Stockscom Report for Sunday Mar 21 2004

Publisher: Colin Alexander     Editor: Ken Wilson

Subscriptions and Administration: Pierre Fichaud (toll-free: 866-487-9711)

 

• Major indexes to fall
• Trend lower for labor force and earnings

 

 

Market Synopsis

 

Markets have most certainly topped out and the correction has begun in earnest. The year-long bull rally will now experience its first corrective phase and just as the Nasdaq led the way on the upside, it will lead the parade once more on the descent. Ironically, or perhaps as a confirmation of the new trend, this past week saw equity funds experience the first withdrawal of the year on the order of $22 million, which we must admit pales in comparison to the $43.76 billion that found its way into equity funds in the month of January alone. (As a matter of note, the January amount was the third largest in the past 4 years.) Naturally the question on most investors’ minds is whether this correction will see a small measured tumble or will it be much larger?

 

Judging by the charts, we see that the 25-week moving average on the Nasdaq has been quickly breached offering only meager support and now the next support level to be tested is the 200-day moving average at around 1885 or 55 points lower than Friday’s close. The Dow Jones and the S&P500 continue to play support roles in this theater and have fallen lower but retain more of their rally-induced gains amid the fallout. In both cases their respective 25-week moving averages lie not too far below current prices however there is no reason to believe that equities will find meaningful support at these levels.

 

In the case of the Dow, it’s worth referring also to Dow theory, which essentially states that what the industrials make, the transports will haul to market. As such those following the Dow theory always look for confirmation of peaks in the separate industrials and transports indexes. The industrials peaked on February 11 and until now this peak has failed to be confirmed in the transports, which broke down heavily in January and continue to weaken with the runaway energy prices.

 

With the drop in the market indexes the element of fear is certainly rising among analysts and stock traders alike. The VIX indicator as well as the tech-specific VXN, having both plumbed new depths recently, spiked higher in the past two weeks as markets suddenly find themselves under pressure. This fear factor, a measure of stock market volatility, should not be terribly surprising as we’ve witnessed equities head north almost in a straight line. Inevitably there are bumps along the way (usually occurring more often than once a year) as well as new analyses driving changes in investments and general outlooks.

 

While it may be impossible to predict the future, we recognize that risk elements in the economy are substantially greater than many bulls give credit to. For more than two years now, the Federal Reserve and the Bush Administration have oiled the economy with immense monetary and fiscal stimuli in a grand effort to stave off deflation and trigger economic expansion. Interest rates have fallen and remained at levels not seen in forty years while the government’s budget deficit has grown exponentially in a heretofore-failed attempt at provoking sustained economic growth. Admittedly, deflation fears have greatly dissipated as inflation takes hold in primary materials and a depreciated US dollar renders exports cheaper and imports more expensive. But even this effort has not been as successful as hoped due to the currency self-destruction of trading partners, Japan and China.

 

If we admit that the threat of deflation is less likely now, then we must also believe that 1% interest rates are as low as they will get and consequently the next rate movement will be in the “up” direction. Already visible signs of inflation are everywhere but especially in primary materials. Copper has increased in price 77% in the past ten months while the price of hot-rolled steel has risen to $29 per hundred pounds, up from $14 last August to give but two examples. This year being an election year, the Fed Reserve is not likely to move interest rates in the run-up to the election in November. Since we can assume, given the language used in the most recent communiqués including Tuesday’s this week, that they are in no hurry to raise rates, we know then that rates will remain at 1% until sometime past the election. After the election though, all bets are off.

 

Therefore we assume that the same monetary stimulus will continue until late in 2004 at the earliest, but that leaves fiscal stimulus. The Bush Administration’s tax cuts to be implemented this year amount to a further $135 billion. Beyond that point, if the Democrats were elected it could mean a repeal of these tax breaks in an attempt to balance the budget.

There is no doubt that there were spikes in consumer spending when the tax cuts were implemented in 2003 and that low interest rates generated record numbers of mortgage refinancings. However, notwithstanding recent jumps in refi activity, the trend in 2004 has clearly been lower. Thus the threat that these one-time events put money into consumers’ pockets and stimulated the economy in limited fashion is very real.

We are left with the same low savings rates from before coupled now with extremely high debt levels – mortgage debt alone soared to $6.8-trillion last year from $4.9-trillion just two years earlier. The underlying problem is that debt service levels will increase in the rising rate scenario putting those with adjustable rate mortgages at the most risk.

Permanent increases in income have been harder to come by. The most recent survey of employment showed hourly earnings increased by 1.6 percent over the 12 months ending in February. Perhaps more importantly is that if we look at the table below, we see that the trend in average hourly earnings has been moving markedly lower since 2001 and now matches the lowest increases that occurred in 1986.

AVERAGE HOURLY EARNINGS OF PRODUCTION WORKERS (seasonally adjusted)

 

 

 

Even if we assume that hourly earnings rebound from these levels, we are presented with another remarkable situation as viewed in the chart below. The most recent employment survey for February reported that the participation rate fell below 66%. This is the first time since 1988 that the participation rate has been so low and more importantly the trend has been inexorably downward since the year 2000. Ultimately with more people simply dropping out of the labor force, the logical result is higher social costs and a lower contribution to the economy.

 

 

 

 

 

 

 

 

 

 

CIVILIAN LABOR FORCE PARTICIPATION RATE (seasonally adjusted)

 

 

New Buy Recommendations:

 

None.

 

New Short Sales

None.

 

Stock Positions to Sell/Exit:

 

We were exited at our stops from both CHU and CYBE this week.

 

Portfolio Comments:

 

BGO, WHT – the retracement in the price of gold was inevitable as it’s moved in inverse relation to the US dollar for a very long time now. The jobs report caused the US dollar to reverse on Friday and this could start renewed selling of the greenback. Both stocks saw significant gaps higher leaving large open spaces below their bars on the daily charts and this represents to us a signal of further moves higher.

 

 

New stops have been added to the list while others have been modified. Those that have blanks, are being carried unstopped for now. Please see our complete list of stops in the table below.

 

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

Stocks marked # are eligible as Canadian content in Canadian RSP funds. Otherwise there is a 30 percent restriction on foreign stocks held in these accounts.

Date of Entry	Name	Symbol	Entry Price	Current Price	Stop	Action Rating
11/13/03	ABB	ABB	6.14	5.60	5.50	H
08/25/03	Bema Gold	BGO #	3.08	3.77		B
12/08/03	BHP	BHP	17.18	18.54	17.25	H
01/12/04	Beta Oil and Gas	BETA	3.25	3.25		B
09/29/03	China Unicom	CHU	8.18	10.49	10.49	SOLD
03/01/04	Consol Energy	CNX	27.50	25.04		H
05/12/03	Cott Corp	COT #	20.02	29.07	28.00	H
23/02/04	CyberOptics	CYBE	16.70	16.00	16.00	SOLD
01/12/04	ON Semiconductor	ONNN	7.59	7.50	7.00	H
12/15/03	Overstock.com	OSTK	20.35	30.01	27.00	H
01/12/04	Sierra Wireless	SWIR #	21.95	31.93	27.50	H
03/01/04	Suncor	SU #	26.25	27.70		H
03/08/04	Transcanada Corp	TRP #	21.34	22.04		B
23/02/04	Wal-Mart	WMT	59.44	58.60		H
11/03/03	Wheaton River	WHT #	2.36	3.12		B+

 

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price