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Quiet December?

(December 7, 2003)

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The Dow Industrials added 84 points last week, the Dow Transports declined 11 points, the NASDAQ Comp declined 23 points, while the S&P 500 added 3 points.  The S&P 400 mid caps and the S&P 500 small caps, meanwhile, declined 5 points (1%) and 3 points (slightly over 1%), respectively.  The more conservative and the large cap stocks outperformed this week, reversing a trend that we have seen for some time.  One obvious reason for this out-performance is the recent lack of insider selling of the large caps, as the insider sell-to-buy ratio declined from 109 in November to only 17 so far this month.  The current insider sell-to-buy ratio for mid caps is at an unbelievable number of 1,244 while the ratio for small caps is 37.

Breadth, however, remains okay, as evident by the following cumulative A/D lines on the NYSE and the NASDAQ:

Cumulative A/D lines on the NYSE and the NASDAQ

While the NASDAQ remains relatively weak, the above charts do not show a deviation from recent experience of higher highs (and a slow grinding up, if you will) - thus showing no signs of a top.  Of more significance is the number of new 52-week highs on the NYSE.  As noted by Lowry's, the number of new highs on the NYSE established a new high of 627 on Monday, December 1st, surpassing the previous high in early June.  Since the number of new highs typically peak six to nine months before the top of the major stock market indices, the breadth indicators are implying that the current rally still has some ways to go.

Under classic Dow Theory, when both the Dow Jones Industrials and the Dow Jones Transports diverge in action, it is taken as a warning sign that the current trend may be over.  Note that there was a divergence last Thursday, along with a total of four daily divergences during the month of November.  Also note that the last closing high of the Dow Jones Industrials was last Thursday at 9,930.82, while the Dow Jones Transports had not bettered its closing high since November 7th (this high currently stands at 2,979.29).

While this may sound troubling to some of us, that fear can somewhat be dispelled by examining the following chart:

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (January 1, 2003 to December 5, 2003)

While this divergence looks dramatic, please note that this recent action has not been too different from the recent action of the last eight months.  The uptrend in both indices remains cautiously intact.  However, I would be more careful if the Dow Transports drop below its recent closing low of 2,845.31 established on November 21st or if the public starts getting more complacent (such as another huge speculative upsurge in internet, biotech, nanotech stocks, or even space tech stocks - check out the action on SPAB last Thursday in light of the Bush announcement to jump star the space program again, dear readers).

The money continues to come in, as indicated by AMG's report of $2.6 billion into equity funds for the week ending last Wednesday.  While insider selling remains generally high, the high amount of mutual fund inflows and the lack of offerings were able to keep the market afloat for the last few months, and there is no sign that the inflows are about to stop.  This is consistent with the sluggishness of both the buying power and the selling pressure index as constructed by Lowry's.  My current guess is that the market should stay fine at least until the end of January.  December is shaping up to be a quiet month.  Come January, year-end bonus money should be coming into the market.  At the same time, insider selling is restricted until after the report of fourth-quarter earnings.  February, however, may be a different story.  Offerings are also starting to creep back into the market, as exemplified by an announcement of a GE filing for a $5 billion and a JNPR filing for a $1 billion shelf offering last week.  The number of offerings should continue to increase as investors get more complacent.  Ironically, because of this, the author is suggesting that the Google IPO (rumored to be held in April of next year) may signal the peak of the bear market rally (one which will "suck up" all the remaining capital out there, if you will) instead of the rebirth of a strong IPO and an overall strong market, as suggested by most of the "experts" out there.

The short-term movements in the markets are inherently difficult to call but it looks like a short correction may take place here.  The following chart of the McClellan Oscillator may help to give the reader a better perspective:

NYSE McClellan Oscillator (Ratio Adjusted)

The value of the NYSE McClellan Oscillator is sitting right at +5, which means the majority of the stocks on the NYSE are still going up - barely.  Once it hits zero or below, chances are that the momentum will favor the downside.  From a short-term perspective, we are now at a critical juncture.  If the McClellan Oscillator turns negative, then the action of the stock market for the next couple of weeks may be favored to the downside.  Conversely, if the McClellan Oscillator can stay positive, then there should be more upside - possibly also negating the potential "heads and shoulders" pattern on the NYSE Summation Index, which is a major positive step for the continuation of the current stock market rally.

