Note: The National Geographic has just done a great feature on China. The following video featuring the rise of the Chinese middle class (courtesy of our poster rffrydr at our MarketThoughts discussion forum) is a must-see.
Let us begin our commentary with a review of our 7 most recent signals in our DJIA Timing System:
1st signal entered: 50% long position on September 7, 2006 at 11,385;
2nd signal entered: Additional 50% long position on September 25, 2006 at 11,505;
3rd signal entered: 100% long position SOLD on May 8, 2007 at 13,299, giving us gains of 1,914 and 1,794 points, respectively.
4th signal entered: 50% short position on October 4, 2007 at 13,956;
5th signal entered: 50% short position COVERED on January 9, 2008 at 12,630, giving us a gain of 1,326 points.
6th signal entered: 50% long position on January 9, 2008 at 12,630, giving us a gain of 219.36 points as of last week at the close.
7th signal entered: Additional 50% long position on January 22, 2008 at 11,715, giving us a gain of 1,134.36 points as of last week at the close.
As of the close last Friday, both our latest buy signals in our DJIA Timing System are in the green. Readers who are interested in the historical performance (as of March 31, 2008) of our DJIA Timing System can refer to our comments from a couple of weeks ago (The End of "Market Fundamentalism"). Excluding dividends, our DJIA Timing System returned 13.76% over the last 12 months, beating the Dow Industrials return of -0.74%, and with lower volatility. Again, our next update would be for the period ending June 30, 2008 - with a move to a semi-annual update schedule thereafter.
Before we go on and outline our thoughts for where the markets are heading in the next six months, I want to do some "house cleaning.". Specifically, in response to subscribers' assertion that demographics may not do much to alleviate the housing crisis (i.e. will the creation of an extra 150,000 households a year really make a difference, given that home sales are currently running at around 6 million a year?), subscribers should remember that one should always focus on available stock (inventory), as opposed to volume (or turnover in houses) as a sign of potentially bottoming housing prices. While volume had been a leading indicator of declining housing prices over the last six months, it is always existing and new housing inventory, general income levels, and demand that will have a bigger impact on housing prices going forward. According to the IMF, new homes inventory is currently running at slightly less than 500,000 homes, as shown in the below chart:
If we include existing homes, total inventory for single-family homes in the U.S. is currently around 2.25 million, up from 2.2 million a year go and from 1.55 million a couple of years ago (source: Census.gov). Giving that existing housing starts (see our mid-week commentary last week) are currently running around 500,000 to 600,000 (on an annualized basis) below the historical average, a 150,000 increase in annual demand for single-family homes suddenly does not seem so trivial. More importantly - should the U.S. government's plan to grant tax credits to first-time homebuyers come to fruition, this could potentially push younger homebuyers (more of the Y-gens) into buying homes sooner rather than later. As far as I know, no one has tried to model the effects of a $5,000 to $10,000 tax credit for first-time homebuyers (one reason is that there is no historical precedent for this) - but this could have a substantial impact on reducing existing housing inventories and cushioning housing prices over the next 12 months, especially given the dramatic increases in the housing affordability index over the last six months, as shown in the following chart from the IMF:
Again, I am not calling for the end of the housing correction just yet. The purpose of my arguments in this commentary, as well as in our mid-week commentary last week, is merely to suggest that there are significant and countervailing forces to the current decline in U.S. housing prices - most of which should be taken seriously by the housing bears. In the meantime, subscribers should keep an eye on the inevitable Option ARMS resets starting in mid 2009, but given that this is still 14 months away (and is a well-publicized fact), it is still too early to factor this into your general investment decisions, unless one is thinking of investing in companies that are holding these securities, such as Wachovia or Washington Mutual. Another data point that needs tracking is global economic growth. If global economic growth starts to falter - then some of our higher-priced markets that have gotten support from foreign buying, such as parts of Los Angeles and Manhattan, may start to weaken as well.
Let us now discuss our roadmap for the next six months. First of all, here is my current perspective on the stubborn rise in LIBOR. The latest rise in LIBOR last Friday occurred before the latest Bank of England's US$100 billion plans to reliquify the British banking system became news. Aside from allowing banks to borrow from the Bank of England by swapping high-quality mortgages assets as collateral, this plan will also allow banks to post unsecured credit card debt as collateral. The latter was unexpected, and should definitely alleviate the upward pressure on LIBOR. Moreover, the Bank of England and the UK government - in return - is also asking banks to prop up their balance sheets. Again, there is no lack of capital on the sidelines and certainly not in the government coffers or in institutions such as the IMF or sovereign wealth funds. My sense is that the Bank of England announcement will come with a promise to do more should strains in the UK financial system fail to abate. More importantly, investors have continued to show interest in taking significant stakes in banks (albeit at significant discounts as the latest $6 to $8 billion National City injection demonstrates), suggesting that LIBOR will definitely come down at some point. In the unlikely scenario that the Pound Sterling come under attack, the Bank of England can always be backstopped by the IMF - which has a $300 billion balance sheet (if you mark to market their 100 million ounces of gold from $9 billion to $90 billion) and which is desperate to increase their loan portfolio and make themselves relevant again. While this is not a good development for common stock shareholders in many of these institutions, this is definitely a good development for the global financial system as a whole and no doubt for the global economy as well. Finally, according to Bank of America, the leveraged loan backlog sitting on banks' balance sheets has declined dramatically from approximately $240 billion last summer to just over $100 billion as of last week. Assuming that Deutsche Bank goes through with its latest scheme to get rid of about $15 to $20 billion of LBO debt from its balance sheets, the total global leveraged loan backlog could easily decline to under $90 billion by the end of this month. Sensing this, the leveraged loan market rallied substantially last week, and is no longer a significant drag on the financial and equity markets.
Second of all, I expect the rally in the S&P 500 to continue for the next several months, as the record amount of capital on the sidelines come back to the financial markets and as the effects of the "fiscal stimulus" kicks in. With regards to the latter - despite the many surveys concluding that the majority of Americans will either invest/save their rebate checks or use them to pay down debts - subscribers should remember the adage that we should watch what we do, not what we say. There is no question that many of us mean well, but the 2001 experience shows otherwise. All of us would like to save, but we just do not have the discipline. Similar to the 2001 "tax rebate" experience, my sense is that much of the fiscal stimulus would have already been spent on discretionary goods/services six months after the checks are mailed out, especially since we are already in a lower interest rate environment relative to when the tax rebates were mailed out during 2001. Based on a recent study by the IMF (see page 73 of the IMF's latest World Economic Outlook) - a fiscal stimulus of this size, combined with monetary easing - is definitely significant in terms of its ability to assist GDP growth 3 to 12 months down the road.
More follows for subscribers...