Is old investors’ adage true? John Robson and Andrew Selsby of the Onassis newsletter read the January barometer – and see how it compares to the other leading stock market indicators.
Stock market analysis: January performance
“As goes January, so goes the year.” It is now possible to report on the January barometer. If reliable, it forecasts a dull year for the UK. FTSE 100 ended 2006 at 6220; after some modest gyrations it closed, on 31st January, lower by 17 points to 6203.
The Dow Jones Industrial Average ended 2006 at 12463, a month later on 31st January it closed at 12621, an increase of nearly 1.3%. For global market conditions, more notice will be taken of the Dow’s rise than FTSE’s fall.
There appears to be no let-up. Global liquidity continues to float assets ever higher, giving growing confidence to UK consumers who, in January, were out spending 5.2% more than in January 2006. According to the British Retail Consortium, shops had the best January for three years.
We reported in the previous issue that the bear fund holdings had been reduced by two thirds; the reduced holding will be watched carefully. On FTSE strengthening further, we will be obliged to reconsider the position and possibly close it entirely. Conversely, it remains a possibility that this investment stance will prove to be correct.
Stock market analysis: the ‘q’ ration
Andrew Smithers of Smithers & Company Limited is the economist who, together with Stephen Wright, wrote the book “Valuing Wall Street” first published in 2000. The basis of the book was that the long-term investment trends for stock markets can be judged by reference to the “q” ratio. The “q” ratio is market value to net worth.
Based upon “q”, Andrew Smithers calculates that on average US shares are at present 77% over-valued and in the UK the over-valuation is 68%. In the short-term anything can happen but in the long-term, over the next five to ten years, it is quite clear that poor returns are likely. Valuations for mainstream stock markets are very rich whilst yields have suffered compression to historic lows. It just makes no sense to have any kind of long-term optimistic view about such markets.
Our four financial horses may not be seeing things in the same way as us. Hay and oats seem to be in abundant supply, they idly munch their feed – why should they worry, the supply seems to be endless (global liquidity).
Stock market analysis: leading indicators
The white horse – false peace – The Volatility Index (VIX)
Yet again the VIX has retreated to its multi-year lows. Each little moment of alarm has been followed by renewed calmness. One is tempted to believe that nothing can end this period of investment tranquillity where borrowing money, buying assets and selling them for more seems to be a guaranteed process.
“It is like there is no fear of the down-side” Jeffrey Rosenberg, head of Credit Strategy Research Banc of America Securities in New York said recently.
The red horse – war and destruction – The Philadelphia House Market Index
The Philadelphia House Market Index continues to rally following its steep sell-off last year. The presumption grows that for the US housing market the worst is over although Lennar’s CEO, Stuart Miller, was recently quoted as saying “We have not yet seen tangible evidence of a market recovery.” The data seems to be getting better, causing the Fed to comment in their recent minutes that economic growth was somewhat firmer, helped by stabilisation in the housing market.
It must be said there are many, including us at RHAM, who think that US housing has more downside to come.
For the moment, the plight of distressed borrowers is not considered important, after all, in the fourth quarter the American economy grew at an annual rate of 3.5% – much higher than expected.
The black horse – famine and unfair trade – Dow Theory
Bulls have been further encouraged. On Friday 2nd February, by a flimsy amount, the Transports confirmed the Industrials’ high. So we have a positive Dow Theory signal although, so far, it is by the slimmest of margins and not enough to justify action.
It’s now 980 days since the Dow Jones Industrial Average suffered a 10% correction to which can be added, it’s now 137 trading days without at least a 2% correction – the second longest period ever.
The pale horse – sickness and death – The Inverted Yield Curve
The yield inversion both in the UK and in the US lives on, the only logic is an expectation by the market that short-term interest rates are due to head lower. Why otherwise would long-term yields be so far below short-term yields? The soft landing in America depends on that outlook being correct. However, interest rates will only be reduced as a result of deteriorating data, hence the inverted yield curve has been an historical and reliable indicator of future economic difficulties.
A recent essay by Paul McCulley, PIMCO’s managing director, made the point that there is a paradox that won’t long endure because either the Fed have to validate the markets’ pricing of easing or if not, the markets will un-price that easing, tightening financial conditions. The Fed, he explains, doesn’t want to signal ease because the data are looking better, but the data are looking better because the market is explicitly betting on Fed easing.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/