DOW 13,000!
Relatively Underwhelming
By Tony Allison, October 15, 2007
The hard charging Dow Jones Industrial Average blew past 13,000 last week. The headlines screamed “all-time high” from Wall Street to Main Street. CNBC breathlessly issued tick-by-tick “Breaking News” updates as the Dow crept closer to 13,000. Is it time to pop the champagne, and pile aboard, joining the celebration of Goldilocks as a beloved Wall Street celebrity? Well, perhaps it’s time to step back and look at the Dow in relative terms; terms that include tangible assets and other currencies. In valuing the Dow in other terms, the cause for celebration may look a little overdone.
Commodity Bull Has Legs
Commodities and natural resources of all types have been in great demand as Asia rapidly develops and catches up to the Western countries. The demand stemming from this 21st century Industrial Revolution looks to continue for many years. The supply of many of these commodities is structurally limited or declining. A commodity “bubble” would necessitate rapidly growing supply and inventories as prices rise. As has been mentioned by Jim Rogers and others, commodities bull markets last a long time because locating, extracting and selling commodities (especially oil, natural gas, precious and base metals) is a long, difficult and expensive process. The regulatory hurdles today make the process even longer than historical norms. Don’t expect the commodity boom to fall from grace anytime soon.
On the other hand, the supply of debt seems ample, even extraordinary, as liquidity has been massively created by the leading nations and sloshes around the globe, looking for a (temporary) home. If there seems to be a global bubble forming, all manner of credit, including derivatives, would fit that definition nicely.
Source: The Economist & Puru Saxena
Dow and U.S. Economy Decoupling
The U.S. economy appears to be slowing, as first quarter GDP came in at a sluggish 1.3%. But the Dow is on a roll, as earnings continue to beat analysts estimates, some of which seem to have been set at a rather low bar. So while earnings are surprising on the upside, they are still decelerating from 2005 and 2006. One reason the Dow seems to be decoupling from the domestic economy is because of the large number of Dow components that derive a significant percentage of their sales from overseas. This alone enhances corporate earnings when the firms are paid in euros, yen, pounds, etc. with the dollar falling against these currencies.
So while the globalization trend is helping keep the Dow chugging upward, is the Dow really doing as well as the bold headlines and “breaking news” stories seem to imply? The following series of five-year charts would suggest otherwise. While the Dow has done quite nicely in dollar terms, when measured in commodities and euros, the Dow’s performance is not exactly breaking news.
Relative Value
“Everything is relative” goes the old saying. So how is the Dow doing relative to other measures of value?
Measured in dollars, the Dow has put in a very impressive performance over the past five years.
Measured in euros, the Dow has been improving slowly, but is still not back to 2002 levels.
Measured in gold, the Dow has had a rough ride.
The ride has been even worse for the Dow measured in silver, down over 50% in the past five years.
The Dow measured in Copper is not a pretty sight either.
The Dow in Crude Oil tells a similar story, although not as bad in recent months.
I could include charts for nickel, lead, zinc, corn, uranium, etc., but this gives you the general trend; the Dow is losing ground to tangible assets. Perhaps that oft-mentioned “benign” inflation picture may not be as benign as most people believe.
The problem is not the Dow of course, but the dollar, which continues to weaken significantly against not only commodities, but against other fiat currencies, specifically the euro.
More Inflation Ahead?
So before you decide that Dow 13,000 begets a “New Era” of bullish exuberance, ponder the relative framework beyond the confines of the US dollar. Yes, the global liquidity tidal wave is lifting all boats, but the SS DOW is not keeping up with the rest of the fleet. And the Dow would be falling farther behind without the large number of Dow components that have international exposure and foreign currency revenue.
Perhaps the markets sense the inflation that lies ahead after the years of relentless global money printing. Or perhaps the markets are watching the credit bubble in the US bulging to staggering proportions. Whatever the reasons, the “awesome” strength of the Dow Jones Industrial Average is a relative term. In terms of copper or silver, the Dow has been in a five year funk of epic proportions.
The following announcement from China is not new, but gives further evidence that they are increasingly nervous about holding over a trillion US dollars. The Chinese can read the trends, and they clearly see the wisdom of diversifying into tangible assets.
Chinese Central Banker Urges Diversifying into Gold, Oil, Metals
By Wang Min and Zheng Jin
The Wall Street Journal
Wednesday, April 25, 2007
SHANGHAI, China -- China should "appropriately" increase its gold reserves and buy strategic resources such as oil and metals in order to broaden the investment channels for its huge foreign-exchange reserves, said People's Bank of China Vice Governor Xiang Junbo.
Historic new highs in the Dow make good headlines, but the talk of a super bull is a bit premature. Compared to other measures of value, the Dow is taking on serious water. If global liquidity growth continues to spiral upward, there is no reason to think the Dow won’t eventually hit 20,000 or even 36,000. But if that eventuality comes to pass, inflation will likely be out of the bottle and spreading out of control. If the Dow continues to move ever higher, check a few relative value charts such as these along the way. The Dow may be rising smartly, but in times of rising inflation, tangible assets and asset-based equities are likely to make the Dow’s advance look rather stodgy by comparison.
Today’s Markets
The Dow Jones Industrial Average fell 58.03 to close the month at 13,062.91. For the month of April the Dow gained 5.7%, the best monthly performance in over four years.
The S&P 500 index lost 11.7 points, to close at 1,482.37. For the month, the S&P 500 gained 4.3%, its best monthly performance since December 2003. The Nasdaq dropped 32.12, to close at 2525.09. The Nasdaq was up 4.1% for April, its best monthly mark since October 2006.
Investors appear to be waiting for the April jobs report to be released on Friday and the ISM reports on manufacturing and the service economy, to be released on Tuesday and Thursday respectively. These reports will either confirm the weak first quarter GDP number, or point to renewed strength.
Gold and silver closed slightly lower, and crude oil ended the day at $65.71 per barrel for June delivery, down 75 cents.
Wishing you a good evening,
Tony Allison
© 2007 Tony Allsion
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