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We Miss Manufacturing

"Should we miss the Manufacturer?"

In this weeks wrap-up -

In this weekends wrap-up we will cover
  1. Fundamentals - The fight over, and issues of outsourcing.
  2. The Current Technical Outlook -
     2.a. Short term Perspective - Channels, Indicators,Counts
     2.b. Long term Perspective - Elliott Counts, and sometargets
     2.c. Gold and Silver
     2.d. Leaders and Shakers
  3. Sentiment Indicators
     3.a. Volatility Studies - VIX
     3.b. Put / Call Ratio
     3.c. Summation Ratios and other Oscillators
     3.d. Commitment of Traders
  4. Conclusion


Although the week ended relatively flat, the last few hours of trading on Friday were a bit of a surprise to all those paying attention, due to the size and speed of the decline. According to CNBC, folks were worried about the continuing attacks in Iraq. That is odd, since they have been occurring frequently for quite some time now. So did traders all glance at the WSJ at the same time Friday afternoon?

With liberal use of the same logic, the Asian markets just gotten hammered (as of the writing of this report) due to fears that terrorist activity will adversely effect the dollar - down 3.6%. Why didn't I think of that. Does the fact that we've grown our money supply 20% in a short period of time have anything to do with it? What about our ballooning deficit?   These issues get little attention as the terrorist scapegoat is brought back in to explain to the needy public exactly why the market makes every little move it does.

The PPI numbers came out this week and showed a surprising 0.8% increase in producer prices - so if a soaring commodities market hadn't clued people in on rising inflation, this report finally did. After such a surprise, the CPI figure will be highly anticipated. However, due to the creative statistics employed in manufacturing the CPI, I doubt it will show anything out of the ordinary.

I was watching clips from the democratic debates last week when I noticed a classic recessionary theme - "With all our hard working manufacturing jobs going to China and India, we need to protect the American people by imposing tariffs, and designing new laws that will prohibit this sort of activity." Oh yes, it's the booming voice of protectionism back on the topic of corporate outsourcing - time to bash companies for shifting around jobs we somehow deserve. Although I am sure (and hoping) that I will get a lot of flack for discussing this, this weeks topic is going to be outsourcing, and why I think everyone should just let it be.


Note: Research on this topic was done at a forum with extensive input from Dr.Stanley Black, and Professor John Stewart of the UNC-Chapel Hill Economics department;Mr. Vivek Wadha, and Valayan Sekraria.

Lets just begin by making sure we are all on the same page with what outsourcing really is. Say I own a car company called Rob's Automotives. The manufacturing plant I own not only builds the cars, but all it's parts as well - an "in house" operation. However, one day, a tire manufacturer comes to me and offers to sell me tires that are not only better than the tires I produce, but cheaper than what it costs me to make mine. This deal will not only reduce my costs, boosting profits, but will allow me room to reduce the price of the car (more competitive), reduce the complexity of my operations, and allow me to concentrate resources in other areas. This is how companies like Firestone got started. Therefore, what we have here is an example of 'vertical disintegration,' and this is generally thought of as being a good thing for companies, and is a form of outsourcing its operations. So in this example, who wins? Well, I would be forced to fire some of the tire-makers if I couldn't put them to work somewhere else in the plant, but people would be hired at the tire-specialization plant, and in whatever special project I start next with the extra money. Moreover, cars would be cheaper, and would come with better tires at a lower cost, allowing consumers to spend that extra money on something else. Therefore, what we have is what we call 'distribution.' Although there were some people at the bottom that got fired, and are the 'losers' in the situation, the economic benefits reaped by the 'winners' is usually much greater. Through these sorts of deals, the market becomes more and more efficient, and can deliver better and better goods over time. Something we like to call progress.

