Zanger Pro-Active Investor
The Zanger Pro-Active Investor Newsletter
October 2010
Markets – Consumer Where Art Thou?
Transport Demand – Still Nothing to Write Home About
Money, Money Everywhere but Jobs Still MIA…
Equities – Separating the Talk from Reality
Election Cycle – Waiting for a Lift
Roundup of Dan’s Stocks – Learning to Play Follow the Leader
Free Report – 10 Keys to Find Winning Stocks by Dan Zanger
Check out The Zanger ReportFree!
It is said that the biggest single factor affecting stock price movement is the direction of the overall market. A strong stock can rise in a falling market, but like a swimming against the tide, the stock usually succumbs to market direction. In the first part of this month’s newsletter, we examine the overall market to see what factors have the potential to influence investor sentiment and stock prices.
Even more important to active investors and traders is in knowing what the market leaders are doing because they often warn of pending changes in trends. In part 2 we will look at what some of my market leaders are doing and what that means to markets. As most successful active investors eventually discover, fundamentals are important but they generally lag market action. The trick is in understanding how the two factors – stock and market fundamentals and price action – work together! This is explained in my article, 10 Keys to Find Winning Stocks but more about that later.
Markets –Consumer Where Art Thou?
We begin with a look at the economy and broader market. One metric that we find is a useful leading indicator (unlike Consumer Confidence or even Consumer Sentiment) is the Consumer Metrics Institute’s Growth Index (next chart). But first a brief description of how this index is constructed.
The CMI Growth Index is a composite of demand from 10 sectors of the economy and measures major discretionary U.S. consumer spending in the following areas – automotives, entertainment, financial, health, household, housing, recreation, retail, technology and travel. Data are smoothed using a weighted 91-day moving average (91-day Growth Index). It is important because consumer spending is responsible for more than two-thirds of U.S. GDP (economic) growth.
Chart 1 – Chart with data to mid-September comparing the CMI Growth Index in this recovery versus 2008. It has been negative since January 14, 2010. Chart – Consumer Metrics Institute
According to the CMI, the Daily Growth Index (DGI) has moved laterally since the beginning of September in a narrow range reflecting a 6% year-over-year contraction. Although better than the 9% drop in August, the number is “negative enough to be pulling our 91-day trailing quarter average (our Daily Growth Index) lower.”
In the next chart, we see the relationship of the CMI Growth Index with the S&P500 and GDP data. It clearly leads both
Chart 2 – Chart from Doug Short showing the historic relationship between the CMI Growth Index, the S&P500 and GDP. Chart – www.dshort.com
One silver lining, if there is one, is that after hitting an all-time low in mid-August, the year-over-year index rate of change has been dropping less quickly. This is good news as long as this trend continues. Translation for investors: consumer demand is still falling in 10 major sectors but for the time being at least, it is falling more slowly.
Chart 3 – Here is the Consumer Metrics Institute (CMI) Daily Growth Index (91-day average) annual rate-of-change. The one possible light at the end of the tunnel is that after dropping in August the most ever on a year-over-year basis, it is falling less slowly which could portend an improvement ahead.
Next we look at transportation, which represents another measure of economic demand given that the vast majority of products and a good many services must be delivered by sea, rail, air or road.
Transport Demand – Still Nothing to Write Home About
Our first transport chart is the Baltic Dry Index. It is an index of the cost for shipping dry goods by sea around the world. When demand for goods is high (and the economy good) rates go up and when demand is low, they fall. What makes the BDI an interesting economic indicator is that there is virtually no potential for speculation – it is not trading on any exchange. Since the cost of shipping is driven by real demand it is therefore not subject to trader fear and greed emotional swings. It also supports the contention that the bubbles in commodity and stock markets were not significantly driven by speculators as many politicians and regulators have charged. This index climbed from around 4,000 in early 2007 to over 10,000 in May 2008 based on pure demand. The BDI then fell off a cliff to hit a low of 663 in December 2008. It has since staged a comeback but since putting in a 2009 high 4661 in December 2009, the index has struggled.
