September Sector Check

Stock market trend: Up.  Watch for pullback

Market Pulse

This week’s newsletter must be viewed as a video at theStreet.com.  In that video, I do a very interesting September “sector check” to handicap the prospects that a likely September pullback will spell the end of the 2009 bull market (The data says no.)   CLICK HERE to view the video.  Do let me know what you think!   

Video link for cut and paste:

http://www.thestreet.com/video/10592467/septembers-sector-check.html#36337362001

Stock market trend: Up. 

Market Pulse

Last week, I warned of a pullback and we got it on Monday, but the markets shrugged that off and ripped for the rest of the week – a very good bullish sign.  The trend remains up.

As for the cautionary flags, the only technical concern now is an overbought condition for many stocks and fewer stocks reaching 52 week highs.  That’s primarily a short term concern.

This chart shows the dizzying breadth of the rally.  It’s a list of the ETFs I use as market trackers and the list of long-rated stocks by Market Edge is a lengthy one.  (Columns 2-8 are closing price as of Aug 21, date Market Edge called a “Long”, price when buy signal was issued, long rating, strength rating, and confidence rating – see the Edge for details.)

The only weak sisters in the bunch are these, which have been downgraded from buys.  Note China, which has gotten ahead of itself and is suffering from a speculative bubble.

Stay tuned….

Stock market trend: Up.  Watch for pullback.

Market Pulse

Economy.com

The battle between consumption C and investment I in the GDP growth equation will define the success – or failure – of the nascent recovery.  Two things are clear:

1.     This is an investment-led recovery as bare bones inventories are finally stimulating the manufacturing sector to increase production again.  This fact is evident in two leading indicators, the upwardly trending ISM Manufacturing Index (shown in last week’s missive) and, most recently, industrial production :

2.     Consumption is lagging in the short term because of a weak job market and likely will lag in the longer term because of the absence of both rising incomes and any new bubble to fuel consumption.  The short term problem is reflected in the latest news on consumer sentiment which brought the market down last week.  The long term problem is really the crux of the matter.  For almost a decade, America has been characterized by a declining manufacturing base and, not coincidentally, stagnant incomes.  In this period, American consumers have funded their expenditure on first the tech bubble and then on the housing bubble, which turned America’s housing stock into an armada of ATMs.  With no new bubble in sight and with our manufacturing base continuing to wither, America’s consumption patterns will inevitably retrench to a lower level.  That will make any long term growth problematic. 

From an investing point of view, it’s critical to understand the tension between C and I in the GDP growth equation.  In the bullish scenario, increased production will lead to more hiring, more wage income, and lift consumption by its bootstraps. 

In the bearish scenario, one of two things can happen.  Firms will increase production without hiring and the recovery will quickly wither.  However, even if firms do hire and workers boost their consumption, it may not be high or fast enough to sustain the recovery. As a trader or investor, this tension between C and I is what you should keep an eagle eye on.

As for other key elements, the story playing out in Europe is fascinating.  Both Germany and France are recovering smartly, with Germany in particular propelled by its capital goods exports to China.  However, much of the rest of Europe remains flat or, in the case of countries like Spain, flat on its back.  It’s important to see how this plays out as we need to sell Europe exports if the American economy is to strengthen.

As a final comment, we know face the specter of two young Democratic Presidents – first Clinton and now Obama – falling prey to a Republican counter-revolution triggered by a misplaced health care reform plan.  After eight years of the reviled Bush-Cheney and with a Republican party in tatters, it seemed unlikely just a few months ago that the 2010 elections could threaten the Democrat’s super majorities in both the House and the Senate just as the 1994 Gingrich revolution ushered in a new era of split government.  But now that possibility is very much beginning to loom.

Democrats in heavily contested districts need to get this message: If you want to get re-elected, don’t vote for health care “reform.”  It’s not that we don’t need reform.  It is simply that the legislation has been so perverted up to this point that nothing can save it in this cycle.

This Week: Watch for the Pullback

Stock market trend: Up

Market Pulse

The US stock market continues in a decisively bullish uptrend on the basis of an improving economy. The consensus -- often a dangerous thing but probably right this time -- is that the economy has hit bottom; and numerous indicators suggest that it is on an upward swing.

The most important short to medium-term driver of economic growth -- and this bull market -- is business inventories. They are as lean as they ever get, and the thinking is that as manufacturers up their production to restock warehouses and shelves, an investment led stimulus will provide the next leg in the upturn, which has been triggered, at least in part by the fiscal stimulus. That this is clearheaded thinking is evident in one of my favorite of leading economic indicators: the ISM Manufacturing index. The chart below clearly indicates a strong upward trend after the index bottomed last December.

 

For the foreseeable future, there should be relatively clear trading skies ahead. The big very short-term danger is a pullback as some traders take some profits and other traders reassess whether this recovery is for real. 

The longer-term danger, which could begin to manifest in just a matter of months, has to do with a variety of negative forces bearing down on the US economy.

