Market Watch - August 8, 2008
The news is so terrible that any rational, thinking human-being, must conclude the last place to put their money is the stock market. Banks are under capitalized, real estate is in the tank, home foreclosures are soaring, and once again both political parties are unable to produce a proven leader and statesman to lead us out of this mess caused by our own elected government.
Unfunded U.S. government liabilities for Social Security and Medicare exceed GDP by a multiple of more than 5 (nobody can pin down our exact unfunded liabilities) and government deficits are setting records while the terribly uneven distribution of the tax burden remains. 44% of the U. S. population (approximately 125 million citizens), pay no annual income tax while 86% of all income taxes are paid by the top 25% of tax payers. In 1787, Alexander Tyler, a Scottish professor, observed that “a democracy will continue to exist up until the time that voters discover they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy.” Bingo! Not only is the tax burden unfair, but more importantly, it diverts money that would be put to use to create permanent capital improvements and jobs in the private sector (productive) to government who redistributes it (unproductive use of capital).
Lordy! Where is my harakiri knife?
But wait a minute. While everything above is true, there have been significant changes in the United States over the last 50 years. Many disasters surround us, but the stock market is not one of them. While the stock market at 11,000 plus points is exactly where it was 8 years ago, the market just may be positioned for a big increase in value. Why?
1. The U. S. is the world’s largest customer representing 30% of the world’s GDP;
2. The U. S. has more innovative companies, staffed with brilliantly educated people, than any other country in the world, by far;
3. The U. S. enjoys a huge energy advantage. Electricity is 44% cheaper here than in the rest of the G8 countries, diesel is 32% cheaper, gasoline is 49% cheaper, and natural gas is 48% cheaper;
4. Our exports, because of the current value of the dollar, have been involved in a parabolic rise for the past few years with no end in sight (and U. S. exports alone exceed the GDP of China);
5. In spite of the loss of manufacturing jobs, America remains far and away the largest manufacturing nation on earth;
6. And America has a culture of commercial and marketing success.
Market Watch looks at the “language” of the market. Market Watch does not care about the news, economists predictions, politicians projections, or anything but the language of the market. While the market is at the same level it was many years ago, and the news is very bleak, the language of the market suggests that all of this bad news has been discounted. Yet, the market still remains at more than 11,000 points. We have gone through all of economic trauma, the wars, the bankruptcies, the banks, and so forth, and the market remains at a very respectable level. If the market was going to fall deeply into the tank, rather than sell off and stabilize like it has, it would have done so before now.
Question: Is there any technical evidence to back up the above statement?
Answer: Yes, there is. Market Watch has written about the 50% principal many times. To review, the Dow 50% principal developed by the great Dow theorist George Schaefer, assumed that what happens at the half-way level of a major extended advance or decline will tell us a lot about subsequent action. The Dow advanced from a base of 7286 points in October 2002 to a high of 14,164 points in October 2007. This five year rise took the Dow up 6, 978 points creating a halfway level (50% level) of 10,725 points (14,164 - 7,286 = 6,978 points ÷ 2 = 3,489 points which, added to the low of 7,286 points equals the half-way level of 10,725 points). The Dow has not breached 10,725 points on the downside. It has come within a few hundred points, but the half-way level has never been breached.
Question: Is there any other important technical matter?
Answer: There is. Charles Dow wrote incessantly about the importance of the industrial average and the transportation average acting in concert. For a bear market or a bull market to occur, the transportation average and industrial average must be moving in the same direction together, and they must breach highs and lows together to confirm each other. While the Dow Industrials have hovered close to the 50% level low, the Transportation Average has not even come close. The divergence of the two averages clearly indicates that goods are being transported all over the world in record amounts creating good profits for transportation companies. And the Dow not breaching the 50% level on the downside indicates that while some components of our economy are obviously bad, the future is bright.
Let’s assume that we are in the shoes of corporate managers who are making decisions on how to increase sales and earnings. We would look at the U. S. markets as being relatively stable with the possibility that sales and earnings may be off a little bit the next 12-14 months. However, the U. S. only represents a population base of 310 million people or less than 5% of the world’s population. That means 95% of the world’s population is available as customers. As managers we realize that more and more of our opportunity is outside of the U. S., so we should concentrate our resources upon developing those markets. That’s exactly what has happened. We are no longer looking at the U. S. market as our largest future customer, but rather, as corporate managers, we must look outside of the U. S. in order to garner the tremendous growth in the future that American corporations have enjoyed in the past.
Contrary to popular belief, the shake-out occurring in the price structure in this country is serving to position the price of assets into economic reality. We have been living in a false world, in spite of this huge shake out, the market is not so bad. It’s not so bad because the future, both in this country after our economy is stabilized, and in world markets, is very bright, indeed, for U. S. corporations.
Question: Then what do we invest in?
Answer: We invest in the same thing that Market Watch has been suggesting for the last several months. We invest in large, multi-national corporations that give the U. S. tremendous competitive advantages: MO, KO, GE, HD, JNJ, MMM, PEP, PG, SYY, WFC, to name a few. These companies are A-rated, low price earnings, high dividend paying businesses with long track records. Why take a chance. All of these international companies not only have well established U. S. markets, but they have manufacturing, engineering and marketing abilities that the rest of the world’s competition simply does not have.
The market is poised for an impressive run up over the next 5-10 years. As the market is establishing a base of around 11,000, investors can establish a base themselves by accumulating well managed, internationally based securities whose upside is terrific and whose dividends currently pay much more than investments in bonds. These dividends are secure, and many of the above companies are not only increasing their earnings, but they are increasing dividends, too. Accumulating good stocks, and enjoying the current dividends, plus the dividend and earnings growth, can be very profitable when coupled with a big upside in the value of these securities over the next several years.
Finally, the two imperatives for a large increase in the value of the market are (1) lots of cash (M3 is exploding), and (2) heavy institutional buying. The former is in place. Institutions are accumulating cash from pension and retirement funds, and when they tire of receiving 2% yields for treasury instruments, they’ll start to gobble up the 4% dividend yields of America’s great corporations.
Carpe Diem.
George Rauch
August 8, 2008
