Michael Belkin : The Best News is Behind

» Normxxx - The Best News is Behind

By Michael Belkin | July 14, 2004

As investors ponder the difference between current economic and market conditions and the utopian hype at the beginning of the year, they might well blame Wall Street for an intelligence failure and themselves for gullibly believing the hype. What is left to be discredited? The last remaining WMD (Weapon of Mass Delusion) is the cyclical and industrial economic recovery. While our model does not yet have a downward forecast for most industrial economic indicators, the slowdown in sales and rising inventories of goods such as autos and semiconductors suggest a cyclical slowdown is approaching.

We won't add much to the hyper over-analysis of the Fed's recent action, except to point out that the fed funds rate is 200 basis points below the CPI inflation rate – a more normal level would be at least 200 basis points above the CPI. The CPI rose 71 basis points last month (annual rate). So 25 basis point fed funds rate increases won't even keep up with the CPI rise that the Fed's negative real interest rate policy has created. What a mess Greenspan has created. Most things now celebrated by awe-struck investors wouldn't exist without ultra-low short-term interest rates (carry trade, zooming emerging markets, financial stock out performance, car sales, home sales, etc.). Investors are firmly planted in Fed-created bubbles that won't survive an interest rate up-cycle. Ironically, hardly anyone is calling this a bubble – when it is a bigger one in many ways than March 2000. That was just TelecomMediaTechnology – this is everything.”

The last thing anyone seems to expect is an economic slowdown in the US. But our model sees early signs of a downturn approaching. The best news is probably behind for home sales, auto sales, economic growth and inflation. The model has an early downward forecast for the ECRI weekly leading index and money supply growth. It has an upward forecast for core PPI, core CPI and initial unemployment claims. An economic slowdown accompanied by rising inflation is not a pleasant environment for consumers, employers or corporate earnings. We expect companies to lower guidance and knock share prices lower. So far, several major US companies have had disappointing pre-announcements or earnings; e.g., WalMart, GM and Washington Mutual. That is a broad industry range – retailer, manufacturer and home lender. Other disappointments are lurking out there. Stock indexes have been stuck in a trading range all year. 2004 highs (so far) were set months ago – but stocks haven't fallen much yet. It has been a frustrating environment for both bulls and bears, as short-term rallies and declines have both stalled out without much follow-through. Mutual fund inflows have dried up, but there hasn't been much on the fundamental side to motivate selling. As economic and corporate earnings news deteriorates, mutual fund outflows will probably increase, sending share prices lower. Weaker groups/markets that appear to be leading the broader market lower include semiconductors, securities brokers and emerging markets.

Semiconductors typically lead technology sector performance, tech leads the Nasdaq and the Nasdaq usually leads other US and global indexes. So semiconductor group performance is vital for other groups and markets.

Semiconductor stocks have been much weaker than the S&P500 and Nasdaq this year. The SOX Semiconductor Index is down 11% ytd – while the S&P500 is up 2% and the Nasdaq is down 1%. The SOX recently turned down again and is close to its early-May lows, erasing most of the May-June bounce. The SOX is also below its 200 day average. Are semiconductors leading tech and the broader market lower? Given the widespread celebration about economic growth and all things cyclical – it is ironic that the leading ‘smokestack tech’ group (semiconductors) is ailing.

Our model’s #1 underperformance prospect in the US and Japan is securities brokers. Brokers typically lead financials in the same manner as semiconductors lead tech. The XBD securities broker index chart resembles that of the SOX – below its 200 day average, back to its May lows – having erased the May-June bounce. The XBD Index has underperformed the S&P500 financial sector by 12% since late January.

The model forecast suggests that that theme will continue. Broker’s share prices are slipping, even while they scour the earth for new ways to keep the financial bubble going. The joke is on them.

The IFC emerging equity market composite index is down 15% from its early April high and has a big downward model forecast. Emerging markets are like balloons – fill them up with helium, release and watch them fly as the gas rushes out. Then watch them flutter back to earth, empty. Those 1% US interest rates generated big capital inflows into emerging markets (which zoomed) – but now the gas is gone and the flutter-back-to-earth cycle is underway.

Bottom Line
Three bull market leaders (semiconductors, brokers and emerging markets) are in distinct downtrends with downward model forecasts. This deterioration stands in stark contrast to the constant chatter about economic growth and stock market rally potential. Whoever is long semis, brokers and emerging markets isn’t buying the happy-talk consensus view – they are selling.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx