| TSG Weekly Market Watch August 22, 2008 |
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| Written by Matt Blackman | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Saturday, 23 August 2008 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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TSG Stock Market LetterWeek Ending August 22, 2008Topics Discussed This Week: Stocks still treading water in low volume well… While leaders outperform New home sales, starts remain soft Government Stats - Perfecting the art of mass deception
Last Week
Quotes of the week “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludwig Von Mises – Austrian economist. Stocks treading water in low volume well It was another week of low volumes but stocks, like a wave-tossed ship heading into the teeth of a storm, experienced violent swings but when it was over had gone nowhere. The difference between this week and last is that while results were mixed a week ago, all indexes fell this time. But what is most interesting when looking at the big picture and considering the challenges, how well the major indexes have held up so far in the eye of the housing and credit and storm. Is it the election lift affect? Or could it be that investors are playing the game with their eyes wide shut to the real risks? Certainly the VIX supports the latter contention. Technically Speaking Leaders surge higher For the first time in three weeks, Zanger’s Sunday pix led the pack this week with a gain of nearly 2% compared to drop of more than 1% last week. His week’s list of 12 stocks included last week’s pix Research in Motion (RIMM), Energy Conv (ENER), Apple (AAPL), Fuel Systems (FSYS), Continental Airlines (CAL), United Airlines (UAUA) and Valero Energy (VLO) as well as beleagured lenders Ambac Financial (ABK) and MBIA (MBI) as well as past pix Dryships (DRYS), LDK Solar (LDK) and Sunpower Energy (SPWR). That these leaders are heading higher is bullish but in this volatile market, anything can happen during the low volume summer doldrums.
Figure 1 –Five-day performance of Zanger’s last Sunday pix (green) compared to the S&P500 (SPX), the Dow Jones Industrial Average (DJX), Dow Transports (DTX), Nasdaq Composite (IXIC), Russell 2000 (RUT) and MSCI Emerging Market ETF (EEM). Data courtesy of The Zanger Report, performance chart courtesy of VectorVest.com. And weekly volumes fell yet again for every major index including the Dow Industrials, Dow Transports, Nasdaq Composite, Russell 2000 and NYSE Index this week. However, since they fell, falling volume is considered mildly bullish but we’ll have to wait until after Labor Day to see what the pros do when they return from their summer hiatus. What is interesting is that the Dow Transports continue to weaken even as oil prices have come down which should have helped them. Meanwhile, after spiking to 27.49 seven weeks ago, the Market Volatility Index (VIX) settled down for a sixth week to 18.81 (from 19.58 last week). This compares to a VIX north of 31 when the Dow last bottomed during the week of March 14 and shows that fear is subsiding. But are investors becoming too complacent especially since September has a well-deserved reputation of being the worst month of the year? After hitting a high of 611.51 six weeks ago, the 19 commodities that make up the NYFE CRB Index bounced this week to close at 519.39, up from 499.11 last week. Only time will tell if this is a sustained rally after the six week correction or simply an oversold bounce. After hitting major support around $785 last week, gold bounced to close the week at $828.50/oz from $788.10 last week but still below its $860.40 close two weeks ago. Gold should have begun enjoying its strong seasonal period from the end of July to the end of September so this might be a late seasonal move. And after five consecutive weeks of rallying, the U.S. Dollar Index took a break this week closing at 76.65 down from 77.12 last week. But much of the dollar move has been due to apparent stronger GDP growth than in Europe, Canada and much of the OECD. But as we will see below in our Synopsis, has our GDP