Now we consider the case where the outsourcing is done overseas. Although China is the usual example, lets turn the tables and use Britain's textile industry as an example. In the mid to late 1800's, Britain was the powerhouse in textiles with a huge amount of people employed by them. However, managers soon realized that all these operations could be exported over to America were labor and land was more abundant, and therefore cheaper (we used to be the China of the world in that sense.) The labor unions in Britain were in a frenzy as factory after factory was closed down due to operations in the United States. Americans, on the other-hand, were happy as can be due to more jobs being available, and more foreign investment being sent to the United States. Although the British laborers lost their jobs, textiles became cheaper all over the world, and countless people benefited from the money saved. Lets fast forward to the present day were we have countless textile workers all up in a fuss because plants are being closed down daily in order to ship them over to the Asian countries. History has a way of repeating itself over and over again. Companies are always going to look for the cheapest source of everything so that they can maximize the profit, and minimize the costs of their goods. This is called competition, and is the foundation of capitalism - and America as well. Granted, there is always a winner and a loser in every situation, but on aggregate, everyone is better off because of it. Moreover, now that America had more money on hand because of increased employment and investment, we bought more goods from other countries such as Britain - the circle always completes itself.

Before we get to some questions and answers, I'm going to give two more examples of where attempts to impede this process has been to the determent of many. A while back, sugar was a major issue as Latin American producers, with their cheap labor and bountiful resources, threatened to collapse the U.S. Sugar Industry. With tariffs and laws, we managed to allow a couple thousand people to continue slaving away in sugar fields - getting the same low wages they got before, and demanding the same higher price. Now the estimated cost of keeping these workers came in at about 125,000 dollars a year, per worker, in lost profits and consumer costs. I would bet that each one of those workers would loved to just take that money and run, but that is not how it works. Similarly, the steel mill unions have fought long and hard to keep foreign producers at bay (an ongoing issue) and the government continues to protect these Philadelphia steel workers with tariffs even though the more expensive (less efficient) steel costs the U.S. economy an enormous sum every year.

In order to speed things along, I will now just answer specific questions concerning the matter. If you have any questions that are not covered, just send me an e-mail.

1. Why has outsourcing become such a big issue all of a sudden?

Because we are in a recession. Every time an economy slumps, society actively looks for someone or something to blame for it - a scapegoat. Corporate outsourcing abroad has been this very scapegoat more often then not. However, the idea that outsourcing is suddenly the source of all our woes is ridiculous. During the 90's boom years, our pride and joy, we outsourced just as many jobs as we are doing right now. IT technicians, mathematicians, and thousands of bright students were hired from foreign schools by American companies - and companies were taking advantage of cheap foreign manufacturing as well. At the time, even Fortune magazine threw it's hands up at the genius of it all - how these bright young U.S. companies were expanding abroad and minimizing costs where ever possible. They saw it to be the economy enhancing act it is. However, as Bill Bonner so eloquently puts it, no body complains or asks questions during a bull market. Now that we are in a bear market, people don't want to hear "it's just the economy," they want to be able to blame something - and leave it to the politicians to pluck at the "Evil slave-labor China" heart strings of the American voter.

However, if you still want to complain, one can say that we really brought this upon ourselves. The wonder of the internet, the instant communication and collaboration that we trumpeted upon our shoulders as the latest wonder of the world is precisely the vehicle that is making a lot of these upper level jobs transferable overseas. Fate is not without a sense of irony. And this is also why I think this outsourcing issue has gained a lot of attention lately - the fact that it isn't just manufacturing jobs anymore (for most that got old in the 80's) but that we are now hiring IT people from India and China - jobs we considered to be well paying and high tech. Although this happened throughout the internet bubble, and really makes up for only a tiny fraction of the IT jobs lost (blame Enron more than China), I think that is what freaks people out.

2. Aren't we exporting away the very foundation of the American economy? How will we ever prosper and replace those jobs?

Let me count the ways this is also something we shouldn't worry about. Go back about 200 years and you would find that the majority of Americans were busy at work on farms raising crops and cattle. Fast forward to today's society and you will find that less than 1% of our population is needed to feed a large part of the world. Now no one looks at this as having been detrimental to society or the economy. In fact, many would call it progress. However, you can bet that when the tractor came out, and large corporations were putting small farms out of business, that people hollered "look at all these people losing their jobs and their lively hoods, what in the world are they going to do now." Why... those very people went ahead and founded GM, AOL, and Microsoft. Similarly, back when the "Machine vs. Assembly line" debate was all the rage, everyone thought it would be impossible to replace all the jobs lost. However, despite these seemingly "impossible obstacles" technology has always come along and employed more and more people. Granted, there are always losers in every situation, such as the small farmers who now had to learn new skills in order to gain employment, but new and supposedly better jobs were created higher up the ladder which is usually considered a boon to the economy. Despite the fact that innovation often puts some people out of work, it always hires more people somewhere else, and puts more money into the economy than it took out. Imagine all the telegram carriers that got put out of work because of the telephone - but we don't see too many people complaining about that do we?

