Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.
“Since 1982, the economic and technological progress unleashed by supply-side policies have ousted some 60% of the incumbent tycoons from the Forbes 400 (list of richest people).
“There are basically 2 kinds of wealth: tangible and financial. Tangible assets already exist: real estate, buildings, mineral deposits, farmland, works of art, stockpiles of commodities, wares of the past. Financial assets consisting of stocks, bonds, and other securities represent not so much tangible wealth as a pledge of future production.
“...Put it this way: Financial assets do best in times of low inflationary growth. Hard assets do best in times of high inflation and high taxes. In the 1980s a sudden shift between these 2 kinds of assets shook the Forbes 400.”
"The Slippery Slope of Wealth," by George Gilder
Forbes, October 21, 1991
While studying the Forbes
400, a couple of things leaped out at me. First, staying rich is almost as difficult as getting rich. Remember oil tycoons, like the Hunt brothers, who dominated the list in the early 1980s? Such folks don’t even make the list. Plainly, it’s one thing to make a fortune; another to keep it.
You know what happened to Bunker Hunt and the oil-patch people. You also know what happened to many of the late-1980s trophy real estate crowd. New fortunes replace old. New industries surge as others slide. New people top the list as the old drop out. Indeed, it’s one thing to make a fortune and another to keep it.
Now, while investors likely didn’t make a fortune off of the March 2009 stock market lows, there was a handsome amount of money made from those lows. Accordingly, since the momentum peak of May 8, I’ve suggested that the trick going forward was going to be keeping those profits. And that’s pretty much been the story over the past 2 months, as most of the major averages I follow are below where they were back in early May.
More recently, that profit-keeping theme has become increasingly important, as many of my indicators have been counseling for caution.
Combined with those deteriorating indicators has been a decline by the various stock market averages below some pretty key support levels. Over the past few weeks, the D-J Industrial Average
(DJIA) has sequentially fallen below its 10-, 30-, 50-, and 200-DMAs. In the process, it's broken below a number of key Fibonacci levels.
The result is a near-term head-and-shoulders top formation in the charts, with the senior index now residing below the neckline, as pointed out by technical analyst Art Huprich:
Click to enlarge
Most of the other indices I follow are also negatively configured. In such a bifurcated market, I continue to opt for caution. The second thing that leaped out at me while studying the Forbes list was the increasing number of people making the list from the emerging market countries. Places like Brazil, China, Russia, Malaysia, Argentina, etc. This is in keeping with my theme of investing in the emerging and frontier markets.
To be sure, while the US recession is abating, the country most likely to pull the world out of recession is China. China’s manufacturing surveys suggest its recovery is sustainable, China’s output is at the year’s high as overseas orders are at an 11-month high, the Chinese government’s subsidies have helped its auto makers (record sales in June), the export tax cut is becoming impactful, new loans are surging -- and the list goes on.
That being said, one of the best indicators on the short-term direction of the Chinese stock market has been the 25-day moving average (DMA) juxtaposed with the 50-DMA. Back in March, the 25-DMA crossed above the 50-DMA, which was a buy signal, and the rally from there to the June top encompassed 65%.
While the 25-DMA hasn’t currently crossed below the 50-DMA, the Halter USX China Index
(HSX) has knifed below both of those moving averages, and is consequently negatively configured in the short-term. I am therefore cautious.
I have, however, become increasingly intrigued about investing in Japan since my visit to the astute GaveKal organization. Reinforcing that view was Credit Suisse’s recent upgrade on Japan. To wit:1.
Japan is a late-cycle play. It typically starts to outperform 4 months after the trough in lead indicators. I believe this is because Japan is a high-cost producer and has the economy that is closest to deflation globally. 2.
Japan industrial production (IP) has had a beta of 3 with global IP. Both the economic surprise index and purchasing managers' indexes (PMIs) are recovering more strongly in Japan than elsewhere.
Japan's heavy-manufacturing bias (manufacturing as a share of GDP is 21%, versus 13% for the US) means that Japan should be particularly sensitive to the global inventory rebuild that has considerably further to run. As a result, relative earnings momentum is improving. 3.
A lagging non-Japan Asian play. More than half of Japan's exports go to non-Japan Asia -- and nearly 20% to China. Japanese equities are now 16% below their (down) trend line relative to non-Japan Asia.4
. Japan is the world's largest creditor (net-foreign assets are 54% of GDP and household net wealth to income is the highest globally at 4 times). In my view, investors should be refocusing on creditors (not debtors), now that credit spreads have fallen to neutral levels (i.e., implying a reasonable default rate).5
. Since 1990, when Japan has outperformed, it has done so by an average of 37% over 7 months. This is because many investors are structurally short of Japan [as confirmed by Europe, Australasia, and Far East (EAFE) data].6.
Valuations are, as usual, mixed. Japan looks 5% cheap on Credit Suisse HOLT (methodology) [but then again, I assume cash-flow returns on investment (CFROIs) will partially normalize]. Cash on balance sheet is 25% of market cap (compared with 17% in Europe excluding the UK and 11% in the US). Price-to-book and price-to-sales are at a 32% and 43% discount to global markets, respectively, but none of this is particularly new.
This is a tactical call (i.e., 3 to 6 months) not a strategic call (1 to 2 years). I remain concerned about: (a) bad demographics; (b) very limited restructuring of domestic services; (c) huge government debt (199% of GDP); and (d) the general inability of the corporate sector to improve return-on-sales or return-on-equity levels.”
I would note, however, that many strategic calls begin as tactical ones.The call for this week:
Even though I remain defensive in the short term, I continue to think it’s a mistake to become too bearish. Still, the DJIA has been in a downtrend since its June 11 intraday high of 8877; we aren’t oversold; new lows have been expanding; we’ve had 3 90% Downside Days; we’ve broken below the neckline of a head-and-shoulders top, rendering downside targets 7791 (DJIA); and senior index resides below most of the moving averages I watch.
Using my day-count sequence suggests the situation should be resolved this week.
No positions in stocks mentioned.
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