Weekday Commentary
from Jim Puplava
Home
The Green Thumb No Longer Working? Source: Elliott Wave - Financial Forecast Short-Term Update
|
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1.18|
|
Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Week in Graphs 
Storm Watch 
Geopolitical News 
Energy 
Precious Metals 
Raw Materials
Tuesday, November 5, 2002
Easy Al's Market-Making Money Machine
There was a time when the financial markets would salivate with the appearance of any financial crisis. A crisis meant that Easy Al would lower interest rates and flood the markets with money. Flooding the markets with liquidity always led to higher stock prices. Initially a crisis would send stocks lower, for example, as in 1997 during the Asian crisis and in 1998 with LTCM. It gave way to the “buy the dip” philosophy of buying into the market at any time the markets turned down. For most of the last half of the 90’s, this seemed to work. So with each new crisis, whether it was Asia, LTCM, Russia, or Y2K, the markets salivated. A crisis meant more money and lower interest rates, which usually drove the markets higher.
After the markets turned down in 2000, Wall Street thought it was merely a correction. When the markets didn’t come back, Wall Street turned to the Fed. It was believed that Easy Al and his money machine would once again bring prosperity to the financial markets as he had done so many times in the past. Flooding the markets with easy money became the Greenspan signature. It worked. Throughout all of 2001 as the Fed cut interest rates aggressively, Wall Street dreamed of a rising stock market. But it never happened. Instead the US economy went into a recession and the stock market produced another year of double-digit losses for investors. The Fed cut interest rates 11 times, bringing interest rates down to the lowest level in half a century. Instead of inflating the stock market bubble, Easy Al created three new bubbles in the mortgage, consumption, and real estate market. The rate cuts failed to resurrect the bubble in stocks.
This failure didn’t stop so many on Wall Street for calling for lower interest rates. Despite the failure of 11 interest rates to resurrect the markets, Wall Street is still calling for more rate cuts. As today’s EWI graph at the top illustrates, lower rates didn’t stop the 89% plunge in the Dow between 1929-32 or prevent the Great Depression from occurring. Lowering interest rates have not helped Japan out of its quagmire. Today the Nikkei stands at 8,937 twelve years later after hitting 39,000 in January of 1990. Interest rates in Japan are close to zero and their stock market, real estate market, economy and banking system is still a mess. What I wonder is what they think a rate cut of 25-50 basis points will do for the economy besides giving the markets a momentary thrill?
Sending The Wrong Message
Rather than allow the markets and the economy to naturally bottom and heal themselves, the Fed seems to be hell bent on preventing any healing process from occurring. The message seems to be that there will be no hangover from the 90’s debt and spending binge. There is this general feeling of omnipotence when it comes to the Fed. Somewhere along the way we have lost the concept of how our economy works. We now believe that we can socially engineer any outcome through various means of monetary and fiscal policy. The message is there will be no more bear markets or no more recessions when in fact, that is what we keep getting. Furthermore, by creating additional bubbles in housing and consumption, the Fed has set itself up for more breakdowns and failures.
We now find the Fed intervening in the stock market, bond market, currency market, and allegedly in the gold markets. They really do believe they can prevent stock prices from falling when they are in fact setting the markets up for a greater fall. At the minimum, investors may go through a long and enduring agony of watching their equities decline year after year over a long period of time, perhaps longer than a decade. The Fed may continue to pump money into the economy, but this money pumping may lead to stagflation, hyperinflation, greater poverty and destruction.
Before you get caught up in all of the hyperbole of another rate cut and its miracle effects on the economy and the stock market, please view today’s graph. It shows supporting evidence of the inefficacy of monetary policy in resurrecting a bubble once it has deflated.
Complacency in Oil Markets
One topic that isn’t receiving more attention is the dwindling supplies of oil and natural gas in this country. As this nation heads towards war, our oil stocks have never been this low. Oil and natural gas prices are up 25% this year. Experts feel that the war with Iraq accounts for a $4-5 premium in the price of oil. Without the possibility of war, oil prices would be much lower. Lately there is a growing feeling in the markets that the possibility of war will become less likely the more that time passes. Regardless of there being a war or not, the oil and energy markets have become far too complacent. The IEA sees oil stocks trending lower this year despite sluggish product demand, poor refining margins and decreased compliance by OPEC. The IEA argues that those who say the market fundamentals remain weak have underestimated the great disconnect between crude and product stocks. Crude oil stocks are low and are still trending lower. The agency believes critical oil stocks remain low heading into the winter heating season. We are now down to about 55 days of forward cover. The big unknown variables at this time are war and weather. Both are unpredictable with the markets remaining far too complacent without regard for any disruption of supply or increased demand coming from foul weather. Moreover, natural gas production in the US continues to decline. It declined by 1% in Q3 and is expected to decline by 5-10% in Q4. Natural gas production has fallen for the fifth consecutive quarter. Rig counts remain low and drilling activity has not increased significantly. We are, in the words of one energy expert, only a winter’s storm away from our next energy crisis.
