Let The Trend Begin
Fortunately Friday was a disposable day because nothing happened. Trading was in a very narrow range trapped between bullishness and profit taking. The eventual draw with the Dow and Nasdaq both closing within six points of zero was on very low volume. No real conclusions about market direction should be drawn from the lackluster results. Monday, however will be a different story.
Dow Chart - Daily
Nasdaq Chart - Daily
Economically Friday was also slow with Construction Spending the only material news. November spending rose +0.3%, which was less than the +0.4% analysts had expected. This was substantially less than the +1.0% from October. It was the third consecutive month that spending increased but it is increasing very slowly. The residential construction component rose +0.9% in November and was the largest component increase. Nonresidential spending is still very weak.
Another weak indicator was the ECRI Weekly Leading Index. This index fell to 117.6 and for the first time since Nov-15th it was under 118. The index had been flat for five weeks and this down turn could be an indication that the recovery is weakening. New mortgage applications fell by -8%. Initial jobless claims grew with the four week average now well over 400,000. With the six month growth rate falling again it could be pointing to another recessionary dip in the 1Q.
The automakers posted both good and bad news today. GM had its best December since 1979 with a +36% increase in sales. Ford posted a +8% increase and DCX +1% overall and +13% for SUVs. That was the good news. The bad news was the consumer addiction to incentives. The incentive war that began after 9/11 has produced a consumer that is demanding more and stronger reasons why they should buy another expensive new car. The automakers are stuck. If they terminate the incentives sales will plummet. If they continue the incentives they lose profits and add to the current addiction cycle. Despite the positive sales reports the majors all finished in negative territory as investors decided there was more trouble ahead.
The earnings warning from Home Depot rattled the home products sector with HD losing -3.50 and LOW dropping -2.43. While that was traumatic to holders of those stocks it was a dose of reality that all investors did not want to hear. Slowing home improvement sales along with slowing mortgage applications means that the consumer may have completed the cocooning phase and is ready to sit out the next economic cycle.
Many of those sitting out the next cycle could be doing so without jobs. The unemployment rate is rising and mass layoff rates are increasing but it appears the government does not want you to know it. While the flag waving for the economy is in full swing the reporting of mass layoffs has been stopped. Could it be that the administration is trying to restrict information that could be contrary to the party line? I am not going to try and paint a conspiracy here but the funding for the mass layoff report was terminated and the November report will be the last one. A reader forwarded me this link from the San Francisco Chronicle. http://sfgate.com/cgi-bin/article.cgi?file=/c/a/2003/01/03/MN120712.DTL
There was another profit warning on Friday that drew my interest. Radio Shack (RSH) warned that slower sales and lower margins on cell phones and other key products would impact results. The keyword here is cell phones. This has been a key product in the minimal chip sector growth and a key growth sector for the last couple years. Bigger, better, faster phones were literally jumping off shelves if we believe the hype. The majority of the Radio Shack problem came from slowing sales of the Sprint PCS phones. Those fully featured, Internet capable models hyped on TV with the stenciled words on phone users foreheads. There are concerns that inventories of cell phones could be backing up in the sales channel and we could be seeing another round of warnings from phone makers ahead.
Want another indication things are tough in retail? McDonalds scrapped plans for a major networking initiative to network all its restaurants, headquarters and vendors. The plan called "Innovate" was scrapped in order to focus on near term benefits and store operations. Are you ready for this? There was a rumor after the close that they were going to rent DVDs to customers through a joint venture similar to NetFlix for 99 cents a day to improve customer traffic. No kidding. Evidently the Blockbuster profit warning did not make it through the network to McDonalds management.
After the close on Friday it was announced that Merrill Lynch analyst Henry Blodget was about to be charged for bogus calls on Internet stocks. Blodget was notified by the NASD that they were going to issue a Wells Notice, which gives him a chance to contest the charges before they are filed. The complaint was that he skewed his research to help win investment banking business for his firm. Get your checkbook out Henry.
The key question for investors this weekend is what does the future hold? The debate over direction could take months but the market tends to pick its own direction regardless of how many analysts agree. There is almost a unanimous agreement that there will be an economic recovery in the 2H of 2003 and the market will gain between 17% and 22% by year end. (9750- 10200) Corporate earnings are expected to increase by +15% to +17% in 2003. Unfortunately this is exactly what the same analysts expected last year. In fact the majority of analysts are almost always WRONG. The amount of bullishness or bearishness is almost an exact opposite of the actual market results. As I reported last week only three analysts of the 65 surveyed by Business week expect the Dow to close below 8500 for 2003.
The rationale for a rebound is strong. The Fed is in overdrive and printing money at a blistering pace. The president will announce even more fiscal stimulus next week to apply even more juice to the economy. There is a pent up tech replacement cycle just waiting to explode. The economy is about to emerge from its soft patch. Corporate profits are expected to be +12% in 4Q-2002 alone. Productivity is soaring. The economy is awash in liquidity, war is good for the economy and the third year of a presidents term is always bullish. Shucks, let's all buy calls. NOT! Does anybody see the problem with this scenario? It is predicated on the perfect outcome. In fact all this bullishness may already be priced into the market.
The problems are numerous. The war is not a given. I think the possibility of a long, messy and globally unpopular engagement is strong. When troops start coming home in body bags the war sentiment could evaporate in an instant. With no weapons of mass destruction yet found it appears Saddam has prepared well and the Jan-27th U.N. meeting could be a challenge for the U.S. If Bush elects to force the issue it could get ugly. Even dragging the start of the war out by a couple months will depress the markets farther because of the negative ramifications.
