One major reason why the economy is getting softer by the month is because this is the "four" year of the decade, and this is when the 10-year cycle always bottoms (usually in the fall of the year). So between now and October-November we'll have to contend with this downside pressure from the bottoming 10-year cycle. That's why 1994 was such a difficult year -- and why it led to a changing of the political guard in the Congressional races of that year. It's also why this year's election is likely to end much the same way -- with a changing of the guard.
Quite a few analysts seem to think the real estate sector is due for a crash in the next year or so. I do not share this opinion. The indicators show a powerful bull market is underway that would likely take at least one full year to reverse, even if we were theoretically at a top right now. Based on the chart of the Morgan Stanley REIT index (RMS) I do believe the sector is due a major pullback in 2004 (REITs are a proxy for the real estate sector). But I don't believe this will mean the start of a long-term real estate bear market, rather, it should only be a much-needed and temporary "correction" of the near-linear uptrend since the year 2000.
Closer to measuring the actual real estate market is a momentum, or rate of change (R.O.C.) indicator for U.S. residential construction. Notice the extremely bullish reading being given by this indicator as of January. The momentum reading is so far above the "zero" line I'm guessing it would take several months to reverse this powerful upside momentum that has built up since the 2002 low in residential construction.
In the latest edition of his Early Warning Report, editor Richard Maybury shares his respected opinion that real estate will likely continue to be one of the hottest investments in this war-time economy. "Many worry that when mortgage rates begin to rise, the real estate boom will be killed off," he writes. "I do not doubt higher interest rates could cause the boom to slow or even stop for a few months, but unless the war ends (fat chance) and the dollar recovers, I think the higher interest rates will give real estate a hiccup, not a heart attack." He adds, "When rates rise [due to a flight from the currency], we are in a situation where millions of investors are trading the currency for something they trust more. In the U.S., a traditional top choice has long been real estate." I believe Maybury has made the correct observation here.
The momentum reading for M3 money supply is quite instructive. It tells an interesting story in and of itself. Essentially, M3 has been contracting on a rate of change basis since 2003 but appears recently to have bottomed and has even turned up in the past couple of months. The 10-month rate of change chart for M3 shows a major double-bottom low at a pivotal reversal area. As you may know, it takes several months for changes in M3 to be felt in the physical economy. I speculated in a previous Gold-Eagle commentary that the rate of change slowdown in M3 that began last year would start to be felt sometime between now and the second quarter of this year and would continue to be felt in the form of a declining economic performance until around election time. This would provide the impetus for a presidential changing of the guard, which means of course that Bush won't be re-elected. Yes, ladies and gentlemen, despite his "successful" completion of the second Iraqi conflict, it appears that Bush Jr. is about to fall victim to the same thing that Bush Sr. (despite his "successful" handling of the original Iraqi conflict) fell victim to 12 years earlier -- "It's the economy stupid!"
On this subject of the U.S. presidential race this year, a very insightful indicator is found on a recent cover of Time magazine. The cover shows two profiles of George Bush facing each other with the headline, "Believe Him or Not: Does Bush Have a Credibility Gap?" For the mainstream press to be asking questions like this of the incumbent president this early in the race is a sign that he has been shunned by the very media that supported him unquestioningly a few months back during he military initiative (just like Bush Sr.!) Political analyst Lawrence Patterson observes, "Interestingly enough, there was no question of believing George Bush when he was pressing to go to war in Iraq! There was no question of a 'credibility gap' when we were about to invade. Isn't it interesting how things change when the controlled media gets exactly what whey want from a president and then immediately develop a question of honesty and credibility?"
He concludes, "With the 2.6 million people out of work and the semi-annual testimony of Alan Greenspan revealing deep anger over the plight of the unemployed by members of Congress -- Bush has got lots of problems." I predict we'll see a changing of administrations come this fall, and in my opinion, this is one reason why the Fed has allowed M3 to fall so precipitously until recently. Add to the mix steeply rising fuel prices (and everyone knows of the Bush family oil connections) and you have a recipe for an angry electorate voting Bush Jr. out of office in November.
After November comes and goes, what can we expect of the economy heading into 2005? I believe 2005 will be a banner year for the stock market and economy, at least compared to 2002 and 2004. It may or may not surpass the stock performance of 2003, but it should definitely outperform anything that happens in 2004. The "five" year of any decade is always a winner where stocks are concerned and 2005 should be no different, especially given that the dominant 12-year cycle bottomed a couple of years ago. And if I'm reading the M3 chart correctly, 2005 should also be a good year for the economy.
What about the credit situation? Bank credit is a vital statistic that many overlook when trying to analyze the economy. I've kept a running 10-month rate of change chart of bank credit for years and I find it to be very trusty in forecasting overall economic conditions in the U.S. The key to interpreting the bank credit indicator below is where the momentum reading is relative to the dashed horizontal line. You'll notice that after spending a good part of 2001 below the horizontal line, bank credit recovered slightly in 2002, only to plunge again into the middle of that year. Then a reversal into early 2003, then another plunge, followed by a big reversal into later 2003. This produces a pattern of higher highs and higher lows and shows the overall long-term trend in bank credit to be up. The latest pullback in bank credit momentum has been quite shallow compared with previous pullbacks and appears to be holding above the horizontal line. While we're still early in the year, it would appear that bank credit is being manipulated to remain loose enough to keep the economy floating through the rough waters ahead until the election is over. As long as credit remains easy, the economy will "muddle through" in 2004, to quote a current phrase.
Beyond 2004, the rate of change reversal in M3 coupled with the rip-roaring bull market in real estate and the long-term uptrend in bank credit, plus the lifting of pressure from the 10-year cycle, should conspire to lift the economy in 2005.
March 19, 2004
Clif Droke is the editor of the Durban Deep/XAU Report, a daily forecast and analysis of DROOY, GLG, KGC, XAU, HUI, and GOX written especially for day traders. He is also the author of numerous books on finance and investing, including the top-selling "Moving Averages Simplified." Visit his web site for free samples of his analysis at www.clifdroke.com