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Retirement – Are You Ready?

(January 28, 2007)

Dear Subscribers and Readers,

Note: The following commentary contains an announcement of our latest newsletter – “The Retirement Advisor” – which is a collaboration between fellow newsletter writers David Korn of and Kirk Lindstrom of

Ever since we started our regular commentary in late July 2004, there have been numerous times (whether it is in our commentaries or on our discussion forum) when we discussed the potential impact of the changing demographics picture on the stock market and other financial assets, not just in the United States but in other developed countries as well, such as Japan, Germany, the UK, France, and Italy.  We kicked off the discussion with our June 24, 2004 commentary (“Aging Demographics – The Other Super Secular Trend”), with a brief background on the rapidly deteriorating demographic situation in many countries in the developed world – concluding that not only will the “social welfare state” not survive in Western Europe, but that many countries in Western Europe (and Japan) will need to become much more competitive in order to compete in the world economy going forward, not only because of the younger (and growing) population in countries such as India, Pakistan, and Iran, but also because of their restrictive immigration policies.  To that end, the United States still has a significant edge.

Meanwhile, our August 29, 2004 commentary (“Economic Survival in the 21st Century”) discusses the three most important questions for financial survival in the 21st century – with those being rising energy prices (oil was at $45 a barrel at the time we penned that commentary), the need to understand your own psychological makeup and how it affects your investment decisions, and finally, the “super secular trend” of aging demographics, as well as the fact that life expectancy will continue to expand going forward.  Our last commentary on the topic (“Demographics do Matter”), published on August 11, 2005, summarizes the possible/probable scenarios on the demographical impact on the world's stock/financial markets, assuming that current savings and spending patterns remain the same.  The conclusions are scary.

That being said, however, there is no reason to expect that savings and spending patterns will remain the same going forward.  There is literally over a hundred variables which could tilt the outcome on the bull's side, such as higher-than-expected productivity growth, or a changing attitude of retirees – whether it is through working longer or taking more equity risk in their retirement portfolios (by definition, if a retiree knows that he is living longer than ever before, he will logically allocate more of his portfolio into equities).  Over the last decade, there has been a growing trend of older workers working past or seeking a new job after retirement – and this trend will continue to grow as the service sector continues to expand and as knowledge becomes ever more important.  In a manufacturing economy, older workers tend to be less productive than younger workers are, but the reverse is true in a service/knowledge economy.  Companies like Home Depot today are going out of their way to hire older and experienced workers.

Our mission has always been to help our subscribers navigate the treacherous financial world of the 21st century, starting with the plunging stock markets in 2001 to 2002, the subsequent cyclical bull in 2003 to today, rising commodity prices, and the proliferation of alternative asset classes such as hedge funds, private equity funds, infrastructure investments, and so forth.  For some people who are active traders or who spend a significant chunk of time managing and investing their portfolios, I believe you should read everything you can get your hands on – whether it is our commentaries or the numerous posts in our discussion forum.  For the majority of subscribers, your best bet would be to evaluate your risk tolerances, your time horizon, and your financial goals FIRST.  The best advice I could give you is to realistically evaluate your current financial situation and save for those goals – through prudent asset allocation and capital preservation.  Make no mistake: We have been 100% long in our DJIA Timing System since late September 2006, but we will not hesitate to go completely neutral or even go short should our valuation, sentiment, and breadth indicators tell us the market is making a significant top.

Again, for the majority of subscribers, your best bet to retire comfortably is through prudent asset allocation and capital preservation.  In this day and age, there are not many subscriptions that can fulfill that role – not the permabulls, permabears, or the majority of anyone in between.  To that end, I am very excited to announce the inaugural issue of The Retirement Advisor newsletter.  This is a brand new newsletter that is the result of a collaborative effort between myself, and fellow newsletter writers David Korn, editor of, and Kirk Lindstrom of

The Retirement Advisor was created to help individuals who are approaching or in retirement.   We are very proud of the newsletter that we have created, and believe that you may have an interest in subscribing.   Our inaugural issue is free to download to give you an idea of the type of content you will receive as a subscriber.  You can access the newsletter by going to where you will see a message at the top of the page telling you how to download your free issue.  Here is the url:

Alternatively, you can directly access the newsletter by clicking here.  I look forward to seeing some of your feedback as well as (hopefully) some support by subscribing!  Together, we can definitely navigate these treacherous financial waters just up ahead.

