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Retail Sector Update

(October 13, 2004)

Update on Mr. John Mauldin of www.frontlinethoughts.com: I got to meet Mr. John Mauldin here in Houston last Friday and we had a great and pleasant conversation.  He is a genuine nice guy and I am glad that I was able to meet him.  I have recorded this “interview” with him and I also intend to follow up with him with more questions/clarifications in the coming days.  Readers please stay tuned – I will post this “interview” up on our website once we get final approval from Mr. John Mauldin.

Dear Subscribers and Readers:

I apologize but I am going to skip the individual stock watch again in favor of a short-term update on the retail sector.  I have not really written anything that pertains specifically to the retail sector for four months – given the importance of this sector and the fact that the stock market is at crossroads right now, I believe that an update on this sector is in order.

To put it briefly, the retail sector is also now at crossroads.  Given that long-term interest rates remain low and home refinancing remains brisk, one would think that the average American consumer will find some capacity to continue spending.  On the other hand, there are high oil and natural gas prices (which acts as a tax for American consumers), along with the fact that housing prices have been showing some signs of weakening in selected cities within the country (the homebuilders tanked again as a group today).  Given that consumer spending makes up more than two-thirds of total GDP, this could be a very important and insightful (hopefully) update.

I will begin this commentary by showing my readers a weekly relative strength chart of the RTH (the American Exchange Retail Sector HOLDR) vs. the S&P 500.  Please note that the relative strength of the RTH vs. the S&P 500 has served as a pretty good leading indicator of the stock market for the last few years (ever since it was incepted):

Relative Strength (Weekly Chart) of the Retail HOLDRs vs. the S&P 500 (May 2001 to Present) - Relative Strength of the RTH is again trying to break out of its recent trading range - a decisive breakout here would be very positive for the stock market.

Currently, the relative strength of the RTH is trading at the top of its trading range – a trading range that began more than seven months ago.  Is the relative strength of the RTH on the verge of breaking out or is it just another head fake?  A decisive breakout of this trading range will have hugely positive implications for the stock market in the coming weeks and months, while another correction will probably not go down well with the market.

The following two-year chart of the RTH (in absolute price terms) also clearly shows the indecisiveness of the retail sector:

Two-year

The 50-day moving average of the RTH is still below its 200-day moving average, although the daily price is still above those two moving averages.  Please also note that the RTH has also been stuck in a trading range for the last eight months or so.  While the two above charts are clearly saying “indecisive,” it is important to keep track of the trend of the retail sector going forward.  From time to time, I will post an update on the retail sector but I urge my readers to also keep an eye on this sector on at least a weekly basis.

Important update: The Investors Intelligence Survey has just been released and it shows another uptick in bullish sentiment concurrent with another downtick in bearish sentiment.  From a contrarian standpoint, this is bearish, especially in the face of declining stock prices that we have seen over the last week or so:

DJIA vs. Bulls-Bears% Differential in the Investors' Intelligence Survey (January 2003 to Present) - This week's increase of the Bulls-Bears% Differential in the Investors Intelligence Survey from 28.4% to 30.6% represents the seventh consecutive week where we registered an increase yet again.  The latest increase coming in the face of a further decline in the market signals futher technical deterioration.

Bottom line: Readers should keep track of the retail sector via the RTH in the weeks ahead since it has acted as a pretty reliable leading indicator over the last few years.  Given the current bearishness of this author (high energy prices and the fact that I believe consumer confidence will need to have another downtick before I think a sustainable bottom may emerge), however, it is difficult to see relative strength of the RTH vs. the S&P 500 breaking out here, but stranger things have happened (especially since this is supposed to be a leading indicator).  In the meantime, given the high volume today and given the technical deterioration that we are still witnessing in the sentiment surveys, I think the market will experience more of a correction here before a bottom can be called.  For now, we remain 25% short in our DJIA Timing System.

Signing off,

Henry K. To, CFA

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