Saturday, July 31, 2004
Market Update
It Does Not Matter Until It Matters, Then It Really Matters
After a long period of low volatility and aimless drifting, the US markets have, in recent days, exhibited an increased amount of volume and volatility, some to the downside and some to the upside. Many hedge funds and traders have been whipsawed and fund managers in general have experienced below average performance. This has indeed been a trying time for Wall Street, as pundits try to ascertain where the market and the economy is heading. Is the economy embarking on a self-sustained recovery built upon increasing employment, wage generation and corporate profit growth, or is the economy beginning to soften in the post-stimulus period where excess industrial and manufacturing capacity, and record levels of federal, private sector and household indebtness persist.
Who will be right? Will the bulls claim a victorious 2004, or will the bears finally take over and show the market how much downside is in store for it? Already recent economic indicators have been poor, except possibly for consumer confidence. Please note however that consumer confidence traditionally has no correlation with consumer spending --- there are plenty of self-professed optimists out there who may at various times clench their fists tight, for reasons known only to them. Consumer spending is not likely to drive the economy as much as it did in 2002 and 2003, with interest rates set to rise, employment remaining muted (despite the abnormally high nonfarm payrolls in April and May), and mortgage refinancing all but wiped out from the face of the American Debt Dynamic, and no more huge tax cuts or tax rebates in store (especially if Kerry wins the election).
In addition to the abovementioned problems that may adversely impact the indefatigable American consumer, various companies in tech and telecom land are now saddled with excess inventory as a result of double ordering along the manufacturing/IT chain all the way from end-product manufacturers to chip foundries. Furthermore, many companies have either reported poorer than expected earnings, or lowered 3Q guidance, or both. As more and more data points are collected, the big picture is falling into place slowly but surely: the great American economy, once driven by Fed-induced reflationary policies and overzealous consumers who spend what they don;t have on things they don't need using nothing but the kindness of strangers (that is, Asian and Japanese central banks who buy large amounts of US treasurys), has begun to soften.
If the US economy begins to soften now while the target Fed funds rate is still at an "emergency" low of 1.25%, this will indeed put the last nail in the coffin for the Fed and the sustainability of the American Growth Dynamic. If the Fed does not get its interest rate up soon, it will have no more ammunition in its policy arsenal to combat the next downturn if and when it arrives. If the next downturns arrives soon, or at least sooner than the Fed can reload its policy cannon, then the Fed will lose all credibility. Shame will be upon it, as people finally realize what a gigantic mess it has created all these years. People will also realize that the entire US economy has been locked in a tighter corner, with all the excesses of the late 1990's bubble still unresolved, and with no more further policy accomodation with which to fight the oncoming recession. When this time arrives, there will be fireworks to the downside, and my prediction will be that the major US indices will cleanly take out their October 2002 lows like a knife through hot butter. It will be an interesting yet gun-wrenching spectacle to behold. Precious metals like gold and silver might initially plunge along with the stock market, but if they do so, they will most likely stage an impressive rebound as folks begin to shift to "safe-haven" assets.
Of course right now these economic dislocations are not yet manifesting themselves in any major way, although weak corporate profits and inventory build-ups have already provided a few hints as to what may be to come. Folks now think the imbalances like the trade and budget deficit do not matter, because they have not yet brought the dollar crashing down and consequently sent the economy into a tailspin. And as long as pundits think that these imbalances do not matter, then the world will really believe that we are in some kind of new era in which globalised financial markets have made investment risk a thing of the past. But one day, one fine day, all these imbalances and dislocations in the US economy will finally matter, and when they do matter, they will matter one big bunch.
On a more technical note, the stock market is still oversold and although a rally is possible, I do not expect it to last. The major indices are clearly in a downtrend. As such US stocks should be maximally underweight at this point in time. I propose that a client portfolio should overweight Asian equities and bonds, with an emphasis on small Asian markets like Malaysia, Thailand and the Philippines. Traders, on the other hand, should stay on the sidelines as far as possible until either a clear breakout or a clear breakdown occurs, with long positions to be established if there is a breakout above S&P 1111, and short positions established should there be a breakdown below 1087. I am looking at S&P 1060 as the target to shoot for.