Traders have driven energy prices down in recent weeks on growing doubts over immediate military action against Iraq. At the same time, they ignore recent weather patterns and declining stocks of oil and natural gas. Energy stocks are declining globally. The complacency in the markets has been reflected in the price of shares within the energy sector. As the graphs below indicate of the OSX (Philadelphia Oil Service Index), the XOI (Amex Oil Index), XNG (Amex Natural Gas Index), and the UTY (Philadelphia Stock Exchange Utility Index), the energy sector has remained weak despite the run up in oil and natural gas prices this year.
The divergence between the price of crude and the oil and service stocks would seem to indicate much weaker prices lie ahead for commodities. Energy stock prices tend to lead the price of the commodity. One of the two is right. Either price will head sharply lower, which is what energy equities are saying, or the price will skyrocket on the first sign of a supply disruption or severe weather. This is what happened in 2000-2001 in the last energy crisis. Crude oil and natural gas stocks are running low and getting even lower so there is no room for error. The price of energy stocks, which remain weak despite their attractiveness in price, look far too complacent to me.
This War Will Be Different
Winter is a variable that is very unpredictable. The consensus regarding the upcoming war is that at best it will be a non-event. We’ll drop a few bombs and the conflict will be over quickly. However, the upcoming war with Iraq will be much more complex than the Gulf War. The last war was simple: drive Saddam’s army out of Kuwait. This time we are talking about a regime change, getting rid of weapons of mass destruction and maintaining the territorial integrity of the country. We don’t have the coalition we did in the last war and the US may be denied access to Saudi land and air space while Saddam may be given use of that space for delivery of his weapons of mass destruction against Israel. This war will have much more complex objectives with the chances for more things to go wrong.
The oil markets have also ignored the change in tactics by al Qaeda. The terrorist group is now targeting economic assets, especially oil assets. The group’s new strategy is to target key nodes of the global economy, which runs on oil. They are now focusing their efforts on the oil infrastructure of the Middle East. They realize that stopping the flow of oil would bring the western economies to their knees. The plan now seems to be to attack the loading piers of oil in the Middle East. Recently they attacked the French oil tanker Limburg. On Sunday a US drone fired and killed an al Qaeda terrorist group in Yemen. Among those killed was Qaed Salim Sinan al-Harethi, believed responsible for the attack on the USS Cole last year. Stratfor reports there is now evidence that the terrorist group killed on Sunday were targeting the Hunt oil facilities in Yemen. Their car was loaded with explosives. Stratfor believes that al Qaeda affiliated groups in Yemen are now shifting their focus towards oil targets in Yemen.
There is now a growing consensus within the intelligence community that al Qaeda is shifting its attention to economic assets. During the Afghan campaign last year, the US picked up plans and photographs of key energy installations in the US, which included refineries, nuclear power plants, pipelines and other energy assets. If you want to stop the economy, you need to stop the fuel, which runs the economy -- cheap and abundant energy. A severe oil shock similar to what happened during the 1970’s would do irreparable harm to an already fragile economy. In fact, a disruption in the supply of energy would do more harm to Europe and Asia as they are more dependent on imported oil.
Outside al Qaeda, there also remains the perilous state of the Saudi monarchy. The royals have alienated the merchant class in the country as well as the nation’s religious leaders. The relationship with Washington is deteriorating. There are many in the country that resent the stationing of US troops on Saudi soil. The US has been steadily pulling out military assets in the country and relocating them elsewhere.
All of the above points indicate an energy market that is priced for perfection and has become far too complacent. The wall that separates the world economies from another energy crisis is razor thin. A severe winter storm or another terrorist attack against strategic energy assets could send the price of energy soaring again. Unlike the last war we don’t have a margin of safety. Another terrorist attack, which seems to be occurring more frequently, would deliver a severe blow to a fragile world economy. The possibility of such an attack doesn’t show up on any energy chart nor is it programmed into any derivative or option model. If it occurs, the markets will have to do some serious repricing.