As for "exporting the foundation of America," that is just a way of making the issue sound more dramatic than it really is. If you think that manufacturing is the "foundation of America" than you need to look again - cause we are a service economy plain and simple. Every industry in every country has a boom cycle, and a bust cycle - and manufacturing is definitely in a bust cycle. Just because a large part of the manufacturing process is going overseas doesn't mean that we don't reap enormous benefit from it that will employ and benefit the whole of the U.S. economy. If 80% of the country was employed in manufacturing do you think we would have had the internet boom that we did? We have thrived by innovation for the past 300 years, and will continue to thrive on innovation for the next.

3. How does foreign labor benefit me as an American?

In a number of ways really. First of all, when a company invests and employ's workers overseas, it benefits that country by employing more of it's citizens and increasing it's presence in the world market place. A lot of these Asian countries are exploding with economic growth due, in large part, to U.S. investment. Along with that explosion, comes a cultural explosion that, more often than not, includes coke, Mc. Donald's, and Nike shoes. Therefore, investing in other countries not only benefits the company by lowering its costs, but it also creates a slew of consumers in growing sectors of the world that will buy plenty of goods and services from the U.S. Moreover, as a consumer, you benefit from cheaper goods - so that when you save 5$ on a pair of pants, that's 5$ that will go into some other sector of our economy. Therefore, both countries prosper from the deal. Granted there are always losers, the people who used to make pants in the U.S. , but such is always the case with distribution and they will have to be educated in order to find work - as a whole we still benefit enormously just like everyone benefits when Rob's Automotive stops making its own tires. Outsourcing has been an enormous benefit in the past, and continues to be a benefit today.

4. Outsourcing is bad for other countries, and we are just taking advantage of people in need, and polluting their environment.

This is another favorite of the anti-outsourcing movement, yet is just as short sited as the other objections. First of all, Nike's game plan is not..

1. Build Factory

2. Capture Natives

3. Put them to work as slave labor

The people working in these factories are real, free people that WANT to work there. The countries that we are sending employment to really have nothing, so although you may think that working at a Nike factory for 12 hours a day would suck, it's a whole lot better then the alternative for them - for them, it's progress. Moreover, despite the fact that 1000$ a year sounds like the cost of a stereo system to you, it's a bounty to them, and a whole lot better then what they were getting paid elsewhere. Nike does not have to beg people to come work... people want to work. The fact that they can work for cheap is their ONLY economic advantage, and to cry about how evil it is to create factories in their poverty stricken countries, is in a way taking away the only economic advantage they have in the world. If you want to be sentimental about it, the factory worker that lost his job in the U.S. and is now forced to take a job at Hardee's, can at the very least go to a community college and educate him/herself or live off welfare. For these folks, they either work in these factories, or have to live in cardboard boxes -- they really don't have such luxurious options. The only gray area in this situation is in the cases of child labor. Granted it's hard to watch young children put to work in any situation, but sometimes its necessary for the family to survive, and to take that away from them is debilitating. I mean, the reason why a lot of these families have so many children is not only because they need someone to support them when they are older (no social security here) but they need them to help support the whole family. When my dad was a child, he was sent to work on a farm in Iceland owned by a rugged old man. When that man was 8 years old, both his parents died and he was left to run the farm along with his younger siblings - and he did because he had to. If you feel strongly about not making children work in these conditions, then adopt, or send money, but don't criticize the family for doing what is often necessary in order to prosper - or the Nike factory for providing the means. Trust me, the majority of these parents would much rather have their kids go to school than to have them work if it were possible. Moreover, when Nike first came to those countries and set up shop, people back at home were appalled at the conditions those people worked in, and protested loudly against it using their wallets. Therefore Nike quickly improved the working conditions in order to regain consumer confidence which was an example followed by a number of companies that have set up shop there. It is in the companies economic interest not to seem cruel in any way so they often give more care to their employees than they really have to - to the employee's benefit.

