A Review of MarketThoughts

By: Henry To | Mon, Nov 28, 2005
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Below is an extract from a "subscriber's only" commentary originally posted at marketthoughts.com on 27th November 2005.

Dear Subscribers,

We switched from a 25% short position in our DJIA Timing System on the morning of October 21st at DJIA 10,265 - giving us a gain of 351 points from our DJIA short on July 14th. On a 25% basis, this equates to a gain of 87.75 points. For now, we are still completely neutral and in cash. The market remains very overbought in the short-run - with the Dow Industrials, the S&P 600, and the Russell 2000 just within a hair's breadth of besting their recent highs (the latter two their all-time highs). My guess is that any "breakout" of these indices will be accompanied by the popular media declaring a "new bull market" and will subsequently result in more retail investors being pulled into the stock market. Contrary to popular belief, I believe that any investors that will be buying will be sorely disappointed - as I have outlined over the last few weeks - given that many of our longer-term indicators are now rolling over, such as our MarketThoughts "Excess M" indicator, as well as the fact that both the U.S. Federal Reserve and now the European Central Bank will remain in a tightening basis at least until January of next year.

I would like to begin this commentary by reiterating our beliefs and the purpose of us writing this commentary - along with what we are seeking to achieve by starting the MarketThoughts discussion forum. It has been a little bit over a year since we started "seriously" focusing on this website, and both my partner/webmaster, Rex, and I are very happy with what we have accomplished so far. We have met many friendly folks (such as many of our subscribers) along the way - people that have helped us quite a bit and whom we have learned a lot from. Not surprisingly, many of these people are actually our current subscribers - folks who are always willing to learn and to share your ideas with us. For this, we thank you.

The mission of this site is two-fold - to help our readers navigate these treacherous and ever-changing markets - as well as to educate our readers and help ourselves learn in the process as well. Advice usually isn't worth anything unless one understands where we are coming from. Hopefully, we have been able to do this for our subscribers over the last 12 months or so. I understand that there are many readers who are more focused on the long-term - readers that are worried about their retirements, kids, and their careers and jobs. Over the last 12 months, we have discussed issues that should be close to these readers' hearts, such as our three-piece article on China, our discussions of globalization, rising energy prices, aging demographics, as well as new trends and ideas that could affect our economy and the structure of our economy. For readers who are more venturesome and who crave the markets and original trading ideas, we have also discussed ideas that are not mainstream, such as calling for a new dollar bull market in our May 1st commentary, the upcoming bull market in natural gas in our July 30th commentary, as well as our latest call on copper in last weekend's commentary. Speaking of trading, we also discussed what to do and what not to do in trading, as well as the importance of knowing your own psychology and finding the trading strategy that suits your own psychology. At some point in the next month or so, we will reorganize our archives just to make it easier on you to search for past commentaries based on the topic you're looking for.

So Henry, what is your current longer-term view of the world economy and the U.S. stock market? I believe as we enter the 21st century, true globalization will come of age. That is, as exemplified by the "opening up" of the Chinese and the Indian economies, trading barriers will come down - including the virtual elimination of tariffs, quotas, and government subsidies of certain industries. In such a world, we should pay attention to the teachings of the late 18th/early 19th century British economist David Ricardo (not only because he came up with great theories but because he also successfully used his beliefs to accumulate a fortune in the financial markets) - especially his teachings of the theory of "comparative advantage." Such a theory dictates that the United States will at some point become a virtual full-service economy - with finance, technology services (such as intellectual property), and the media/entertainment industry (I will call them the "three predominant industries") being at the top of that list. General manufacturing such as the auto, steel, and textile industry will all relocate overseas (the only manufacturing that will remain locally is specialized manufacturing or manufacturing that is essential to national security). Unfortunately for manufacturers and for manufacturing workers, this is the logical path to take if the U.S. is to remain as the number one economic power going forward. Whoever controls the "three predominant industries" will control the world (as a "tribute" to Mayer Amschel Rothschild who once stated: "Give me control of a nation's money and I care not who makes her laws.") so to speak, and right now, the U.S. still reigns supreme.