The Fed is printing money 24/7 to "reflate" the economy. They may reflate the economy but kill the dollar in the world markets. That would bring us full circle and back to a weak economy again. A weak dollar means a strong Euro and problems for our trading partners around the world. Should the economy actually begin to spark the Fed is already poised to raise rates again. We are in that precarious point where the Fed is holding down the throttle of the economy as it gains speed towards the next peak. However, it has to be alert for that approaching peak and reduce speed in just the right increments to insure we don't lose momentum and slide backwards or hit the top too fast and race off the cliff on the other side. When that first rate hike occurs the housing market will screech to a halt and with it the feeder sectors of building materials and home furnishings.
While analysts tell us that the U.S. economy is beginning to improve they also tell us that Europe and Japan are beginning to weaken. Along with the consumer we have depended on Europe and Asia to buy our products and keep our factories rolling. If those countries are now sagging then the purchases from the U.S. could slow just as the U.S. started to move again. This could be another blow to the potential recovery.
Corporate and consumer debt is at an all time high with foreclosures at a 30 year high and auto repossessions soaring. The consumer has been the backbone of the economy but with rising unemployment we saw the weakness start to appear with the holiday shopping. The Home Depot news is just another clue that things are not rosy. The oil crisis is adding a monthly $7 billion tax on the consumer for every $1 over $25 a barrel. Oil soared to a two year high of $33.08 on Friday. Venezuela is spiraling downward and is threatening to destabilize adjoining countries. It could be months before oil begins to flow again.
If the inspectors do not find the weapons in Iraq and the U.S. decides to attack anyway or force the issue with the U.N. it is entirely possible that oil shipments will slow from the OPEC members friendly to Saddam. There is huge uncertainty brewing with the Iraq situation and the outcome and timetable is far from clear.
Bush will announce his stimulus package on Tuesday but the details have already been floated. Guess what? The stimulus is already priced into the market. Once the November election was decided the markets roared off from the November low of 8300 to the December 2nd high of 9043. That nearly +10% gain was the accelerated tax cuts, the change in taxes on dividends and a favorable policy towards business and health care being priced in.
Everything hinges on the technology replacement cycle or so we keep hearing. Unfortunately as long as employers keep cutting employees they don't need to upgrade. The good equipment is claimed by the surviving employees and the old stuff is retired. There is another problem with the cycle and that is the selective upgrade process I spoke about earlier this week. Small purchase orders, minimum quantities and no rush to get it done. There is also the price problem. There is so much capacity in the system that prices are minimal. I upgraded a 300 MHZ, 256MB Pentium-II this week to a 2.0GHZ, 1GB P4 for $346 including shipping. I paid nearly $2,000 for the original PII. The PC is more of a commodity today than ever and nobody is going to get rich selling them. Where are the tech profits going to come from? The Internet has leveled the playing field so completely that the giants are stuck competing with the ThreeStoogesPCSales.com's of the world. When a P4 is a P4 regardless of who you buy from there is no reason to pay double or triple from Dell.
Productivity is soaring. Yes, it has to because corporations are laying off more people to cut costs and produce those all important earnings gains. The problem with this picture is that the earnings gains are not repeatable. Not unless you cut more people each quarter. Until companies actually begin spending more money on goods and services there will not be any real earnings gains. The Goldman Sachs survey this week predicted a drop in spending for 2003 not a gain. This means the expectations for +15% to +17% gain in corporate profits could be just smoke, again.
Almost everyone agrees that the economy hit a wall in the 4Q-2002 and the 3Q recovery stalled. The Fed reacted sharply but earnings estimates for the 4Q are still at the inflated 3Q estimates of +11%. Several (bearish) analysts are predicting they will actually come in at 7% to 9%. If so this will start another wave of downgrades for 2003 and stock prices will fall with them.
This is a real challenge for investors. 98% of analysts are predicting a major gain for the markets in 2003. It could happen. If the stars line up correctly and all the events fall into place just right, it could happen. Unfortunately the markets are already priced for perfection. Unless perfection happens we could be in for trouble. I have trouble with this analysis. I want to be bullish for 2003. I want to cling to the fact that there have not been four down years since 1929-1932 in the Dow. I want to cling to the fact that since 1939 the 3rd year of a presidential term has been bullish. I want to believe that Abbey Cohen's prediction of 10,800 Dow close for 2003 is possible. The problem is what do I base it on?
If I base it on fundamentals I lose because there are none. Every indicator of corporate profits keeps shrinking. Even Abbey is only expecting an 8% growth in profits for all of 2003. I want to base it on technical analysis but the charts do not support it. If I depend on the charts completely I could easily see a retest of prior lows with a rebound back to 9000 by year end. That would be a +25% rebound but only a +8% gain for the year. However, it could be the start of an uptrend and a bullish 3rd year of the presidents term. Yes, statistics have a strange way of asserting themselves.
Since I have no divine insight into the real fate of the markets over the next year I have reached my own conclusion. There will be a lot of volatility as bulls and bears do battle. I don't know which side will win but I am focused on being a capitalist and making money regardless of direction. Weapons manufacturers don't pick sides in war, they just sell weapons. My New Years resolution is to not choose sides. Trade in the direction of the trend and hope for big moves. 2003 will be a stock pickers market but if you only play the upside you could miss half the fun.
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Enter Very Passively, Exit Very Aggressively!
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