As for the environment - although we all like pretty trees and rolling hills, the environment is still a luxury not everyone can afford - it still comes after food, shelter, and clothing on the list of important things in life. All growing cities go through a "slum" period where exhaust is flying everywhere, and once everyone is "rich enough" to care about not breathing in toxic fumes, people will demand better conditions and things will improve - just like it did in the U.S. throughout the industrial revolution.

5. If your so smart, what would you do about all of this. Are you just going to leave Americans unemployed?

We have high unemployment not because of outsourcing, but because of much larger macro-economic issues that are plaguing the U.S. economy at the moment. The amount of jobs we are sending abroad is something our economy should be able to handle with ease, yet isn't doing so because of reasons I have discussed in previous articles. Therefore I disagree with any tariff or restrictions placed on companies that plan on taking their operations abroad since history proves that it will cost us more than it helps us. However, if I was in office (now there's an idea) I would put measures in place that would help educate people who are loosing their jobs overseas. For instance, I would put programs in place that would help those who are losing manufacturing jobs retool for 'newer' jobs. This would allow the inevitable process of capitalistic outsourcing to continue while easing the pain of those left on the "losing" side of the distribution. I would also just like to add that some serious thought and money needs to be put towards how we are educating our children (and myself) since according to my experience abroad, Americans really aren't the genius they think they are with a great many countries beating American kids in math and science on a regular basis. We have just been lucky that over the years, we have stolen all of the best talent from other countries and brought it to the states which has been seen as the only place to join the technology revolution - something the internet is going a long way to change.

Here's some advice that Prof. John Stewart gave to those students listening... "Want to get a job? Then learn something that will make you indispensable, with emphasis on math and science."

Start studying America! The world is catching up with you...

Now on with the charts!

2. The Current Technical Outlook -

2.a. Short term Perspective

It was a flat, yet interesting weak on the technical side of things. The bears are defiantly getting giddy as all four indicators shown here have weakened since last week - the drop on Friday adding to that amusement. Well we are right back down on the trend line with the RSI sitting on top of the decisive 50 mark, the MACD falling inside a wedge, the OBV sliding despite stable pricing, and the -DI bouncing sooner than usual. Does this mean we are about to crash? I doubt it, although it could be a sign that the much anticipated correction is near at last. Glancing at the Asian markets that are down about 4% at the moment, it sure does cast an ominous glare on the U.S. markets for the Monday open.

I should warn the bears, however, that this rally will probably not die easily without more external influence (terrorist attack, scandal, etc.), and that there is an extraordinary amount of momentum behind this market - plenty of people are going to try and buy the dips. A warning goes out to the bulls as well, however, that with all the things going out of whack lately (i.e. the dollar market trends, gold rising, bonds weakening, valuations high) things aren't exactly rosy at the moment. What is required here is caution from both sides, and a lot of it. Keep your stops close and the opposing viewpoint closer.

Last Weeks Forecast : Things are looking pretty top-e already, but the marketcould pull out a hat trick here and jump. However, if we decline past 1950, Ithink 1900-1920 would quickly be next. If the decline looks fast paced, it couldvery well be a start of something new - which a decline past 1850 would suggest.

We declined to about 1920 last week which hit the upper range of my target although we bounced quickly after that. That bounce did not last long since we dropped right back down in a single day on Friday. Do we have a head and shoulders formation here? One of two things is going to happen here, either we are going to decline past 1925, and quickly make our way towards 1850 and below, or we are going to bounce VERY soon and continue northward towards new highs. This week, I am leaning heavily on the bearish option because of the "sell on good news" effect we've had lately, and because of the strong selling Friday. Divergence is also beginning to pull down on the market on all time frames. Exciting times indeed.

Next Week : Although the market could fool the bears once again, this week I am going to lean decisively towards the more bearish outlook IF we dive past 1925 head first. Any hesitation early on in the week will give me reason to rethink the bearish posture. However, if we do pass 1925 in such a manner, I wouldn't look for an end to the move until we reach the 1850-1875 level.

Charts of Interest

Well, bonds sure did fake me out, so using the genius of hind-sight I figure that this was more of an ending diagonal B wave then a new wave down. So what would make me optimistic on bonds for the near term - if we roll past 42 in a decisive manner.