Before we continue with the rest of our commentary, let us do an update on the two most recent signals in our DJIA Timing System:

1st signal entered: 50% long position on September 7th at 11,385, giving us a gain of 1,102.02 points

2nd signal entered: Additional 50% long position on September 25th at 11,505 giving us a gain of 982.02 points

As we discussed last week, some of our readers have specifically asked when we would exit our long positions in our DJIA Timing System – given the “profits” that we have made over the last four months or so.  My answer: The U.S. stock market remains in a cyclical bull market, and until we see signs of a significant top, we are not scaling back just yet.  Whether we will just scale back to a 50% long position or go short – this will depend on my future convictions.  For now, those convictions are firmly in place for a continued run in this bull market.  If, however, the Dow Industrials rallies 500 points within the next week or so (on weak breadth or weak volume), then we will scale back our long position to a 50% long position in our DJIA Timing System.  Readers please stay tuned.

As of Sunday afternoon on January 28, 2007, we are still fully (100%) long in our DJIA Timing System and is still long-term bullish on the U.S. domestic, “brand name” large caps – names such as Wal-Mart (which is now making a serious effort in the Chinese market by acquiring Taiwanese-owned Trust-Mart and naming a more aggressive new head of operations in China), Home Depot (which is now also expanding in China), Microsoft (I expect Vista to rake in the cash over the next couple of years), IBM, eBay, Intel (Intel is now close to two generations ahead of AMD), GE, and American Express. We are also bullish on Yahoo, Amazon, and most other retailers as this author believes that “the death of the U.S. consumer” has been way overblown.  We also believe that the combination of Microsoft Vista, Office, commercialization of the solid state hard drive, and commercialization of solar energy will be a boon to semiconductor companies, such as SanDisk, Samsung, and Applied Materials.  Moreover – judging by what we saw at the Consumer Electronics Show in Las Vegas a couple of weeks ago, there is a good chance we are now seeing a revival of Sony as a great global corporation (barring a global economic recession, the rest of this and the next decade will be known as the age of the emerging market consumer).  We also continued to be very bullish on good-quality and growth stocks in general.

In the short-run, the narrowing breadth in the market continues to bother me, but as long as folks are selective with their individual stock picks (or as long as they are invested in a large cap index such as the S&P 500 or the Russell 1000 index), the rally should still have further to go before fizzling out.  For now, I believe the upcoming week should be okay for the stock market.  Watch out for February, however, as it not only has been a historically seasonally weak month, but the February 9 to 10th weekend is also time for the G-7 meeting – which could potentially act as a catalyst for a stock market correction (e.g. if the governments of the G-7 decides to coordinate a rise in the Yen – thus prematurely ending the Yen carry trade).  As for the global stock market rally we have been witnessing over the last few years, I also believe that rally will narrow going forward – with the U.S. stock market being the stand-out.  I also believe that energy has made a good short-term bottom, and that while energy should continue to struggle this year, the secular energy bull should remain intact – as long as there is no significant breakthrough in battery or solar energy in the next few years.

Speaking of the Yen carry trade, the rubber band is now getting very overstretched, as exemplified by the record short position held by the large speculators (and record long position by the commercials) of Yen futures contracts on the Chicago Mercantile Exchange.  At this point, however, small speculators are still neutral, with 52% of them bullish.  Once small speculators (who historically have been the greatest contrarian indicators) go net short, then it may be time to start thinking about going long the Yen for the inevitable short squeeze.  Following is the relevant chart from showing the net positions of the large speculators, the small speculators, the commercials, and the total open interest of the Japanese Yen futures contracts:

Net positions of the large speculators, the small speculators, the commercials, and the total open interest of the Japanese Yen futures contracts

Besides the Yen carry trade, there is another market we are keeping watch on – and that is, China.  For subscribers who have been keeping track of our discussion forum, you may know that I am getting increasingly weary of the Chinese market.  There is no doubt that the Chinese market – most notably the financial sector – is now in a bubble (ICBC now has a market capitalization of more than $250 billion, which makes it the second largest bank in the world in terms of market cap and trailing Citigroup by less than $20 billion).  Let us now take a look at the market capitalization of the Shanghai Stock Exchange.  Following is the monthly chart showing the market cap of the Shanghai Stock Exchange from January 1995 to November 2006:

Market Cap of Shanghai Stock Exchange (US$ millions) (January 1995 to November 2006) - Market cap of Shanghai Stock Exchange most recently surpassed US$900 billion - doubling in less than a year - but amazingly, the Shanghai Composite has risen another 40% since the end of November 2006!

