Turning Point
Victor Hugo
Major JSE sector groups are in retreat and acting according to the way the indicators suggested they would -- as discussed in previous issues and in our Market Strategy updates. A pleasure to have markets at last doing what they "should." The last two years have seen the most difficult markets I have ever tried to read.
Still very difficult global dynamics, despite the better looking growth and unemployment figures coming out of the US, to the extent the figures are really representative. There are lots of ways to count employment and growth. Let's have a brief look at the major drivers for the JSE and global markets and scenarios for where to next.
According to my thinking, the main issues the average JSE investor has to take a view on -- are whether interest rates are going much higher, whether the Rand will go much weaker and whether the commodity run is over for another few years or not.
The US still influences the global show mightily. Mr. Greenspan and team are at the point where they cannot defy basic economic truths. They are now warning that there are no free lunches and say they are less concerned about US private debt and the huge US trade deficit than burgeoning federal and national debt and expenditure. Mr Greenspan emphasizes the structural problems in reducing this type of debt and expenditure once incurred -- and is starting to warn that the free lunches have to be paid for. Is he preparing the market for the worst scenario? Inflationary recession -- in which rates and prices rise and growth reduces?
"No free lunches. " Talk about massive understatement. The global financial system has had a huge stake in maintaining the status quo and crafting more time for the US to maneuvre while it deals with a war on terrorism. The global community doesn't need a long US recession now - to slow their own a vulnerable upturns.
The US' s ability to deal with its debt and trade deficit are closely linked to global slowdown and spin-off risk. So G7 countries and even the Muslim world and Chinese have been disinvesting only gradually from the US -- in their own self- interest. This has helped the US make a window of time to maneuvre up to now -- but that help will only be as long as there are no better alternatives. The better alternatives are now here -- other areas of the world e.g. Asia and some emerging markets which can show healthier returns over the medium and long term.
A weaker US$ mainly helps the US with its trade deficit -- so it has not been a particularly good idea for others to sell US Treasury Bonds and other US assets too fast, putting more pressure on the US$. A domino effect, resulting in more devaluation of the buying power of the US$, would reduce demand for Treasury Bonds and US $ denominated reserves elsewhere. And there isn't enough gold outside vaults to go around -- to go back to the gold standard . The mishmash of other currencies and even the Euro are not that appealing either.
Uncle Sam is still managing to keep the show together -- for now. Whether one likes them or not -- the world's stability depends on them. I think they have been doing a great job during the last 60 years -- even though they have been doing unpopular things. A look at history shows how the world was at war every few years until a sometimes- benevolent superpower said enough. The armchair journalists who wave their fingers at the US in disgust while living the benefits of a stable global environment are just as naive as they allege the US is.
The problems the US face though are massive. Exposure of the average American to debt is huge. ( Have a look at sites such as www.safemoneyreport.com and www.dailyreckoning.com ). US personal debt profiles shouldn't be lightly dismissed: here is the typical ease with which credit has been available to Internet surfers in recent years :
"USA Platinum Card
* $7500 Line of Credit
* No Credit Checks or Credit Turndowns
* Monthly Credit Increases
Click here to apply! www.usaplatinumcard.com"
Or how about this:
"Right, Tired of being in debt? Get Help Now!
Lower your payments up to 60%!
Save more cash each month!
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NO credit checks! Poor credit record - no problem!
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Meanwhile credit card debt and household mortgages and motor car buying, happily continued increasing in the last few years - almost as a cock a snoot thumb on nose to Osama and his thugs. Yet the oil price and Federal debt has also increased. A recipe for a blowout or a puncture. After it happens -- all will think the probability was obvious and will wonder why their investment advisers were not concerned.
Debt cost going higher with interest rates is painful enough when it comes to the mortgage loan on a house, but when it impacts on credit card loan cost and motor cars often bought with cheap credit -- it becomes easy to forget the inflationary times and high interest rates of the 1970's and other examples too numerous to go into here. Innocent Americans who have never experienced or forgotten higher interest rate impact are going to be very hurt as many of them scramble to sell when they can't afford to service debt. For many years now they have not had a taste -- of what it's like to live with interest rates high and inflationary pressure.
Long-suffering South Africans who have been entrepreneurs and employers while trying to juggle this environment are among the most nimble and resilient in the world by now -- and they know it's just not worth taking on too much debt. Contrast the Americans who have run up debt. If jobs and confidence become less in a recessionary and inflationary environment - real values collapse. Remember the Weimar Republic in 1919 and the world in the 1930's? Then as now, I am concerned that the US can lead the world into recession after a long period of complacency and relative wealth.