For hundreds of years, both the modern Chinese and Indian civilizations were proud peoples - not only because they had accumulated vast amounts of wealth but also because they were very technologically advanced on a relative scale. That is until the onset of the Industrial Revolution, of course. There is now no doubt that both the Chinese and the Indians will do their utmost to catch up with the "west" in terms of both standard of living and in terms of stature. Going forward in the 21st century, many new names on the Fortune Global 500 list will be Chinese and Indian companies (the Indians are still far behind the Chinese in this "race" to the Global 500, however). At the same time, "newer" companies such as Microsoft, Dell, Oracle, Cisco, Amgen, Amazon, Google, eBay, and Yahoo will continue to move up the rankings - displacing older and more familiar names such as SBC, AT&T, Xerox, Delta, Northwest, Delphi, and not to mention - General Motors. Unfortunately, one is hard-pressed to find companies that are similar in nature to Google, eBay, and Yahoo, for example, in the Western Continent, and given its hugely deteriorating demographics, high tax structure, and lack of innovative/capitalistic spirit (for example, Germany is still essentially a manufacturing economy today), one's logical conclusion is that Western Europe will continue to lose its clout as a group in the world economy going forward.

That being said, the 21st century and the advent of the internet will result in the huge empowerment of the individual - should one choose to accept that role. While nation-states can fight among themselves for bragging rights, that does not mean you, as a citizen of the United States, will "lose out" should the U.S., for example, lose her place as a technology leader. As long as the U.S. possesses a business-friendly environment, and as long as there is ample financing, a free press, and access to education, I believe that one can still choose his or her destiny.

As an aside, I highly recommend reading the latest December issue of Inc. Magazine, which had chosen Ms. Ping Fu as the entrepreneur of the year. Ms. Fu is the President and CEO of Raindrop Geomagic - a company that designs software to better enable many of the products and objects in the physical world to be represented in digital form. This is important, since 99% of our physical world does not have a "digital representation." In Ms. Fu's words, such a "digital convergence" will mark a great change in the manufacturing world - paving the road for customized products, rebuilding "classic products" through reverse engineering, as well as cut down significantly on manufacturing time due to great improvements in quality management. In a somewhat bold statement, Ms. Fu claims that such a technology can potentially mean an end to the outsourcing of manufacturing - as better products can be built locally using this kind of platforms as well as on a relatively low-cost basis (as a side note, this still doesn't help the unionized workers at GM, since the prerequisite for operating such software is most probably at least a B.S. in Computer Science at an accredited university).

As for the stock market, this author still believes we are currently in a secular bear market - a secular bear market that began in early 2000 and that will most likely be similar in nature to the 1966 to 1974 secular bear market. While earnings will most likely continue to grow in general (much more in the finance, technology and entertainment industries than the manufacturing industries, however), my guess is that P/E ratios will continue to come down to more historical norms. Let's now take a look at the following long-term chart showing the historical P/E ratios of the S&P 500 from 1925 to October 2005, courtesy of Decisionpoint.com:

S&P 500 Index Relative to Normal P/E Range 1925-2005 - Current P/E of approximately 20 still overvalued relative to historical norms.

More follows for subscribers...


Henry To

Author: Henry To

Henry K. To, CFA

Henry To, CFA, is co-founder and partner of the economic advisory firm, MarketThoughts LLC, an advisor to the hedge fund Independence Partners, LP. Marketthoughts.com is a service provided by MarkertThoughts LLC, and provides a twice-a-week commentary designed to educate subscribers about the stock market and the economy beyond the headlines. This commentary usually involves focusing on the fundamentals and technicals of the current stock market, but may also include individual sector and stock analyses - as well as more general investing topics such as the Dow Theory, investing psychology, and financial history.

In January 2000, Henry To, CFA of MarketThoughts LLC alerted his friends and associates about the huge risks created by the historic speculative environment in both the domestic and the international stock markets. Through a series of correspondence and e-mails during January to early April 2000, he discussed his reasons and the implications of this historic mania, and suggested that the best solution was to sell all the technology stocks in ones portfolio. He also alerted his friends and associates about the possible ending of the bear market in gold later in 2000, and suggested that it was the best time to accumulate gold mining stocks with both the Philadelphia Gold and Silver Mining Index and the American Exchange Gold Bugs Index at a value of 40 (today, the value of those indices are at approximately 110 and 240, respectively).Readers who are interested in a 30-day trial of our commentaries can find out more information from our MarketThoughts subscription page.

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