Where Have All the Stock Market Bulls Gone?
(June 26, 2008)
Dear Subscribers and Readers,
For subscribers who may have missed the real-time email sent to your inboxes today (please let us know if you did not receive it), we decided to add to our 50% long position in our DJIA Timing System and bring it up to 100% long earlier yesterday at a DJIA print of 11,863. While our signal was a little bit early, I fully anticipate it to be profitable – for many reasons including 1) the unprecedented amount of investable capital sitting on the sidelines, including in US money market funds, sovereign wealth funds, and private investment partnerships such as distressed debt funds, private equity funds, etc., 2) the dark pessimism that is not only enveloping the US, but also the global investment world as well, 3) our belief that crude oil prices will correct over the next several months, 4) very decent valuations in the US stock market, especially given the low U.S. Dollar, and 5) the fact that the Bernanke-led Fed is still more prone to adopting “growth policies” as opposed to a hawkish policy designed to bring down headline inflation.
Speaking of headlines, following is a sampling of notable headlines over the last few days:
Missing from the headlines this week, however, is the latest cover story on the “future of energy” and a detailed discussion of various credible alternative energy resources from the Economist. I highly suggest reading all the articles in full (over a dozen pages in all) – but the message is clear: For the first time ever, there are many credible alternative energy resources – along with the technology to deliver them to the transportation sector – looming over the horizon, especially with crude oil prices above $130 a barrel. Also missing is welcomed news from the geopolitical front, as Shell reported that its 225,000 barrels/day offshore facility at the Bonga Field in Nigeria is now back online after a six-day outage. Finally, the latest OECD inventories for crude oil (as of the end of the first quarter) are running at about 53 days of supply, or right at its five-year average:
Given the dramatic rise in oil prices and the demand destruction we've witnessed since the end of the first quarter, it is reasonable to assume that OECD inventories have ticked higher over the last three months. This was finally manifested in yesterday's unexpected build in crude oil and distillate inventories in the US – despite the fact that US crude oil imports have declined by an average of 600,000 barrels per day on a year-over-year basis over the last three weeks (as shown in the following table courtesy of the EIA)!
Coupled with the severe cuts in fuel subsidies in many emerging market countries (including China and India) that we discussed in last weekend's commentary – as well as a continued slowdown in global economic growth – my sense is that crude oil prices will continue to correct over the next several months. This will be supportive for both the US Dollar and US equities, as well as the currencies and stock markets of many Asian (both developed and emerging) countries (note that a $20 move in crude oil prices is equivalent to around 1% of US GDP on an annualized basis given our current consumption rates).
However, as we mentioned in the title of this commentary: Where have all the stock market bulls gone?
While the sentiment of stock market investors is not as pessimistic as where it was back in mid January and mid March, there is no doubt that widespread pessimism is now more persuasive in mainstream society than it was relative to three months ago. This widespread pessimism is evident in the latest readings of the Conference Board's Consumer Confidence Index. Newer readers may not know this, but the Conference Board's Consumer Confidence Index has acted as a very reliable contrarian indicator from a historical standpoint. While it has always been significantly better in calling bottoms during a bear market, it has also worked well in calling for significant tops during the 2000 to 2002 cyclical bear market – with one of its most successful contrarian signal coming on March 2002 at a Consumer Confidence reading of 110.7 and a DJIA print of 10,403.90. During the subsequent four-and-a-half months, the DJIA declined more than 2,500 points. More recently, the Consumer Confidence Index gave us a “strong buy” signal during October 2005, and foretold the beginning of a bear market with its “rounding top” during the first half of 2007. Following is a monthly chart showing the Consumer Confidence Index vs. the Dow Industrials from January 1981 to June 2008:
The last time the Consumer Confidence Index gave us such an oversold reading was at the end February 1992, when it hit a reading of 47.3 (compared to today's 50.4 reading). In fact, this month's reading of 50.4 is the third most oversold reading going back to January 1981 (and the fifth most oversold reading ever). Such readings have generally been very favorable for equities over the next 3, 6, and 12 months, or at the very least, have meant limited downside over the same timeframes (I like these odds). Interestingly, the “Expectations Index” is now at an all-time low going back to the inception of the Consumer Confidence Index in 1967! The fact that these readings are now at a historical oversold level suggests that subscribers who are still cautious should start to think about implementing long positions in the stock market, if you have not done so already. I also continue to like Japanese equities as well as both US technology and Asian technology stocks, in general.
Henry To, CFA