Question is, will all warnings from the Fed that an interest rate bias to higher is coming -- be listened to by the markets? I think yes. If the prevailing belief continues that yes, interest rates will go higher -- but that the application of them will be slow enough and careful enough not to damage confidence -- the markets will only work gently lower from here. If the realisation spreads quickly that there is little prospect of relatively painlessly and quickly dealing with national and federal and private debt and damaged pension funds -- selling can accelerate on Wall Street and property prices and Treasury Bonds and the US$ can come under pressure very quickly. Markets anticipate anything from six to eighteen months ahead -- especially when they hit confidence bumps.
After writing the above last week - I am adding here just before this newsletter goes out -- that the 5% sell off in Japan this morning 10 May and other markets down heavily, suggests that the market is reacting fairly simplistically at the moment: right now markets see a very strong jobs report from the US and that assuming the figures are reliable, interest rate hikes will have to come quickly and not far apart. So they are dumping stocks and bonds -- often to protect the gains of the last eighteen months -- an easier sell than lower down where the usual emotion is to refuse to sell until you absolutely "have to". It may take a while before markets realise that the Fed is going to drag its feet as far as possible. That will fuel a rally -- but the bottom line is whether the Fed will have no option but to hike rates and apply the medicine quickly and strongly?
I am having doubts that the Greenspan team or successors will put pressure on the system by actually applying the degree of higher rate medicine needed. I guess that they will delay as long as possible and that when the first hike comes, it will be as little and late as possible and subsequent hikes will be as little and as late and as slow as possible e.g. for only quarter point moves and irregularly, months apart. And that unfortunately will only prolong and deepen the problem.
So to summarise, the risks of the US recession are so severe in the current geopolitical , terrorism and financial climate - I suspect that the Fed will apply as little interest rate medicine as late as possible -- hoping it will give opportunities while confidence is okay to solve economic problems. But markets are selling as we prepare this to send off - thinking that the Fed will have no alternative but to hike aggressively and soon. Yet the Fed knows that the implications of an asset price meltdown for financial and eventually military strength are just too catastrophic to permit. The US will even resort to lower interest rates again if needed. All the right noises are being made about shifting bias to interest rates higher, but when it comes to the time to do it in order to encourage debt profiles lower -- my guess is that there will be more tap dancing.
Being slow on interest rate rises also helps the Republicans a bit in the next couple of months -- before the election. Yet all this is doing is making the bubble bigger and thinner.
Problem for the world is that the convivial party of G7 countries may be over. Even China has co-operated to help the US$. Japan, the second biggest economy in the world -- is starting to wake up after 14 years of recession and is becoming less dependent on the US consumer. China and other Asian tigers improve their buying and export power. Shrewd Japanese bankers and perhaps the Chinese and the Muslim world as well -- are quietly accelerating the sale of their huge US Treasury Bond holdings ( up to now the US's passport to creating money when needed) -- particularly now that the Japanese' own JY 10 Year Treasury Bond yield is showing signs of heading higher from here.
It doesn't make sense to pay higher interest rates at home in order to hold US Treasury Bonds that are beginning to look less attractive for capital appreciation than they did a few years ago. Another reason why the US 30 Year Long Bond yield has moved higher.
Let's have a look at the US 30 Year Long Bond yield. We mentioned before that it would take trending or consolidation above the 5.20% area to suggest that the medium or long-term turnaround of the bigger trend to lower yields since October 1994 January 2000 is underway. Well there has certainly been three weeks of enthusiastic trending above 5.20%. Yet after the strength of the move from the 4.64% area in March 2004, a reaction for a few weeks back below the key 5.20% area would not be surprising at all. A typical scenario could also be some sideways work between 5.00% and 5.30% as the Fed tries to calm fears about interest rates and sell the story that it won't be too much nor too quickly. Action showing trend maintenance or development above 5.62% would be very bearish for the US and world markets and could be a warning that the hawks at the Fed who remember the ravages of inflation have beaten back the tap dancers. Then we would know that the Fed cannot delay more.
Either way, the market is now beginning to accept that higher interest rates are coming -- and the only debate is how quickly and how strongly will equities and property prices [and the US$] react lower? I suspect the bears are starting to realise that the news is not good for equity prices and bond prices -- whether the landing is gentle or hard. So profit- taking and defensive positioning has started and if the behaviour of the markets since March is a guide, we are at a key point of make or break consolidation and recovery from here or acceleration towards 2002's lows or below. I think that the latter scenario is underway.
