Brief Market Notes:
What Now, Dow?
Chip Hanlon, Michael Pento
and Bruce Zaro
Delta Global Advisors
Oct 6, 2006
From Michael Pento:
The Dow Jones 30 Industrial average has finally reached its
all time record high (although unconfirmed by the S&P 500
and NASDAQ and well below a record if adjusted for inflation).
The Dow and S&P are trading above the historical average
PE ratios of 13 and 15, respectively. Does the outlook for earnings
growth justify these levels? Clearly not. Q2 GDP was 2.6%,
that's a deceleration of more than 40% from the first quarter.
The equity markets are clearly pricing in a soft landing- a
rare phenomenon-which puts the onus on the economy to produce
that rosy scenario.
This optimistic view is bolstered
by the softening in the oil market which is being touted as a
panacea for the consumer and the housing market. Energy is a
small part of both consumer's budget and the U.S. economy. The
reverse wealth effects from declining home prices far outweighs
the relief felt at the gas pump and as the real estate bubble
unwinds, look for the consumer to continue to reign in his spending.
Currently the stock market
is giving a nod to ebullient expectations for earnings. Investors
are confident that the Fed Funds rate of 5.25% will gracefully
decline to meet the ascending 4.6% yields of treasuries somewhere
in the middle. If they are correct, perhaps I'll be proved wrong
and this Dow record will be looked back upon as merely the beginning
of a significant advance. If, however, the Fed Funds rate collapses
in response to a recession or Treasury prices plummet due to
intractable inflation, things could get ugly. If the optimistic
scenario does not pan out, investors can capitalize on betting
against the very crowded Goldilocks trade.
From Bruce Zaro:
Investors would be wise not to force money into the markets after
the rally we've seen, waiting instead to deploy more capital
on pullbacks, especially with the spooky market month of October
having arrived. While September- historically the market's worst
month- was surprisingly positive due largely to the Federal Reserve's
pause, fears that the Fed already went to far are likely to intensify
in October, leaving stocks at risk in the short-term. However,
as more risk is wrung out of the market and today's overbought
conditions ease, I will be looking to re-deploy funds in select
sectors of the stock market and worry that if I'm wrong, it'll
be in waiting for a pullback, that stocks will just keep rolling
from here.
Note: mid-term elections have
typically been followed by strong advances in stocks stocks,
as was the case in 2002 and 1998. In fact, 10 out of the last
13 mid-term cycles marked significant market lows. Perhaps an
October stock market correction would set the stage yet again,
with even a modest pullback allowing for a vigorous rebound later
in the year and into 2007. I believe this outcome is likely
and that it will center around investors focusing on the next
Fed move: lowering interest rates. That outcome, should it occur,
will likely be farther away then many think, but investors may
start to anticipate it later this year. Stocks will react very
favorably to the Fed lowering rates and my outlook for 2007 is
very optimistic under this scenario.
Sectors: energy, metals and
mining stocks have fallen off the top of my list and have been
replaced by healthcare providers, software and semiconductors.
Longer-term technical conditions are really lining up for the
latter, which suggest the odds favor these new sectors outperforming
for some time to come. In the ETF and mutual fund universe,
large cap value and non-U.S. assets continue to lead, for now.
From Chip Hanlon:
While Stephen Roach gets all the headlines at Morgan Stanly,
it is another analyst there that I personally find to be at least
as compelling: Richard Berner. His thesis, essentially: that
the bond market is going overboard in pricing in a recession
and the end of inflation. If economic growth rebounds, as he
expects, inflation fears will return and interest rates will
rise. I find this idea quite plausible.
If Berner's theory plays out,
then today's stock market makes more sense; with the Dow making
new highs it certainly isn't signaling recession in 2007. Perma-bears
will tell you about the 1970's, when every Dow rebound to its
previous highs turned out to be false and was followed by another
nasty, multi-year plunge. Well, I certainly believe such history
should be studied; if it is, then it's clear to see today's chart
of the Dow looks nothing like it did then.
As the stock market initially
rallied from its late-2002 lows, I was one of those who was skeptical,
at one point early on even calling it the "mother of all
sucker's rallies." Whoops. Looking now, however, at the
way the Dow has spent the last 3 years nibbling away at the overhead
resistance of its old highs (the same 3 years it spent building
that top from 1999 to 2001-take a look at a long-term chart),
it amounts to very impressive action, technically.
Are we overbought in the near
term? Yes, but not wildly so. Certainly breakouts in most asset
classes the last couple of years have tended to pull back, not
carry through, so we might soon see something similar from stocks.
That being said, the area between 10,000-11,000 should amount
to massive support for the Dow, leading me to suspect that any
corrections will continue to be short-lived and that the next
major, long-term move in the Dow will be up, not down. Really,
the Dow's long-term monthly chart it about as explosive as a
chart can look.
Finally, sentiment has failed
to become wildly bullish despite these fresh Dow highs; major
market tops are not made when there remains so much mistrust
of stocks.
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Oct 4, 2006
-Chip Hanlon
President
website: Delta Global Advisors
email: chanlon@deltaga.com
800-485-1220
Chip Hanlon
is currently the President of Delta Global Advisors and the founder of
Green
Faucet.
321gold Inc
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