Tags: Dow | Theory | Predicting | New | Market | Highs

Dow Theory Predicting New Market Highs

Friday, 12 August 2005 12:00 AM

Wilkinson's Edge
The Cutting Edge of Financial Analysis

MoneyNews Analysis
By Andrew Wilkinson

Dear MoneyNews Reader,

Throughout the week I get the chance to chip in on MoneyNews articles on behalf of NewsMax Media.

Christopher Ruddy has asked me to compile a special analysis and commentary of my own each weekend for readers to dive into.

My aim is to give you my view on markets from equities and bonds to commodities and foreign exchange. As a former trader in the City of London, I have personally taken risky positions across all of these asset classes and like to keep abreast of what's driving markets.

Let's get underway.

State of the Markets

In January 2005, most analysts put on their rose-tinted spectacles and forecast a 10% gain in equity indices for the rest of the year.

"Analyst Richard Moroney of Dow Theory Forecasts says that observers are premature in their call to a bear market. He claims Dow Theory states that we are in the early phases of determining whether or not the bull market is set to come undone.

While the early January lows were broken through on Thursday, Dow Theorists should have expected such a decline or test of the trend.

Investors should expect a bounce in the index over the coming months and only then - if the market fails to test the January high for both transport and industrial indices - should we look for a break lower. And that would have to occur precisely below lows set in place at the current sell-off."

So just as Wall Street was getting bearish, I was making bullish noises.

It's just as well, because the market has rallied 717 Dow points, or 7.2% off its lows set five days after that article was published.

Let's take a look at how Dow Theory stacks up right now in the following chart:

Dow Industrials and Transports Must Hit New Highs

In order for Dow Theory to stack up and support this current rally, we need to break the 2005 highs on both transport and industrial averages. I expect that to happen before the end of September. There is a chance that markets will top out prematurely, but that wouldn't strictly mean a confirmed bear market. Rather, price action would continue sideways.

Earnings Support Dow Theory's View

Earnings season is one of my pet peeves.

On too many occasions I have patiently waited for companies to report strong earnings � only to see shares fall from grace without any real reason, despite the fact that they beat the street's magic number or estimate.

Often it's simply blamed on a failure to be more optimistic about the remainder of the year. Other times, it's simply the result of a mini-rally in the shares prior to the number.

But I'm beginning to believe that this current quarter will mark a watershed for the equity markets.

When analysts made their final forecasts for the second quarter, they had anticipated the weakest growth in earnings since 2003. At the time, I made the point [ see this article ] that with the S&P 500 trading at a price/earnings multiple of just 16.1 times forward earnings, the risk of a positive surprise existed.

Back then I said: "With investors already discounting minimal growth in second-quarter earnings, there is always the element of positive surprise to factor in. In recent days, investors have been delivered two key pieces of survey evidence that companies are more optimistic than had been predicted. That news seems to catch the market on the hop."

With 90% of S&P 500 companies having reported their numbers to date, profits have jumped by an average of 16.6%, compared to the 7.4% consensus at the start of July.

That's important because it says a lot about investor perceptions.

Before the earnings season began, many clearly felt that there was a "soft patch" in place and that it represented a hurdle for future stock gains.

As it turns out, the soft patch was more the result of companies running down their inventories to clear their shelves.

Many automakers depleted their stock of cars on their lots. And when GM announced added employee pricing for all incentives, not only did industry sales soar, but it also shed some light on retail and industrial demand across the board.

The result is that investors have begun to wake up to the fact that the remainder of 2005 is set to be strong. And talk of a soft patch � or any other slowdown � was misplaced.

If you think that markets are simply treading water, check out the following chart. It tracks the S&P 600 index of small-cap companies, which continues to reach new highs. Small-cap stocks tend to lead large-cap stocks and could be a precursor to the return of new highs for large-caps in the S&P 500 index.

Small-Cap Stocks: The Place to Be

Europe and Asian Markets Breaking Higher

Meanwhile life goes on around the world.

Check out my next chart of Britain's FTSE 100 index. Like other European indices, this has been pretty much on a roll for the last two years and has outpaced its American cousin by some 8% since July 2003.

Britain's FTSE: Off to the Races

Over in Asia, the strengthening of the Chinese yuan has boosted growth forecasts and led directly to a rise in the stock markets.

Take a look at South Korea's benchmark Kospi index, which recently reached an all-time high. [ See our recent MoneyNews article detailing local analysts' belief that the South Korean high will cause a spike in other Asian indices ]

South Korea Leading the Way in Asia


 

Protecting Yourself From the Coming Real Estate Crash

Many real estate analysts and most government officials seem to be in denial, but subscribers to NewsMax's Financial Intelligence Report (FIR) have been following the sound advice of Warren Buffett and Sir John Templeton in protecting themselves immediately from the coming real estate crash.

