| Weekly Market Update for the Week
Commencing 24th July 2000 (Please refer to TSI's Glossary for an explanation of terms used in the Market Update) |
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| Overview Bonds & Oil – bonds were firm during the past week, although they failed to make a substantial move upwards despite a significant drop in the oil price and further signs of an economic slowdown. Further strength in bond prices is likley over the next 1-2 weeks, but as stated last week we expect that long-term interest rates will move higher and short-term interest rates will move lower over the coming few months. The oil price correction is likely to continue, but acceleration in the rate of credit expansion between now and October should ensure that the demand for energy products remains strong. A sustained fall below $25 is unlikely. Stocks – the market's `overbought' condition has not been entirely worked-off by last week's decline. Further selling pressure will probably be evident at the start of the coming week, following which the market will be hostage to economic reports and company earnings. Gold – last Thursday's drop in the Dollar Index may turn out to be an important reversal. If so, the prognosis for gold has just improved substantially. Inflation and GreenspeakThe Liquidity TrendA reasonable measure of liquidity in the financial system is called MZM – money of zero maturity. MZM comprises currency and all checking-type assets including money-market funds. Here is a chart of MZM and the MZM month-to-month annualised growth rate from 1990 to June 2000.
From the chart it can be seen that the MZM growth rate trended upwards from early 1995 until late 1998. In fact, it is clear that the rate at which liquidity was being added to the system peaked near the end of 1998 and has been declining ever since. Note that this slowdown in the MZM growth rate over the past 18 months is not `deflation', it is a slowdown in the rate of `inflation' (inflation went from a very high level during the final quarter of '98 to a high level during the final quarter of '99 to a low level during the second quarter of '00). It is noteworthy that the rate of MZM growth had already been declining for 6 months when the Fed embarked on its tightening cycle in June '99. This illustrates a point we have made before: the fed follows the market. In other words, market forces initiate a tightening or a loosening and the Fed follows with a lag of several months (the lag probably occurs because the Fed responds to backward-looking and sanitised economic indicators). Furthermore, this `Fed lag' creates a sizable problem since it results in official interest rates being held at unrealistically-low levels for a period of time prior to the commencement of a tightening cycle and at unrealistically-high levels towards the end of the tightening cycle. Economic oscillations are hence magnified. Returning to the above chart and zooming in on the recent past we can see that an upward spike occurred during Q4 '99 as the Fed forced liquidity into the system in preparation for Y2K, followed by a downward spike into Feb '00 as the Fed's `Y2K mop-up' got underway, another thrust upwards into March as stock market speculation reached fever pitch, and lastly a spectacular dive into May/June. If we are correct in our forecast for the remainder of this year then that small `up-tick' shown on the chart for June will blossom into another huge burst of liquidity that peaks around Sep/Oct. GreenspeakThe popular interpretation of last week's Greenspan Testimony seems to be that the Fed Chairman thinks the US economy is headed for a soft landing. This was not our interpretation. In our opinion Mr Greenspan does not know whether the US is headed for a soft landing or a hard landing or no landing at all, and he does not pretend to know. What he told us last week, as clearly as the Master of Obfuscation ever says anything, is that there will be no further rate hikes before the elections. Unemployment Vs. InflationDuring the Q&A session of last week's HH Testimony, Greenspan suggested that the NAIRU concept might be invalid (many economists believe that inflation increases when the unemployment rate drops below the NAIRU – the Non-Accelerating Inflation Rate of Unemployment). On this point we are in total agreement with the Fed Head. Following is a short extract from an article by Dr Frank Shostak that appeared in the latest edition of “The New Australian”. It is an elegant summary of the relationships between economic growth, unemployment, inflation and money supply. “Contrary to mainstream thinking, strong economic activity doesn't cause a general rise in the prices of goods and services and an economic overheating known as inflation. Regardless of the rate of unemployment, as long as every increase in expenditure is supported by production no overheating can occur. The overheating emerges once expenditure is rising without the backup of production. This can only occur when the money stock is increasing. Once money increases it generates an exchange of nothing for something, or consumption without preceding production, which leads to the erosion of real wealth.” The US Stock MarketEverything is out of whackA typical year for the stock market sees the majority of upside occurring during the first and fourth quarters with the May-October period being flat or down. An important low is often reached in October, a point from which the “end-of-year/Xmas/new-year” rally is launched. However, so far this year the market has not followed the typical pattern. The two major factors contributing to the market's atypical behaviour this year are:
We expect this year's divergence from the norm to continue, perhaps leading to an important stock market peak in October (a time of year that often provides an intermediate low). An October high also appears quite likely from a market psychology perspective since it would probably be occurring at a time when the majority are anticipating both a run-up into the elections and the start of an end-of-year rally. Current Market SituationLast week we pointed out that “those who insist on irrefutable technical confirmation before buying or selling will often find themselves buying near short-term peaks and selling near short-term bottoms.” The action over the past week provided a good example of this phenomenon as those who became bullish (and bought stocks) based on the market's obvious strength during the week before last would probably be feeling a little stressed at the present time. In our previous Market Update we outlined four short-term negatives, three of which are still applicable. The one risk that was eliminated by last week's decline was the uncomfortably-low put/call ratio. Below is a chart showing the 5-day moving-average of the CBOE equity put/call ratio. On Monday July 17 this ratio was 0.37, the lowest reading since the beginning of April. By Friday, however, it had recovered to a more-healthy 0.46.