Today's Markets
Looking at the day’s headlines it was more of the same. WorldCom misstated more than $2 billion in income according to an SEC suit. The dollar fell to a new 3 1/2 month low versus the Euro. The service economy continues to slow down and head back towards recession. Prudential posts a loss of $302 million after losing $280 million the previous year. The earnings figure the company used to beat analysts’ estimates excludes investment losses and costs for discontinued operations. Priceline.com reported a third quarter loss that widened on declining sales.
Stock prices recovered from earlier losses in the S&P 500 and the NASDAQ to post minor gains. The markets have now moved beyond rate cuts and are rallying on the possibility of a Republican victory in congressional races. The S&P 500 gained less than 1% driven mainly by oil and defense issues. Wall Street analysts cite the fact that the market has been able to ignore a slowing economy, rising unemployment, declining profits with no improvement for next year, deteriorating corporate and household balance sheets, new scandals, an approaching war, and the rising frequency of terrorist attacks as a sign that the market has bottomed. The Dow hit a 10-week high on hopes of rate cuts and a Republican victory in the Senate.
In other markets, things aren’t going as well. The dollar continues to decline and the bond market continues to lose ground with long-term interest rates rising again. In this bubble economy we now live in, what happens to the bond market may be more important than what happens to stocks. The consumer consumption binge is totally dependent on the refi market. Housing is also dependent on long-term interest rates as are the incomes of senior citizens that depend on the investment returns on their portfolios. With markets declining and interest rates headed to zero, income for many seniors is putting them in a difficult situation as short-term rates fall. Many money market funds are going to have problems earning income as returns fall below the cost of operating the money fund.
Besides a falling dollar and bond market, the price of commodities and gold are rising again as they have since the beginning of the year. A declining dollar, rising commodity prices, and rising interest rates place this stock market rally on very tenuous ground. A few observers see the parallels to fourth quarter of last year when the market rallied on false hopes of a strong economic recovery and profit rebound that never materialized. Others see the similarity to the markets of 1987 prior to the crash when the dollar fell, commodity prices rose, gold went up, and the bond market fell.
Bear market rallies are built on hope more than reality. Sometimes they go up just because they have gone down for so long. It is as if when things are down someone says, “lets have a party.” Don’t try to read too much as to why the markets rally. There are no sound fundamental economic or financial reasons for the markets to do so. The sentiment with investors is they are now worried they may miss out on the next big rally in stocks. There is still a hangover of bullish sentiment remaining from the bull market of the 90’s. The markets may rally for a little longer as the investors and analysts look for something to hang their hat on. A Republican victory in the senate seems to be the next big hope. Winning the war may come after that. None of this will disturb the primary trend in the market, which is still a bear market in its infancy. The more the government intervenes to prevent it from achieving its logical conclusion, the more torture investors will face. It could become a long drawn out process of interest rates declining to zero and stocks losing ground until the prices of equities become a bargain. The markets will become a bargain when the Dow is between 1000-2,500, 250 for the S&P 500 and around 200 for the NASDAQ.
Volume fell sharply during today’s rally, a pattern on most days that the markets go up. Volume on the NYSE came in at 1.31 billion shares and was 1.71 billion on the Nasdaq. Market breadth was weak with advancers barely beating out losers by a 17 to 15 margin on the NYSE. On the Nasdaq the two sides were about even. The VIX continues to fall, declining 0.19 to 34.28. The VXN rose 1.98 to 51.20. Oil, natural gas and defense stocks were today’s clear winners. Select gold and silver stocks also rose with the HUI and XAU both rising, the XAU just barely. Gold still remains the strongest performing sector this year with the HUI up over 83%.
Overseas Markets
European stocks rose, led by insurers such as Allianz AG, Aviva Plc and Munich Re, on optimism an equity-market rally will boost the value of their investments and help revive earnings. The Dow Jones Stoxx 50 Index rose for a second day, adding 0.6% to 2627.21. It earlier shed as much as 1.5%. All eight major European markets were up during today’s trading.
Japanese stocks rose, with the Nikkei 225 Stock Average completing its biggest gain in three weeks. Exporters such as Fanuc Ltd. led the rally on optimism the U.S. Federal Reserve will cut interest rates tomorrow. The Nikkei added 2.9% to 8937.56.
Bond Market
Treasuries closed lower for a third session as investors digested the first leg of the refunding auctions. The 10-year Treasury note lost 7/32 to yield 4.075% while the 30-year government bond fell 1/4 to yield 5.075%.
Copyright © Jim Puplava