measure been grossly distorted to give an unrealistically positive reading? If so, it could have dire consequences on the dollar as well as push interest rates rapidly higher. Oil looks to have hit resistance around $115/bbl as a barrel of NYMEX crude contract closed at $114.78/bbl up from $113.95 last week. But it is off more than 20% from the weekly high of $145.15 July 11 and that is good news for consumers. But it is the twenty-fifth consecutive week that oil has remained above $100. Normally, oil hits a seasonal high in mid-October but like gold, seasonality appears to have given way to economic forces. The U.S. bank prime rate held again this week at 5% and the Fed funds target rate remained at 2%. The 3-month London Interbank Offered Rate (LIBOR) ticked up again to 2.81% (from 2.8088% last week). After holding steady for two weeks, Freddie Mac mortgage rates slipped to 6.47% (from 6.52% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) jumped to 5.29% (from 5.18% last week). LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. Corporations around the world have the interest rates on roughly $9 trillion in debt pegged to LIBOR and rates on more than $380 trillion in derivative interest rate swaps also are based on LIBOR. Earnings In the seventh week as Q2-08 reporting season winds down, a total of 3796 companies have now reported (up from 3413 companies last week) and average earnings fell again and are now down -39% (from -37% last week, -32% two weeks ago and -22% three weeks ago) versus Q2-07. Financial services were by far the worst performers (-99%) followed by consumer services (-34%). This compares to an overall 30% drop at the end of Q1-08 earnings season with a grand total of 4214 companies having reporting. This also marks the third quarter that earnings have shown a consistent trend to drop as more companies have reported. Looking at past seasons, there was a drop of 57% for final Q4-07 (3900 companies), a 21% drop (4205 companies) for Q3-07 and a 13% jump for Q2-07.
Chart 1 – Charting year-over-year GDP growth over the last three years. The trend remains sharply negative and there are few signs of an earnings bottom here. Economic ReportsHere are the reports we were watching this week. We learned that the Producer Price Index (PPI) rose at the sharpest rate in 27 years in July confirming the CPI spike we witnessed last month. But there are two undeniable positives. First, the U.S. dollar has experienced a strong rebound in the last month and commodity prices have experienced the biggest month drop in a decade, both are good for helping tame inflationary pressure. Before looking at another government agency economic report (like GDP), be sure to watch Chris Martenson’s excellent video presentation entitled Fuzzy Numbers (link below). It explains why our indicators, that have been pointing at a recession for a while now, have yet to be confirmed by reported GDP numbers and why each recession has been marked by increasingly less negative GDP numbers. That reported numbers have remained so upbeat in the current recession is further testament to the increasing skill of government minions and politicians to generate false confidence. Reviews have started to come in for the new documentary entitled I.O.U.S.A. that highlights the dire debt situation facing our nation (see article below “IOUSA…”). I’m certainly going to see it. New homes, housing starts and permits still soft“Anybody who says they know when [home price declines are] going to end with confidence is delusional. But yes, you can get a sense of where things are going.” Karl Case, co-creator of the Case-Shiller home price index.
Chart 2 – Reports kicked off Monday with the National Association of Home Builders housing market index reading for August of 16, the same reading as July as the lowest on record as homebuilders continue to be plagued by foreclosure sales and large inventories. Chief economist David Seiders did his best to put a positive spin on the reading and hoped that we were near a bottom in existing home sales but did admit that there was nothing in the data to support that view.
