Well, it was just a speculation, so don't cash in your shorts, yet.
A little early, but following is my "traditional" annual layout for the market, take it for what it is worth, about two pence. Apologies for the length of this disertation....Mauldin and Roach will be proud of me (g).
The turnips apologize for a bad call of a minor retrench prior to Christmas, though the Naz really has gone essentially nowhere (it is becoming a tradition to apologize for misreading December…).
In the following, they are going to try and layout their thoughts on the market for 2005. There are a number of parameters going into building the “scenario” including the political environment, international markets, were is the economy going and what will be the public perception of where the economy is going, liquidity and market psychology (TA) as well as valuation metrics. In the following, I will muse about these and then “design” what I believe might be a likely scenario for the market in 2005. Others are invited to layout their maps, of course.
Politics
The three major political events early in the year are the state of the union, the election in Palestine and the election in Iraq. Later in the year we will have issues of taxation and particularly debates on the pharmaceutical industry and the privatization of social security. Random terror events will also be in the background, but I believe by now we are getting accustomed to that background noise, so I expect no major problems from that quarter, short of a really bad event such a dirty bomb going off in a major city. (HEPH is a play on current counter measures to handle the consequences of such an event). Additionally, there are still some wild cards in Pakistan and in Russia.
I have no idea how the elections in Iraq will play out, they have less than a month to get the country pacified. If it was up to me, I would spread the election over a week, and concentrate troop each day in the area were the elections are carried out, thus obviating the need to increase force concentration. I don’t see any move in that direction, so I guess the election will be of the 60% fair representation type. Not conducive for post election quiescence. As a result, terror premium on crude will probably stay in place despite the very mild winter in the northern hemisphere. My model assumes that crude premium will be slightly reduced, but China demand continue to increase thus keeping crude prices in the $38 to $48 range for most of the year.
Elections in Palestine will probably be a resounding success, and there will be a general feeling of “peace in our times”. However, the current local elections indicates that Hammas is getting some very serious support, and that will prevent pacification for some time, probably until the population understands that Israel will not be destroyed and a modus vivandi will have to be found. That is a long time out, and I expect post election terror to increase again, and as a result no immediate peace agreement there. I expect no major impact on markets from whatever happens there.
The State of the Union will set up the stage for tax and social security reform, which I think might have a serious positive, though temporary effect on the market (thus my first top in the 1/19 to 1/25 window).
The problems in Russia (de-democratization and insecurity of foreign investments) and Pakistan (possible murder or coup against Musharef) should not have a major impact on our markets (we have our own problems as Roach has been elaborating on for four years now). I think that Israeli defense outfits will benefit from both situations (MAGS a possible play on that). A major question is if a Government owned oil industry can indeed be vibrant and raise current Russian production levels. I doubt it, one reason I don’t think that crude will get much under $40/barrel (increased Russian supply could put pressure on prices).
There are other areas of flare up such as Venezuela that might impact crude pricing, but not outside the band I expect.
Economy
With crude staying above $38 for most of the year, a real tax is imposed on US consumers (not the European and Asian, because of their strong currencies) and slight inflationary pressures might appear. The Feds will probably keep raising rates until it becomes clear that economic growth is stalling. That may not happen till the end of the year. I think that the dollar vs the Euro got most of its punishment (I had a max for the year of $1.40 to one Euro, so far we got close to $1.35). At $1.60 to the Euro, the dollar will be halved from its peak, I doubt we go that far. As for the Yen, the worst I expect is an excursion under 100 yen to the dollar, maybe 90 to 95. Since I still do not expect major inflation to appear this year, that puts a cap on gold in the $480/$490 for 2005. (recent divergence between the miners and the metal should worry gold bugs, IMTO).
Short term though, we must take into account that there is very little additional stimulus that can be applied to the economy, the spigots have been fully opened for too long. I read many people forecasting GDP growth in the 3.5% to 4% range for 2005, but I think that most of the advance will be in the first half. The consumer has done its share and is more or less tapped out. Unless we see major advances in employment (like 250,000 new jobs per month for a good six months or so), I just do not see the consumer increasing spending at a rate of 3 to 4% per year. With rising interest rates, one should assume that the rate of refinancing of housing will decline, and we might even get a slight decline in new housing. If that happens, that could tip the scale into a consumer led recession (two main engines of growth in the last two years have been housing and automotive and both seems to go into “stall mode”) starting late in 2005.
Usually, with so much money sloshing in the economy (M3 is about 5.4% higher than a year ago, growth greater than economic growth), one would expect inflation to become a major problem, however, capacity (except in some commodities like oil, copper, aluminum and even steel) is still excessive, keeping price pressure subdued. The growth in money aggregates over the last year, however is not sufficient to create major inflationary pressures.
Liquidity
Right now there are no real liquidity constraints, if at all both the Feds and the government are working very hard to stimulate the economy and even directly, the market (the “dividend” exemption is nothing but a ploy to support equity markets, it has no economic justification as I have harped about for quite some time, this year they will add to that social security privatization, another “harping” point for me <g>). Note that MZM is now well above $6.6 Trillions, but it has stalled there for almost half a year now, and YOY it is just some 3.5% ahead, like the GDP growth, possibly indicating the start of a mild liquidity crunch.
