Market Watch - May 2, 2008
A lot has happened to the markets over the last 6 months, and while the mainstream media is talking about how bad things are, most of what has happened is good for the market. The market is primed to seek new, higher levels. Let’s take a technical look.
There is a little known mathematical factor first exposed by Charles Dow called the 50% principal. This exercise assumes that the halfway level of major advances or declines determines the long-term direction of the market. For example, in 1980 the DJIA was 759 points and the 2000 high was 11,723 points. The half-way, or 50% level, of that advance was Dow 6241 (11,723 – 759 ÷ 2 +759 = 6241). In January 2000 the market began to decline until obtaining 7286 points in October, 2002, 1000 points above the 50% level of 6241 points. The conclusion, therefore, is that while the market sold off, we were still in an extended bull market.
From the low of 7286 points in 2002, the Dow headed to a new record of 14,165 points in October of 2007. The 50% level from this advance would be 10,725 points. The new 50% level, then, is 10,725 points, 2,000 points less than the current DJIA.
The mathematical conclusion is that the 2000-2002 down turn in the market was only a correction in a bull market—it was not a bear market. Further, if the market was going to give us a strong indication of returning to a bear market posture, the first signal would be when 10,725 points is breached on the downside. The next signal, of course, would be the market dipping below 6,241 points. Neither of these scenarios appears to be part of the existing situation. Theoretically, we are still in the great bull market that began in 1980—it’s now the most prolific, profitable, and longest bull market in history. Dow theorists would go a step further and predict that the market high of October 9, 2007 of 14,165 points will be exceeded sometime in the next few years.
Question: The media says we have the worst economic conditions since WWII. How can anyone assume that the market is primed to hit new highs?
Answer: The market is a compilation of millions and millions of bits of information, and the market is smarter than all of us. With the terrible news that has existed, including our own bankrupt federal government, the market continues to consolidate above the 12,000 point range. The market has resisted any tremendous downward movements.
Question: We read recently that the short interest in the market is at an all-time record of 16 billion shares on the NYSE. Doesn’t that indicate that the real brains and insiders expect the market to go down?
Answer: No, it does not mean the market is primed to go down. The market has already discounted the trouble with the banks, housing, indebtedness and consumer buying. If the market remains at these levels for an extended period of time, the short position in the market will work itself off. If the market spikes up, the short sellers will get hurt and have to cover their shorts. Many of them will go bankrupt which we have seen many times since the 1960s. It’s the nature of their business: big fortunes—big losses.
Question: Does the transportation average play any part in this?
Answer: Yes, the transportation average plays a very large part in analysis of the market. The Dow Transportation Average continues to set new records. Theoretically, for a spike up in the Dow Industrials to occur, one average needs to be confirmed by the other. While the Dow Industrials were going down earlier this year, the transportation average remained stable, or was increasing in value. The transportation average has been stronger than the industrials the last few years because of all the international commerce carried on by the United States (U. S. exports, alone, exceed China’s GDP).
Question: We have read about the huge losses of financial institutions from sub-prime mortgages. Won’t this affect the market further?
Answer: The market, as mentioned above, has already discounted all of these potential problems. UBS has pointed out that banks have written off over $150 billion because of sub-prime losses. They estimate that the worst future possibility is that the banks would write off another $200 billion, which they point out is unlikely. It’s important for us to remember that while these numbers seem very large, on a relative basis they are not as great as the savings and loan fiasco in the 1980s. Furthermore, historically, of these huge write-offs, there is at least a 50% recovery rate. It would appear the market is saying that we have a liquidity problem in this country, not a solvency problem. With the hundreds of billions of dollars that the Fed has added to the monetary supply in the last several months, it appears that liquidity is becoming more and more available.
Question: The University of Michigan’s well known consumer sentiment poll is showing the lowest confidence in 26 years. I thought that Market Watch had written in the past that consumer spending was the largest segment of our economy?
Answer: Consumer spending is by far the largest component of our economy. While consumer spending has been hurt, it certainly has not been crushed, and consumer spending continues to remain a considerable, healthy percentage of our economy.
Conclusion:
The Dow is poised to set new records in the next few years. Conservative investors should continue to buy big stocks, like the DJIA stocks, when those stocks are selling at low price-earnings ratios, and paying a high dividend yield, relative to their historical prices. The big stocks are international in scope, providing investors with downside risk protection and currency swing protection. Big stocks are also positioned for high potential future growth in sales and earnings.
“A” rated big stocks currently available, well below their historical median prices, are: BAC, GE, HD, JNJ, KMB, PEP, PG, SYY, TGT, WMT and WFC. Each of the above stocks has produced a remarkable record of dividend growth averaging in excess of 10% annually over the last 12 years.
Carpe Diem.
George Rauch
May 2, 2008