The momentum evidence on the Dow Jones Industrial average, Dow Jones Utilities, Dow Jones Transports, S&P Retail Index and the NASDAQ Composite Index look as if the selling developing could actually be more intense than the Fed would like and more intense than consensus expects. For instance on the NASDAQ Composite now at 1917, while upward momentum fails to build above the 2125 area, downward momentum counts projecting from the beginning of the bear in 2000, highlight scope for a move back to October 2002 lows at 1107 by October 2005 or an alternate scenario for about a year later for near 800! The Dow Jones Industrial Average is showing a sell on a smoothed 12 month stochastic and other momentum indicators and this from near the upper side of or long-term linear regression range -- measured from January 2000's highs - to the 5500 to 7000 range.
I think that the most serious of all scenarios is busy developing for the US -- inflationary recession. Where rates have to be hiked but growth is not sustained to counterbalance it. That will fuel the domino effect on US asset prices - I have been warning of. Bonds, property, stocks and the US$ can all fall hard in this scenario.
As our readers know, I've never conceded that the US bear market that started in 2000 has ended -- the problem has been how high the rally would go and for how long. After a two-year down phase 2000 to 2002-- and a two-year up phase since -- the four year cycle profile would typically enable an aggressively weaker phase for the next year or two years.
Crash? Perhaps. Aggressive selling in a meltdown? Perhaps. Stagnancy and softer - perhaps - if you believe that the Fed will manage confidence successfully. Along the way though, hard or soft, confidence in global equities will be damaged. Up from here on Wall Street? No - not until a signal that bias for rates has shifted to neutral or lower again and that inflationary recession can be avoided.
Impact in South Africa on the JSE ? Definitely yes, despite help from the Rand which will work a bit weaker during the initial phase of global market selling. Have a look at comment on individual shares and sectors below.
The dip/pullback meltdown /sell off I have been warning is near -- is underway. The issue is to decide how deep and how long. At the moment, momentum is calling as if it could play out in the next few months as a 30% dip in Alsi 40 terms -- back to May last year's lows. Down there - subject to macro developments then prevailing -- maybe the heaven- sent dip buying opportunity for the JSE I have mentioned.
Even resources shares are anticipating that company earnings will suffer as demand for commodities slows. Demand for commodities and the shares that benefit from strong commodity prices, can increase again as a safe haven refuge when the US$ sells heavily again [as I expect]. Risk is that share prices will anticipate a global downturn for a year or so before anticipating a e.g. a year ahead for recovery. That scenario would take our Anglo and Billiton quite a lot lower. Yet US$ weakness is almost a certainty and that means that the resources dip will be temporary - although in Rand terms a stronger Rand resuming ( after current selling) will also put pressure on this sector group.
On the US$ - I persist with my within 18 month counts on the Euro to between 141 and 155 ( after some work between 112 and 121 and for the US$ Index to 70 or below ( after some work in the current 90 to 98 area). It is in this context that I've been saying that the current dip in commodity prices and related shares is a heaven- sent buying opportunity on a two year view. The current dip can take several more months though -- although I suspect that when the world wakes up to the fact that China and India and Asia are not going to slow their growth very much or for too long while they wait for the US and Europe to recover -- commodity prices will head higher in Yen and Euro terms -- not only to compensate for a weaker US$.
So let's wait for reversal evidence and watch the RAND before buying the Resources sector. A weaker Rand working e.g. the $ZAR6.90 to 7.50 area for a while to e.g. third week in June ( key chart resistance at 7.20) , will help keep SA resources shares stable - perhaps a bit higher - as the market does a wait-and- see on underlying commodity prices in other currency terms. The counts for year-end warning of the below 6.00 area are still persuasive while the Rand trades below 8.21. So yes, a stronger Rand later this year will also put pressure on the Resources sector until new long term investment in the sector starts generating earnings prospects and the global commodity demand revives.
I am giving particular attention to finding lows for $ commodity prices and am watching the first candidate cycle window between June and August. The US$ will be one of the first and most important indicators to warn us that a reversal to up is underway and to remind us that the commodity cycle doesn't usually give up the bull after only four years. China's credit tightening is not a bad thing and does not mean the end of Asian economic growth -- being fuelled by China and Japan. Eight and twelve- year cycles are much more typical, even though there are breathers of some months along the way.
