EERILY LIKE LATE SUMMER 1987
Monday, November 4, 2002 (Puplava Monday market wrap)
rich clip:
A falling dollar goes along with rising commodity prices. Rising commodity prices are closely linked with rising interest rates, and rising interest rates are bad news for stocks. An upcoming Storm Update will explore this issue in much more depth, but if the trend continues on its present course, it looks eerily similar to what preceded the 1987 stock market crash. In 1987 the stock market rose double digits against a backdrop of a falling dollar, plunging bond market, and rising commodity, especially gold prices.
Johnny, It's Technicals, NOT Fundamentals
It is often times forgotten that in a Bear Market, stocks can rally for no other reason than they have become oversold. The rally that started on October 10th, began from a position of the markets being oversold. Stocks gapped up on three separate occasions, spurring a rash of short covering. From that point, institutions jumped in along with traders and drove prices up. So far, this has mainly been a technical-driven rally with short covering, institutional and day trading driving stock prices upward. The little guy has been conspicuously absent from this rally.
October will be the fourth consecutive month that equity funds experienced monthly outflows. The momentum behind this rally has been lacking with fewer new highs, declining volume, and lagging momentum. Nonetheless, prices have risen. Volatility levels are now heading down rapidly showing that fear is being replaced by complacency. The spin coming from Wall Street doesn’t jive with what CEOs are saying about future revenues and earnings. That doesn’t stop The Street from calling a bottom to the longest running bear market since the 1930’s. Everything about this rally has a false sense to it including its breakout, it’s continuation, and the way that actual news is being reported. Troubling events are overlooked; while the most superfluous events are overemphasized.
A company such as IBM reports lower earnings and the earnings news is spun around to look better by emphasizing that the company beat moving lower targets. The company’s warnings over future pension costs eating into this and next year’s earnings are glossed over. The story instead is that companies are beating estimates, which makes for a better story.
No Illusions or Delusions Here
The fact that stocks had become oversold should not delude investors into thinking a new bull market has begun. There are more serious problems now confronting the economy that are going to impact the markets in the weeks and months ahead. One of them is the consumer. Investors should pay particular attention to what is happening to retail sales and housing in the months ahead. The consumer’s willingness to go deeper into debt in order to maintain consumption has been one of the main support pillars behind the economy’s resiliency this past year. The retail sales reports for November and December will be a key telltale of signs of an impending slowdown in consumption. Consumers now account for over two-thirds of this nation’s economy. The slowdown in consumer spending showed up last month in the plunge in auto sales. Zero down, zero interest, and factory rebates failed to lure buyers into showrooms. This is one trend to keep your eye on for it could offer a clue to a trend towards retrenchment. Once the consumer pulls back there is nothing else to hold up the economy besides government spending.
Consumers Weary and Leary.
Some Are Out of Jobs.
One reason consumers may be pulling back is that job layoffs and corporate firings stepped up again last month. According to a report issued today by the out placement firm Challenger, Gray & Christmas, US companies more than doubled their planned job cuts last month. The monthly tally of planned cuts rose to 176,010, up 151% from the previous month. The layoffs cut a broad swath across American Industry from finance (Citigroup, J.P. Morgan), airlines (Delta Air), manufacturing (Kodak, Boeing), technology (Lucent), to pharmaceuticals (Abbott Labs). Job cuts averaged 7,600 a day last month. The only good news was that for the 10 months this year job layoffs were down 27% form last year. We’re still over 1,000,000 this year and the year isn’t over. For all of those analysts and economists that are forecasting robust economic growth, accelerating earnings, and healthy consumer spending, they want to take note of the rising unemployment rate and accelerating firings by corporate America. A fired worker doesn’t make a happy consumer. The drop in consumer confidence to a decade low tells us more about future spending plans and why auto retail sales are starting to recede.
What is and What isn't
As far as earnings are concerned, let’s just say that what is reported as earnings (which always beat estimates) and the real bottom line numbers are two different stories. One is fiction and the other that goes unreported is non-fiction. It is the non-fiction number that investors should learn more about. It lines up with the rising layoffs. Companies don’t fire workers if business conditions are improving. The government reported factory orders fell in September, indicating that businesses aren’t investing in the key capital goods sector that would point to an economic turn around. Corporate profits remain tenuous. Furthermore, next year earnings comparisons will become more difficult. Unlike this year, they won’t be comparable to a recessionary year. Even then, this year’s real bottom line numbers are still terrible if you look at GAAP earnings. The S&P new standard of adding back and accounting for expenses that companies and analysts conveniently like to ignore shows a much more dismal outlook for earnings than what has been reported. The S&P report shows that stocks are more grossly overvalued today because earnings have declined much faster than stock prices. To paraphrase Warren Buffett, we’ve only made a down payment in this new bear market. “The bubble has popped, but stocks are still not cheap.” Buffett has stopped buying stocks and is instead buying companies. He stopped buying stocks because in his opinion, prices are too high for his taste. In his 60 years as an investor, he bought stocks in 50 of those years. The last ten have been simply unattractive. So he has resorted to buying whole companies and special situations, especially in energy.
