Last Friday Bush fired his Treasury Secretary Paul O'Neill and his chief economic advisor Lawrence Lindsey. Treasury Secretary O'Neill was seen as a problem. He toured with rock star Bono and contradicted the President's tax policies even in his hearings when he said the 10-year $1.3 trillion tax cut wouldn't do much for the economy. It won't but that's beside the point. Lindsey was seen as a poor communicator in an administration that goes out of its way and stresses through repetition its message. On Monday he quickly announced the replacements in John Snow for O'Neill and Steve Friedman for Lindsey.
Since Bush used to have an ownership stake in the Texas Rangers baseball team this switch in mid-stream had all the feeling of a baseball coaching change because the team was spinning wheels. Initially the stock market viewed it positively shaking off the bad news of the loss of 40,000 jobs in November and the unemployment rate reaching 6%. It was perceived that O'Neill was reluctant to provide the stimulus to the market required to make it move ahead faster. With the announcements on Monday the market started sliding on the perception that Snow would be soft on the dollar and any further stimulus and tax cuts would merely add to the already growing budgetary deficits.
Go figure. Maybe it had nothing to do with Snow et al at all but more to do with a market that quickly become full of itself once again with sentiment reaching over 70% bullish on the Dow Jones Industrials and over 80% on the NASDAQ. Or once again maybe everyone realized that the P/E ratio on the average S&P stock was still north of 30 when earnings are barely growing at 5%. And earnings season is about to be upon us once again and maybe just maybe there would be another healthy dose of reality in the numbers. In a word the market is as it always has been over the past few years overvalued.
Bush has a real concern that a moribund economy may hurt his election chances in 2004 as it did to Papa Bush in 1992. While Papa Bush enjoyed high marks for the Gulf War the weak American economy did him in. Bush the younger is trying to prevent the same thing from happening and both O'Neill and Lindsey were reluctant to pursue the kind of stimulus that he wants. Supply side economics, that was popular under Ronald Reagan, has been largely discredited as a failure. Tax cuts are of limited use as well. Instead the Reagan legacy was the largest deficits in American history and already the current Bush administration has slid into serious deficits to finance the war on terror and deliver tax cuts. But then both Snow and Friedman are viewed as better salesmen and what Bush wants is to sell his agenda.
But as the nursery rhyme says "all the king's horses, and all the king's men…." can't put this economic mess back together again. There are three main areas that domestic economy focus's on. They are housing, retail spending on consumer goods and business spending. The past year has been a boon to the housing market as low interest rates have fueled both a house building boom and a hot resale market. But sales of new homes may have peaked in June and since then it has come off. Of course it has not collapsed but if interest rates were to rise the housing boom would come to an abrupt end. And it is no sure thing that interest rates are going to stay low. A weakening US Dollar and fiscal budget deficits are two sure ways to ensure that interest rates will rise not fall.
Propping up consumer spending over the past year has been car sales. But car sales took a big drop in the August/October period. Seems that 0% financing can only go so far in enticing consumers to spend and then the market becomes satiated. And eventually as well the standard becomes meaningless and is expected. Heaven help them if they had to increase financing rates. And the situation is the same with other consumer goods where a sign in the window saying "SALE - up to 50% off" becomes normal and expected. Trouble is the consumer society is over saturated with goods. There are no shortages. There is little room if any for growth. Early indications are that Christmas sales are sluggish at best and at worst in retreat.
On the other side personal income growth is sluggish growing only 0.1% in the third quarter and personal expenditures grew faster at 1.4% in the same period. At the same time savings growth was actually negative and consumer debt continued to grow. Foreclosures and bankruptcies were going at a record pace throughout the year. With the consumer over indebted, with little or no savings, his income not growing and unemployment rising he will not be in a mood for spending.
The final key is business spending. Capital expenditures in goods and equipment peaked in 2000. Since then it has fallen roughly 15%. Given overcapacity in many industries particularly the telecommunications industry and to a lesser extent other technology industries growth here questionable. Corporations like the consumer are also overburdened with debt. Government expenditures are rising to fill the void but that is a two edged sword as deficits are also rising.
If the consumer is tapped out and business investment is not growing the odds of profits growing are also slim. Profits peaked in 1999 and it as well has been in a general downtrend ever since. With earnings season about to be upon us more earnings surprises could be in store. Another area that has and will continue to be a drag on profits is the ongoing record current account deficit. At roughly 5% of GDP and over $500 billion annually this means that more funds are going out to foreigners then is coming in. While it may make consumers feel better because the goods coming are in cheap this illusion may not last much longer.
The US dollar is falling and the new Treasury Secretary may like it even cheaper to encourage US exports. Trouble is it is a two edged sword. If the dollar falls the goods coming in are more expensive and the consumer will defer buying. Once again as we noted earlier the US has no shortages. There are too many goods and most of them are produced anywhere but the US and brought in for consumption. Japan has a trade surplus but they have their own problems and do not want to see their Yen strengthen, as it would hurt their exports. Seems to me that both wanting their currency lower means that nobody is going to win and that eventually everyone loses. Nobody has ever won in an ongoing competitive devaluation war.
Is there any gleam here? Well yes. But that lies in a negative as well. The Fed can continue to pump the money supply and maintain the low interest rate environment. But maintaining low interest rates in the face of a falling dollar and falling bond prices (rising yields) has never worked. Similarly the new Treasury Secretary may launch further fiscal stimulus. But this will add to the deficits and further spook the bond market. None of this engenders much confidence.
As we had noted in a previous article we may have put in our final high before another huge downdraft to new lows. If that happens it should result in a significant low for several months. We have often noted the comparison between the 1929-1932 stock market collapse and the current market. That market lasted roughly three years (September 3, 1929 - July 8, 1932 - 1039 days) and fell in 13 distinct waves. Using the Dow Jones Industrials top on January 14, 2000 the projected low would be around November 18, 2002. That date has passed. More likely is to use the S&P 500 top on March 24, 2002, which targets January 27, 2003. That doesn't mean that the low will occur at that time but by our wave count we should have one more big wave down. If the 1932 final down wave is used as a measurement it could be substantial. We are targeting to at least 600 S&P 500. Note how the recent rallies in both August and November could only reach up to the neckline of what appears as a huge four-year head & shoulders pattern on the S&P 500.
But this current upswing has been greeted with a very high degree of enthusiasm and instant bullishness. Call it the "we are tired of the bear market" effect. But the bottom line after many years of overvaluation the market must find a new equilibrium at considerably lower levels. And the economy tells us that we will eventually get there. And all the maneuvering in the world by the Bush Administration to get the new men to put things back together again on the domestic economy is just not going to work.
December 12, 2002
Charts and technical commentary by David Chapman of Union Securities Ltd. 69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email david@davidchapman.com
The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.