A very real risk for JSE Resources shares though -- is that they will initially be dumped along with other sectors as a global market meltdown accelerates. Gold shares and other resources shares could be the quickest to recover though. Cash is again becoming second in line to being king -- cash enables buying dips and falls. (Better than cash is getting short where appropriate -- wouldn't short resources sector now).
The R153 RSA Gilt is still a very important indicator for strategy as well. Right now the count ranges relative to the time ranges are suggesting some more work to be done around the major technically and psychologically important 10.10% area before working a bit higher e.g. to probe chart resistance at 10.52% or on a shock to the global system even briefly to 11.17%. The 2 year average is at about 10.20% but shorter period momentum is up just enough to worry the broader market. Interesting though how the property sector is little fazed by this yield rally. I still think interest rate pressure in SA will only be temporary. There is too much money leaving Europe and North America looking for new long term investment growth; SA has become interesting for the reasons we have talked about before.
I am not concerned about my view that the property sector in SA is still in the young phase of a bull market and that despite the bumps emanating from the US and UK bubble punctures or pops coming, more money from both the West and East is coming into SA in the next few years enabling property values to be buoyant and higher. (The only red flag here is that the ANC has to keep on convincing the world that Rule of Law is absolute, that the Law will stay entrepreneur- friendly enough and that Laws will not be created irresponsibly). Any irresponsibly handled land or education issues or attempts at more central control -- will put the country back quickly -- as the Zim experience has shown.
Yet the new black middle class also does not want chaos - so for now South Africa holds its head high. It confounds the doomers and gloomers who since the 1960's have been saying that South Africa is finished.
If on the other hand you believe that the Rand can only go weaker and stay weaker from here -- then your money has to go overseas.
JSE Sectors
As I prepare this, the market has already started accelerating weaker. Here are some JSE sectors and an indication of the scope that the current behavioural and momentum counts suggest for downside in the dip. Classic momentum, divergence, pattern factors, Elliott count, Gann cycle, and/or relative strength indicators in monthly, weekly and daily time frames are indicating.
The buying opportunities pullback base could be as soon as 4th week in June on the three month cycle -- or as late as September next year - no-one really knows. All we can do is monitor momentum and macro factors and let you know when the market action shows tech evidence for basing. I suspect that the falls may not be as far as indicated and will not stay down there for more than a couple of weeks - depending on the extent of global confidence deterioration and how soon "new" investment destinations such as the JSE become interesting again.
You may find that the targets move in coming weeks as the market sets up its key momentum and price relationships; that is okay as long as one can attempt to stay on the right side of the market and be prompted when to take evasive action such as now -- or to enter on opportunity. Still too soon to buy and depending on your own strategy - there may be still be big enough pullbacks to come -- that justify making some cash and protecting profits. Either take a view to ride out the noise on a long term bullish view while taking big risk of being wrong -- or tighten exit parameters so as to buy lower within weeks or months in the dip buying opportunities (perhaps) coming.
JSE Alsi 40 - 7550 to 6745 from current 9479
JSE Resources - 7521- 9040 from current 10158
JSE Financials - 7500 - 8225 from current 9702
JSE Indu25 - 4608 - 5790 from current 7420
JSE ITEC - 160-280 from current 400
JSE Retail -- 8720-10160 from the current 11911
JSE Property Loan Stock - 360-403 from current 479
JSE All Gold Index -- 1490 to 1675 from current 1798
JSE Construction and Building Materials Index --10400-11320 from current 13724
On these scenarios, you can see the need to be defensive if already in the market and the extent of opportunity lower down. In order to get this newsletter out sooner to you now - I will publish on individual shares later this week. Keep a close eye on Europe and the US for panic selling -- I did not like what I saw on the Nikkei this morning.
As I watch my own tendency to hesitate on sells and how many investors struggle to implement sells when the market trades at the prices decided on -- I have found it can often be useful to take a view -- instruct you broker accordingly and make cash at a vulnerable time such as now - and sell before the market confirms by selling aggressively. In an aggressive selling phase it is even more difficult to sell lower.
On the other hand there are medium and long term strategies and tax considerations. Perhaps the main risk is I am wrong about this being a temporary setback coming and the market stays low for several months before a new base is built. I don't think so though. The unique growth potential South Africa is positioned for -- with relatively low debt and of interest to both West and East with resources and initiative - could mean a positive long term investment phase into SA accelerating -- at least that's what share prices across most sectors and property prices in the last year may have been indicating as a likely scenario.
Victor Hugo
www.HugoCapital.com
www.SAgolds.com
www.GoldSignals.com
12 May 2004
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