Chart 4 – Daily chart of the Baltic Dry Index showing the price for shipping dry goods by sea from late 2005 to mid-July 2010. Data courtesy of Capital Link Shipping.
As the yellow rectangles in chart 4 indicate, the first six months of the year have typically been a time of increasing transport demand. Not so in 2010 as demand has weakened again. As the black horizontal dashed line in the chart shows, dry-goods transport demand has been falling since May.
Rail demand is somewhat stronger. August was the best month with highest number of carloads since November 2008, up 5.7% over August 2009 but it was down 11.6% from August 2008. Although railcar traffic is up from 2009, it remains well below 2008 levels. September traffic was up 7.7% from 2009 but still down 7.5% from September 2008. But another positive about the September data was that carloads continued to increase in September, unlike both 2009 and 2008.
Chart 5 – Chart from the American Association of Railroads showing overall U.S. rail traffic to September. Source – AAR.org
Traffic at Los Angeles ports, which handle roughly 40% of the containers entering and leaving the country, surged 24% in August over August 2009 thanks to higher imports. Inbound traffic was up 4% over August 2008.
But exports (outbound traffic) were down 2.6% versus August 2009 and are down 17% from 2 years ago according to CalculatedRiskBlog.com. Weak exports continue to compress U.S. manufacturing demand.
Money, Money Everywhere but Jobs Still MIA…
A government study recently brought attention to why jobs in America are still hard to find. Entitled Jobs Created from Startups in the United States and published by the U.S. Census Bureau’s Business Dynamics Statistics group, it highlighted the fact that business startups accounted for 3% total private sector employment between 1980 and 2005 compared to 1.8% net employment for the private sector. This means that if startups are removed from the equation, companies across the nation would have suffered a net annual loss of 1.2% of U.S. jobs over the period!
In other words, new companies are not just the biggest contributors to private sector jobs creation they are the only job generators! Here is a chart to demonstrate.
Chart 6 – Chart comparing job creation for companies from startup stage (0 years) to mature companies 26 years an older. As it shows, companies lost the greatest number of jobs in year two than any of the other single years.
We examined the period from 1995 through 2005 because it contained the most data of any decade since the study was begun in 1977. As we see, startups created nearly 35 million jobs over the period. Companies aged from1 through 26+ years lost jobs in every year, with the possible exception of companies in the oldest cohort (26+ years).
On a net basis, mature companies 1 year or older shed a total of more than 11 million jobs over the period for a net gain of 22.7 million jobs when startups were factored back in to the equation.
If government-mandated employment programs are to work long-term, they must be aimed specifically at helping entrepreneurs start new companies. Without this pivotal step, jobs and this recovery will be hard to maintain.
From a market perspective, once conditions are right for startups, it will be very good news for both markets and the economy, especially given the length of time conditions have remained tough. This should translate into a pent-up startup demand and potential exponential growth once the conditions improve.
Equities – Separating the Talk from Reality
Interesting data from the Investment Company Institute (ICI) shows that on a net monthly basis, money continues to exit mutual funds. In the next chart, we have graphed net domestic and foreign mutual fund equity flows (red) versus the S&P500 Index.Funds first began to exit the market in August 2007, two months before stock markets began to drop in earnest.
Flows hit rock bottom with a net outflow of more than $72 billion in September 2008, 6 months before stocks hit bottom in March 2009. Fund flows moved back into positive territory briefly before falling again in February, only to recover again before dropping into negative territory once more. As we see from the chart, flows have been negative for the last five months (to September 14, 2010).
Until funds start flowing back into equities again (and stay positive for a while), stocks will continue to encounter headwinds. However, given that October has a history as one of the strongest months of the year don’t count stocks out just yet, especially if the election cycle performs as usual.
Chart 7 – Monthly net mutual foreign and domestic fund flows (LHS in red) showing the relationship with the movement in the S&P500 Index (RHS in blue). Chart – Metastock.com, Fund Data – Investment Company Institute
Election Cycle – Waiting for a Lift
Our last overall market discussion focuses on the election cycle. Labeled the most powerful short-term cycle impacting markets, it describes the effect that cutbacks (after each election) followed by stimulus programs (leading up to each election) have had on markets and the economy. Those who aren’t familiar with this government brakes-then-gas approach to economic management usually underestimate its impact and that can be costly.