Chart 3 – Easy come, easy go… Last month we learned that housing starts jumped 9.1% in June and this month we discover that starts dropped 10.9%. Ditto for housing permits, which rose 16.4% in June only to fall 17.7% in July; taking both back to where they were in May. As we see from the chart, while volatility has increased, there is the potential that the worst is at least temporarily over but only time will tell if this is a bottom. The challenge is that for the first time in a number of years, the excess of permits/starts (homes being built) now exceeds new home sales – not a good omen for the burgeoning inventory of new homes. Next Week Here are the reports we’ll be watching next week. The ones emboldened are leading or useful indicators we are tracking, the others have the potential to impact markets short-term. - Monday, Jul Existing Home Sales (previous -2.6%). - Tuesday, Jul New Home Sales (previous -0.6%). - Wednesday, Jul Durable Goods Orders (previous 0.8%). - Thursday, Q2-08 Preliminary GDP (previous 1.9%), Q2-08 Preliminary Corporate Profits. - Friday, Jul Personal Income (previous 0.1%), Jul Personal Spending (previous 0.6%), Aug Chicago PMI (previous 50.8), End-Aug Reuters/U Mich Sentiment Index. Synopsis Government Stats - Perfecting the art of mass deception “The truth that survives is simply the lie that is pleasantest to believe.” H. L. Mencken We have often questioned why our most reliable market (and economic) indicators have been pointing toward a recession for more than a year (and in one case, three years) even as government statistics have shown the economy to be growing and inflation relatively benign. This week we examine why. But first, here is noteworthy quote that appeared in the opening screen of Chris Martenson’s excellent 16 minute video entitled Fuzzy Numbers that provides a hint. “Ever since the 1960s, Washington has gulled its citizens and creditors by debasing official statistics, the vital instruments with which the muscle and vitality of the American economy are measured.” – Kevin Philips, April 27, 2008 Harper’s magazine entitled Hard Numbers: The economy is worse than you know. It is no secret how fast overall debt has grown and how government agencies fudge the numbers to make the economic picture appear far more pleasing than it really is. This week we take a closer look at how they do it. Why has the spotlight of media attention suddenly illuminated this problem now? We’ll explore this question in a moment. Since the U.S. was taken off the gold standard by Richard Nixon in the early 1970s, the government has become far more creative at using inflation indicators to lull citizens although real inflation has skyrocketed, especially come election time. The double whammy is that they are also artificially boosting economic growth figures. As Martenson points out, various administrations, both Republican and Democrat have used some very clever methods to achieve this end. Real growth occurs when inflation is low and economic growth is high. Martenson tracks how each president from JFK to Bill Clinton has added their own special sauce in dealing with undesirable stats to make things seems rosier than they really were. While these fibs have grown in both proportion and scope, their forecasting value has steadily declined. How has this goal been achieved? In an effort to keep inflation down and accentuate growth, statisticians shamelessly distort and manipulate the data. For example, the Consumer Price Index measures inflation in part by comparing a basket of goods over the years. But what is not publicly understood is that each year, that basket changes. In 1996 Clinton instituted changes to how the statistics are calculated that provided government economists with three new powerful methods to fudge the numbers; substitution, weighting and hedonics (derived from the Greek word for pleasure). They in effect, give government agencies three new tools to change the way they measure and present inflation and economic data at their pleasure. Here is just one example of how one of these tools, namely substition, works. If the price of salmon goes up too much, the Bureau of Labor Statistics substitutes it for a cheaper food item like say hot dogs. The result is that from 2007 to 2008, CPI showed a 4.1% rise in the price of food. But according to the Farm Bureau, that tracks the same basket (without using substitution, weighting or hedonics), food prices actually rose 11.3%!
