WAVETECH ENTERPRISES, LLC
Private Account Wealth Management Services
Newsletter Issued 04-10-06:
By: John T. Moir
Chief Editor: Sara E. Collier
Position overview . . .
Our recent newsletter, dated March 14th, forecasted that the DOW was continuing it’s topping-in-price process and expected a trading range for the month between 10,560 and 11,165. The actual range proved to be elevated, between 10,922 and 11,334, as investors chose to continue purchasing the most popular stock index. There are expanding price divergences between the major stock indices — with the Utility Index already down for the year even with others remaining positive — leading us to conclude that the rotation lower in price is beginning. There has always been a flight to larger capitalized stocks, as offered within the DOW, during previous stock market peaks and this one is no exception.
The US dollar was anticipated to resume it’s bearish decline, with a euro fx equivalent trading range between $1.19 and $1.23. This proved to be very accurate for the month, as the actual euro fx equivalent trading range was between $1.1847 and $1.2278. The US dollar was lower for the entire period, as the large trade imbalance and current-account deficit put undo pressure on the currency.
The US treasuries were forecasted to have a peak yield for the 10-year note at 4.75% during the month. In reality, the US treasuries were forced lower in price and higher in yield, as they factored-in further interest rate hikes by the Federal Reserve in the coming months. There are some concerns by the Fed that inflation could be rising, which would cause the Federal Reserve to continue raising the prevailing fed funds rate even further. There could be justifiable reasons to raise them to a fed funds rate of 5%, but not much further, since additional rate hikes could substantially slow the US economy and produce another recession.
Looking forward . . .
Last Friday’s stock market action was most telling, after the release of the March employment data — opening higher, but closing much lower . The non-farm payroll number was on the strong side — a 211,000 increase in jobs, about 20,000 more than consensus, however, after an 18,000 downward revision in February’s number, it was an outright wash. The jobless rate ticked down to 4.7% from 4.8%, but one of every six new jobs was at eating and drinking establishments. These positions were filled with US citizens, since they could not be performed in other countries, which notably offer lower labor rates for shippable products and various technical services.
The stock markets reaction to the employment report was remarkable in part because it scaled nominal peaks only to see a resounding round of selling. The S&P 500 Index, over the past 40 years, had never reached a new high only to see such breadth of selling that sent three stocks lower for every one that rose. And on Friday, four stocks fell for every one that climbed. The stock market has continued to remain in a guarded stance, even as stocks advance with measures of investor sentiment generally noncommittal.
The S&P 500 Index has gradually advanced for over 775 days without suffering a 10% correction, which is close to becoming the third longest winning streak since 1966. The length of the prolonged advance and trading action on Friday, gives us further evidence that the major stock indices will re-test near-term various support levels. These key formidable levels will either hold, resulting in another counter trend rally or be breached, confirming a resumption in the bearish stock market trend.
Auto sales typically rise 18% in March from their February level. Anything below that level would be a below-par advance. So, if auto sales rise 16%, as they did last month, that number would be reported as 2% below par — seasonally adjusted. Autos’ failure to clear the bar hardly boosts well for retail and housing going forward.
The March Redbook Retail Sales Index was indeed poor. The greatest potential for disappointment, however, is housing, where the March existing home sales are expected to surge 33% over February’s level. The current Fed interest rate tightening cycle expectation could reduce in a hurry, if things play out with a less than anticipated increase in existing home sales.
POSSIBLE REASON BEHIND THE US DOLLAR ADVANCE IN 2005:
There have been many different opinions expressed for the US dollar of 2005. First, foreign central banks — notably China’s and Japan’s — purchased US treasuries to maintain a stable and favorable trading environment. Second, the rise in short-term rates made the US dollar more competitive. Third, the US dollar was oversold and was due for a rebound. Fourth, too many folks, especially hedge funds, were shorting the US dollar or participating in a carry-trade play and got squeezed — forced to cover (offset) their short positions. Most of these theories were in place as the US dollar declined throughout 2004.
The more obvious theory can be easily missed, which may have been the case. The US dollar rally began in early January 2005 and ended just prior to the Christmas holidays, matching the calendar year almost perfectly. The critical factor that the aforementioned theories do not address is the timing sequence.
What we believe that has been overlooked is the government’s tax incentive, which encouraged US companies to repatriate foreign earnings. This incentive was available in 2005 for the entire calendar year, which worked very effectively. An estimated $300 billion of corporate earnings were repatriated, a significant amount of funds, especially when compared to last year’s trade deficit, around $725 billion. So it seems all to obvious that the critical driver of the 2005 US dollar rally was the massive repatriation of corporate foreign earnings. The US dollar could certainly resume its decline in value, now that the incentive window has closed.
Long-term conclusions and current month expectations . . .
The counter trend stock market advance has been showing signs of it maturity and buyer’s fatigue. Statistical momentum has been unimpressive, with the move to new five-year records. The number of stocks setting highs has contracted from prior index highs and represents one of the longest stretches ever without experiencing a mentioned 10% pullback. The March-April period has seen nasty and quick stock market sell-offs the past two years, not to mention the generational major peak in 2000.
Penny stock share volumes surged in February to levels last witnessed near an interim market high in January 2004. Discount brokers are seeing heavy customer trade flows, as the small investors return to stocks. Equities and mutual funds took in 80% more in net cash in January and February than in the year-earlier period. Another large marginal buyer of stocks has been companies themselves, who are repurchasing shares at record levels to support share values — a common occurrence at stock market peaks.
At the same time, corporate insider sales jumped 400% in the last two weeks of March, and the ratio of insider-sale proceeds to the cost of option exercises rose to levels last seen in December 2004. That was not a disastrous time to be a buyer, but lower prices become available before very long thereafter.
