This is a "Momentum Market"

On April 20th and April 25th of this year, all three Dow averages (Industrials, Transportation and Utilities) closed at simultaneous historic highs. This has happened only a few times in the last 100 years. Additional record highs continued to occur through early June, and during that time, the Standard and Poor’s Index of 500 Stocks also established new highs. The S & P 500, confirming the Dow record highs, is an important indication of what is happening to the other 470 companies that are not included in the Dow Jones Industrials. Since early June the market has had a backing off in price from those highs as the market settles back and takes a breather.

The market indicates, however, that it will probably continue to set new highs. We are not in a value market. This is a momentum market that shows a striking resemblance to the market run-up that began in the late 1990s.

Question: This is really confusing. Could you elaborate a little on “value markets” and “momentum markets”?
Answer: A market that is increasing from low values is a market that is “cheap”. By cheap we mean that the price earnings ratios are below historical averages and that dividend yields are above historical average yields posted by the market. This current market is selling at a price earnings ratio that is already 35% over the historical average value of price earnings ratios. Dividend yields are about 50% of the historical average dividends paid. So the market is certainly no bargain even though it continues an upward trend. When an over-valued market, like the late 1990s, continues to increase in price, that is known as a “momentum market”. In other words, there is no mathematical justification for the market’s increase. However, the demand for stocks exceeds the availability of stocks, and the price of securities continues to increase because of the momentum of the public’s demand.

Question: This sounds very dangerous. Market Watch mentions the market is already considerably overvalued, yet all indications are that the momentum of the market may carry it higher. Why?
Answer: Let’s list the possible reasoning for the market’s unprecedented march north:

1)		Housing is a very large part of the U. S. economy. Inventories are increasing as houses remain unsold. There is hardly any good news at all in the housing sector, yet the market has ingested all of this news, and the market’s reaction is “this difficulty can be absorbed and handled in our economy”.

2)		The Federal Reserve System continues to print money in record amounts as Market Watch points out almost every month. The magic formula of keeping both the government, and the economy, compatibly in business is the mass manufacturing of money by the government to pay bills that taxes cannot cover. As the public has gotten used to this constant flow of cash into the banks, the public has discounted the dangers involved in having money backed by nothing but the “full faith and credit of the Federal Reserve System”. Money in the economy that is printed to cover federal government deficit spending is inflationary because cash is inserted into the economy in excess of goods and services for that cash to purchase. This causes inflation. Everything inflates. Housing, cars, fuel, restaurants, groceries—everything increases in an inflated market. To keep inflation “in balance”, the government must issue enough new cash to cover their bills,…..but not so much cash that inflation increases at a level that is “out of control”. Our government’s inflation target for the economy to remain “under control” is less than 3%. It has been the charge of the Federal Reserve System from the executive branch of the government over the last several decades to ensure there is a lot of cash in the economy.

3)		Government tax revenues continue to increase. At current spending levels, prominent economists are predicting that the federal budget could be balanced by 2009 (Market Watch comment—no way!).

4)		The Dow transports are not selling off like the rest of the averages. This probably has to do with the components of the Dow Transports being huge international shippers of goods. Economies around the world with which the U. S. does business are enjoying a boom in their GDP, their productivity, and their standard of living. The U. S. consumer happily purchases those cheaper goods that must be “transported” around the world. The Transportation Average not tapering off from its record high is a very interesting potential indication of a positive business attitude and environment around the world.

Question: Market Watch’s last point about business around the world being good is interesting. Are there any mathematical indications to support that statement?
Answer: There are 17 different major stock markets around the world that Wall Street follows: Hong Kong, Spain, Mexico, France and so forth. All of these markets are up; some are setting records like our own markets; and all of them are selling above their 200 day moving average. We do not know if this has ever occurred before in history as statistics to verify the historical trend would have to be pulled together by hand. That’s how rare this set of circumstances happens to be. The conclusion is that buying momentum in stock markets all around the world is up. There is no indication that such demand will not continue. If it does, and the retail investor gets involved, a run-up of this market similar to the one in the late 1990s would take the Dow Industrials to more than 20,000 points.

Question: That’s a terrific 45% gain from current levels, and in a momentum market, you can’t lose money, can you?
Answer: Not so fast. You can lose money in any market. In fact, most of the people you come in contact with do manage to lose money in bull markets. The possibility of losing money is lessened in a bull market, but doing something stupid can cause people to lose money in any market.

Question: What would be stupid?
Answer: Going into debt that cannot be handled is not smart. Buying stocks on margin is too risky for the retail investor. Buying just any stock is not very smart, and listening to your neighbor’s hot tips, or even your brokers, can be costly. One must be discriminatory in the investments they make in all markets.

Question: What investments could be made that will keep us from losing money?
Answer: There is no investment guaranteed to keep one from losing money. However, there are securities to be purchased that are selling at great values in almost any market. Last month Market Watch listed several securities that are selling at their historical lows. They are priced below the Dow Industrial’s historical price earnings ratios. Some of those Dow companies are Bank of America, Citigroup, Home Deport, Johnson & Johnson, McDonald’s, Pfizer, Proctor & Gamble, and Wal-Mart. Several other stocks that are not Dow Industrials are also available at value prices in this market. Purchasing value stocks lowers the downside potential of an investor’s portfolio. Similarly, a large market increase from these levels could yield an investor a big return because such stocks are currently cheap.

Question: What about gold? It has not gone anywhere for months and Market Watch has written a lot about gold over the years.
Answer: Hold your gold and buy more at these levels. Gold is cheap. Before President Roosevelt, by a mere executive order, confiscated all the gold held by the public in 1932, dollar bills of various denominations had these words written upon them: “This certifies there has been deposited in the Treasury of United States of America the exact amount of this note in gold coin to be paid to the bearer on demand”. At that time, the U. S. government had on deposit enough gold (and silver) to redeem all outstanding dollars for “gold and silver species” as required by the U. S. Constitution. Market Watch has previously written that if each ounce of gold was redeemed for the dollars in our money supply at this point in history, each ounce of gold would have to be revalued to almost $50,000. This is what the government has done to our money. With gold selling at $660 an ounce, and with paper money out there to cover each ounce equal to $50,000, gold must go up in value.

Conclusion

The fate of the world economy really rests on the shoulders of the American consumer. He must continue to consume, and right now, the American consumer is being accommodating to the world’s economy. As foreign economies progress and mature, their own consumers add to the momentum of GDP increases around the world. Fifty years ago the chairman of GM said, “what is good for GM is good for the U. S.”. The U. S. economy represents almost 30% of world GDP which is huge, and, generally, what’s good for the U. S. economy is good for the world’s economies. We are definitely the tail that wags the dog. The generally happy state of our economy is driving the rest of the world’s economies to new-found gains. Our own economy continues to prosper, and our institutions continue to increase in value. While these values cannot be justified by use of historical statistics, we are in a momentum market that appears to be headed higher. One’s risk can be modified in a big bull market, just as it can be modified in any market—by purchasing only those securities that are selling at value prices in any particular market.

The market is trying to correct but is having a hard time doing so--indication of a bull market. Institutional buying has brought the market to these levels without significant retail interest--indication of a bull market. Government tax revenues are increasing rapidly--indication of a bull market.

With all the problems economically out there that we have analyzed and written about over the years, the market has discounted them all in its march to new highs. All indications are that this uptrend will continue and turn into the greatest bull market of all times.

Carpe Diem.
George Rauch
June 29, 2007

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