The market capitalization of all the stock exchanges in China has surpassed $1 trillion at the end of November 2006 – a double in less than 12 months!  Moreover, as I am finishing this commentary, the Shanghai Composite is up another 2%, and 40% higher than the November closing highs.  Official data has not been released yet, but it looks like that the market cap of the Shanghai Stock Exchange could easily surpass US$1.25 trillion by the end of this month, or in other words, a triple in just over a year.  The combined market cap of the Shanghai and the Shenzhen securities exchanges is now approximately 55% of China's GDP – which is about the same as the U.S. average for the last 80 years (but still trailing India's 100% number).  The trailing P/E is now 33.  Is the Chinese stock market now in bubble territory?  You bet – but as in all liquidity-driven booms, it will only end when liquidity disappears.  And given the recent recapitalization of the Chinese financial sector (with the $70 billion of new money coming in from the recent spate of IPOs to multiply with), and given that many foreign investors are now obsessed with investing in China, there is no question this will go on for the foreseeable future – possibly (and probably) until the Beijing Olympics in September 2008.

Look – it does not take much to move a $1.25 trillion market.  From the end of September 2006 to the end of 2006 (in three months time), the market cap of the NYSE Composite increased from $18.7 trillion to $20.2 trillion – an increase of $1.5 trillion.  During the same time span, the market of the S&P 500 increased by $700 billion.  Given that China is still growing at a 10% pace, a couple of 25 basis point hikes will definitely not slow investments and potential overcapacity.  Moreover, it now looks like that the U.S. economy has recovered from its slowdown during the third quarter of last year – paving the way for further investments in Chinese manufacturing and construction going forward.  Short China at your own peril – especially since we are now in the very emotional/possible “blowoff” stage. 

Going forward over the next couple of weeks and leading into the G-7 meeting on February 9th to 10th, I will provide more frequent updates on where I think the stock market is heading – starting off with this week's mid-week commentary.  For now, let us just wait for the market to give us a better indication of where it is heading (Treasuries may be a good leading indicator, as the Barnes Index is now getting up there in terms of valuation).  Let us now discuss the most recent action in the U.S. stock market via the Dow Theory.  Following is the most recent action of the Dow Industrials vs. the Dow Transports, as shown by the following chart from October 1, 2003 to the present:

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (October 1, 2003 to January 26, 2006) - For the week ending January 26th, the Dow Industrials declined 78.51 points while the Dow Transports declined 146.29 points. While the latest decline of the Dow Industrials is probably no big deal, readers should keep an eye on the Dow Transports - as its failure to surpass its November 16th high of 4,881.57 is definitely an ominous sign. More ominously, the market is continuing to narrow each passing day, and my guess is that the rally from July will only be sustainble in nature should the Dow Transports close above its November 16th high of 4,881.57 soon. Given that February is a seasonally weak month, subscribers should now temper their bullishness.

For the week ending January 26, 2007, the Dow Industrials declined 78.51 while the Dow Transports declined 146.29 points – with the latter failing to surpass its closing high of 4,881.57 made on November 16, 2006.  Readers should therefore continue to keep an eye on the Dow Transports, since any further weakening could be a precursor for more weakness in either the Dow Industrials or the S&P 500.  Given that February is a seasonally weak month, subscribers should now temper their bullishness – unless they have a lot of conviction on their individual stock picks.  We also continue to remain 100% long in our DJIA Timing System, although readers should not be surprised if we choose to lighten down in the days leading to the February 9th to 10th G-7 meeting (but only if the Dow Industrials rises substantially between now and the G-7 meeting).

I will now continue our commentary with a quick discussion of our popular sentiment indicators – those being the bulls-bears percentages of the American Association of Individual Investors (AAII), the Investors Intelligence, and the Market Vane's Bullish Consensus Surveys.  The latest four-week moving average of these sentiment indicators bounced from an extremely oversold level of 1.7% in late June to 27.7% for the week ending January 26, 2007.  Following is a weekly chart showing the four-week moving average of the Market Vane, AAII, and the Investors Intelligence Survey Bulls-Bears% Differentials from January 1997 to the present week:

Average (Four-Week Smoothed) of Market Vane, AAII, and Investors Intelligence Bulls-Bears% Differentials (January 1997 to Present) - For the week ending January 26, 2007, the four-week MA of the combined Bulls-Bears% Differentials decreased from 30.3% to 27.7%. The 30.3% reading last week was the highest reading since the week ending January 20, 2006. Sentiment levels are now getting close to the extremes we have witnessed over the last few years - so it is now time for the bulls to be careful. In the meantime, however, the intermediate trend is still up but breadth is getting narrower by the day. It is now time to be selective with your stock pickings.