Investor attention will soon presumably pivot toward corporate profits where all may appear to be calm on the earnings front. The pre-announcement season has been fairly tame, though the typical peak of the warning period should come in the next couple of weeks. The pattern has been that quiet pre-announcement seasons seem to set up for more turbulence in the actual earnings seasons, and vice versa.
The timely driver of stock prices in recent years has been less the strength of earnings growth than what investors are willing to pay per dollar of profits. Valuations have been compressed with limited reasoning for a re-expansion of multiples in the near future.
All of these factors point to a lower stock market, with an expected DOW trading range for the month between 10,680 to 11,270. A breach of the support level at DOW 10,500 should produce a move lower to the formidable support level at 10,000. A resumption in the long-term bear market decline would be confirmed once the DOW has an end-of-the-trading-day close below 9,950, which could occur in the coming months.
The new Federal Reserve Chairman, Ben Bernanke, has suggested that the current flat yield curve does not mean that the US economy was about to slow, or worse, head into a recession, even though every economic contraction has been presaged by a flat or inverted yield curve — higher short-term than long-term rates, the inverse of the usual shape.
The previous Happy Days of low and stable interest rates preceded the recessions from August 1957 to April 1958 and April 1960 to February 1961, even as the entire yield curve remained flat and not inverted. Real rates were even negative going into the 1957 downturn, when the Fed was not exactly tightening aggressively.
A flat to inverted yield curve is not so much a cause as a symptom of what is happening in the credit system. Investors are willing to lock up money for a decade more without getting paid any extra only because they think short-term rates are going to fall in the future.
Another symptom is when housing begins to roll over. That sequence has been apparent in Britain and Australia, where their curve is inverted, and air is coming out of their real estate bubbles. Just two weeks ago, we show news of new homes sales last month had plunged 10.5%, their biggest decline in nearly nine years, while the number of unsold homes rose to a new record.
A single report may not necessary give pause to the Fed’s expected policy, but the more cracks in the housing foundation might persuade the Federal Reserve to stop raising the fed funds rate sooner rather then later.
There is now a high probability (75%) of an increase in the federal-fund rate to 5%, from it’s current level of 4.75%, at the May Federal Open Market Committee Meeting (FOMC). A fed funds rate of 5% will have the same affect on the US economic as $3 per gallon for gasoline, due to the recent slew of weaker economic data. It will slow things down, perhaps, more than what would be preferred by the Federal Reserve. We believe that Ben Bernanke will be a bit more hawkish in the future and may receive some guidance from the financial markets. Growth within the labor markets could cause the Fed to continue raising the prevailing fed funds rate on a restrictive path that would increase the chances of another recession. This path could cause them to in effect “over raise” the fed funds rate, and produce the next recession.
The yield on the US treasury 10-year note is currently at 4.98%, which is close to the expected peak in the fed funds rate of 5%. There is major yield resistance for the 10-year note at 5%, which would lead us to conclude that a major peak-in-yield may be occurring. The US treasuries could start to rally in price and decline in yield, even though the Fed is likely to raise the prevailing fed funds rate another 25 basis points (0.25%) at their upcoming May FOMC meeting to 5%. This is an very attractive yield, with the US and global economic uncertainties, and should draw underpinning price support in the days and months ahead.
The US dollar should resume it’s bearish decline, with the completion of the repatriation period, however, our wave pattern technical analysis suggests that we still could remain within a narrow trading range — at least in the near future. Therefore, we are expecting a trading range for the month between euro fx equivalent of $1.19 and $1.24. These two currency values now represent key support and resistance levels that, when breached, would cause us to conclude if the US dollar will be continuing a counter trend rally or resuming it’s bearish long-term decline.
SUGGESTED INVESTMENT ALLOCATIONS:
1. A 75% to 85% allocation of their taxable ordinary funds and/or tax-deferred funds into a conservative as well as flexible investment strategy using various no-load index mutual funds and exchange traded funds (ETF’s) offered through our Private Account Wealth Management Services. The minimum investment criteria are determined after reviewing the investor’s current assets and fund allocations. These services are ideal for individuals, trusts, foundations and privately held corporations that have large stock, bond and/or real estate holdings and are seeking an active management service to generate a long-term average rate of return on investment between 15% to 20% per year (after fees) through either a rising or declining stock, bond or real estate market.
2. A 15% to 25% allocation toward cash, Treasury bills, CDs or money market funds with short maturities which will allow investors to rollover these instruments and obtain a higher level of return as interest rates move higher.
If there are any questions regarding the information discussed within this newsletter, the investment allocations mentioned above or our unique management service, please call the number provided below or e-mail us and we would be happy to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
Acknowledgements: Federal Data, Ned Davis Research, Jason Goepfert with Sentiment Trader, Phillippa Dunne and Doug Henwood of the Liscio Report, MacroMavens, Houssels and Co., and Northern Trust.
Note: These newsletters have no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. These newsletters are issued for informational purposes and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. These newsletters are based on information obtained from sources believed to be reliable, but are not guaranteed to be accurate, nor are they a complete statement or summary of the securities, markets or developments referred to in the various newsletters. Recipients should not regard these newsletters as a substitute for the exercise of their own judgment. Any options or opinions expressed in these newsletters are subject to change without any notice and the Wavetech Enterprises, LLC newsletters are not under any obligation to update or keep current the information contained within. Past performance is not necessarily indicative of future results. Wavetech Enterprises, LLC and its newsletters accept no liability for any loss or damage of any kind arising out of the use of any or all parts of these newsletters.