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   -- Weekly Market Update for the Week Commencing 26th January 2004

Big Picture View (Most recent update: 12 January 2004)

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

Bond yields (long-term interest rates) bottomed in June of 2003 and will move considerably higher during 2004 and 2005.

The stock market rally that began in October of 2002 will end during the first half of 2004. The October-2002 bottom will be tested during 2005.

The Dollar will make an intermediate-term bottom during the first half of 2004 in the vicinity of its 1995 low and then rally for at least 6 months, but a long-term bottom won't occur until 2008-2010.

Gold will make an intermediate-term peak during the first half of 2004 and then consolidate for at least 6 months, but a long-term peak won't occur until 2008-2010. 

Commodities, as represented by the CRB Index, will make an intermediate-term peak during the first half of 2004 and then consolidate for at least 6 months, but a long-term peak won't occur until 2008-2010. 

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The price-fixers get together again this week

The Federal Open Market Committee (FOMC) gets together this week to decide what the price of short-term money should be. There will obviously be no change in the Fed Funds Rate as a result of this meeting, but our forecast has been that the January meeting would be the one at which the Fed would move to a 'tightening bias'. In other words, we've forecast that the FOMC's next post-meeting statement on monetary policy would talk about the risks being skewed towards higher inflation. 

However, we no longer think there will be a significant change in the way this week's monetary policy statement will be worded because, from the Fed's distorted perspective of the world, there does not appear to be any reason to make a change. In particular, T-Bond futures are close to a 6-month high despite Friday's potentially-important downward reversal and the CPI is showing almost no signs of life. Having done such a good job over the decades of convincing most people that the CPI is a measure of inflation and that a rampant expansion of credit (which is continuing, by the way, despite the pullback in the monetary aggregates) is not a problem unless it causes the CPI to rise, the Fed is now in a position where it could not justify making any change to its stance.

Japan is supporting the US bond market, but not much else

Over the past year the Bank of Japan (BOJ), acting on behalf of the Japanese Ministry of Finance, purchased about 200 billion US dollars in its attempts to prevent the Yen from appreciating against the US$. And almost all of the dollars purchased during these currency-market interventions were invested in US Government debt.

Now, the BOJ's currency management efforts have not exactly been a resounding success because the Yen has strengthened considerably against the US$ over the past year. It could, perhaps, be argued that without this intervention the US$ would be even weaker, and this might be true. However, as long as the Japanese keep buying US bonds with the dollars they purchase in their efforts to manage the Yen-Dollar exchange rate the results of their interventions will be muted as far as the currency market is concerned. This is because they are not reducing the supply of dollars; they are, instead, re-cycling dollars (the dollars are being returned to the market in exchange for US Treasury debt). The intervention would likely be much more effective if the dollars were retained by the BOJ.

The greatest effect of Japan's attempts to support the US$ has been evident in the US bond market. This is not only due to the direct effect of Japanese buying on US bond prices, but the fact that massive Japanese buying of US bonds puts downward pressure on long-term interest rates; and the relatively-low level of US interest rates helps to weaken the US$. 

The US Stock Market

Don't get hung-up on the "bull" and "bear" labels

In June of last year (refer to http://www.gold-eagle.com/editorials_03/milhouse062103.html) we began to seriously consider the possibility that a bear market had not yet begun in the US stock market. Instead, we said that the stock-market action of 2000-2002 might have simply removed relative excesses within the market and that a bona fide bear market lay in the future, not the past. 

Clearly, the NASDAQ has experienced a bear market of historic proportions and, given the extremely high valuations of many NASDAQ stocks, the bear market is not over. In other words, the NASDAQ's rally over the past 15 months is most likely a very powerful rebound within a secular bear trend. However, many important sectors of the market have moved to new all-time highs over the past 6 months and are clearly not immersed in bear trends. For example, the Philadelphia Bank Index, the MS Cyclical Index, the MS Index of Commodity-Related Stocks, the S&P Retailing Index and the S&P Homebuilding Index are at, or near, all-time highs. In the case of the Bank Index (see chart below), the recent upside breakout from a 6-year consolidation range might turn out to be a 'bull trap' of similar nature to the Dow's move to a new high in January of 1973. At this time, though, the technical evidence does not indicate that a bear market is in progress. 

There is also scant evidence of any bear trend in the below chart of Walmart (NYSE: WMT), the world's largest company in terms of both sales volume and number of employees. Rather, it looks like WMT has been consolidating over the past few years in a similar vein to its 1993-1996 consolidation. 

What the post-October-2002 market should not be labeled, in our opinion, is a NEW bull market. In some sectors of the market the old bull market never ended whereas in other sectors there have been sizeable bear-market rallies. In any case, labels such as "bull" and "bear" are rarely of any practical use because a 50% profit achieved during a bear-market rally is just as good as a 50% profit achieved during a bull market. Perhaps the only relevance is that long-term investors who purchase stock during a secular bull market will probably get bailed out by the market's upward trend if they are prepared to hold for long enough, even if their purchases were ill-timed. However, the opposite is true in a secular bear market.

As an aside, one thing that has the potential to precipitate a general bear market in US stocks is a breakdown in the bond market (higher interest rates). Once bonds break below their August-2003 lows it will be difficult to justify owning ANY stocks.

Current Market Situation

Below are weekly charts of Intel (NASDAQ: INTC) and Applied Materials (NASDAQ: AMAT), the world's largest semiconductor company and the world's largest semiconductor equipment company, respectively. These two bellwether stocks haven't participated in the upward move that has occurred in the broad market since early-November, a possible bearish divergence. AMAT, in particular, has been quite soggy and is a stock we'll be watching closely over the coming weeks.

The Dow and the NASDAQ dropped last week, ending their respective winning streaks at 8 weeks and 6 weeks. The S&P500, however, has now risen for an incredible nine weeks in a row. 

A pullback probably began at last week's highs, but we wouldn't be surprised to see a re-test of the highs this week before corrective action becomes a bit more pronounced. The FOMC Meeting should provide some support to the market during the second half of the week assuming the Fed makes no changes to its monetary policy statement, as should the buying that typically emerges during the last few days of each month.

This week's important economic events
 

Date Description
Monday Jan 26 Existing Home Sales
Tuesday Jan 27 Consumer Confidence
Wednesday Jan 28 FOMC Meeting
Durable Goods Orders
New Home Sales
Thursday Jan 29 Employment Cost Index
Friday Jan 30 Q4 GDP (pre-lim)

Click here to read the rest of today's commentary

 
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