Market Wrap Up May 19/05

by Martin Goldberg

Mr. Market Discounts More Debt for the US Consumer
Is It Possible?

As of Wednesday evening, the US stock market posted its largest 3-day gain for several months, and the leadership is clearly the US consumer stocks including Winnebago’s, homebuilders, department stores, specialty retailers, hardware stores, restaurants, electronics, boat manufactures, computers, and truckers to deliver all this chattel from China to the US malls and stores. Similar to August of 2004, after a lackluster low volume start to the rally, Wednesday’s action intensified in volume and turned the rally decisive with the US consumer leading the way. Also in the lead are speculative stocks such as airlines, which were UP over 5.5% on Wednesday. Given their almost century-long failure to deliver any real value to shareholders, when a rally is led by such a sector, I’m skeptical.

It’s astounding to see that the stock market is discounting another round of US refinancing and home purchases and even more debt on the part of the US consumer. The fuel for this spending has been creative loan packages available to US consumers and historically low interest rates which are being reduced even more by the recent decisive bond market rally. But what is different in this bond market rally is that the Fed continues to raise short term rates while the long term rates are moving down. The result is a flattening yield curve – an event that typically portends economic slowing; however, this phenomenon is being ignored by the stock market which only sees another round of consumer purchases and debt on the way. You can’t necessarily blame the stock market for acting on the good times in bonds – that’s the general relationship that exists between the stocks and bonds in non-deflationary times. What’s good for bonds is good for stocks. But in deflationary times, bonds rally while stocks swoon. Is it time to look at the stock and bond market rally and determine that Mr. Greenspan has taken the US economy to safe waters? Similar to today’s stock market, they also partied on the Titanic after the iceberg scraped a fatal gash through the bottom of the ship.

I think that the Fed will now have to scramble to keep the lid on the perception of deflation amongst the US public. If the US consumers perceive deflation, they will pull in their spending since a dollar tomorrow will be worth more than a dollar today, and that would cause the retail/ housing bubble, and stock market bubble to burst. The Fed’s next move is likely to be talking the bond market down (interest rates up) with Fed governor statements and economic data. This will allow them to continue to raise short term rates without flattening the yield curve. For example, as of Wednesday night, I’ll predict the weekly jobless statistics on Thursday morning will be lower than expected (less jobs lost) and the bond market should drop on the news (more on this in “Today’s Market”). Yet, if the US public perceives too much inflation, this will not be good for consumer spending either (prices go up). This would hurt the bond market and higher interest rates would burst the housing bubble. So Maestro Greenspan will have a tough task on his hands as he prepares for retirement. And with two bubbles – real estate/retail, and overvalued stocks - perhaps almost ready to burst, he will have to come up with his best acting job to date.

Is Bernanke the One?

If that goes off without a hitch, Mr. President will soon have the task of replacing John Law and this will be an extremely difficult task considering the unique talents of the retiring Fed Chairman. If the conventional wisdom is that his replacement will be Ben Bernanke, consider me a contrarian. Consider Bernanke’s statement about “Helicopter Money.” This was a flippant remark that shows a lack of the basic wisdom in what it takes to be a successful Fed Chairman. With only “trust” and paper behind our currency, the Fed Chairman has to project trust and confidence in their manner of speaking, and expressions, as well as how they say what they say. (It’s best to keep what they say a partial mystery though.) Without trust and confidence, money is only paper. Unlike Bernanke, I think that Mr. Greenspan could have made a helicopter money statement without using the inappropriate word (“helicopter”) and all the while having a room full of adoring congressman letting out a knowing and admiring “ahh” after the statement was made. Indeed, unlike the President, the Fed Chairman has to look like a smart person at all times - no exceptions. When before congress, he needs the talent of staring down a senator who asks a tough question with an expression that both intimidates while he also avoids speaking directly to the question. In this regard Mr. Greenspan is a modern day Babe Ruth.

Let us not forget that as chief bubble blower, the Fed chairman appointee needs to be intelligent enough to know the gravity of what current John Law policies are doing to the US society in the long term while implementing these policies all with a straight face. So the person needs a level of intelligence and ethics together that may be difficult, if not impossible to find.

Is Bernanke the man for the job? You decide!

Key Consumer Socks

Below are the charts of some key consumer-related stocks. While the rally was sharp and decisive in this sector, it may not be time to proclaim a long-term bull market anchored by the US consumer. In general the action looks erratic and not indicative of a sustainable bull market (although some short term gains are likely given the current momentum environment).

S&P Retail Index

The chart of the S&P retail index shows an amazing whipsaw indeed. Trend followers saw a good entry point to short just as the index approached the convergence of its 50-day, 200-day and trendline. So what did the technical analysts get for their efforts? Whipped! Hope their stops were in or option positions were modest!

Homebuilders

Amazingly, Wednesday’s action in the homebuilding stocks was decisive and confirmed by very high volume in the individual stocks. Last week, I mentioned how the homebuilding index decisively sliced through its 50-day moving average to the downside, only to come roaring back this week. I’m watching the weekly jobless claims and how the homebuilders react to “the number.” (More on that in “Today’s Market.”)

As was pointed out before in this space, NVR Homes (NVR), a former leader in the sector, is now lagging in the face of a homebuilder’s rally. If lagging homebuilder stocks such as NVR start to advance with the entire sector, that would be bullish for the entire sector. Yet, Wednesday’s action didn’t bode well for NVR as it finished exactly where it started while other homebuilders posted gains of over 4%. The candlestick shows a downward pointing arrow – a bearish short-term sign.

