I’m extremely uncomfortable siding with any opinion that Alan Abelson of Barron’s holds because he’s been a perma-bear for the better part of 25 years. He makes the same point about Chinese acquisitions that I made in my last post, i.e. don’t worry because China won’t be taking over the world anytime soon. Despite Abelson’s column, I will stand by my assertion that China is buying bad businesses that US companies are better off without anyway…
"What we urge you to remember is back in the waning decade or two of the last century all the fuss and furor when Japan was seized by a seemingly insatiable yen for buying up our golf courses, our majestic hotels, our soaring office buildings, our irreplaceable Impressionist paintings and lots of other great stuff in this fair land — and price was no object. As it turned out, of course, the Japanese got stiffed big time, and when their stock market and their economy went poof, they wound up selling virtually every trophy piece of real estate and assorted gaudy bauble and showy trinket at a monster loss.
That’s what you should remember about Japan when you’re tempted to join in the growing clamor, not a little of it emanating from Washington, about China’s increasing appetite for bits and pieces of Corporate America. What got the nativistic juices flowing is that, in the past six months alone, one Chinese company bought IBM’s PC business, another is making goo-goo eyes at Maytag and, just last week, China National Offshore Oil Corp. — Cnooc Ltd., for short — offered $18.5 billion for Unocal.
We do sympathize with the Chinese. They’re sitting on close to $691 billion in foreign-exchange reserves, not a little of it resting in U.S. Treasuries. Buying something, anything, American with that mountain of money is a heck of lot better than building another steel mill or pouring yuan down a rat hole in an effort to prop up a sinking stock market. Instead of being downright rude when the Chinese come a-courtin’, then, let’s keep that $691 billion and the memory of Japan’s mad pursuit of our assets firmly in mind, and joyously echo President Bush’s famous cry, uttered in a slightly different context: "Bring ’em on."
But I should really check my head when I read three articles in Barron’s that made me increasingly bullish. The driving theme behind all the articles is that the Fed is close to being done raising rates. And if it is, the market should respond fairly well. Remember, markets discount even Fed rate moves by three to six months so if the Fed stops raising rates in September, the market should begin moving higher in short order.
The first article that backs the thesis that the Fed should be done raising rates soon is called, ominously, The Big Slowdown. However, in reading the article, it’s actually quite bullish. The article is an interview with Nancy Lazar of the world renowned International Strategy & Investment Group. Mrs. Lazar makes the point that the US is merely experiencing a "mid-cycle" slowdown. In other words, like in 1995 or 1985, the markets could start moving higher once it gets the sense that the Fed has stopped raising rates and that the economy will accelerate once again.
In the 1980s and ‘Nineties you had very long expansions. But within both, there were roughly three cycles. The first cycle I’d call the strong advance, in which the economy finally comes out of recession and accelerates enough so there is some inflation concern and the Fed tightens. That happened in 1984, that happened 1994 and that happened in 2004. Then, in both the previous two decades and maybe again now, in part as a result of that tightening, the economy slowed. It slowed in 1985, it slowed in 1995. In both of those periods, the Fed then eased and the economy reaccelerated. Today, there is a comparison not only to the ’95 period but also maybe to the ’85 period, where the economy slows because of central-bank tightening and higher oil prices. We are moving into the mid-cycle slowdown.
What sets this period apart?
In both ’85 and ’95, the stock market absolutely had a very strong run. In the 1985 period it was more of a step function, where the market rallied and then went sideways for several months then made another significant rally and then went sideways again. By the time the mid-cycle slowdown was over, there was still a very significant rally in 1985. In 1995, it was just a steady climb in the stock market for roughly a year straight. This stock market is not behaving like 1995 so far. It has similar characteristics to 1985, because the market rallied last fall and then went sideways and rallied again this spring before going sideways. It is still early in the mid-cycle slowdown and, I think, on a historical basis there should be a decent rally in the market, though maybe not as much as occurred in 1985, when the markets rallied about 40%. We are not expecting that, but we do think the market can rally roughly 15% from its spring low of April 20.
The second piece of bullish information that I gleaned from Barron’s was the tongue in cheek article about the Market Technicians meeting. Barron’s has never been a big fan of technical analysis and this article follows the same tired theme… technicians practice reading tea leaves and chicken entrails and therefore should be relegated to the back room. That said, the article did have an interesting line that I thought summed up the consensus opinion perfectly…
Dojis, Bearish Engulfing Patterns and Elliot Waves aside, the big guns at the seminar seemed to have the same general take on the imminent direction of the stock market as everyone else on Wall Street. In other words, while the party is perhaps not yet over, it is starting to get late.
Acampora suggested that, while there might be one more good rally in the current cycle, the market would probably remain mired in a wide trading range for the next five years. Ken Tower, chief market strategist at the online brokerage firm CyberTrader, said this meandering period would provide a "great time for traders," noting: "Our technical tools work better in a trading market." Or, as an old Japanese proverb might put it, "He who is with wife and child but without doji hath given hostages to fortune."
I believe in "contrarian technical analysis" as much as I believe in contrarian fundamental analysis, meaning that if everyone looks at a chart and sees the exact same thing, then it’s probably already been discounted by the market. If all traders see the giant head and shoulders pattern in the S&P 500, then they have probably already acted on it and, therefore, the pattern is less likely to come to fruition. If everyone at the MTA is expecting a trading range, every hedge fund is expecting a trading range and the public at large is expecting a trading range, then most likely, we WON’T get a trading range. We’ll either get a monster bull or bear market. Given what I read in Barron’s this weekend, I’m leaning towards the Bull side.
Finally, the last piece of bullish information was located in a small table in the Preview section. The crux of the table implied that Fed Chairman Greenspan actually does know what he’s doing, despite much evidence to the contrary. And if he does know what he’s doing, he should know that the Fed needs to stop raising rates in short order or cause a much more dramatic economic slowdown than necessary.
The Numbers:
Oct 1990: Average yield on 10 year Treasury peaks at 8.9%
February 1991: Core CPI inflation peaks at 5.6%
January 2000: Yield on 10 yer peaks at 6.7%
February 2001: Core CPI peaks at 2.8%
June 2004: 10-year yield at 4.7%
March 2005: Core CPI inflation at 2.4%Under Greenspan’s tenure, core CPI inflation has peaked at successively lower levels. If the March peak holds, the bear market in such inflation remains in tact.
Always remember, the Fed’s main objective should not be creating jobs, spurring the economy, propping up the stock market, fixing social security or popping bubbles. The Feds main job is to maintian the integrity of our currency and maintain price stability (i.e. no inflation). And by the numbers (if you believe "core CPI" is a good measure of inflation), the Fed has done a good job of that over the past 15 years.
In sum, if the Fed gets the message of the markets and drops a hint that it will stop raising rates at the 3.5% level, then I think the market will be in excellent shape. However, if the Fed decides to ignore the markets and relies on its own in house economics team to guide it, the markets will have a hard and bumpy ride for the rest of the year.