Since 1902, the two years leading up to an election have been by far the best time to be in stocks. A study conducted by TradeSystemGuru.com showed just how skewed the result of holding stocks in the two years pre election versus the two years post-election can be.
Chart 8 – A composite chart shows how the Dow Jones Industrial Average has performed on average in each of the four election years from 1888 through 2004.
In fact, more than 90% of all Dow Jones Industrial Average gains occurred in the two years before elections versus less than 10% in the two post-election years. As well, the majority of major market correction occurred in post-election years.
If this cycle holds this time around, it will be very positive for stocks. As the composite election cycle chart in Chart 8 shows, the cycle low occurred in September, 26-months before each election, which means October 2010 through November 2012 should be a good time to be in stocks.
Looking at the best year to be in the election cycle, the pre-election year was responsible for more than 60% of the Dow gains over the 104-year period (a big positive for next year), followed by gains of slightly more than 17% in election years – good for next year and 2012.
On a quarterly basis, the best quarter was the second quarter of the pre-election year which bodes well for Q2 2011. However, the second best quarter was Q4 of the mid-term year. This also has positive implications for the final quarter of 2010.
But there is a giant caveat. Historically, governments have gotten the tough jobs of keeping economies healthy (cutbacks, interest rate and tax hikes etc) out of the way in the 2 years post-elections. They waited until the end of the mid-term year before turning on the stimulus spigots. As we know, this has certainly not been the case this cycle as stimulus and bailout programs together with the printing presses and Fed monetary policy (Quantitative Easing) have been operating in overdrive since 2008. Trillions have been spent trying to keep the fragile, bubble-driven economic blimp aloft. How much more the government and Fed can ramp up spending remains to be seen. As most seasoned traders and investors can attest, it never pays to short the Fed. But what happens when the fiscal well has been pumped dry? We may not have to wait long to find out as the government looks to be getting ready for launch of Quantitative Easing 2.
In summary, the macro environment for stocks remains challenging. Consumer demand is still weak and credit remains tight, especially for new ventures, which is a big challenge given the importance of startups in jobs creation. Transport demand has also been anemic.If this recovery is to stay alive, we need to see a big increase in new jobs and a gradual but consistent easing in credit to help spur demand. Any increase in interest rates would be potentially catastrophic given its current fragile economy. But any efforts by the government and Fed to throw more money at curing our economic ills could cause markets to rally, at least for the short-term. For more on this topic, be sure to read the October 2 paper Will Quantitative Easing Save the Equity Markets? in More Reading below. It will give you a new understanding of how liquidity affects stock prices and where it comes from has changed since 2008 as well as how important liquidity is in driving stock rallies.
Here is a chart showing bank and Fed liquidity versus the S&P500 that speaks volumes. Note the changes in liquidity and the impact on stock prices roughly four months later.
Chart 9 – Impact of changing liquidity on the price of the S&P500 from 1998 through 2010.
Now it’s time to take a look at a few of the movers Dan Zanger has been tracking these days! They often provide advance warning of a market move.
Roundup of Dan’s Stocks – Learning to Play Follow the Leader
First on the list is a stock that has nearly tripled in price in the last year (above). NetFlix offers streaming video rentals and downloads to subscribers for one low flat monthly fee and recently announced that it was expanding into Canada. If the charts are any indication, business is booming.
As we see from the next chart (lower subgraph), the NFLX fundamentals look positive. Its current PE of 41 is high but not outrageous, at 23% earnings growth is strong (red line) and sales growth is even stronger at 27% (purple line). Sales-per-share of $36 is downright impressive. This baby has gone parabolic so only time will tell how long it will last.
Chart 10 – Dan’s daily chart (upper) and chart of fundamentals (lower) for Netflix Charts courtesy of ChartPattern.com and VectorVest.com
Next we take a look at one of Dan’s perennial favorites, Apple Inc. After first peaking in April 2010, it has been more or less stuck in a trading range which is frustrating for those who have been holding it in their portfolios. But it continues to dominate the phone market and the iPad has been an unparalleled success forcing its competitors to play catch-up.