SPEs: Blue Chip Skeletons
What should be more worrisome for investors is the fact that real earnings are not being reported and are ignored by analysts and anchors; while undisclosed debt by companies is becoming a ticking time bomb. Last week’s story that the SEC is proposing companies be required to disclose an estimated $3 trillion in off-balance sheet debt should merit more attention by investors. It should alert investors that there are other potential Enron’s lying out there. The debt levels of corporations are much worse than what the balance sheets disclose. GM shows $304 billion in liabilities on its 2001 balance sheet. That is up from $213 billion five years ago. Of the $304 billion, $180 billion is long-term. But GM also has $136 billion in debt in SPEs (special purpose entities). Many companies such as GM and GE have brought their interest rate on debt down by using interest rate swaps by swapping long-term debt. This is no problem as long as interest rates remain stable, or trend downward. It becomes a problem if rates go in the opposite direction. (See Rogue Waves & Standard Deviations Part 1 & 2) Many companies are not fully disclosing all of their debt by hiding it in these SPEs. It makes them look much stronger than they actually are.
The fact that the SEC is now proposing that companies report this off balance sheet debt and disclose the difference between what they report as pro forma earnings and their real earnings will paint an entirely different picture than what is widely reported today. A move in this direction, along with major contributions to pension plans next year, will not bode well for earnings. The current hype or hyperbole in this rally, which ignores actual earnings and the deterioration in the economy, reminds me of last year at this time when a strong rally emerged in the final quarter of the year. The rally was based on assumptions about earnings and economic growth that never materialized. When that reality set in during January, the result was a plunging stock market.
Noteworthy to Watch: Falling Dollar, Rising CRB Index & Rising Interest Rates
While the emphasis in the financial markets has been on the sudden pop in the major indexes that came from three major gap days, there are other markets worth watching that spell trouble ahead for the markets. Please review the charts below of the falling dollar, rising CRB Index, and the rise in interest rates. If this trend persists; while stock prices continue to rally, the markets are ignoring a very important set of warnings. A falling dollar goes along with rising commodity prices. Rising commodity prices are closely linked with rising interest rates, and rising interest rates are bad news for stocks. An upcoming Storm Update will explore this issue in much more depth, but if the trend continues on its present course, it looks eerily similar to what preceded the 1987 stock market crash. In 1987 the stock market rose double digits against a backdrop of a falling dollar, plunging bond market, and rising commodity, especially gold prices.
It is key for investors to keep their eyes on these charts of the dollar, gold, the CRB, and rising long-term interest rates. If this trend persists, we are headed for big trouble. The one missing element in this latest bear market rally has been the absence of a bond market rally. Bonds and stocks have begun to diverge. Unlike the late summer rally when both stocks and bonds rose in tandem, this time bonds have begun to sink. This means interest rates are going up. The dollar’s chart is looking weak; while the chart of commodity prices looks like it just broke a long-term resistance level.
It's The Big Boys - Not the Little Guys
This rally is looking more and more like a sucker’s rally as Jim Sinclair has written in last evening’s post. However, the suckers in this case may be the institutions since this rally has been mainly institutional in its genesis. This has been a big boy’s rally; mainly fund managers playing with other people’s money. As I’ve reported over these last few months, John Q. has been slowly exiting the stock market. This is one reason why, in my opinion, volume has been anemic, the number of new highs low, and momentum has remained weak. The institutions have been sticking with the large liquid stocks buying the familiar tech, telecom and typical large cap growth stock. They have been dumping defensive stocks such as consumer staples, defense stocks, utilities and other defensive issues in favor of the last bull market favorites. The SOX has risen 52% from its October 9th low, despite the fact that most of the companies that make up the index reporting terrible earnings. This pattern is very similar to Q4 of last year when it was widely believed that techs would lead the economic recovery.