It Does Not Matter Until It Matters, Then It Really Matters
After a long period of low volatility and aimless drifting, the US markets have, in recent days, exhibited an increased amount of volume and volatility, some to the downside and some to the upside. Many hedge funds and traders have been whipsawed and fund managers in general have experienced below average performance. This has indeed been a trying time for Wall Street, as pundits try to ascertain where the market and the economy is heading. Is the economy embarking on a self-sustained recovery built upon increasing employment, wage generation and corporate profit growth, or is the economy beginning to soften in the post-stimulus period where excess industrial and manufacturing capacity, and record levels of federal, private sector and household indebtness persist.
Who will be right? Will the bulls claim a victorious 2004, or will the bears finally take over and show the market how much downside is in store for it? Already recent economic indicators have been poor, except possibly for consumer confidence. Please note however that consumer confidence traditionally has no correlation with consumer spending --- there are plenty of self-professed optimists out there who may at various times clench their fists tight, for reasons known only to them. Consumer spending is not likely to drive the economy as much as it did in 2002 and 2003, with interest rates set to rise, employment remaining muted (despite the abnormally high nonfarm payrolls in April and May), and mortgage refinancing all but wiped out from the face of the American Debt Dynamic, and no more huge tax cuts or tax rebates in store (especially if Kerry wins the election).
In addition to the abovementioned problems that may adversely impact the indefatigable American consumer, various companies in tech and telecom land are now saddled with excess inventory as a result of double ordering along the manufacturing/IT chain all the way from end-product manufacturers to chip foundries. Furthermore, many companies have either reported poorer than expected earnings, or lowered 3Q guidance, or both. As more and more data points are collected, the big picture is falling into place slowly but surely: the great American economy, once driven by Fed-induced reflationary policies and overzealous consumers who spend what they don;t have on things they don't need using nothing but the kindness of strangers (that is, Asian and Japanese central banks who buy large amounts of US treasurys), has begun to soften.
If the US economy begins to soften now while the target Fed funds rate is still at an "emergency" low of 1.25%, this will indeed put the last nail in the coffin for the Fed and the sustainability of the American Growth Dynamic. If the Fed does not get its interest rate up soon, it will have no more ammunition in its policy arsenal to combat the next downturn if and when it arrives. If the next downturns arrives soon, or at least sooner than the Fed can reload its policy cannon, then the Fed will lose all credibility. Shame will be upon it, as people finally realize what a gigantic mess it has created all these years. People will also realize that the entire US economy has been locked in a tighter corner, with all the excesses of the late 1990's bubble still unresolved, and with no more further policy accomodation with which to fight the oncoming recession. When this time arrives, there will be fireworks to the downside, and my prediction will be that the major US indices will cleanly take out their October 2002 lows like a knife through hot butter. It will be an interesting yet gun-wrenching spectacle to behold. Precious metals like gold and silver might initially plunge along with the stock market, but if they do so, they will most likely stage an impressive rebound as folks begin to shift to "safe-haven" assets.
Of course right now these economic dislocations are not yet manifesting themselves in any major way, although weak corporate profits and inventory build-ups have already provided a few hints as to what may be to come. Folks now think the imbalances like the trade and budget deficit do not matter, because they have not yet brought the dollar crashing down and consequently sent the economy into a tailspin. And as long as pundits think that these imbalances do not matter, then the world will really believe that we are in some kind of new era in which globalised financial markets have made investment risk a thing of the past. But one day, one fine day, all these imbalances and dislocations in the US economy will finally matter, and when they do matter, they will matter one big bunch.
On a more technical note, the stock market is still oversold and although a rally is possible, I do not expect it to last. The major indices are clearly in a downtrend. As such US stocks should be maximally underweight at this point in time. I propose that a client portfolio should overweight Asian equities and bonds, with an emphasis on small Asian markets like Malaysia, Thailand and the Philippines. Traders, on the other hand, should stay on the sidelines as far as possible until either a clear breakout or a clear breakdown occurs, with long positions to be established if there is a breakout above S&P 1111, and short positions established should there be a breakdown below 1087. I am looking at S&P 1060 as the target to shoot for.