Speaking of mutual fund inflows -- of some significance (especially to gold investors) is this statement from AMG: "Gold & Natural Resources funds report an inflow rate of $142 million/week (as measured over four weeks), the highest rate on record."  Could it be that the current rally on the HUI or XAU is getting ahead of itself?  We do not know, but we know that gold is in a primary bull market and that the US$ is still making new lows as this is being written.  Long-term investors should continue to hold.  It is interesting to note that Hong Kong Tycoon Li Ka-Shing (the wealthiest person in Hong Kong and one of the richest people in the world with an estimated net worth of nearly US$8 billion) has now established a gold trading company and trading platform, both of which is designed to compete with the local gold exchange.  We may look for Warren Buffet or George Soros over here at the States when seeking investment advice, but if you're in Asia or mainland China, Li Ka-Shing should be one of your first people to turn to.  Like all other great businessmen or investors, Li Ka-Shing has a firm grasp of the big picture and a bold and clear vision of what the future holds (the same cannot be said for his son, Richard Li).  He would not even think of venturing into the gold trade unless he thinks the trading of it (and hence, the price) will get very popular.

Just what is the big picture here, one may ask?  And what separates the person who can recognize it to the person who cannot recognize it?  I will first attempt to answer the latter.  Ordinary people are so engrossed in the day-to-day events that they don't take the time out to think about the long-term trends, nor do they want to independently think about them and learn about financial or political history.  They do not have a grasp of major events unless they are spoon-fed by the popular media (or in some cases, business professors who never made money in the stock market), or only in retrospect.  I recall the early days of 2000.  It was obvious to me that the greatest bull market in history was ending at the time, and I sent a series of emails to my closest friends and associates stating my reasons why, with the final email going out on April 2, 2000, two days before the earth-shattering 15% intraday decline of the NASDAQ market.  Probably less than 20% of them listened to me at that time, and I stood in awe of their extreme complacency.  I just could not understand why they did not grasp it.  After the events that transpired on April 4, 2000, it was obvious to me that no amount of money in the world can make the NASDAQ, S&P or the NYSE A/D line (the latter of which peaked as early as April, 1998) regain their former highs again.  And yet, most people still would not believe.  To them, it was only clear in retrospect.

I also recall the days of late 2000, with the gold price trading at $275, the Philadelphia Gold and Silver Index (XAU) at 40 (now at 111.33) , and the American Exchange Gold Bugs Index (HUI) also at 40 (now at 252.60), the latter two both trading at all-time lows.  The fundamentals for gold were also bullish at the time, with the stock market gripped in a huge bear market and with the U.S. running huge deficits month after month.  I was a frequent visitor to the message boards of the major gold mining stocks at that time, and I noticed that long-term gold bugs at that time were literally capitulating, with some of these people actually selling gold or gold mining stocks which they have held for over a decade.  If this was not the bottom of the gold bear market, what is?  I recognized this at the time, and made a suggestion to some of my friends and associates to purchase some gold and silver.  Of course, other people taunt me at the time, but these purchases have proved to be extremely rewarding.  Unfortunately, most investors today still do not recognize that there is a primary bull market in precious metals (and still ridicule us)

A funny story is a forwarded email that I received a couple of weeks ago from a former coworker of mine.  This email was written by a UT business professor, who criticized Warren Buffet's position on the U.S. deficits and his subsequent bearish position on the US$.  In his email, he belittled the people who warned about Japan "owning America" in the late 1980s (at the same time, neither suggesting that he did not have the same view at that time) and the same people who warned that Reagan's economy policy was leading us into disaster.  He basically stated that well, if this calamity has not happened by now, then it will never happen.  Pure BS, I say.  My response was basically this:

The period from the 1980s to today is only a little over 20 years.  You can't extrapolate recent experience (the last 50 years or so) into the indefinite future.  Look at a time line from the peak of the Roman Empire to its decline and final wipeout.  Did it only take 10 years?  Or 20 years?  The answer is "no."  If a Roman citizen even suggested that the Empire's arrogance, lavishness, laziness, and excessiveness (and the debasement of the currency) would lead to the ultimate collapse of the Roman Empire some time after its peak in power, then he or she would probably have been hung.  A collapse of the economy or decline of an empire takes a long time and only a few visionaries can really catch it.  Buffet is one example.  Look at the experience of Britain.  Its power peaked in the 19th century and it took over 100 years for it to lose its world power status and finally be relegated to a second class country.  The Japanese and Chinese are now the largest and second largest (respectively) of Treasury bond holders.  Foreigners today own 46% of all treasury bonds.  And like I have said before, the debt to GDP ratio is now over 300%.  Make no mistake, Japan and China does own America.  We are at their mercy.  If they choose to sell even a small portion of their U.S. Treasury bonds, then interest rates will go sky high and no amount of intervention by Alan Greenspan will be able to stop it.  And more:

This is something that hardly anyone can grasp.  I find this quite shocking since it is such a simple concept:

The current account deficit does not matter until it does.

One can put everything on credit and pay the minimum payments and rack up more debt in the meantime.  The United States is just doing it at an infinitely slower process.  Buffet tried to simplify it so laymen can have an attempt in understanding it, and yet this professor at UT is criticizing him for it.  Deny it all you want.  I was labeled as a "chicken little" when I told everyone to sell their stocks in spring of 2000.  Did this professor ever "help" his readers make money or help them make economically sound decisions?  The answer is probably a resounding "No."  If you told me that he warned his readers to get out of stocks in January to March 2000, then maybe he will sound more convincing.  If you told me that he bought gold or gold mining stocks in the winter of 2000, then maybe his arguments may actually be sensical.  In fact, he probably has 0% of his assets in gold and 0% of his assets in foreign currencies and does not even know that there is a primary bull market in gold.

He then stated that Buffet should be more concerned with the growing asset bubble in China, our blocking of agricultural imports, and the poorly thought-out steel tariffs.  I agree with the latter two but while there may be a bit of a bubble in China right now, this is nothing compared to the stocks, housing, debt, and derivatives bubbles we have in the U.S.  Don't say we didn't warn him.  One day, he will wake up and find his house taken over by a Chinese bank and his daughters and granddaughters being married off to China or India and will never see them again.  Maybe he will then change his view.

So whose advice would you take?  Buffet, the richest man in America (Bill Gates has now been surpassed) or a professor from UT Austin who really does not have much real-world experience compared to Buffet, Soros, Sir John Templeton and Jim Rogers (all who share the same stance).  And finally, to quote John F. Kennedy from his speech at Rice Stadium on September 12, 1962: "William Bradford, speaking in 1630 of the founding of the Plymouth Bay Colony, said that all great and honorable actions are accompanied with great difficulties, and both must be enterprised and overcome with answerable courage."

In doing what he did and making it public, Buffet has chosen the most difficult path, for obvious reasons.  The professor at UT has not.  It is easy to sit back and go along with the consensus, isn't it?  Wasn't it easy to be bullish in spring of 2000?  Isn't it easy to be bullish on America and the US$ right now?  People will come and slap you on the back and tell you how "patriotic" you are.  What Buffet stated in his article is not and will never be the popular view, even if he is proven to be correct.  By stating the facts and bravely speaking out against the consensus, Warren Buffet is doing a great service to America.  The professor has chosen the easy path, one which is stained with great dishonor and one which will ultimately be a great disservice to America.

Today's big picture is: There is a primary bear market in the US$, U.S. stocks, and U.S. bonds.  There is a primary bull market in precious metals and commodities.  Sell all the former and buy all the latter, hold them for five to ten years and I bet you will make a killing in them.  At some point down the road, we will see who was right.

More: In light of President Bush's plans to jump start the space program once again, I recommend my readers to listen to the following speech delivered by John F. Kennedy at Rice Stadium on September 12, 1962.  It is an awesome speech which I think should be required listening in all schools and colleges today.  It is in very good quality and is actually in color.  You can find it at the following link:

http://www.rice.edu/webcast/speeches/19620912kennedy.html

Henry K. To, CFA

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