The bottom line is that we are still in a bear market and this is nothing more than a bear market rally. If you are very knowledgeable in technical analysis and are adept at trading, this has been another opportunity to profit from volatility. If you look at the last two weeks of trading and count the wide swings from losses to gains, a measure of how unstable this market has become should be most prominent. Once again, if you are good at technical trading, then trade and profit from it, and hope that a ten-sigma event doesn’t catch you off guard. There are plenty of potential candidates out there that could produce a rogue event that no one expects. Derivatives, terrorism, and war are three quick examples that come to mind. Unless you are knowledgeable and adept at trading with tight stops, this has become a very unstable and dangerous market to sail. An investor might do better adhering to or following the primary trend of the market, owning gold, defense stocks, and energy. If Buffett is buying natural gas, pipelines and silver, there is a reason. For those who are skeptical of the smartest investor of the 20th Century, he is still the second richest man in the world and his shares of Berkshire Hathaway have out-performed the stock market even though they are down slightly over the last few years.
Today's Market
Looking at today’s casino results, the markets rallied strongly this morning after Friday's news that a federal judge approved of Microsoft’s antitrust suit with the government. Financial stocks rallied on the belief that the Fed will cut benchmark interest rates when it meets in Washington tomorrow. Computer and financial shares contributed almost the entire advance. The three major indexes climbed to their highest level since August. Four stocks rose for every three that fell on the NYSE. On the NASDAQ, the breath was less positive with only three stocks rising for every two that fell. The rally today was very narrow. Big board volume rose 14 percent above the three-month daily average.
Wall Street is still hoping they can draw the little guy back into the markets, but it hasn’t happened so far. Fund flows were neutral as of the end of last week. Most of the little guy’s money is going into bonds just at the time that the bond market appears that it has topped. The preliminary report for October indicates that $9.5 billion flew out of stock funds last month making it the fourth consecutive month of outflows. Wall Street’s new calendar of IPOs is also heating up, so the spin machine is likely to get louder. The ducks are quacking like they usually do, so the BS is going to get louder.
Tomorrow the Fed will meet in Washington where it is widely expected that they will cut interest rates a quarter of a point. The 25 basis point cut has already been priced into the market. The Fed last cut interest rates in December of 2001. Tomorrow is also Election Day. The fate of the Senate and the future course of economic policy could very well be decided on Tuesday. The Republicans favor tax cuts, increasing national security and tax reform. The Democrats are in favor of targeted tax cuts, more spending, and expansion of unemployment benefits. The elections tomorrow will determine economic policy that will be drafted in response to what is looking more like a double-dip recession.
Eyes Open, John Q
Once again, this is a traders rally not the beginning of a new bull market in stocks. Trade if you're knowledgeable. Otherwise, use this rally as an exit point before the next leg of the downturn begins. Watch retail sales for signs of consumer retrenchment. Watch the dollar, the CRB Index, and the bond market for rising interest rates. If the dollar continues to fall, commodity prices rise, bond prices fall as interest rates rise, and stock prices rally, then we are headed for a crash. And as far as the approaching war, if it seems that it is becoming a non-event, or as many now feel it is unlikely to occur, bear in mind that the US just activated its reserve fighter squadrons. This is something that hasn’t been done since the Korean War. An entire Naval Air Reserve squadron has been activated to deploy on board another carrier battle group headed for the Persian Gulf. Guam has also resumed its role as a submarine base as more attack subs are sent to the region to watch Asia as the US deploys battle groups to the Middle East.
Overseas Markets
European stocks rose as companies including lender ABN Amro Holding NV, airline Ryanair Holdings Plc and travel company Kuoni Reisen Holding AG posted profits above analysts' forecasts. The Dow Jones Stoxx 50 Index added 3.6% to 2612.67, climbing for the third day in four and cutting its loss for the year to 30%. All eight major European markets were up during today’s trading.
Asian stocks rose on expectations the U.S. Federal Reserve will lower interest rates this week to boost economic growth. Samsung Electronics Co. had its biggest gain in nine months. Hong Kong's Hang Seng Index climbed 3.3%, its biggest advance in three weeks. Markets in Japan, Singapore, Malaysia and India were closed today for public holidays.
Bond Market
Government bonds ended lower for another session as fixed-income investors have priced in a rate cut at Wednesday's FOMC meeting by rallying furiously over the past weeks. The 10-year Treasury note lost 10/32 to yield 4.04% while the 30-year government bond lost 9/32 to yield 5.065%.
Copyright © Jim Puplava
November 4, 2002 |