As mentioned on the above chart, the four-week MA of this indicator has been rising consistently since early August – although it did dip slightly from mid November to mid December.  Subscribers should note that last week's reading – at 30.3% - was the highest reading since the week ending January 20, 2006, and is thus now very overbought.  That being said, the uptrend still remains for now – but don't be surprised if we lighten down on our long position in our DJIA Timing System should the Dow Industrials rise a quick 500 points leading up to the G-7 meeting in February 9th to 10th (let's just say that this author is scared to death of a possible dislocation if the G-7 finance ministers decide to do something about the lowly Yen).

I will now close out our commentary by discussing the latest readings of the ISE Sentiment Index.  For newer subscribers, I want to again provide an explanation of ISE Sentiment Index and why it has turned out to be (and should continue to be) a useful sentiment indicator going forward.  Quoting the International Securities Exchange website: The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.

When the daily reading is above 100, it means that more customers have been buying call options than put options, while a reading below 100 means more customers have been buying puts than calls.  As noted in the above paragraph, the ISEE only measures transactions initiated by retail investors – and not transactions initiated by market makers or firms.  This makes the indicator a perfect contrarian indicator for the stock market, and it has had a great track record so far according to the following Wall Street Journal article.  Following is the 20-day and 50-day moving average of the ISE Sentiment Index vs. the daily S&P 500 from October 28, 2002 to the present:

ISEE Sentiment vs. S&P 500 (October 28, 2002 to Present) - More consolidation this week. After rising relentlessly from late September to mid November, the 20 DMA of the ISEE Sentiment pulled back from mid November to mid December and both the 20 and the 50 DMA are now once again consolidating at around the 140 level. While the ISE sentiment is not that overbought (suggesting that stocks should continued to be purchased on the dips), that doesn't mean the S&P 500 may not correct from current levels.

As one can see from the above chart, the 20-day moving average of the ISE Sentiment has been rising relentlessly since late September (bottoming at 101.5), after dipping slightly from mid November to mid December, has been, and is (along with the 50 DMA) still consolidating in the 140 area.  While the latest pullback and consolidation in both the 20 and 50-day moving averages is definitely “healthy” for bullish sentiment, there is no guarantee that the stock market will “take off” from current levels.  On the contrary, the 20-day moving average has now sunk below its 50-day moving average, which could possibly be a precursor for some kind of stock market correction.  That being said, any subsequent correction from current levels should be a relatively shallow one, and we should see higher prices again later this quarter.  We are still not close to exhaustion just yet.

Conclusion: As the baby boomers start retiring, it definitely pays to study what they are doing – and if you are a baby boomer yourself, it is even more imperative to study what others are doing and to start building a nest egg in preparation for some enjoyable years as you get older, if you have not already done so.  With the death of the defined benefit pension plan industry, and with the gross inadequacy of social security benefits, it is more important than ever to learn how to manage your own finances, or to at least gain a good understanding of it if you have left it to someone else.  Both and is here to help.

As for current events in the world's financial markets, this author is currently watching both the Japanese Yen (especially leading into the February 9th to 10th G-7 meeting), as well as the Chinese stock market and real estate markets.  While the rubber band on the Yen is now getting heavily overstretched, this is not necessarily the case in China, as there is still plenty of liquidity out there interested in finding a home in the Chinese financial markets.  The latest boom or bubble in the Chinese financial sector or stock market can only end in exhaustion, and given that the market capitalization of the Chinese stock markets is only a mere $1.25 trillion or so, there is still plenty of room for it to rise in a liquidity driven environment.

And finally, based on all the indicators I am currently watching (monetary, liquidity, fundamental, technical, valuation, etc.), the intermediate uptrend in the U.S. stock market remains intact.  However, breadth has been noticeably weakening, and given that February has historically been a seasonally weak month for the stock market, I would not hesitate to scale back our 100% long position in our DJIA Timing System should the need arises.  Subscribers should note that I am continually on the look-out for possible read flags, such as what we discussed last week regarding the S&P 600 A/D line.  For now, we remain 100% long in our DJIA Timing System, although we may shift to a less bullish stance of 50% long should the Dow Industrials experience a quick rise to 13,000 or so (on weak breadth or weak volume) in the short-run.  Readers please stay tuned.

Signing off,

Henry To, CFA

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