Market Watch - August 30, 2007
From Last Market Watch Article Published July 5th, 2007:
First two paragraphs
On April 20 and April 25, 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. Since early June, the market has had a reduction in price as the market settles back and takes a breather.
The market indicates, however, that it will probably continue to set records. We are not in a value market. This is a momentum market that shows a striking resemblance to the stock market run-up that began in the late 1990s.
Last two paragraphs
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.
Current Market Posture:
The market is trying to correct, but it is having a hard time doing so. This is a strong indication of a stock market in a primary bull market trend. Since July 24th we have had five days when downside volume represented 90% of the volume on the New York Stock Exchange. Such market action historically has resulted in severe market sell offs that ended in bear markets. Not only has the market resisted such a downturn for the first time history, but in the last several weeks there have been a few days where 90% of the NYSE volume was securities increasing in price, also extraordinary.
Question: What does Market Watch mean by a trading range?
Answer: The Dow Jones Industrials trading range is 14,000 points on the high side and 12,874 on the low end of the range. 14,000 points is the historical high the Dow reached a few months ago, and 12,874 points was the close of the Dow on August 16th, from which it has rebounded to current levels in the 13,000 point range.
Question: How are trading ranges established?
Answer: On the high end, 14,000 points represents the all-time high on the Dow reached a few weeks ago. On the low end, 12,874 represents the low point of the recent market sell-off. The trading range of 1,126 points is a fairly narrow trading range, representing 8% of the 14,000 point high of the Dow.
Question: Why is a trading range of 8% of the value of an asset considered a “narrow” trading range?
Answer: Wall Street considers a “correction” to be significant if the correction is 10% or more. The recent sell off in the Dow of 14,000 points to a low of 12,874 points was an 8% correction. A 10% correction would have taken the Dow to 12,600 points, and 12,600 would still be above the December 31st, 2006 close of 12,463.
Question: From what Market Watch is saying, one would think that the recent downward disturbance in the Dow is unimportant. Is that so?
Answer: No, any sell-off of that magnitude is important. It’s difficult to figure out why the sell-off occurred. There is plenty of cash in the economy. The money supply, and the creation of new money, continues to set records. Sometimes a good “scare” will take the market down, temporarily, in defiance of logical economical thinking. Perhaps this time it could have been the negative press about the sub-prime loan situation.
Question: Couldn’t sub-prime losses alone bring the economy down?
Answer: Believe it or not, the sub-prime loan situation is not that serious. While 3-5% of all mortgages outstanding could be rated sub-prime, that loss could be absorbed by the existing investment community. For example, many of the sub-prime loans are in money market funds which are estimated to hold up to $300 billion of sub-prime loans. All money market funds presently total $2.5 trillion, and remember that not all sub-prime loans are going to go bad.
Question: $300 billion is 12% of all the money market funds outstanding. Doesn’t that represent an awful lot of risk out there?
Answer: In terms of the number of dollars involved, yes, it is significant. But in terms of the overall picture, for example, money market funds are basically profits that are being parked until they need to be used elsewhere or paid out to stockholders/business owners. If the entire 12%, or $300 billion was lost, money market investors would simply be out an average of 12% or their holdings. Their funds would be reduced to $88 for every $100 they had invested. Money market fund managers buy sub-prime loans because they have higher yields. The downside of those higher interest rates is more risk, for which they may now have to pay.
Conclusion:
There is bad news all over the world today. The market’s generally positive reaction to that news is very bullish. The market’s reaction to news is what we, as investors, are really interested in, and the markets reaction to news has been bullish. With all the hysteria, neither the Dow nor the S & P 500 have suffered a correction of 10% in a long time.
There are two additional reasons the market may continue to climb:
The Fed just made the first step to cut rates. The 14 previous times the Fed cut rates, the market was higher one year later in all but two instances. While the sub-prime problem is large, equally large is the Fed’s ability to create enough new money to absorb losses that the existing money supply cannot fully absorb. Recent stock market action appears to have been a correction within a long-term primary bull market.
The sovereign funds of other countries now total $2.5 trillion. Morgan Stanley predicts that at the current rate of growth, those funds will equal $12.5 trillion by 2017. Our current prosperity is based on the rest of the world continuing to accept dollars for their goods and services. The world’s economy is dependent upon the United States continuing to buy goods and services. Our trade deficits build up profits in other currencies (sovereign funds) that will probably come full circle back to the United S tates through the purchase of U. S. assets like real estate, stocks, and bonds (debt).
The generally favorable existing world economic climate makes the U. S. stock market look very, very attractive for the next several years.
Carpe Diem.
George Rauch
August 30, 2007