Now you can too.

In this FREE special report from FIR, you'll learn why John Templeton is warning that a 50% drop in home values is possible. You'll also discover what experts say will ultimately burst the housing bubble.

PLUS:
  • The ten steps you must take now to protect yourself from the coming crash
  • 53 bubble stocks to sell right away
    And much much more �

Get your copy today. Go here now.


The Edge on Bonds

Fed Raises Rates in Midst of Unwinding Conundrum

One of the easiest predictions of the past week was the Federal Reserve's U.S. interest rate hike � a move that had long been hinted at. It took the official Fed Funds rate to 3.5%.

For six months Chairman Greenspan has been sounding off about the decline in bond yields during this cycle of rate increases. The Greenspan Conundrum is fast sliding away, and that can be blamed on low inflation or even a soft patch. Undoubtedly, the conundrum will be a key topic in future editions of economics textbooks.

But for now, the message is being driven home in financial markets.

In order for Federal Reserve policy to be effective, bond prices need to tow the line and make corporate and consumer borrowing more expensive. So far the Fed has been fairly lax with rate rises and its policy has only recently become somewhat restrictive.

And when I say "restrictive," I mean that the level of interest rates is now greater than the pace of change in the core consumer price index. When rates are below inflation, policy is said to be expansive, since the cost of borrowing is negative.

All the while, Chairman Greenspan has referred to monetary policy as still being expansive.

That message didn't change this week, and I actually took something new away from the Fed's statement at their recent meeting.

They said that "aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually."

That's a new comment � and it addresses two key driving forces.

First, rates will continue their ascent. Second, the real economy is strengthening, meaning that the stock market will reach new highs soon.


Revision to Growth and Official Rate Projections

Indeed, following a recent strong jobs report for July, several investment houses took the opportunity to raise their official forecast regarding the path of interest rates.

Goldman Sachs raised its prediction for economic growth in 2005 to 3.8 from 3.4%. Similarly, it boosted its forecast for interest rates a further half-percent to 5% by the middle of 2006.

Goldman Sachs joins Bank of America, Lehman Brothers and Barclays Capital in making their rate projections more aggressive.

The ramification is that yields on the government 10-year note will likely continue to rise. In fact yields jumped to 4.43% - the highest since April � prior to the Fed's decision on rates.

That's quite a move, considering that as recently as the end of June the yield stood at 3.92%.


Implications for Homebuilders

Rising bond yields have direct implications for homeowners on standard mortgage products, which are linked to bond prices.

It's hardly breaking news, but the Greenspan Conundrum ensured that despite the Fed's move on rates since June 2004, there has been little impact on homeowners who have been steadily withdrawing equity from their homes as real estate prices continue to surge.

So the recent events have been fun to watch � to say the least.

Despite a good backdrop for stocks in general, shares in homebuilders took a huge tumble as the bear market for bonds strengthened its grip during the week. Take a look at this chart of stock in the iShares Dow Jones Real Estate Index Fund (IYR). Shares plunged 9.25% in the four business days to August 8.

Rising Interest Rates Finally Affect Real Estate

I made my comments about the likely continued rise in bond yields in this article [ see article here ]. Here I predicted the yield on the benchmark 10-year note would jump up into a new 4.50-4.75% window.

Only when we reach that level will I see any remote value in recommending bonds to SectorTrade readers through the appropriate bond exchange-traded fund (ETF).


The Commodity Edge

Hurricanes and Orange Juice Futures � What would you expect?

I have always enjoyed my role as an analyst. Even in high school I felt confident interpreting charts and data tables put in front of me during exams. At the time, others seemed to miss the point, failing to understand the message contained in the data.

As I grew older I was keen to learn how to trade as a career, and my analytical mind served as a great support for making decisions.

These days, I live and work in South Florida, where locals like to say that they have found their very own "piece of paradise."

As my family found out last year, there is another side to that coin.

I'm talking about the hurricane season (of which we are now in the third month.) So far we have been left alone, but with 21 tropical depressions in the current forecast, I figure that sooner or later, the Treasure Coast is set to take a pounding.

2004 was a real strain on paradise, as three major hurricanes landed on our doorstep. The devastation ravaged Florida's orange groves, which produce the second-largest crop in the world after Brazil.

