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Beware booming asset markets!
The upside potential for equities appears to be very limited despite the likelihood that the Fed will not increase the Fed fund rate at its August meeting. There is much resistance for the S&P 500 between 1290 and 1320 and technical conditions are not supportive of a strong and sustainable rally.
Wednesday, August 23 - 2006 at 21:10
Dr. Marc Faber RSS feed
I also believe that investors will increasingly focus on corporate earnings, which are likely to disappoint, than on monetary policies.
For investors who must own equities, I would, as indicated in the past, be positioned in relatively depressed big market capitalization stocks, such as pharmaceutical shares including Merck (MRK) Schering Plough (SGP), Pfizer (PFE), Bristol-Myers (BMY), and Johnson & Johnson (JNJ). Equally, at this stage of the cycle, I would feel more comfortable owning Citigroup, a stock that has done nothing for the last few years, than brokerage companies whose fortunes are about to change.
But, for now, I maintain the view, which I expressed last month. Two-year US Treasury notes yielding close to 5% (yields have come down 35 basis points over the last two month) offer a valid alternative to asset markets for the next three months or so.
Since 1981, the long-term bull market in brokerage stocks has been accompanied by a secular decline in interest rates. But, lately, interest rates have been rising, and the only way they could resume their downtrend would be by very tight monetary policies, which would cool down the current synchronized global economic boom. In fact, the 17th baby-step increase in the Fed fund rate to 5.25% on June 29, and the market reaction on June 29 and 30, perfectly illustrates the dilemma the Fed is facing.
Dollar decline
On the 29th, admittedly from a short-term extremely oversold level, all asset markets soared. (Even bonds staged a minor rebound.) However, the dollar fell on June 29 and 30 against gold and against the Swiss Franc, with the result that by the close on June 30, expressed in Swiss Francs and gold, the S&P 500 hadn't risen but, instead, had declined! A similar situation occurred in the last few days of July. At the time, stocks and even bonds rose, but the dollar declined.
Now, the financial sector bulls will argue that a weakening economy will benefit the financial sector, but I look at it differently. I think brokerage stocks could decline by as much as the homebuilders did over the last 12 months. Please note that homebuilding stocks are down more than the housing index because the housing index also includes other building related companies. Brokerage stocks seem to have completed a similar decline as homebuilders did between July and October 2005.
But why should brokers decline much more? On the first sign of economic weakness, the Fed will cut again interest rates, which will in the long term be even more inflationary. The point is that while the Fed has increased short-term interest rates since June 2004 and again on June 29, no real tightening has yet occurred, because if money was really tight, the dollar would have rallied and asset markets would have declined much more.
No way out!
Now, either the Fed allows debt growth to accelerate further in order to sustain growth in consumption (economic growth), which will lead over time to far higher inflation and interest rates, as well as stagflation, or the Fed actually begins to tighten in order to contain debt growth, which will lead, at best, to only a modest economic slowdown or at worst to a severe recession. But, it should be clear that neither option is particularly favorable for the over-leveraged financial sector.
A year ago, we turned very negative about the homebuilding sector. We noted at the time that despite positive earnings surprises and buoyant conditions in the housing industry, the shares of homebuilders had begun to decline. (They are now down 45% from their peak.)
The same seems to have happened recently with brokerage stocks. Despite very solid earnings gains in the first quarter, the stocks of brokers and investment banks have begun to weaken. Lastly, the flurry of high takeover offers among listed stock exchanges reminds me of the numerous takeovers we saw in the TMT sector prior to its March 2000 peak.
Beware booming asset markets!
The upside potential for equities appears to be very limited despite the likelihood that the Fed will not increase the Fed fund rate at its August meeting. There is much resistance for the S&P 500 between 1290 and 1320 and technical conditions are not supportive of a strong and sustainable rally.
Wednesday, August 23 - 2006 at 21:10
Dr. Marc Faber RSS feed
I also believe that investors will increasingly focus on corporate earnings, which are likely to disappoint, than on monetary policies.
For investors who must own equities, I would, as indicated in the past, be positioned in relatively depressed big market capitalization stocks, such as pharmaceutical shares including Merck (MRK) Schering Plough (SGP), Pfizer (PFE), Bristol-Myers (BMY), and Johnson & Johnson (JNJ). Equally, at this stage of the cycle, I would feel more comfortable owning Citigroup, a stock that has done nothing for the last few years, than brokerage companies whose fortunes are about to change.
But, for now, I maintain the view, which I expressed last month. Two-year US Treasury notes yielding close to 5% (yields have come down 35 basis points over the last two month) offer a valid alternative to asset markets for the next three months or so.
Since 1981, the long-term bull market in brokerage stocks has been accompanied by a secular decline in interest rates. But, lately, interest rates have been rising, and the only way they could resume their downtrend would be by very tight monetary policies, which would cool down the current synchronized global economic boom. In fact, the 17th baby-step increase in the Fed fund rate to 5.25% on June 29, and the market reaction on June 29 and 30, perfectly illustrates the dilemma the Fed is facing.
Dollar decline
On the 29th, admittedly from a short-term extremely oversold level, all asset markets soared. (Even bonds staged a minor rebound.) However, the dollar fell on June 29 and 30 against gold and against the Swiss Franc, with the result that by the close on June 30, expressed in Swiss Francs and gold, the S&P 500 hadn't risen but, instead, had declined! A similar situation occurred in the last few days of July. At the time, stocks and even bonds rose, but the dollar declined.
Now, the financial sector bulls will argue that a weakening economy will benefit the financial sector, but I look at it differently. I think brokerage stocks could decline by as much as the homebuilders did over the last 12 months. Please note that homebuilding stocks are down more than the housing index because the housing index also includes other building related companies. Brokerage stocks seem to have completed a similar decline as homebuilders did between July and October 2005.
But why should brokers decline much more? On the first sign of economic weakness, the Fed will cut again interest rates, which will in the long term be even more inflationary. The point is that while the Fed has increased short-term interest rates since June 2004 and again on June 29, no real tightening has yet occurred, because if money was really tight, the dollar would have rallied and asset markets would have declined much more.
No way out!
Now, either the Fed allows debt growth to accelerate further in order to sustain growth in consumption (economic growth), which will lead over time to far higher inflation and interest rates, as well as stagflation, or the Fed actually begins to tighten in order to contain debt growth, which will lead, at best, to only a modest economic slowdown or at worst to a severe recession. But, it should be clear that neither option is particularly favorable for the over-leveraged financial sector.
A year ago, we turned very negative about the homebuilding sector. We noted at the time that despite positive earnings surprises and buoyant conditions in the housing industry, the shares of homebuilders had begun to decline. (They are now down 45% from their peak.)
The same seems to have happened recently with brokerage stocks. Despite very solid earnings gains in the first quarter, the stocks of brokers and investment banks have begun to weaken. Lastly, the flurry of high takeover offers among listed stock exchanges reminds me of the numerous takeovers we saw in the TMT sector prior to its March 2000 peak.