In the market, however, there was a big injection of liquidity from MSFT, which by now should have been absorbed, and the rush of IPO and the excessive insider selling in recent months is, probably, soaking liquidity from the markets on balance, IMTO. Some dollars repatriation by foreigners, just as the dollar bottoms could put additional pressure on liquidity. On balance, I believe liquidity is at best neutral, if not slightly bearish for the equity markets.
Valuation/technical analysis/road map
The basic thesis from early 2000, namely, that we have entered a lengthy period of a secular bear market holding the indices in a wide range still holds. Until we get unusual and uncommon valuations to start the next major secular Bull market, I am staying with this thesis. Namely, give me PE’s under 10 or so and then a rebalancing would have occurred. Talking about rebalancing, Roach has made a religion out of it, so I will not repeat this here.
It is quite clear that valuation models on the Naz are going to keep a ceiling on that market over the next 12 months. However, if one looks at the DOW with an earnings estimate of $600 for the current fiscal year, the PE is only 18, in an environment where the 10 years treasuries are yielding 4.18% (Equivalent PE of 24) , however, the long terms rates are climbing and may be above 5% (5.4%?) before the year is out making this measure just fair value. (Remember that secular bear markets create “uncommon values”).
As for the technical picture, we are getting very close to some major top like behavior in volatility indices. The EPC 21 days moving average has stayed under .58 for more than a month. Many of the BP are flattening out (BPTRAN at 100%, and for quite some time, it cannot go higher….). Advisors bullish are above 62%, an area from which a major bear could start. New highs on the NYSE have also reached levels approaching excesses, but not so, so far on the Naz. VIX and VXN keep hitting new lows. While these are all figures that are commensurate with a major peak, these can stay that way for quite some time, and the bears amongst us, should not, IMTO, anticipate a top and go short before a downtrend is actually established.
My roadmap has included, at least since early August of this year, a top in the January-February period above 2275 on the Naz, and for now I am staying with that target. Tentatively, I have the top, or I should say a first top, in the Jan 19 to 25 window. I have also mentioned that I expect a sizeable nassacre early in the year, post that late January early February top. Thus I have a low in the 1700/1750 before July 4th. That is the broad map for the first half. Before I actually get back zipped in my bear suit, however, I would be waiting to see the white in the eyes of the MM’s. I do not see that top yet, and we could easily have a double top with the second one marginally higher in some indices, while other market measures (NH, BP etc.) not confirming that second top. Thus for now, the map will have the high at 2275, a dip of about three weeks to 2040/2150 area (depending how high we get late in January), ending, nominally on 2/09. Then I’ll decide if a last hurrah to the neighborhood of 2350 plus minus 50 is possible, on the Naz. My next turn date is 3/25, that is supposed to be a minor local bottom, possibly as low as 1820 on the Naz. Note this could be a real nasty move of 500 Naz points in about six weeks. The details of the map have two forks, the first is that late January is the ultimate high, and we go into a grinding but relatively “orderly” decline to 1820 late in March, and the second fork, the one I favor now, is a more volatile market with a sharp retrench from the late January top to and interim bottom in February and another sharp advance attempting to better the January highs in February and then a fast and devastating decline into 3/25. A lot depends on how the VIX and VXN behave on the beginning of the first leg down and whether or not early January yields EPC under .40 or not.
The 3/25 bottom should be followed by a sharp advance, most of it ending before the beginning of May (nominal top is 5/9). Note that it is quite possible the Dow bottoms about a week before the Naz did (as it did in 2001), if that happens, the Naz may not bottom till the window of 4/6 to 4/13). If we indeed reach the low 1800’ in late March, the April run could get the Naz to the 2040/2150 window. That should be enough to turn recent “late to the party” bears to turn bullish again, while covering their shorts into massive street and insiders selling. The next leg down should be from 5/9 to 6/22-29, ending in the 1700 to 1725 area on the Naz. From here I expect a labored run (mind you, this low could involve a double bottom stretching to Wednesday post July expiry, or 7/20) to 1940 or so. If 1940 showed no latent bounces in the decline from the January/February top, I will then have to add another 100 Naz points to that summer rally to around 2040, we will know in the “Fullness of time” as Jim so succinctly put it.
I should mention that this map assumes some expectations in some indicators behavior, such as sub .40 EPC before the end of January, failure of a possible February top to generate volume above the January volume at the highs, and few others, so as we get close to these events, I will reexamine this map.
As for the second half of the year, my most probable model has continuation of the bear into a broad double bottom in October and then early December a retest, with a low around 1400 on the Naz (a nasty 500 to 600 Naz points decline). One fork has a low just under 1000 on the Naz in December, but for now, it is just an outside possibility.
As usual, the turnips absolutely reserve the right to be wrong, change their mind and change it often.