The 2004 harvest (at 149.6 million boxes) was the smallest in 13 years. This year an increased forecast for rainfall has contributed to the growing conviction that the orange crop isn't set to face the squeeze again this year. That has helped send the price of frozen orange juice futures plummeting in recent days.

"Analyst Richard Moroney of Dow Theory Forecasts says that observers are premature in their call to a bear market. He claims Dow Theory states that we are in the early phases of determining whether or not the bull market is set to come undone.

While the early January lows were broken through on Thursday, Dow Theorists should have expected such a decline or test of the trend.

Investors should expect a bounce in the index over the coming months and only then - if the market fails to test the January high for both transport and industrial indices - should we look for a break lower. And that would have to occur precisely below lows set in place at the current sell-off."

So just as Wall Street was getting bearish, I was making bullish noises.

It's just as well, because the market has rallied 717 Dow points, or 7.2% off its lows set five days after that article was published.

Let's take a look at how Dow Theory stacks up right now in the following chart:

Dow Industrials and Transports Must Hit New Highs

In order for Dow Theory to stack up and support this current rally, we need to break the 2005 highs on both transport and industrial averages. I expect that to happen before the end of September. There is a chance that markets will top out prematurely, but that wouldn't strictly mean a confirmed bear market. Rather, price action would continue sideways.

Earnings Support Dow Theory's View

Earnings season is one of my pet peeves.

On too many occasions I have patiently waited for companies to report strong earnings � only to see shares fall from grace without any real reason, despite the fact that they beat the street's magic number or estimate.

Often it's simply blamed on a failure to be more optimistic about the remainder of the year. Other times, it's simply the result of a mini-rally in the shares prior to the number.

But I'm beginning to believe that this current quarter will mark a watershed for the equity markets.

When analysts made their final forecasts for the second quarter, they had anticipated the weakest growth in earnings since 2003. At the time, I made the point [ see this article ] that with the S&P 500 trading at a price/earnings multiple of just 16.1 times forward earnings, the risk of a positive surprise existed.

Back then I said: "With investors already discounting minimal growth in second-quarter earnings, there is always the element of positive surprise to factor in. In recent days, investors have been delivered two key pieces of survey evidence that companies are more optimistic than had been predicted. That news seems to catch the market on the hop."

With 90% of S&P 500 companies having reported their numbers to date, profits have jumped by an average of 16.6%, compared to the 7.4% consensus at the start of July.

That's important because it says a lot about investor perceptions.

Before the earnings season began, many clearly felt that there was a "soft patch" in place and that it represented a hurdle for future stock gains.

As it turns out, the soft patch was more the result of companies running down their inventories to clear their shelves.

Many automakers depleted their stock of cars on their lots. And when GM announced added employee pricing for all incentives, not only did industry sales soar, but it also shed some light on retail and industrial demand across the board.

The result is that investors have begun to wake up to the fact that the remainder of 2005 is set to be strong. And talk of a soft patch � or any other slowdown � was misplaced.

If you think that markets are simply treading water, check out the following chart. It tracks the S&P 600 index of small-cap companies, which continues to reach new highs. Small-cap stocks tend to lead large-cap stocks and could be a precursor to the return of new highs for large-caps in the S&P 500 index.

Small-Cap Stocks: The Place to Be

Europe and Asian Markets Breaking Higher

Meanwhile life goes on around the world.

Check out my next chart of Britain's FTSE 100 index. Like other European indices, this has been pretty much on a roll for the last two years and has outpaced its American cousin by some 8% since July 2003.

Britain's FTSE: Off to the Races

Over in Asia, the strengthening of the Chinese yuan has boosted growth forecasts and led directly to a rise in the stock markets.

Take a look at South Korea's benchmark Kospi index, which recently reached an all-time high. [ See our recent MoneyNews article detailing local analysts' belief that the South Korean high will cause a spike in other Asian indices ]

South Korea Leading the Way in Asia


 

Protecting Yourself From the Coming Real Estate Crash

Many real estate analysts and most government officials seem to be in denial, but subscribers to NewsMax's Financial Intelligence Report (FIR) have been following the sound advice of Warren Buffett and Sir John Templeton in protecting themselves immediately from the coming real estate crash.

Now you can too.

In this FREE special report from FIR, you'll learn why John Templeton is warning that a 50% drop in home values is possible. You'll also discover what experts say will ultimately burst the housing bubble.

PLUS:
  • The ten steps you must take now to protect yourself from the coming crash
  • 53 bubble stocks to sell right away
    And much much more �

Get your copy today. Go here now.