Similarly the action in Dominion Homes (DHOM) shows that unlike previous homebuilder rallies, not all stocks in the sector are advancing. During Wednesday’s rally, DHOM dropped marginally on greater than average volume.

Best Buy

A pure play on the American Consumer buying cheap stuff made in China. Another big screen TV for me! Note the decisive trend break confirmed on high volume. Having broken the trendlines and moving averages, it could get to about 60. Best Buy has now got momentum.

Winnebago Industries

The stock of this mobile home company has been a bit irregular in the last year. It’s difficult for me to believe that long-term business conditions in a company that makes gas guzzling moving houses can continue to do well in this environment. Still WGO participated in this rally with gusto. It should see resistance at the gap-fill and the intermediate term picture is still bearish (but improving, obviously).

Brunswick Corp.

Recreation product maker Brunswick is not a stock that you can easily put a trendline on. For the last 6 months the stock has whipped around wildly in a similar fashion to Winnebago. Yet note the divergence between the recent rally and its volume – a rally of 8% in three days, and it has yet to approach an average day’s worth of volume. BC sits at resistance of its 200 and 50 day moving averages as well as the top of the long ugly red candlestick.

La Z Boy

This maker and distributor of cozy recliners broke out of an apparent rectangle only to come roaring back to the former support level. Considering the failure to make any headway in the last year, I doubt if one more round of consumer debt is going to do much for this consumer stock. If I was bearish on the stock, I’d want to see lower than average volume as the stock moved back to the former support line.

Utilities

The utilities look a little tired and there is a wedge that has not been confirmed as of yet. This chart is an important one to keep an eye on because normally we would expect the utilities to confirm the bond market rally. The trend break was whipsawed; still the utilities chart looks a little tired.

Today’s Market

The impressive rally continued for a 4th straight day as all of the indices were up on healthy but less impressive volume than yesterday. Over the last 4 trading days the S&P 500 has surged about 5%.

There are a considerable amount of fund managers who maintain their pay and job security on not missing these rallies and this is likely to be contributing to the sharpness of the rally. Similarly there are fund managers who’s livelihood is at risk if they get caught in losing positions in a rally such as this, and covering these positions are probably also contributing to this rally. With the shear amount of hot money around, there is no telling how long this trading range environment will last. With each trading range go-round, there become more active participants. In the end, fundamentals and valuation will prevail and the tricky part (of course) is establishing when this will finally occur. In the meantime, there’s a party going on, and bears can look to minor resistance at our current S&P 1191 as shown in the chart above. Bulls can look to the convergence of the 20-day EMA and 50-Day SMA (about 1170) as a point to enter if there is a low volume pull-back. The dark blue line at the top of the graph is the point at which the stock market will again make bullish headlines, and it appears that in the short run, if resistance is cleared, we will get to the dark blue line (~1230).

As predicted, the weekly jobless number coupled with the Fed Chairman’s Freddie talk resulted in an ever so slight staring down of the bond market. As the daily chart of the 30-year Treasury yield indicates, although there has been a lot of talk about the bond market rally, we are now at a higher low. Mr. Greenspan has expressed the lowering of the 30-year rate as a “conundrum” (unlike “helicopter”, a good Fed Chairman word), and in doing so, indicated that his expectations were for higher long interest rates. The last time I can recall Mr. Greenspan making such a bad call was when he uttered “irrational exuberance,” and we all know how that turned out. It appears that the long bond market requires news to push it lower (interest rates higher), but it is rising all by itself. Sort of like a bubble rising.

In spite of today’s ever so slight increase in long interest rates, the homebuilding stocks took the news in stride as the index was up slightly, and NVR Homes outperformed the sector, almost punching through resistance and confirming good times for all homebuilders. (Dominion Homes DHOM was down today and the stock market performance suggests something is wrong there.)

While at some point it is obvious to me that these stocks will make for great bearish positions, considering the recent action, there are not good risk/reward ratios in doing so now. Given the favorable action in the sector there is reason to believe that the US market may see these companies as “non-cyclical” and award trailing P/E’s of 20 to 30. Additionally, the index sits above all three important intermediate term moving averages. It's clear – Mr. Market is predicting another round of creative finance and re-finances and at least 2 more real estate specials on CNBC. I think technology is to October of 1999 as real estate is to May of 2005. At that time semi-conductor stocks were seen as non-cyclical. It can happen to homebuilders as well because that’s what happens near the top of bubbles.

Although precious metals is not an exciting trade of late, the chart of the Central Fund of Canada (which contains practically all silver and gold in an approximate even split), shows a support area where it can be bought with little risk and a logical stop out point. If you are in the “precious-metals-are-being-manipulated” camp, consider that further significant drops in precious metals prices will appear deflationary and therefore “won’t look good.” Therefore, there may be incentive to actually support the price of precious metals, especially gold.

Finally, my soon-to-be-established newsletter will focus primarily on investment and trading ideas within retail US consumer-related stocks. Over time this is a cyclical sector and there is significant opportunity on both the long side as well as the short side of the trade, depending on the irrational exuberance and irrational depression shown by the stock market over time. Currently, we are experiencing irrational exuberance in these stocks. At irrational depressed extremes, shares in consistently profitable companies with no debt could be had for less than the cash on their balance sheets. The newsletter will focus on finding good risk reward ratios in the consumer related sector. In short, I aim to find the next Krispy Kreme and have my subscribers profit from good inverse value investing while using technical analysis to not get hurt by an over exuberant Wall Street. When the Street becomes depressed, I will look for actual value.

Have a great evening!

Martin Goldberg

Martin F. Goldberg, MS, P.E.
Market Analyst
email mdelmgoldberg@comcast.net