock performance of America’s biggest industrial corporations, you have to admit that something is terribly wrong.
Consider that for the ten great American industrial corporations – General Electric, IBM, Intel, 3 M Company, Boeing, United Technologies, DuPont, Honeywell, Caterpillar and Alcoa -- with a total market cap of $839 billion, their capitalization dropped an average -13.3 pct in just the past 90 days.
Even the Russell 2000 index last week took a huge hit (-3.2 percent W/W) as traders are shying away from the greater risk that smaller caps entail. Over three months, this small cap index is now down -10.4 percent.
The big Financials, which I refer to as Humungous Bank & Broker, have run into a wall too. The great European banks, Credit Suisse, UBS and Deutsche Bank, are down in price -15.7 percent, -13.3 percent and -13.5 percent respectively, over three months. This past week, Lehman Bros dropped -4.9 percent, Morgan Stanley -3.4 percent and JP Morgan -2.6 percent, respectively, Week over Week.
So, while Talking Heads in the popular media, and of course the President and his new Treasury Secretary, are telling us that there is nothing wrong with the U.S. economy, it seems that Fed Chairman Bernanke is the only one in a position of high authority to acknowledge what the rest of us are seeing, and experiencing, in capital markets.
In a word, they are receding.
I feel the best strategy in a downward trending market is to sell into the brief rallies, and continue to raise cash, which is what I recommended here in March. Nimble traders can play the short-term rallies on the long side if the holding period is a brief one.
Enjoy your trading but pay close attention to prices, and not the stories, in markets.