Mike Norman's view -
Only We Can Kill This Rally
By Mike Norman
Special to TheStreet.com
09/03/2003 02:55 PM EDT
URL: thestreet.com
Economic Analysis BULLISH
Once-vaunted indicators have recently proved useless.
Expect the dollar/yen exchange rate to eventually hurt the Japanese market.
The Fed will sit tight on interest rates.
Stocks finally broke through barriers that had been providing formidable resistance for most of the summer. All of the technicians had been heaping caution on the recent rise, calling for its imminent end. Others had claimed the advance had no rhyme or reason, not fully understanding the power of combined monetary and fiscal stimuli and the liquidity and demand that they provided.
Many of the once-vaunted technical indicators have been reduced to useless algorithms. The poor VIX, the options volatility index, was once a widely respected technical tool, but is now so widely followed you're better off using it as a contrarian contrarian indicator. (In other words, do the reverse of what it tells you to do.)
Another indicator that has outlived its usefulness is insider selling. For how many months have we been warned of this? Had you heeded the advice, you would have missed out on a nice advance.
Why anyone pays attention to insiders these days is beyond me. In the last year, we've witnessed enormous financial destruction brought about by their missteps. We constantly rail at their high compensation, presumably because we think they're paid beyond their performance. Yet we're told to follow their stock market moves? I prefer to fade the insiders.
Threats to the Markets and Economy
The job now is to determine what will stop the rally and give us reason to take profits and go short. I've said before that we'd need to see a policy change, an external shock or a severe foreign exchange adjustment before getting worried.
A forex adjustment has been occurring, but mainly against the euro. After hitting $1.19 in May, the euro is now down to $1.08. This has been bullish for Europe stock markets, and if it goes further, could be negative for the U.S. market. But as it stands now, I don't think it's something U.S. investors need to worry about. Remember, too, that the dollar's rise against the euro is being offset by weakness against the yen.
If anything, the dollar/yen exchange rate should be worrisome -- to Japan. It's a potential deal-killer for the Japanese economy. Japan knows this and that's why it has been spending a fortune on keeping the yen from blowing through the roof.
At some threshold, the dollar/yen exchange rate will hurt the Japanese market and I think we may be approaching it. That threshold may be 115. We were at that level in May, and I think we're headed there again. I expect the Bank of Japan to resist this move, but there is a lot more speculative buying of yen with the Japanese stock market so strong, and it will be tougher to keep the yen pinned down.
If the dollar/yen exchange rate crosses the "line in the sand" at 115, then it will likely set up a very big correction in the Japanese stock market. I'm liquidating my Japan stocks as we rally and move closer to this currency exchange rate, and I think I'll short the Japanese market once we break through 115.
Potential Shock
An external shock to the U.S. economy, particularly something on the scale of a terrorist attack, is always possible, but hopefully it won't happen. However, one potential external shock can be removed from our watch list: an oil price spike. Yesterday's 9% decline in gasoline prices was the biggest fall in two years. Petroleum not only will be less of a factor, but it will begin to be a positive as it moves lower.
In the end, what can do us in is ourselves. That means policy change. It's the ultimate market disruptor (just as it can be the ultimate market savior when used correctly). I believe it's only a matter of time before we see politically inspired policy change.
This can occur on a number of fronts: deficit spending, Iraq and trade policy. I thought all three looked precarious recently: First, you had Treasury Secretary Snow and Office of Management and Budget Director Josh Bolten talking about reining in spending. Then you had the U.S. pressuring China to let the yuan float. And now you have the president going back to the U.N. for help in Iraq.
Each of these could disrupt the rally and the recovery, either from their effect on government spending (to bring it down) or by some trade policy shift (weakening China's economy, etc.).
But now, the president will reportedly ask Congress for a significant increase in spending for Iraq -- as much as $60 billion. Should that request be granted, it would be bullish for the economy and the markets. As for an agreement between the U.N. and the U.S., there is none yet. If and when one does come, we'll have time to determine if it's a rally-killer.
Chinese Yuan
The Chinese are correctly resisting U.S.-led pressure to let their currency float. They realize that if they did that, there would be a massive wave of speculation and that would be very destabilizing.
Rather, the Chinese are smartly offering concessions -- like buying more U.S. Treasuries. What can be better than that? The result is that their economy continues to modernize and grow, and we (the industrialized world) get lower capital costs. China's buying of Treasuries is nothing more than another manifestation of the deflationary forces emanating from that country.
The factors that could scuttle the U.S. stock market rally haven't materialized yet. I didn't mention a possible interest rate rise, but it hasn't fallen off my radar screen. I don't think it will become a negative factor for the market or economy because I believe the Fed when it says it will sit tight on rates. The result will be that interest rates may not rise that much. This is one area where I could be wrong, but for now, I don't anticipate much higher rates, particularly with the Chinese prepared to provide so much new liquidity. So the rally will continue, with plenty of rhyme and plenty of reason.
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Mike Norman is an international economist who has also been active as a trader, money manager, broker and market analyst since 1980. He is also the publisher of the Economic Contrarian Update, a daily report that covers global trends in stocks, interest rates, currencies, commodities and geopolitics. At time of publication, Norman had no holdings related to this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he welcomes your feedback. |