Now Dan is seeing this powerful flag pattern that looks potentially promising for this perennial market leader.
Chart 11 – Dan’s daily chart (upper) and chart of fundamentals (lower) for Apple Inc. Charts courtesy of ChartPattern.com and VectorVest.com
Fundamentals for AAPL remain very strong. A PE of 15.6 (thin blue line) is quite reasonable for this tech company and look at the sales per share of $62.50. After declining in 2009, sales growth (purple) is ramping up again and now sits at 61%. But since price generally leads fundamentals, any signs of more softening in stock price ahead could indicate more volatility or even another drop.
Next on Dan’s list is Chinese internet service provider Baidu.com.
Chart 12 – Dan’s daily chart (upper) and chart of fundamentals (lower) for Baidu.com Charts courtesy of ChartPattern.com and VectorVest.com
After nearly doubling this year alone, BIDU remains in a strong uptrend most recently exhibiting a bullish flag pattern. At 43 the PE is high but quite acceptable for this stock.Earnings growth is strong at 38% as is sales growth at 74%.
Chart 13 – Dan’s daily chart (upper) and chart of fundamentals (lower) for Chipotle Mexican Grill. Charts courtesy of ChartPattern.com and VectorVest.com
Chipotle Mexican Grill which was operating nearly 600 restaurants in 2006 has so far weathered the downturn very well and continues to look bullish. With a PE of 28, a sales growth rate of 20 and steadily improving sales per share of $53 it has strong top line growth plus a very respectable earnings growth rate of 24%.
Some of the other interesting market leaders Dan is tracking right now include Research in Motion (RIMM) as well as Rovi Corp (ROVI) and relative new stocks to his list Oclaro Inc (OCLR) and Motricity Inc (MOTR) but more about those in our next issue!
Free Report – 10 Keys to Find Winning Stocks by Dan Zanger
Those of you not familiar with Dan Zanger and how he finds stocks, you probably have a number of questions before being able to apply what has been presented here. We include a number of useful links below for more background on Dan’s approach and how he chooses his market winners.
Also be sure to get our Free Report that explains in detail the criteria Dan uses when looking for stocks called Ten Keys to Find Winning Stocks by Dan Zanger. For your free report, click here. (Link: http://www.chartpattern.com/10Key_Characteristics.cfm?TrackVal=mttart07 )
The stocks outlined above are just a few of the many stocks Dan is tracking. To see for yourself which stocks are leading the market today, click here to get a no-obligation free trial of The Zanger Report. (Link: http://chartpattern.com/media.html
More Reading…
Will Quantitative Easing Save the Equity Markets?
http://www.scribd.com/doc/38803628/Will-Quantitative-Easing-Save-the-Equity-Markets-Oct10
In Search of the Magic Market Mix – Right Combination of Fundamentals and Technicals
/content/view/303/61/
Understanding Chart Patterns
http://www.chartpattern.com/understanding_chart_patterns.html
Trading chart patterns and the market – An interview with Dan Zanger
/content/view/300/61/
Dan Zanger’s 10 Golden Stock Trading Rules
http://www.chartpattern.com/10_golden_rules.html
Election Cycle Primer – The Government Cutback/Stimulus Effect
at /content/view/305/61/
LA Port Traffic In August: Imports Surge, Exports Down
http://www.calculatedriskblog.com/2010/09/la-port-traffic-in-august-imports-surge.html
Election Cycle Primer – Everything You Wanted to Know About the Election Cycle
/content/view/305/61/
Articles…
Blackman, Matt [2010] Pick Your Patterns Wisely
http://www.sfomag.com/eSFO/eSFO2010_10.aspx
Zanger, Dan and Blackman, Matt [2010]. “Is Trading That Simple?”
Blackman, Matt [2003]. "Chart Patterns, Trading, And Dan Zanger,"
Interview,Technical Analysis ofSTOCKS& COMMODITIES, Volume 21: August.
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Last Updated ( Wednesday, 17 November 2010 )