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Equities: Long Term Consolidation

September 12, 2004

Constituent companies of the Dow Jones Transportation Index are in the business of:

  • Marine Transport
  • Airlines
  • Railroads
  • Trucking
  • Air Freight
  • Industrial Services
  • Transportation services

This is important information in context of the fact that on the monthly relative strength chart (courtesy Bigcharts), the Dow Jones Industrials Index has recently given a parabolic "sell" signal, whilst the Dow Transport Index has given a technical "buy" signal as it has risen to its highest level since 2001.

It is arguable that these conflicting signals are canceling each other out and are jointly pointing to an era of long term consolidation and overall sideways movement.

Why have the Transports given a "buy" signal? Intuitively, given the fact that the oil price has been rising, one would have expected transport companies to be suffering.

The answer may lie in an anticipated increase in Gross Profits in absolute dollars as transport companies raise their prices to maintain Gross Profit percentages. Implicit in this assumption is that the market is not expecting transport volumes to fall significantly.

And if volumes are not anticipated to fall, an implication is that retail trade volumes are also be expected to hold up even as retail margins get squeezed. In such an environment we could expect sideways movement in overall profitability as natural growth in volume is offset by contraction in margins flowing from increased landed costs.

The following Amex Retail Holding Index shows sideways movement for the past year or so, and is indicating a market that is not particularly concerned about oil's impact on retail sales.

Even Walmart's chart seems to be anticipating benign results - which will neither rise significantly nor fall significantly. It has been traveling sideways for nearly four years now.

Yes, it is Human Nature to want "certainty". Markets should be going "up" if they are not going "down" and vice versa. Treading water - or "rotation without translation" (in mechanical terms) - is not a particularly exciting concept.

But, is it conceivably possible that the markets will do nothing?

The following is an analysis of the movement of the ratio of Public Debt:GDP going back to 1929

The last entry might just as easily have read: "Debt as percentage of GDP treads water until GDP growth kicks in"

Is there anything on the horizon that will cause GDP growth to kick in?

Well, markets in the "hottest" growth area on the Planet, viz Asia, are relatively bearish, as evidenced by the following: (Charts courtesy Yahoo):

1.The Japanese Market has been in a downtrend since 1990 and is currently battling to stay above its falling 200 day MA

2. The Shanghai Index has recently given a long term sell signal. It is below its 200 day MA and is now trading at its lowest level since 2000.

3. The Bombay Index has retreated from what appears to have been a double top formation and is struggling to stay above its 200 day Moving Average.

4. The Korean Market has been travelling sideways for four years and is battling to get above its 200 day MA.

Why do I pick on these four geographic locations? Because, between them, they account for approximately 21.9% of the World's GDP relative to the USA's 26%, and around 23.9% of Germany, France, UK, Italy, Spain and Netherlands combined. Source: www.eia.doe.gov/pub/international/iealf/tableb2.xls

OK, so if the USA equity markets travel sideways and the Asian equity markets travel sideways and US Public Debt as a percentage of GDP travels sideways, can one make money out of the bond markets?

Well, from the chart below, it would appear that long dated bond yields in the USA have bottomed (Chart courtesy Bigpond) :

The diamond reversal pattern has been drawn in by hand and is shown in blue. Of interest is that notwithstanding the reversal pattern having been completed, yields are still weak, and are resting on the most recent uptrend line that represents the outer boundary of the Diamond reversal. Could it be that the signal was in fact a "continuation" pattern? Will yields continue to fall from here?

The short answer is "no", yields will probably not continue to fall from here. There is a "non confirmation" as reflected in the PMO. Note how it has shown RISING bottoms even as the yield chart itself has shown FALLING bottoms. Technically, this implies that there is a very low probability that yields will continue fall from this point forward. i.e. The diamond is probably a genuine reversal pattern - indicating that the down trend in yields has reached a culmination point.

Another indication that yields have bottomed flows from the short dated yield chart below, which is giving buy signals, but where the PMO is reaching overbought territory. Again, this is indication of a consolidation.

Conclusions

  • In both the USA and Asia (representing economies which in combination account for around half the world's GDP), equity markets are treading water and have neutral direction with a mildly negative bias.
  • Yields in the USA have probably bottomed, and may move sideways from this point forward.

So, what do we do? We can't just sit on the sidelines and grow old while we wait for the markets to make up their minds.

Where are the risks and opportunities?

Risks

The politicians screw up. Bush, under the influence of the Neocons, moves to super-impose "Western" values on an essentially anachronistic culture in the Middle East, and all hell breaks loose as the religious fanatics in this region retaliate. To be objectively fair, Bush is not "causing" the problems in the Middle East, he is trying to proactively address the imbalances that exist. One may question the wisdom of this, but he is not acting in a vacuum. The region was a seething cauldron of discontent to start with, and the issue ultimately boils down to "oil". If the West was not so dependent on Middle Eastern oil, it might have been wiser to just let the region just stew in its own juices.

Unfortunately, to fund the increasing hostilities, the USA's domestic budget will need to go deeper into deficit. Public Debt as a percentage of GDP will rise under such circumstances, thereby causing interest rates to rise as the USA is forced to pay a higher price for the capital that it will need to raise to fund the hostilities. But if interest rates rise, significant amounts of capital will be lost in the bond markets, and we might find ourselves facing a capital "crunch" which could impact very negatively on the property markets and, in turn, on US private consumption and, in turn, on world equity markets.

Personally, I rate the risk of conflagration as relatively high, and it is for this reason I hold gold investments as an insurance policy.

Opportunities

Life will carry on regardless of whether there is "peace" or "war". People will still need to get out of bed in the morning to continue in their daily lives.

In times of trouble, there is typically an escalation of activity in three areas:

  1. Escapism, flowing from "problem avoidance" behaviour
  2. Proactive "problem solving" behaviour.
  3. Social bonding (people lean on each other more)

There are also those who become catatonic through "loss of hope", and the primary objective of Society's leaders will be to minimise the size of this segment of Society.

Overall Conclusion

Whether the World Economy treads water for the foreseeable future or whether it enters "free fall" will be a function of the "problem solvers" contributions. There is a way out of this mess and that way is paved with technologies that are less dependent on oil, with the ultimate objective of Society becoming totally oil independent.

Such an outcome is eminently possible. The technologies exist, but they need to be perfected and commercialised, and there are two ways to achieve this:

  • Proactively cause a war which - as it did in WWII - will rally the troops and will cause a focus of attention on getting the job done regardless of cost.
  • Positive Social Leadership.

Unfortunately, there seems to be a shortage of Leadership. That, ultimately, is the reason I have a relatively high investment in Precious Metals.

Paradoxically, I hope I am proved wrong. I hope that the markets will continue to move sideways as the threat of conflagration recedes. Within sideways moving markets there are always niche opportunities for growth.


In 1934 President Franklin Delano Roosevelt devalued the dollar by raising the price of gold to $35 per ounce.
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