The Edge on Bonds

Fed Raises Rates in Midst of Unwinding Conundrum

One of the easiest predictions of the past week was the Federal Reserve's U.S. interest rate hike � a move that had long been hinted at. It took the official Fed Funds rate to 3.5%.

For six months Chairman Greenspan has been sounding off about the decline in bond yields during this cycle of rate increases. The Greenspan Conundrum is fast sliding away, and that can be blamed on low inflation or even a soft patch. Undoubtedly, the conundrum will be a key topic in future editions of economics textbooks.

Get your copy today.

But for now, the message is being driven home in financial markets.

In order for Federal Reserve policy to be effective, bond prices need to tow the line and make corporate and consumer borrowing more expensive. So far the Fed has been fairly lax with rate rises and its policy has only recently become somewhat restrictive.

And when I say "restrictive," I mean that the level of interest rates is now greater than the pace of change in the core consumer price index. When rates are below inflation, policy is said to be expansive, since the cost of borrowing is negative.

All the while, Chairman Greenspan has referred to monetary policy as still being expansive.

That message didn't change this week, and I actually took something new away from the Fed's statement at their recent meeting.

They said that "aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually."

That's a new comment � and it addresses two key driving forces.

First, rates will continue their ascent. Second, the real economy is strengthening, meaning that the stock market will reach new highs soon.


Revision to Growth and Official Rate Projections

Indeed, following a recent strong jobs report for July, several investment houses took the opportunity to raise their official forecast regarding the path of interest rates.

Goldman Sachs raised its prediction for economic growth in 2005 to 3.8 from 3.4%. Similarly, it boosted its forecast for interest rates a further half-percent to 5% by the middle of 2006.

Goldman Sachs joins Bank of America, Lehman Brothers and Barclays Capital in making their rate projections more aggressive.

The ramification is that yields on the government 10-year note will likely continue to rise. In fact yields jumped to 4.43% - the highest since April � prior to the Fed's decision on rates.

That's quite a move, considering that as recently as the end of June the yield stood at 3.92%.


Implications for Homebuilders

Rising bond yields have direct implications for homeowners on standard mortgage products, which are linked to bond prices.

It's hardly breaking news, but the Greenspan Conundrum ensured that despite the Fed's move on rates since June 2004, there has been little impact on homeowners who have been steadily withdrawing equity from their homes as real estate prices continue to surge.

So the recent events have been fun to watch � to say the least.

Despite a good backdrop for stocks in general, shares in homebuilders took a huge tumble as the bear market for bonds strengthened its grip during the week. Take a look at this chart of stock in the iShares Dow Jones Real Estate Index Fund (IYR). Shares plunged 9.25% in the four business days to August 8.

Rising Interest Rates Finally Affect Real Estate

I made my comments about the likely continued rise in bond yields in this article [ see article here ]. Here I predicted the yield on the benchmark 10-year note would jump up into a new 4.50-4.75% window.

Only when we reach that level will I see any remote value in recommending bonds to SectorTrade readers through the appropriate bond exchange-traded fund (ETF).

Orange juice futures predict no hurricanes eh?

During the coming week, respected forecaster Elizabeth Steger will release her latest forecast for the Florida orange crop. And that might help shape future price direction on this key crop.

Orange juice futures are traded on the New York Board of Trade (NYBOT) and allow growers to protect the value of their future crops against adverse events such as severe weather.

Traders help provide liquidity by speculating on future prices and base their decisions on near-term weather and harvest forecasts.

Now orange juice futures are risky and don't suit everyone's investment objectives.

However, I'm left wondering whether the recent factors driving down the forward price of juice might not face a sudden reversal over the summer. All it takes is the sniff of a hurricane and whoosh! � futures will take off again.

Look at the shaded area on the chart above and you'll see how juice surged when last season's storms arrived. The latest fall in prices tells me that speculators are selling short orange juice futures in anticipation of a better crop.

Now I'm sure that's a clever thing to do so early in the season.

109-109-109-109-109

© 2019 Newsmax. All rights reserved.

   
1Like our page
2Share
Pre-2008
Wilkinson's EdgeThe Cutting Edge of Financial AnalysisMoneyNews Analysis By Andrew WilkinsonDear MoneyNews Reader,Throughout the week I get the chance to chip in on MoneyNews articles on behalf of NewsMax Media.Christopher Ruddy has asked me to compile a special analysis...
Dow,Theory,Predicting,New,Market,Highs
3731
2005-00-12
Friday, 12 August 2005 12:00 AM
Newsmax Media, Inc.
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
America's News Page
© Newsmax Media, Inc.
All Rights Reserved