2.b. Long term Perspective

It looks like the December 02 top could be the turn around point for this rally if things don't spice up soon. With the 50 day moving average catching up, I would not be surprised to see the market dip back down to it's 200-day and take a breather (if not something more serious.) Like I've said before, the pitchfork has been flawless so far creating a range for this advance, and is going to be a damper on this rally for the time being.

I have always stressed that the markets ride a wave of sentiment, but as I discussed in my previous article, sentiment has been a bit hard to place at the moment. I noticed a nice quote not long ago that summarizes the situation quite nicely :

"On one hand, you can say it's a sign that investors are blinded by their bullishness, and that there will come a time of reckoning when they finally realize that there are actually still problems in the world and things that can go wrong. Or you can say investors have actually taken all of the bad news into account and still find stocks attractive -- a sign that the market can go higher. Take your pick. Good luck." -- Justin Lahart CNN/Money

Good luck indeed.

2.c. Gold and Silver

All the gold bulls, me included, now stand ready with our champagne bottles and pointy hats as Gold is makes a valiant assault on the fabled 400 level. As I speak it has been floating around the 399 level over in Asia - exciting times indeed. We are, however right at the very bring of the uptrend channel for gold. Could gold go parabolic?

If gold is truly in a bull market, it could very well be time for gold to go for a little parabolic rise along with it's HUI index although I am still going to yield to caution until the market truly breaks out above, and stays above, it's recent channel. Similarly, the HUI index partied like it wasn't overbought and posted a brand new high.

The question only remains .. is it off to the races, or is this bull market going to get just enough people excited in order to disappoint even more people on the next correction. Time will tell, although I must say that people are not nearly as bullish on the metal as they were on the January spike - which is bullish indeed.

Glancing at the latest headlines off yahoo I am noticing statements such as "dollar cratered," which makes me excited to know just much the dollar has been leveled in overnight trading. This is, of course, very bullish for gold despite the sad repercussions for U.S. investors. However, one cannot say that people haven't been warned since this index has been falling for a long time. Earlier today I planned on writing, If we surpass our previous lows, we will in all likely hood dive down for one more low before correcting. Since it looks like the dollar is going to surpass those lows, that suggestion stands. If I were to guess by the channel, I think that we'll see 80-85 before seeing any serious rebound attempts.

3. Sentiment Indicators

3.a. Volatility Studies

The VIX and the VXN are still hanging out at their lows after only a marginal increase on Friday's action. This is encouraging for the bears to say the least with divergence calling for an explosion sooner rather than later.

3.b. Put / Call Ratio

Wow, this index fell even lower on Friday despite the sharp decline - more good news for the bears. We have seen this act before, however, and only seen a marginal decline - so don't get too excited just yet.

3.c. Summation Ratios and other Oscillators

This index has been bouncing off the 360 mark since September and it looks like it will be broken this time around due to topside pressure from the trend lines. Although this indicator has given an unusually large amount of useless signals lately, I think we could be in for a trend change if we roll down past 300 and below. Generally, it has always been a good idea to stay on the right side of these summation index's.

3.d. Commitment of Traders

Everyone went short but the small investor this week as the Commercials have seemingly changed their minds about easing up on the shorts and just picked up some more. The commercials and large investors have defiantly lost a lot of money lately betting on the short side. Is it time for them to make it all back?

Charts available from www.vtoreport.com.**

4. Conclusion

I usually don't keep tabs on the overnight markets but tonight's 4%-drop action is an exception. Things are definitely heat up here according to the charts so be prepared for a lot of movement in the coming weeks. This does not mean I am either looking for, or expecting a crash - just a correction.

Outsourcing has become a sensitive issue in the media lately with a lot of people wanting to ride the publicity wagon by calling for tariffs and regulation. However, one can't allow oneself to be carried away by the sensationalism of it all. It's easy to blame someone because it gives us something to focus our confused anger on which makes us feel good and useful inside. However when such blame is unduly placed it can have a negative effect that will not only effect thousands of people economically, but socially as well - with growing stigmas against other countries and their supposed plans to destroy the U.S. economy. This debate has raged on for decades and has always ended up with the nation being more employed with a higher standard of living than ever before. Capitalism may put people out of work but it also drives innovation which is what generates the jobs of tomorrow.

Some people ask me, "So what new innovation is going to bring about this bout of hiring?" and I just smile and say "I don't know, but if I did I'd make millions."

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