Sunday, July 18, 2004
Market Update: Turning Points
On Friday, the US stock market as measured by the bellweather S&P and NASDAQ indices closed below key technical levels, indicating the high chance that more downside is in store. The outlook now is for the S&P to fall to as low as 1060 before staging a technical rebound. This is how I expect the market to play out in the coming days.
Earnings have clearly deteriorated. Even in those companies whose earnings did not deteriorate, forward guidance has been lowered and warnings sounded. Many tech companies in particular have a marked increase of inventory on their balance sheets; chief amongst them are Intel and Dell. The hype about Local Number Portability (LNP) and the much-anticipated corporate IT rebound that was circulating in 2003 did not materialise as expected, leading to many handset companies like Nokia and many tech companies ordering too many parts, and resulted in double ordering and an inventory build all the way up the chain.
Economic indicators have also come in weaker than expected, pointing to a potential slowdown in the economy. The bond market as well as gold has started to react to a potential economic downturn by slowly moving higher. Indeed, yields have fallen since their interim bottom of 4.8% on the ten year note and gold has finally moved --- and stayed --- over US$400 per ounce. Stocks are still heading south even after a length consolidation period that lasted from early June. Clearly the market is trying to tell us something --- I suspect that the market is beginning to price in a weaker economy and a weaker US dollar.
The timing of all these macroeconomic events is, of course, largely undetermined and subject to speculation. I think I have painted the broad macro picture fairly accurately, but I do not think anyone can get any fix on the timing as to when all the malaise will start. If you recall, the bears (including myself) got the timing WAY off in 2003 and many of us missed the entire rally. But as I said, it was a rally to fear, and not to cheer. It was rally supported neither by strong macroeconomic fundamentals nor cheap stock valuations. It was rally built on liquidity created by the Federal Reserve, continued speculation in paper assets, as well as one-off factors such as the ending of the Iraq war, tax cuts, and the final bouts of mortgage refinancing that placed more confetti dollars into the wallets of savings-short, over-indebted consumers. And neither have we seen any sustained increase in employment or wage generation that can save the day. Although March and April saw an encouraging increase in non-farm payrolls, the job numbers tapered off in May and June, and furthermore, detailed inspection of the payroll numbers in the past four months suggest that jobs creation has been focussed on low-valued added sectors like temporary help. Without a sustained uptick in employment or wage generation, the continued vigour of the American consumer must be called into question.
I have also mentioned before that in order to understand the global economy, it is largely sufficient to think about it as comprising the Chinese producer on one side, and the American consumer on the other. Both are now at risk, with an anticipated soft landing in the Chinese economy at hand, and a renormalization of Fed policy, higher interest rates, soaring oil prices, and the slow unwinding of the frothy US housing market impinging on the American consumer.
Putting a summation under all these considerations, it is my opinion that we are at a major turning point in the global economy and the US financial markets. The best investment opportunities are now to be found in small Asian markets like Malaysia, Thailand and the Philippines. Traders should take profits on Asian markets and short the US stock indices with a target of S&P 1060.
On Friday, the US stock market as measured by the bellweather S&P and NASDAQ indices closed below key technical levels, indicating the high chance that more downside is in store. The outlook now is for the S&P to fall to as low as 1060 before staging a technical rebound. This is how I expect the market to play out in the coming days.
Earnings have clearly deteriorated. Even in those companies whose earnings did not deteriorate, forward guidance has been lowered and warnings sounded. Many tech companies in particular have a marked increase of inventory on their balance sheets; chief amongst them are Intel and Dell. The hype about Local Number Portability (LNP) and the much-anticipated corporate IT rebound that was circulating in 2003 did not materialise as expected, leading to many handset companies like Nokia and many tech companies ordering too many parts, and resulted in double ordering and an inventory build all the way up the chain.
Economic indicators have also come in weaker than expected, pointing to a potential slowdown in the economy. The bond market as well as gold has started to react to a potential economic downturn by slowly moving higher. Indeed, yields have fallen since their interim bottom of 4.8% on the ten year note and gold has finally moved --- and stayed --- over US$400 per ounce. Stocks are still heading south even after a length consolidation period that lasted from early June. Clearly the market is trying to tell us something --- I suspect that the market is beginning to price in a weaker economy and a weaker US dollar.
The timing of all these macroeconomic events is, of course, largely undetermined and subject to speculation. I think I have painted the broad macro picture fairly accurately, but I do not think anyone can get any fix on the timing as to when all the malaise will start. If you recall, the bears (including myself) got the timing WAY off in 2003 and many of us missed the entire rally. But as I said, it was a rally to fear, and not to cheer. It was rally supported neither by strong macroeconomic fundamentals nor cheap stock valuations. It was rally built on liquidity created by the Federal Reserve, continued speculation in paper assets, as well as one-off factors such as the ending of the Iraq war, tax cuts, and the final bouts of mortgage refinancing that placed more confetti dollars into the wallets of savings-short, over-indebted consumers. And neither have we seen any sustained increase in employment or wage generation that can save the day. Although March and April saw an encouraging increase in non-farm payrolls, the job numbers tapered off in May and June, and furthermore, detailed inspection of the payroll numbers in the past four months suggest that jobs creation has been focussed on low-valued added sectors like temporary help. Without a sustained uptick in employment or wage generation, the continued vigour of the American consumer must be called into question.
I have also mentioned before that in order to understand the global economy, it is largely sufficient to think about it as comprising the Chinese producer on one side, and the American consumer on the other. Both are now at risk, with an anticipated soft landing in the Chinese economy at hand, and a renormalization of Fed policy, higher interest rates, soaring oil prices, and the slow unwinding of the frothy US housing market impinging on the American consumer.
Putting a summation under all these considerations, it is my opinion that we are at a major turning point in the global economy and the US financial markets. The best investment opportunities are now to be found in small Asian markets like Malaysia, Thailand and the Philippines. Traders should take profits on Asian markets and short the US stock indices with a target of S&P 1060.
