Being Street Smart December 17/04
by Sy Harding
December 17/04
ENJOY THE MARKET RALLY – BUT REMAIN ALERT!
Since hitting a low for the year at 9,750 on October 25, the Dow has
rallied 10% and is now in positive territory for the year. The major indexes
have all broken out above overhead resistance, and the market’s
favorable season should produce still more gains.
On the economy there’s not much wrong short term. Economic numbers
continue to come in mixed, but with recent and current activity positive
enough to keep investors confident and moving cash into mutual funds.
Yet threats of future problems indicated by longer-term economic reports
are enough to prevent the market from running away in unsustainable enthusiasm.
The economic reports this week followed that mixed pattern. The Commerce
Department reported that the U.S. international trade deficit widened
by a huge 8.9% in October, to yet another new record. The Treasury Department
reported that foreign purchases of U.S. stocks and bonds declined significantly
in October (to $48.1 billion from $67.5 billion in September). And the
Commerce Department reported that new housing starts plunged 13.1% in
November, the sharpest monthly decline in more than ten years. But those
reports indicate problems the economy and stock market will face down
the road.
More immediate, the market got a pleasant surprise on inflation with the
report that the Consumer Price Index of inflation rose only 0.2% in November,
after it had shocked Wall Street with a scary 0.6% gain in October (which
was an annualized rate of 7.2%). The Philadelphia Fed Index of factory
activity, and the NY State Business Index both came in considerably stronger
for November than economists had forecast, and the Fed reported industrial
production rose 0.3% in November, also stronger than forecasts.
Meanwhile, concerns about high energy costs, which began to spook the
market when oil reached $45 a barrel and then $57, have lessened some.
Over the last couple of weeks crude oil declined to the low $40s, then
rallied back up to $46. Strangely enough, after previously reaching higher
levels, $46 oil seems to now be okay with the market.
Regarding the market’s technical underpinnings, trading volume leaves
something to be desired, but market breadth has been impressive, and relative
strength and momentum reversal indicators remain positive and have quite
a ways to go before they would normally become overbought.
On valuations levels, the S&P 500 is selling at 20.6 times trailing
earnings, and 16.5 times Wall Street’s consensus earnings estimates
for 2005. Those are not cheap levels, but neither are they extremely expensive,
although that perception will change if earnings begin to falter.
Meanwhile, thanks to good earnings many corporations are awash in cash.
But given the troublesome longer-term outlook for the economy, not many
are willing to spend their excess cash on hiring more employees or buying
equipment. So using the cash for merger and stock buy-back activity has
been picking up, and that’s also usually positive for the market
for awhile.
Putting it all together the market seems to be in good enough shape to
remain positive.
However, as I’ve been saying for awhile, enjoy the rally as long
as it lasts, but don’t get to thinking the economy, or the stock
market, of the 1990s is back. That was an unusual decade, seen only once
before, in the 1920s. Historically, economic recoveries last 3.5 years
on average. This one has already been underway for three years. And it
hasn’t been all that impressive either, with the employment picture
still dismal, and the recovery needing as fuel the most aggressive stimulus
efforts ever undertaken by Washington. As you know the stimulus was in
the form of heavy government spending, tax rebates, and tax cuts, (which
produced record federal budget deficits), and aggressive cuts in interest
rates, zero-percent financing, cash incentives from auto manufacturers,
and massive amounts of mortgage refinancing to take equity out of homes,
(producing record consumer debt).
It’s becoming a much less friendly atmosphere for consumers now,
with high energy costs and a reversal to rising interest rates, at a time
when debt loads are already heavy. With this week’s rate hike the
Fed has now raised rates five times since June and it indicates several
more hikes are in the works for next year.
So consumer spending, which carried almost the entire load of producing
the current economic expansion, may peter out in the coming year. It’s
just possible that the disappointing holiday sales being reported by retailers,
and the 13.1% plunge in new home starts in November, are warning shots
across the bow.
So again, enjoy the rally as long as it lasts, but remain alert!
Sy Harding is president of Asset Management Research Corp., publisher
of The Street Smart Report Online at
www.streetsmartreport.com and author of 1999’s Riding The Bear
– How To Prosper In the Coming Bear Market.