The Rita-Katrina Effect

Presently the economies of the U.S. and Canada are cranking along at about 3.5 pct Year over Year (Y/Y) according to government agencies that track these things. Unfortunately, the data is a little behind the reality. The post-Rita-Katrina era is likely to see the GDPs of these two leading nations fall to about half that growth rate, at least for about two quarters.

Normally that’s not a bad deal – it could be worse – but this time around it’s happening at a time Fed chairman Alan Greenspan is telling us there is too much money in the system, whatever that means. And so, Greenspan’s Fed raised the Bank Rate for the 11th consecutive time, by +25 basis points (bp), now to 3.75 pct.

Canada’s central banker David Dodge did the same a week earlier, raising the Bank of Canada rate by +25 bp to 2.75 pct. The European Central Bank has kept its rate at 2.00 pct since 2003, so I guess that shows where the inflation concerns are coming from, and which economies have been strongest.

So the issue is this: the U.S. is likely to pour some $300 billion into recovery and rebuilding post-Rita-Katrina, which is inflationary, but at the same time the growth in the economy is going to be cut in half for a long while because of those storms and their impact on higher energy costs, and the central bankers are raising rates because there is already too much floating cash around that is chasing prices higher.

Moreover, it was just a month ago that Greenspan was telling Americans that they ought to spend more time assessing risk, and a week ago he was summoning the top 15 U.S. banks to his office to warn them that their handling of credit derivative trading and timely settlements was, let’s say, shoddy.

Is this image of capital markets one that inspires confidence in the average trader? I hardly think so.

But don’t take it from me; have a peak at the Relative Strength Index (RSI) of the Dow 30 stocks or the various sector funds of the U.S. equity market. Whether you are looking at Monthly, Weekly, or Daily price series data, there is a consistent portrait being rendered – kind of like “paint by numbers”.

RSI, which is a good technical indicator of price momentum, is telling us that the bull cycle that was confirmed in 1Q03 (following a 4Q02 bottom) is coming to an end for large cap stocks and most sectors.

That’s not a surprise to active traders – those pragmatic individuals who believe that what goes around comes around (i.e., prices rise and fall in a pattern known as reversion to the mean) – but the problem today is that too many traders are passive.

Passive investors have been taught to believe the ‘buy, hold and prosper’ mantra.

Here’s the rub as I see it. Passive traders who buy and hold tend to buy diversified funds for risk management purposes. And when broad equity markets are rising, that can be an effective strategy. But what happens when markets go sideways or fall, as they must at times.

I mean the Dow 30 and the Nasdaq indexes, which by definition are the broadest of broad markets, have sidetracked and fallen for five years. No rising market there.

Oh, you say, that’s an aberration. Well, in response I’d say that you might consider yourself lucky. Your parents or grandparents might have been long stocks throughout the 12 long years of the 1966 to 1978 period. If you check the record, you’ll see that the broad equity market did not rise at all through those years.

You’ll even see that the venerable Dow 30 index has to continuously release dogs like Kodak and Sears out of embarrassment over their failure to continue to rise in share price. That ‘change the index’ routine happens a lot when the Dow is not looking so healthy.

I mean, just a week ago Delta Air Lines Inc. (DAL) and Northwest Airlines Corp. (NWAC) were deleted from the Dow Jones Transportation Average index. Overseas Shipholding Group (OSG) replaced DAL and JetBlue Airways (JBLU) grounded NWAC.

After filing for protection under bankruptcy laws, Delta and Northwest Air have poor optics to traders.

And for the past four weeks, optics for the Dow 30 have been awful too, what with CAT being the top performer. Caterpillar Tractor for Pete’s sake!

So in the Industrials index, maybe the powers-to-be today ought to be replacing IBM with GOOG or EBAY, just as EK and S were dropped in 1999, right at the cycle top?

So, yes, the Dow 30 index closed the week at 10,419, down 2.1 pct, which was about the same as the Nasdaq, down –2.0 pct and the Russell Small Cap Index, down 2.5 pct, Week over Week (W/W).

A week ago Saturday I wrote of the Dow 30 in my blog: “You’ll note that 15 were up and 15 down (this week). Suffice it to say that the glass is not half full. That’s because the ones that were down, were DOWN a lot more!” So, readers laughed.

Well, this week there were 25 DOWN, and only 5 up. Who’s laughing now?

The five winners were: CAT up +2.08 pct; PG up +1.41 pct; UTX up +0.62 pct; HPQ up +0.46 pct; and XOM up +0.28 pct, all W/W. And I can’t even match that with five BIG losers.

That’s because there were fully TEN BIG LOSERS -- all down 3.5 pct or more! AA down –8.47 pct; MCD down –4.67 pct; HON down –4.61 pct; MRK down –4.43 pct; GM down –4.34 pct, AXP down –4.31 pct; DD down –4.27 pct; PFE down –3.94 pct; DIS down –3.69 pct; and HD down –3.43 pct, all W/W.

And for my blog readers, I monitor 10 different sector-based Exchange Traded Funds. This past week, there were 9 down and 1 up on the week. XLE (Energy) was up, barely. And that was an improvement over the past two-week performance, where there were zero ETFs (from my list of ten popular ones) that were trading higher. And for the past four weeks, only XLE plus XLU (Utilities) and IYH (Healthcare) were up at all.

So if these all-blue-chip Dow stocks or ETFs are in your portfolio, you should be taking notice about what’s happening in this market. It’s not as healthy as some Talking Heads would have you believe – not in the past few weeks or even the past few years.

Those who are, in fact, buying and holding are not prospering.

Of course, if you happen to be listening to my advice... ;-)