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Quick “Market Thoughts” for the Upcoming Week

(November 25, 2007)

Dear Subscribers and Readers,

I hope all of our US subscribers had a great Thanksgiving.  The shoppers in us certainly had – as according to ShopperTrak, retail sales on “Black Friday” increased 8.3% from last year, versus a projected increase of only 4% or so.  However, despite this optimistic reading, it is important to keep in mind a few things:

  1. “Black Friday” is by no means a benchmark for December retail sales.  It is important to keep in mind that the US also experienced a strong “Black Friday” last year, but retail sales ended up struggling for the rest of 2007, despite a brief surge immediately before and after Christmas.  Given that many stores had opened earlier this year, and given the discounts we experienced, it is not a stretch to imagine that a significant part of “Black Friday” sales had “cannibalized” sales for the rest of this weekend and into December.  Moreover – at this point – it is still too soon to tell the profit margin impact of the discounts.  We will find out more over the upcoming few days, and in particular, on December 6th , when many retail stores report same-store sales for November.

  2. Credit card companies, such as Capital One and Discover Financial, have been seeing some evidence of deteriorating quality of their credit card portfolios over the last few months.  Moreover, they now project charge-offs to increase for 2008.  While the projected 4.25% to 5.25% charge-off rates are still significantly lower than what we witnessed during the 2001 to 2002 period (when charge-offs at many major card companies approached 7%), there is no doubt that consumers are now starting to hurt.  The mind-blowing “Black Friday” sales may just have been the “final blowoff” for retail sales this year.

  3. It is important to remember that retail sales – even on a real-time basis – are still coincident economic indicators.  As tracked by both the ECRI and the Conference Board, US leading indicators are now signaling a significant slowdown in the US economy over the next 3 to 12 months.  This is also being confirmed by the OECD leading indicators.  Moreover, it is important to remember that the latest indicators, in particular the Conference Board and the OECD indicators, had not taken into account the stock market decline over the last few weeks.  Finally, as discussed in our November 18th commentary, the OECD leading indicators for much of the world, especially in Western Europe and Japan (and even in South Korea) are now dramatically slowing down – which is being confirmed with the decline of copper and base metal prices, as well as the significant weakness of the “commodity currencies” in recent weeks, such as the Australian and the Canadian dollar.  In other words, many US consumers may not realize it yet, but unemployment levels (especially in the financial sector) and credit tightening should continue to rise over the next 3 to 12 months.

As can be witnessed in the latest general elections in Australia, change is in the air.  An incumbent Prime Minister who presided over one of the great growth periods in Australian history had not only been swept from office, but is also on the verge of losing his seat in Parliament.  Now that the world has gotten a taste of unprecedented economic growth over the last 5 years, we want more.   Australia wants a set of industrial relations laws that are more labor-friendly, as well as being proactive on the issue of climate change and withdrawing her troops from Iraq .  Here in the US , the message for the 2008 Presidential elections has generally gotten more populist in nature over the last 12 months.  If it hadn't been for the continued decline in the US Dollar Index, there would be no doubt that politicians would be calling for trade tariffs after 2008.  Finally, companies are now being squeezed on all sides – whether it is commodity prices, wages, or a continued lack of pricing power in value-added consumer goods and services.  Given that US profit margins are now near an all-time high, it is probably not a good bet to look for a continuation of the double-digit earnings growth that we have witnessed since the end of 2002.

As for the US stock market – given the “ramp” that we witnessed last Friday, our “sell condition” that we discussed in our latest mid-week commentary is no longer valid .  Rather, we will continue to take the current market one day at a time.  I will provide a more comprehensive update in our mid-week commentary on Thursday morning.

Finally, as pointed out by one of our posters, mtvk, on our discussion forum, the Shanghai Stock Exchange Index is now tracing a potential “heads & shoulders top.”  A confirmation will occur if it declines further over the next few days on “significant volume.”  We are still not there yet.  Given the stock market and economic weakness in the US, Japan, and Western Europe, and given the continued monetary and credit tightening in China (not to mention the blatant overvaluations and speculations), my inclination is to look for this “heads & shoulders” top in the Chinese market to eventually be confirmed over the next couple of weeks (following is the relevant chart showing both the value of the index and the trading volume on the Shanghai Stock Exchange).

Shanghai Stock Exchange

Signing off,

Henry To, CFA

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