Figure 2 – Difference between how CPI is calculated today by the BLS and how it was calculated in the 1960s without all the smoke and mirrors. As a result real inflation is now running at 13% not the 5%, the BLS would have us believe. Chart ChrisMartenson.com Fuzzy Numbers (see link below). Without a doubt, hedonics is the most insidious tool in the hands of government statisticians. It allows them to creatively reduce CPI (inflation) on one hand while making economic growth appear bigger than it really is on the other. Without giving away the whole story, these minions can change the price of a product, service or good by imputing a higher value (in the case of the economy) to make growth appear greater while imputing a lower value (in the case of an inflation measure like CPI) to make inflation appear lower than it really is. Hedonics, substitution and weightings changes currently represents 46% of reported CPI and 35% of reported GDP growth according to Martenson. In other words, about one-half of the CPI reported is real while less than two-thirds of reported GDP growth is real.The result is that inflation is growing at least twice as fast as CPI shows while economic growth appears to be nearly 50% greater than it really is. What if CPI were calculated the same way it was in the 1960s? Using the techniques employed more than 40 years ago, John Williams of ShadowStats.com estimates that CPI in 2008 is running at 13% not the 5% reported by the BLS (see Figure 2). It’s no surprise that some economists are quick to discount William’s conclusions but one only has to examine the rapid recent rise in global inflation to see the problem. Even with all the fudging techniques now used by government, the problem eventually becomes impossible to hide once it becomes acute. It doesn’t take a genius to realize what will eventually happen if inflation is continually under-reported while the economic output is distorted higher. Those who rely on this data to make decisions are relying on increasingly incorrect data and therefore make erroneous decisions – the most obvious of which is to assume the economy is growing when its not. Consumers spend more money (and go further into debt) thinking the economy is better than it is and get themselves in financial trouble. More troubling is that the majority of workers remain oblivious to job losses, an error that only becomes apparent to most when they unexpectedly lose their jobs. What motivates governments to engage in this deceptive practice? Undoubtedly, the strongest effect of this practice is seen in the election cycle. A number of studies show that markets do so much better leading up to elections versus after each election is over. What causes this skew? It is the overriding desire of each successive administration to get re-elected. It is a well-understood reality that voters deal harshly come election time with encumbant governments if the economy is in trouble. Governments know this and over the years they are getting better at perfecting ways of putting voters in a good mood as they get ready to head to the polls. And inflation is the most powerful tool in their arsenal. How much better have stocks done leading up to elections versus afterwards? Read our Special Report that track pre-election versus post election gains in the Dow at http://tradesystemguru.com/content/view/82/58/#Primer Getting back to our first question above, why are these documentaries and reports now gaining public attention? When bubbles are in the process of forming, everyone is too busy figuring out how to profit. It is only when they begin popping and the economy deteriorates that we reflect on our fates. What happens when the foreigners financing our debt habit, who have also been lulled by government statistics, realize they’ve been duped? Interest rates will rise as the cost of money skyrockets to reflect true risk. Unfortunately, this usually occurs at the worst possible time when the economy is most vulnerable and the majority is unaware of their impending fate, if history is any guide. Fuzzy Numbers - How government agencies shamelessly distort economic statistics (16 mins) http://www.chrismartenson.com/fuzzy_numbers Stories of interest this week… Banks Warn Credit Card Legislation May Hurt, Not Help Consumers http://www.bloomberg.com/apps/news?pid=20601068&sid=aaa1JxMwNFRM&refer=economy In Various Ways, Economists Try to Find Right Price for a Home Japan's Exports Rebound, China Becomes No. 1 Customer http://www.bloomberg.com/apps/news?pid=20601068&sid=alNAZJHgTmp8&refer=home Commercial-Mortgage Bond Spreads Soar on Harlem Loan http://www.bloomberg.com/apps/news?pid=20601087&sid=aM3zwmra0p5Q&refer=home Madonna's Bra, Clapton's Guitar Latest Targets of Investment Funds http://www.bloomberg.com/apps/news?pid=20601213&sid=aEFEhsFWo_m8&refer=home OPINION No Limit to Greenspan's Once-In-A-Century Events: Caroline Baum http://www.bloomberg.com/apps/news?pid=20601039&sid=aQDn.ZYPabIg&refer=home The problem with playing banker God http://www.bloomberg.com/apps/news?pid=20601109&sid=a0v71H6gketc&refer=home VIDEOS IOUSA – Greenspan Warns of Disastrous Debt (Movie Review) http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a8CDIG7H3F_0 The Short History of Bubbles (14 mins) http://www.chrismartenson.com/bubbles Fuzzy Numbers - How government agencies shamelessly distort economic statistics (16 mins) http://www.chrismartenson.com/fuzzy_numbers ---------------------------------------------------------------------------------------------------------------------- If you find this newsletter insightful, please feel free to forward this newsletter and share it with a friend (or simply have them opt-in free from our home page http://www.tradesystemguru.com to be added). DisclaimerTradeSystemGuru.com obtains information from sources deemed to be reliable; |
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