Opening Whisper - Are You Listening?

According to the National Bureau of Economic Research (NBER) the last business cycle peaked in March of 2001. The NBER Committee subsequently determined that a trough occurred in November of 2001. That recession lasted 8 months which, according to NBER is "slightly less than average for recessions since World War II". The NBER has not yet identified a peak in the subsequent business cycle which we are in at this time. I pose this question. Have we seen the peak in the current business cycle?

The NBER website gives us some broad criteria to help in identifying the peaks and troughs as follows. "In choosing the dates of business-cycle turning points, the committee follows standard procedures to assure continuity in the chronology. Because a recession influences the economy broadly and is not confined to one sector, the committee emphasizes economy-wide measures of economic activity. The committee views real GDP as the single best measure of aggregate economic activity."

"On July 31, 2002, the Bureau of Economic Analysis released revised figures for gross domestic product that showed three quarters of negative growth in 2001-quarters 1, 2 and 3-where previously the data had shown only quarter 3 as negative. This revision shows why the committee does not rely on a simple rule of thumb such as two consecutive quarters of negative growth, nor relies on GDP data alone, in making its determinations, but rather looks at a broader array of statistics." Even though the NBER does not use only GDP data, they advise that GDP appears to be the best single measure of the business cycle. A perusal of their website reveals that the most recent business cycle peaks lag the peaks in real GDP. See their business cycles page at http://www.nber.org/cycles.html/.

George Dagnino, Editor of The Peter Dag Portfolio Strategy and Management advisory has been most kind in giving me permission to reproduce his very informative Business Cycle chart below. George has lots of intuitive information on the Peter Dag & Associates, Inc. website including an article on the Business Cycle entitled "Timing your investment strategies using business cycles and stock sectors". You can find that article at: http://www.peterdag.com/s_files/FAzTJGEFBOnt.pdf

In that article George clearly describes the performance of the most salient points of each portion of the business cycle quadrants including the economy, ISM indexes, commodities, interest rates and inflation. Each section of his report goes on to identify the best investment strategies for that part of the cycle. We don't have time to go into all of the aspects of each quadrant of the business cycle in this abbreviated report.

Diagram Courtesy of the Author - Dr. George Dagnino; www.peterdag.com

I should specifically note here that the following are my own personal opinions and are not those of NBER or George Dagnino. The question we need to think about is where we are in our current business cycle. Are we still on the up-swing of the cycle - Phase 2 or have we seen the peak already and are on the decelerating part of the cycle, perhaps between points 5 and 6 of Phase 3 in the Cycle diagram above?

Take A Look At The GDP Chart Below

This week we saw the preliminary U.S. GDP for 2005 quarter 1 fall from 3.5% (2004q4) to 3.1%. Do we have a trend beginning to form? Have we seen a GDP peak for this economic cycle? From the GDP chart below, the most recent peak in the 3^rd quarter of 2003 (7.4%) appears to be telling us that perhaps, the current business cycle peaked at that time since the 3 quarter moving average has moved down consistently, with some lag, since that time period. Remember that the peak in economic activity lags the peak in GDP by several quarters. From the data on the NBER site and shown in our Table 1 below, we see that recent GDP Peak-Economy Peak time lags were 2 quarters for the 1990 cycle and 5 quarters for the 1999 cycle.

Since 1990 we can generalize by saying that the time lag between GDP peaks and the peak in the Business Cycle was anywhere from 2 to 5 quarters. We are now currently in the 7^th quarter since the 2003 3^rd quarter peak in GDP. Do we therefore have enough data to tell us that we are approaching the end of Phase 2 and the start of Phase 3 of the cycle? The stock market may be telling us that the economy peaked in the final quarter of 2004. That would be a 5 quarter time lag consistent with the time lag in the prior cycle.

	GDP Peak	Econ Peak (Per NBER)	Date	GDP-Econ Peak Time Lag	Econ Peak to Peak Time Lag
Cycle A	4.7%		1990q1
		July 1990	1990q3	2 quarters	108 months
Cycle B	7.3%		1999q4
		March 2001	2001q1	5 quarters	128 months
Cycle C	7.4%		2003q3
	Market Listener Peak?	Nov - Dec 2004 ???	2004q4 ?	5 quarters ?	39 months ? Short Cycle

Perhaps we have passed point 5 at the peak of the cycle (Nov.-Dec. 2004) and are moving toward point 6 in Phase 3. If that is true, then where could we find the "trough"? Again, referring to the NBER website, we find that since 1945, the duration of the Peak-to-Trough periods ranged from 8 to 16 months.

Now assuming that we hit an economic peak in December of 2004, we should expect the trough to occur between August of 2005 and April of 2006. If you are an adherent to the Elliott Wave theory and believe that we are in a wave 3-3-3 down, then maybe the bear could extend the peak-trough cycle period for many more months.