One force is government policy. I'm all for healthcare reform, but the wasteful garbage working its way through Congress under pressure from the president would add a significant layer of costs onto an already fragile private sector and a loaded-with-debt public-sector.

A second negative force is all money washing through the economy from the various fiscal and monetary stimuli. This genie is out of the bottle no matter what reassurances we get from the Fed about exit strategies. The inevitable result must be a declining dollar, rising inflation, and another likely commodity and energy bubble -- and of course contractionary Fed rate hikes.

Still a third negative force is the employment situation. The markets rose last week not because this economy is generating jobs but rather because the pace of job losses slowing. This is a misplaced optimism if you look at the chessboard properly. In order to have long-term job growth recovery, the US has to have a stronger manufacturing base. This issue has not been dealt with by the Obama administration, and it is the single greatest obstacle to long-term prosperity in this country.

As a final comment, as I was watching the president give a speech in Elkhart, Indiana last week, I didn't know whether to laugh or cry when the president made his claim that it would be education that would get us out of this whole mess. The president was absolutely correct, of course, that we need to teach our children well if they are to compete in the coming decades. However, here in California, all I see is massive budget cuts, teacher cutbacks, contracting school programs, and the descent further into mediocrity not just at the K-12 system but also at the university level where I teach. My fear is that the kids that are in high school and college now will be a lost generation, robbed of a high quality education and facing few prospects in the economy. We will see how that plays out, but Obama is not going to be the "education president" any more than Bush was unless he deals with the basic reality of America's declining manufacturing base and the desperate need for trade reform.

On the need for reform, see the new book by the Alliance for American Manufacturing climbing up the charts on Amazon -- I have a chapter in that book along with others like Clyde Prestowitz.  It's a pretty good overview both of the problems we face and possible solutions. If you buy the book, please read it carefully, send your congressman a letter or e-mail about the importance of manufacturing in America, and then forward your copy of the book to the White House.

Click here to review my videos on TheStreet.com.  

Stock market trend: Up

Market Pulse

Geez.  I take a few weeks off for some summer vacation and a rally hits.  I don’t usually get surprised by the market, but this takeoff was unexpected given the macro headwinds we have been fighting.  That said, with the Dow decisively breaking 9,000, the sideways pattern we’ve been trapped in has clearly been broken, and we are now in an upward cyclical bullish trend that is supported by most technical indicators.

In fact, this pattern is consistent with the arc of events discussed some months ago in this newsletter.  In particular, the combination of a massive fiscal stimulus and even more massive monetary/credit stimulus is likely to trigger a strong bounce back at some point. That is what we are experiencing now as the country is awash in stimulus.

The bigger question mark is what happens after the effects of the stimulus are exhausted -- towards the end of 2010 and into 2011. My concern has been, and remains, that the United States really does not have a foundation for long-term growth. Historically, that foundation has been our manufacturing base.

Manufacturing jobs both pay more than service sector jobs and, perhaps even more importantly, have a higher multiplier effect when it comes to creating new jobs. Since 2000, however, this country's manufacturing base has been devastated by an emergent China rising on the wings of its unfair trade practices and cheap labor -- with its unfair trading practices far more important in the equation.

What I find most remarkable about all of this is the inability of the popular press and the many pundits trying to wax eloquent on the economic problem to grasp the significance of the erosion of our manufacturing base. A far too typical case in point is the ABC news show that runs on Sunday morning hosted by George Stephanopoulos. Watching that show this week, it featured both Treasury Sec. Timothy Geithner and former Fed Chairman Alan Greenspan along with four pundits on its roundtable.

During the entire hour, nobody on that show mentioned the importance of manufacturing in America. Instead, there was a lot of prattle about whether consumers would get out of their funk and spend our way out of this recession -- again, with all of these commentators oblivious to the need for Americans to have decent jobs at decent wages in order to be "good consumers." And by the way, the days of America's spending its way to prosperity are long gone. We are too deep in debt for that and we no longer have the job base to generate income for it.

From an investor's point of view, my point is that as you try to take advantage of this bullish uptrend, it is important to keep your eye on two things. The first is the possibility of a double dip recession. The second is something that people are calling the "new normal" whereby America's rate of economic growth stays positive but well below historic trend lines.

On the possibility of a double dip recession, I'm particularly paranoid about that possibility living here in California. The state's budget crisis has created a wave of new unemployment while all state employees are experiencing significant wage cuts. The effects of this crisis have to ripple through the state economy and given the size of the California economy relative to the nation's economy, one thing we know is that "what happens in California, doesn't stay in California." What I'm saying in a roundabout way is that the contractionary shock rippling through the California economy because of its budget crisis will inevitably have a contractionary effect on the US economy.

As for the new normal, this problem is what I've been warning about for years now. It follows directly from the loss of the American manufacturing base. This country cannot enjoy robust growth and rising income if we don't make stuff anymore. It just can't be done.