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October 08, 2004

Slowing Economy, Bullish Market!
by David Chapman

After a consolidation of over six months the S&P 500 broke its downtrend line from the March 2004 highs on October 4. So is this it? The long awaited third leg up for the bulls? The move that will take the S&P 500 to its next level of nirvana at 1225 to 1275. We don't think so but we can never rule out a fool's gold rush. Key to this is that the S&P never trades back under 1120/1125. Knowing this one could continue to scalp long to the nirvana levels even if you don't believe it. And the sectors that must perform in order for this to be achieved are the financials, healthcare, information technology and of course consumer discretionary for if the consumer is not there adding to his bloated credit card debt then this doesn't stand a chance.

Of course the major Wall Street and Bay Street firms will never tell you that things are about to go to hell in a hand basket. Without the flow of funds and commissions from the public they wouldn't be in business very long. But the truth is we have been going through a drifting market now for 10 months and commissions are down sharply for the firms so any talk either fundamental or technical that supports the bullish case is good news. And that we are down only a little or up a little depending on which market you look at is also bullish. Too bad the bulls are really trapped in a still overvalued market.

Everyone is still in the market because as we pointed out in an earlier missive there has never been in the history of the markets a year ending in 5 that saw a down year. We are reproducing the table below of the history of the 10-year stock market cycle. We first saw the complete table in the August issue of the P.Q. Wall Forecast.

Down years, as you can note are more likely to happen in years ending in 7 or 0. But years ending in 5 have thus far been perfect including the best year ever in 1915 with an 81.7% gain. Statistically anomaly? Might be. Odds would tend to increase that as time goes on that a down year could happen.

We know that every Wall Street firm and Bay Street firm plus any money manager worth his salt knows this. So is it a lay up? It might be but then again ....

We were quite struck with the recent headline of The Economist - Scares ahead for the world economy, October 2-8, 2004. The Economist is not of course known for being shrinking violets when it is necessary to say what needs to be said but in reading the article there was a sense of déjà vu. What they were saying is what we have been reading for so many years at web sites such www.gold-eagle.com, www.financialsense.com, www.safehaven.com, www.prudentbear.com, and many others and of course written by the "Scoop".

Of course as the bulls would have it any of the problems even those outlined in The Economist are not insurmountable and that the market is just climbing the wall of worry that it always does. So one should just look past the sharply rising oil prices; that the consumer will hit a debt wall and stop spending; that housing prices will bust; and, that China will have a hard landing and instead just stay the course. Those were the risks to the economy outlined by The Economist. We might add global/political risks which we believe are equally important, such as the forever war on terror; the US created quagmire in Iraq; the Israeli/Palestinian conflict that continues to escalate; the threat of unilateralism by Russia to join the unilateralism of the US; and the threat of a terrorist attack on US soil. Any of these could roil the markets if an unexpected event were take place.

The optimistic economic outlook is backed by the forecasts of the IMF, the OECD, the Federal Reserve and the European Central Bank. Pretty powerful accomplices to flow with the bullish tune of Wall and Bay Street. So has The Economist lost its mind and joined the ranks of the doom and gloomers, gold bugs and perennial bears? We doubt it. Of a number of publications that we read The Economist is definitely not known for irrational forecasts and statements.

The concerns expressed in The Economist are in some respects looking more viable as we are continuing to see softness in the job markets with a very high number of announcements of job layoffs recently; a softening profit picture; the Fannie Mae problem that could still derail the market as reports continue to point to serious problems; lacklustre retail sales some related to the hurricanes but overall seeing softness everywhere once again raising concerns as to whether the consumer is tapped out; slowly rising interest rates; continued sharp increases in oil and gas prices which will hit the economy down the road; continued softening in numerous economic indicators especially sentiment indictors, and economic activity indicators.

And as we get closer to the election even "Scoop" would have to voice its desire to see Kerry in over Bush. After all can the US economy afford four more years of what the first four years of the Bush/Cheney administration has brought? The statistics are appalling. Average family income has fallen with median incomes down $1500 in real terms; over one million jobs lost, the first administration since the Great Depression to see an actual decline in jobs; the number of Americans not covered by any form of health insurance up by 5.2 million; the number of Americans in poverty up in the last year alone by 1.3 million; a budget deficit that is now 5% of GDP whereas it was a surplus of 2% of GDP in 2000; record trade deficits that are now higher then they were in 1987 when the markets crashed; and tax cuts that basically only benefited the richest. And this is to say nothing about the quagmire in Iraq; a war that was based on lies (no WMD and no ties to Al Qaeda) and that has been deemed in numerous circles as illegal.

But the markets continue to move higher but even as they move higher the divergences just seem to get bigger. While the NASDAQ, S&P 500, TSX and the Dow Jones Transportations have moved to new highs for the move the Dow Jones Industrials is below even its recent highs. The bulls will rationalize that away with the problems at Merck but on a pure technical basis these divergences should not be ignored especially the Dow Theory divergence between the DJI and the DJT. The bulls site this as a sign that the market will move higher and that the DJI will eventually catch up we can only note that we would agree if the market was at a bottom as was readily seen in the October 2002 and March 2003 lows but it is not at lows it is occurring at highs.

The other major divergence that we continue to note is the one between the markets and the Volatility indicators (VIX for the S&P 500 and the VXN for the NASDAQ). These indicators continue to point to extreme complacency in the markets with the VIX and the VXN hitting record lows even as the markets remain well below not only their highs earlier in the year but also with the all-time highs in 2000.

Another negative indicator is the rise in the short interest, as the specialists are getting shorter as the market rises. The specialists are usually ahead of the curve. On the other side money flows have continued to be positive but that might be a result of the sharp monetary growth that has been seen this year even after July numbers indicated a pull back. Monetary numbers grew sharply, however, once again in August and continued to rise in September. Even as the Fed is slowing hiking short interest rates (which still remain below inflation levels) they continue to allow rapid monetary growth.

On a positive note we can't help but note that the precious metals markets are rising and are threatening to break out to higher levels. As usual a weakening US$ is driving gold. Gold can go up even as the broader market goes down but it can outperform even if the broader market goes higher. This was seen in 2003 when the metals markets outperformed the broader market. So no matter what happens going forward the precious metals markets appear to be a place to be. The energy markets also keep going higher but we are approaching some longer-term targets near $55-$58 for oil. But for the oil and gas markets in general we see little signs of a significant top forming.

With the important employment numbers due out on Friday October 8 it could prove to be a watershed. A higher than expected number of course will send the markets higher but a lower than expected number would confirm that the economy is slowing and the rational for the bullish markets will weaken considerably.

In our last Scoop we showed a chart of the Dow Jones Industrials and the Dow Jones Transportations. We are showing this chart once again. The DJT has broken out of what may be an ascending triangle. But the DJI is not only not making new highs it is below the highs seen in early September. This is unprecedented level of divergence we have never seen before. We suppose that one could argue that there are 5 clear waves seen on the DJI with the 6^th wave seen up to the September highs. But sometimes these corrective waves go to 7 waves or even 9 waves. So until the DJI clears the September highs and then the June and February highs this is an unresolved major divergence. We note that at the highs in 1973 it was the DJI making the new high and the DJT not confirming. But that happened only once not the three times the divergence has occurred this time around.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2008 David Chapman

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