Just one more point. Notice in Table 1 that the "Econ Peak to Peak Time Lag" for the recent cycle (39 months) is less than half of the two prior cycles (108 and 128 months). But, of course, that short cycle is based on the supposition that we have seen a economic peak in November - December 2004. If we have not yet seen the peak in this cycle, then maybe there is a real peak coming in the next couple of years. If that were the case, we had better see some improving GDP numbers in the next few quarters.

But the GDP trend for now is definitely down.

Our Trading System - What The Numbers Are Telling Us

OK, so on Friday we gave up Thursday's profit. But let's look at some key indicators. The big news is that the 50 day moving average of the NDX has crossed below the 200 day moving average (DMA). The SPX just barely closed the month with its nose above the 200 DMA. The Dow Industrials have spent the last couple of weeks below the 200 DMA. The more time the Dow spends below that level leads us to become more bearish in our outlook for the next few months.

For the week, the NDX was relatively flat. The attempts at rallies failed. Someone is selling the rallies. This sets the stage for a possible break to the downside next week.

Our system model remains on SELL signals across the board. We have relaxed our stop exit points a little. In general, we are not getting any significant rallies. The longer we hold at the current plateaus, but more confident we become that there are some more legs down before we get a rally of significance that would move us to cash temporarily.

Sentiment seems to be somewhat bearish, but capitulation is not even on the horizon. Everyone is concerned but hopeful. That feeds into our sell signal quite nicely.

NDX - 6 month Chart Model - Friday April 29, 2005

What Is The Current Sentiment?

The VIX was relatively flat on the week. Not much help here.

VIX Volatility Index - 12 months

And below is an interesting relative strength chart. Here we compare Phelps Dodge (symbol PD) to Citigroup (symbol C). What does this comparison tell us? It tells us that the copper producer has appreciated consistently over the last two (2) years against the financial giant. But look at what may be happening now. Are we seeing the strength of copper/metals beginning to erode against the financials? This would be a signal of a weakening world demand for materials and a weakening world economy. Or is it just a Phelps Dodge earnings aberration?

2 Year Relative Strength - Phelps Dodge vs. Citigroup

No, it is not just a Phelps Dodge problem. Below is our Basic Materials / Financials relative strength chart and it is showing a similar recent trend. If the trend has truly changed, this could be bad for commodities and gold!

Ask yourself these questions. If commodities have peaked, then what is that telling us about inflation and an overheating economy? Is the world slowing down? Will the Fed stop raising rates? What does that mean for the stock market? Are we moving from inflation to something more like a stagnating economy or even deflation? Only time will tell, but I'm watching gold closely for some sign of weakness.

3 Year Relative Strength - Basic Materials vs. Financials

The CBOE Put/Call ratio (chart below) relatively unchanged this week and the 8 day moving average has fallen below the 18 DMA. This could be a significant rally signal. But we don't want to be premature in looking for a bounce. Let the market tell us what it wants to do. The 8 DMA could start rising again.

$CPC CBOE Put/Call Ratio - 6 mos.

Where Do We Go From Here and How To Listen For the Next Signal?

This next week we have the Fed FOMC meeting again to confuse us on interest rates.  What happens if they begin to hint that they might stop raising short term rates? What happens if they continue the 25 basis point regimen? Either way I suspect that the markets won't like the outcome. But, in a contrarian way, if we do not get a big sell-off after their announcement on Tuesday afternoon, I would expect a minor rally as the shorts begin to cover. We also get the monthly jobs numbers on Thursday.

Keep watching the VIX and $CPC (P/C ratio). They may have peaked already and begun to pull back. If we get a bounce from here we may have to reduce our short position. Here are our stop ranges which have been widened for the expected volatility of the FOMC announcement and jobs data week. If we get a serious sell-off next week, subscribers should be alert for emails to take some profit and go to cash. Watch for the VIX to peak above 21. Look for a $CPC daily to shoot above 1.4 again. If both of these things happen, and we get a significant multi-day sell-off, I will begin to take profits and go partially to cash.

The Market is SHOUTING now, but may not be finished shouting yet!

Are you listening?

The Market Listener Indicators

Listen To What He Says

From Luke 4:15-21 (KJV): "And he taught in their synagogues, being glorified of all. And he came to Nazareth, where he had been brought up: and, as his custom was, he went into the synagogue on the sabbath day, and stood up for to read. And there was delivered unto him the book of the prophet Esaias. And when he had opened the book, he found the place where it was written,

'The Spirit of the Lord is upon me, because he hath anointed me to preach the gospel to the poor; he hath sent me to heal the brokenhearted, to preach deliverance to the captives, and recovering of sight to the blind, to set at liberty them that are bruised, To preach the acceptable year of the Lord.'

And he closed the book, and he gave it again to the minister, and sat down. And the eyes of all them that were in the synagogue were fastened on him. And he began to say unto them, This day is this scripture fulfilled in your ears."

I am working on the art of listening and hope that you are too.