Last week's drop has created its own risk – one of a completely technical nature. On Friday the SPU (Sept S&P500 futures contract) closed right at critical support around 1490. Since the futures closed with a very small premium to the cash market the SPU is likely to bounce at the beginning of Monday's session. It will then probably reverse course and re-test the support around 1490. If 1490 is taken out decisively (to the downside) on a closing basis then a quick drop of another 70-80 S&P points is possible. While this is not our expected outcome (we suspect that 1490 will hold) the short-term situation is quite dicey. If the market does drop to 1420 or so it will almost certainly be a buying opportunity. This week's important economic/market events
Gold and Gold Stocks Current Market Situation Although the press did not pick up on Greenspan's strong hints that there will be no more interest rate hikes prior to the elections, the currency markets certainly did. The day before Greenspan's testimony (July 19) the Dollar Index achieved its highest close since May 25, but reversed lower in the wake of the Fed Head's July 20 utterings. Further to last week's Update, a close below 106.9 (basis cash) in the Dollar Index is needed to break the sequence of `higher lows' and usher-in a more serious decline in the Dollar (perhaps down to the major up-trend line at around the 100 level). The Dollar Index has been moving up in a well-defined channel since last October. Correspondingly the Euro, prior to its recent breakout, had been moving in a down-channel over the same period (see chart below). Near the end of April the Euro broke downwards out of its channel, a move that proved to be a `fake-out' as it quickly returned to the channel. In early June it then broke out to the upside and has, thus far, remained above its previous down-channel despite experiencing a pullback over the past few weeks. The Euro's fake downside breakout in April/May was mirrored by a fake upside breakout by the Dollar. However, thanks mainly to Yen weakness the Dollar has, to date, stayed within its up-channel during all pullbacks. A close below the 106.9 level mentioned above for the Dollar Index would result in a break below the bottom of the 9-month long up-channel. It should be emphasised that the Dollar is in both a short and a long-term up-trend. We are anticipating a change in at least the short-term trend, but have yet to receive any technical confirmation of a trend change. As Mr Greenspan was kind enough to point out last week, the fact that the Dollar is still strong is undeniable proof that the US current account deficit is not an immediate problem.
The above chart is provided courtesy of Pacific Exchange Rate Service and is the copyright of Prof. Werner Antweiler, University of British Columbia, Vancouver, Canada. Two week's ago we suggested purchasing short-term (long) trading positions in gold stocks if the XAU spiked below 50 or closed above 60. However, with the XAU closing at 50.75 on Friday and with a potentially-important reversal in the Dollar having just occurred, we don't feel the need to wait any longer. We recommend the immediate purchase of Normandy Mining below A$1.00 (ASX: NDY), Lihir Gold below A$0.70 (ASX: LHG) and Harmony Gold Mining (NASDAQ: HGMCY) below US$5.00. These stocks have been selected because they look good from both a technical and fundamental perspective. Sell-stops should be set 10% below the purchase price. If we are correct in our assessment then these sell-stops will not be approached. Previous Market Updates |
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Copyright © 2000 Steven A Saville
