June 22, 2005
Samex Capital's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
This excerpt from the June 20th issue has been posted
to coincide with receipt by snail-mail subscribers.
Jim Bianco (www.biancoresearch.com)recently made the point that there is "...little to no talk that the bond marketmight be in a bubble," offering the interesting view that bond sentiment was sobearish that all the sellers have already sold. Mr. Bianco pointed to latestBloomberg survey showing 58 of 61 economists (95%) still looking for higher interest ratesand the latest J.P. Morgan survey showing only 10% of clients long and 53% short. Hecogently adds "... it is the act of selling that drives prices lower and we don'thave that now." We would expect that the eventual consequence will becapitulation by the bond bears, wherein prices are driven even higher. We would addthat if a rapid spike does arrive, it will probably warn the end of the bull cycle isimminent. But until that time arrives, it does not appear that rates are likely toreverse. Sentiment remains the key, as it is for most markets. As Bianco hascorrectly inferred, if there are so many bond bears, we can only assume a goodlycontingent will soon turn bullish and buy bonds.
In the March 28th issue of Crosscurrents, we forecasted that theFed was likely to end the current process of periodic rate hikes at the slightest signthat 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 theeconomy was 3%." CFO optimism is now at a three-year low. The Fed islistening, witness Dallas Fed governor Richard Fishers' statement that "We've gonethrough eight innings here, 25 basis points an inning. The next meeting in June isthe ninth inning. We'll take a look after that. We may have to go into extra innings inthis contest against inflation." If we are correct, unless CPI inflation beginsto rise sharply, the next increase will be the last for awhile.
Last week’s release of tame CPI numbers may have even placedthe game in the bottom of the ninth inning. Given the Fed’s primary objectiveof fighting inflation, why carry the fight further? Rather than permit economicweakness to develop, simply continue to watch the inflation numbers and respondaccordingly. Not that we believe the inflation stats to begin with, but if the Fedis satisfied, they will hold off on further rate increases. As well, consider thatsentiment on long rates is so one-sided that we must expect long rates to continuelower. 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 wouldrather avoid. In conclusion, although we certainly cannot guarantee there will notbe extra innings, we are inclined at the very least to believe the umps are about to calla “Time Out.”
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A recent Bloomberg report pointed out what we've always known; thatthe best environment for investing is often when investors have totally capitulated. Hedge fund manager Hugh Hendry claimed the logical outcome that, "Japan gives you thebest opportunity because share prices have fallen by 70% and Japanese investors have givenup on the stock market." Now that the 1.3% dividend yield on Japan's stockmarket is higher than the 1.2% yield on the 10-year Japan government bond, it makes sensethat stocks may once again gain sponsorship. The last two times this happened inJapan were during the third quarter of 1998 and the first quarter of 2003 and those weregood opportunities to make money in Japan's stock market, which rose by 40% and 35%respectively in the subsequent six-month periods.
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Dr. Steve Sjuggerud recently penned a fascinating analysis couplewith long term stock market projections at http://tinyurl.com/a9by5. The good Doctor placed in our view a table lifted from a new book by Ed Easterling, calledUnexpected Returns. We haven’t heard about the book but are familiar withsimilar 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 andpredictably, the highest returns were when P/Es were the lowest and the lowest returnswere when P/Es were at their highest. The worst decile was relegated to averagebeginning P/Es of 19 and subsequent returns for the next generation ranged from 1.2% to4.5% annually, and averaged 3.2%. In case you hadn’t noticed, the S&Ps P/Emultiple as of last week was over 20.
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Unlike two weeks ago, overbought conditions now existand 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 thannominal movement. Although volatility dipped again to a multi-year low, with so manysummer vacations for traders and investors on the horizon, there seems no reason to assumean 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 toearly ’00.
We still see this pattern as bearish andultimately resolving sharply to the downside, most likely in the fall.
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the firstissue was published in May of 1990. Mr. Newman is also a member of the Market Technician'sAssociation and has been widely quoted for years by the financialpress, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published 20 times per year and focuses oneconomic and stock market commentary, often covering controversial subjects. Severalproprietary technical indicators are usually featured in every issue accompanied bycurrent interpretation. Broad samples of our work can be viewed at
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