Saturday, August 14, 2004
Continued poor earnings guidance from various tech companies and a falling stock market more or less confirms economic weakness in the months ahead.
I see that stock market action is trying to price in the possibility of a recession in 2005. Note that the market generally tries to predict 6 months into the future.
The precarious situation we have now is as follows: the Fed funds rate is still at a historic low of 1.5%, employment remains very muted, and the economy is showing VERY definitive signs of slowing down. The Fed has no more ammunition in its policy arsenal; neither can it afford to leave rates where they are in the face of rising inflation due to oil and commodity prices.
Clients should overweight investment grade bonds of short duration and scale back on risky assets such as equities and long duration bonds. In addition, Asia should be overweight and the US should be as underweight as possible. For those interested in precious metals (up to 10% of CPF-OA may be used tobuy gold), please email me directly.
Tuesday, August 10, 2004
Weak Employment Number Says It All
In my last market update, I mentioned that if the US markets broke out to the downside, then S&P 1060 is the target to shoot for. Indeed, the S&P fell on Friday to close at 1063.97, near my downside target. Now it is time to look for a brief oversold rally before the next leg down. But be very patient. Although sentiment has been visibly shaken and technical indicators are oversold with some making very impressive positive divergences, we need to see a bit more of capitulation and panic before I can confidently make the buy signal. Stay tuned and be careful out there.
In a nutshell, I would say that the weak employment number released on Friday says it all. 32,000 jobs created vesus the original estimate of over 200,000? What a washout. In addition, June's numbers were revised downwards from the already low 112,000 to 78,000. Together with weak earnings and lower corporate profit margins, this confirms that we are now in the post-stimulus period. The 13 Fed funds rate cuts, tax rebates and refunds have worked their way through the system and their ability to keep the economy afloat is now waning, not to mention that the "use-your-house-as-a-credit-card" scheme known as Mortage Refinancing has come to a standstill in the light of higher long term interest rates.
Why can't the US economy embark on a self-sustained economic recovery? The answer is that the excesses of the late 1990's bubble has not been corrected, but only exacerbated in the past four years as consumers made use of artificially low interest rates to take on more debt, and the outsourcing of labour to cheaper localities keeps both job creation and wage generation in check. We are in a unique point in economic history where the massive misallocation of capital during the 1990's mania has been compounded and even more leverage built into the system, coupled with a global economic environment with an almost infinite supply of cheap labour and where cross-border IT-enabled interconnectivity has brought the productivity paradigm and the global labour arbitrage to a whole new level.
The Federal Reserve is now stuck in a corner, where it must deal with a weakening US economy, but cannot lower rates or keep them stagnant due to rising inflation and the fact that they are at historic lows to begin with. Indeed, this will be a rising interest rate environment coupled with a slowing post-stimulus, debt-laden economy --- the perfect recipe for stagflation. But I do not think that long-term, we are going to repeat the experience of the 1970's like a page out of history. This is due to the massive disinflationary / deflationary forces at work in the world economy today, as I have mentioned in my last market update. We are indeed heading for a turbulent period with few history precedents to guide us.
I do not think a 1987-style crash is going to happen anytime soon, but I believe we are heading for a down year on the major stock indices. I am looking at the NASDAQ to challenge 1650 before the year is out. Longer term, the better investment opportunities are to be found in Asia and in emerging markets, with special focus on smaller economies like Malaysia, Thailand and the Philippines. Investors should also overweight debt instruments of higher grade and shorter duration. Good luck and happy investing!
