Crosscurrents June 22/05
June 22/05
by Alan M. Newman
Jim Bianco (http://www.decisionpoint.com/TAC/CCWEBASP/www.biancoresearch.com) recently made the point that there is "...little to no talk that the bond market might be in a bubble," offering the interesting view that bond sentiment was so bearish that all the sellers have already sold. Mr. Bianco pointed to latest Bloomberg survey showing 58 of 61 economists (95%) still looking for higher interest rates and the latest J.P. Morgan survey showing only 10% of clients long and 53% short. He cogently adds "... it is the act of selling that drives prices lower and we don't have that now." We would expect that the eventual consequence will be capitulation by the bond bears, wherein prices are driven even higher. We would add that if a rapid spike does arrive, it will probably warn the end of the bull cycle is imminent. But until that time arrives, it does not appear that rates are likely to reverse. Sentiment remains the key, as it is for most markets. As Bianco has correctly inferred, if there are so many bond bears, we can only assume a goodly contingent will soon turn bullish and buy bonds.
In the March 28th issue of Crosscurrents, we forecasted that the Fed was likely to end the current process of periodic rate hikes at the slightest sign that the economy was slowing. We cited a survey of 293 CFOs in which "35% claimed the highest level the Fed Funds rate could reach without doing damage ti the economy was 3%." CFO optimism is now at a three-year low. The Fed is listening, witness Dallas Fed governor Richard Fishers' statement that "We've gone through eight innings here, 25 basis points an inning. The next meeting in June is the ninth inning. We'll take a look after that. We may have to go into extra innings in this contest against inflation." If we are correct, unless CPI inflation begins to rise sharply, the next increase will be the last for awhile.
Last week’s release of tame CPI numbers may have even
placed the game in the bottom of the ninth inning. Given the Fed’s
primary objective of fighting inflation, why carry the fight further?
Rather than permit economic weakness to develop, simply continue to watch
the inflation numbers and respond accordingly. Not that we believe
the inflation stats to begin with, but if the Fed is satisfied, they will
hold off on further rate increases. As well, consider that sentiment
on long rates is so one-sided that we must expect long rates to continue
lower. If short rates continued higher, we’d soon see an inverted
yield curve, a signal of an impending recession to many and a circumstance
we believe the Fed would rather avoid. In conclusion, although we
certainly cannot guarantee there will not be extra innings, we are inclined
at the very least to believe the umps are about to call a “Time Out.”
A recent Bloomberg report pointed out what we've always
known; that the best environment for investing is often when investors
have totally capitulated. Hedge fund manager Hugh Hendry claimed
the logical outcome that, "Japan gives you the best opportunity because
share prices have fallen by 70% and Japanese investors have given up on
the stock market." Now that the 1.3% dividend yield on Japan's stock
market is higher than the 1.2% yield on the 10-year Japan government bond,
it makes sense that stocks may once again gain sponsorship. The
last two times this happened in Japan were during the third quarter of
1998 and the first quarter of 2003 and those were good opportunities to
make money in Japan's stock market, which rose by 40% and 35% respectively
in the subsequent six-month periods.
Dr. Steve Sjuggerud recently penned a fascinating analysis couple with long term stock market projections at http://www.investmentu.com/IUEL/2005/20050509.html The good Doctor placed in our view a table lifted from a new book by Ed Easterling, called Unexpected Returns. We haven’t heard about the book but are familiar with similar tables we have seen in past years, but you simply must see it for yourself. All 86 periods of 20-year returns for the S&P from 1919-2004 were ranked by decile and predictably, the highest returns were when P/Es were the lowest and the lowest returns were when P/Es were at their highest. The worst decile was relegated to average beginning P/Es of 19 and subsequent returns for the next generation ranged from 1.2% to 4.5% annually, and averaged 3.2%. In case you hadn’t noticed, the S&Ps P/E multiple as of last week was over 20.
Unlike two weeks ago, overbought conditions now exist and short term sentiment is at levels more likely to trigger a price correction. However, as before, there just does not yet seem to be a setup for anything more than nominal movement. Although volatility dipped again to a multi-year low, with so many summer vacations for traders and investors on the horizon, there seems no reason to assume an imminent huge expansion in volatility. A broadening top continues to form, looking more like consolidation rather than the top that preceded it in late ’99 to early ’00.
We still see this pattern as bearish and ultimately resolving sharply to the downside, most likely in the fall.
PLEASE NOTE: OUR BREAKING COVERAGE OF A POTENTIAL SHORT
SQUEEZE OF NOVASTAR FINANCIAL STOCK HAS FORCED US TO TEMPORARILY DISCONTINUE
FREE TRIALS. IF YOU REQUEST A FREE TRIAL,
YOU WILL BE GIVEN SEVERAL ALTERNATIVES. THE FREE TRIAL PROGRAM
SHOULD BE REINSTATED WHEN THE ARTICLE SERIES IS COMPLETED, PROBABLY IN
FEBRUARY 2005.
ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published 22 times per year and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
Subscription rates are $169 for one year and $89 for
six months. A FREE 3 issue trial subscription is available by emailing
us (click the "free trial" link above). Please note: trial requests must include name,
address and phone number and must originate from the email address
the trial is to be delivered. Trials are only
available by Email (.pdf files). U.S. Mail subscriptions are available
but include a nominal surcharge for postage and handling.
