Trouble Ahead for the The Four Horsemen and Europe's Not So Sunny Side
By Frank Barbera CMT. June 24, 2008
Falling consumer confidence, falling home prices, profit warnings -- all of these are par for the course in a recession. Of course, there is nothing new about any of this, except that Alan Greenspan finally realized that the US may be in trouble with his comment yesterday that we are ‘on the brink' of a recession. Now talk about a forecasting coup, huh? Now we know why they pay him the big bucks. "On the brink" -- really? How about admitting to the idea that the US economy has been mired in recession for months, let alone debating whether we are in a recession. In my view, such questions beg credulity. Oh, I suppose that we must all wait for the NBER to officially declare a recession and so far, quarterly GDP reports have just missed the mark of being negative.
Amazing what you can achieve by understating inflation and over-reporting growth, isn't it? For anyone who actually believes the official party line on the US economy, you have my deepest sympathies. In his latest update to investors, PIMCO bond guru Bill Gross makes the case of how badly off mark US economic data has become by using a pair of charts courtesy ISI Group economist Ed Hyman. Ed is one the best economists out there and the good folks at ISI do a great job collecting and tracking the universe of economic stats. In the first chart, we see the reported inflation rate of 24 foreign countries, which in the most recent 12 months has moved up from 4% to close at 7%. In the second chart, we see the US CPI which has remained unchanged now for a decade at 4%. Makes you wonder who the government statisticians think they are fooling. If global inflation is on the rise everywhere else, should it not be moving up here as well?
Going back decades, the US has always been closely aligned with economic trends present in other countries. Why has our inflation series disconnected in recent years? The answer is, of course, that the index has been mathematically altered, using hedonics, substitution, and geometric weightings so that it is no longer the same index, and no longer capable of moving up. Do we have statistical nirvana at hand, or is it simply a case of a badly misleading index?
Source: Bill Gross PIMCO (www.pimco.com) and ISI Group
In our view, the path ahead is going to be very difficult and last for a very long time. While there may be statistical ‘rallies' in the economic data from time to time, this is a function of any time series to at least partially, periodically, mean revert. Real world, for average Joe six-pack, the economic path ahead will be unchanged or deteriorating in all likelihood for the remainder of 2008 and likely all of 2009. How could things get worse? One very real possibility is a currency crisis later this year, possibly following the Chinese Olympics. When I got up this morning, the major news channels were already counting down the days, with headlines like, "45 day to go" to the Chinese Olympics. It hit me that once the games are over, China may very well decide to let the Yuan appreciate at an even faster rate, or revalue the Yuan all together. That type of sudden sea-change in policy would not be a shocker as domestic inflation rates in China are putting a huge strain on the current status quo. For Wal-Mart shoppers, and indeed the US population at large, a Yuan revaluation will be felt in dramatic fashion and would serve to intensify to a high exponent, the current inflationary shock we are already experiencing in food and energy. For the US consumer under siege, much higher prices for clothing and other basic goods would be a huge negative and would accelerate what is clearly already a consumption led recession.
A big lesson from the past: in consumer led recessions, stocks do very poorly. In our view, the S&P 500 is at great risk in the balance of this year. Key support at 1270 looks very likely to come under full scale assault in the days just ahead. There is a modest chance that it may hold and a pretty good chance that it may break down. This morning, the S&P opened sharply lower in reaction to a slew of bad economic news. As the day progressed, stocks rallied on the hope that perhaps the news is so bad that the Fed will not include a strongly worded anti-inflation statement in its official commentary to the markets following tomorrow's meeting. For our money, we see no chance that the Fed will or could under take an increase in interest rates. The financial economy is simply taking on water too rapidly, like a mortally wounded warship. The list is increasing with each week and is now pushing toward a very dangerous 30 degrees. A full roll over – a capsizing -- may be unavoidable, and would more definitely be accelerated by any hike in rates.
With that said, the Fed may still believe that a simple statement will not do ‘much harm,' and I would not be surprised to see a forcefully worded anti-inflation statement emerging from the Fed at the end of tomorrow's meeting. In my view, stocks will not like this one bit, and are very likely to resemble Greg Luganis coming off the high dive in the days just ahead. This also goes for the DJIA and the NASDAQ, with the 10,800 the next long term major support for the Dow. As for the NASDAQ, there are those out there about to learn a very painful and expensive lesson. Namely, technology is a deeply cyclical business. The argument that technology is somehow immune to the recessionary cycle is, at least in this author's view, pure bunk. In a recession, P/E multiples for Tech will contract as growth estimates slide down a long and slippery slope. Of course, most tech investors never want to hear about the downside risk in tech shares, but even in the best names, there is substantial risk at hand. In the table below we show the current forward P/E's for the vaunted Four Horsemen of Tech: Amazon, Google, RIMM and Apple.
|Four Horsemen of Technology||P/E||Growth Rate||PEG||P/S|
|Research in Motion||26.21||34.18||1.08||13.39|
Plain and simple these P/E Ratios are ‘very high' given the potential downside risk from the deteriorating global macro situation. Now, before the chorus of e-mail is hurled my way explaining PEG Ratio's and adjustments to P/E, I will acknowledge that when viewed on the PE to Growth basis, these stocks do not look all that expensive except for Amazon with a PEG over 2.00. However, PEG Ratio's can be deceiving at this point in the cycle. Past experience has shown me that in a downside correction – a sales adjustment -- it is the growth rate which falls rapidly, and as expected growth recedes, PEG Ratio's balloon. To this end, I would point tech investors in the direction of the Price to Sales metric, which is generally high throughout the sector. In my view, we could easily see another 20% sell off in Tech and prices may still not necessarily be anywhere close to a bottom for the down cycle.
In the instance of the NASDAQ Composite, in the chart above we have plotted a long term set of monthly Bollinger Bands. The Time Span counter in the lower clip counts the number of weeks the NASDAQ has gone without hitting the lower band. As you can see, the NASDAQ is still overdue for an additional downside thrust to hit the lower band and end the time span. That's a recipe for more pain ahead. What's more, in the next chart, I show the NASDAQ with a long term median line which we use in our in-house analysis. Most of the time, the NASDAQ will reside above the line, but when prices break down below the line, bad things tend to follow.
In the case of the current situation, any move to go down and get the lower Bollinger Band will, of necessity, break the NASDAQ long term median line and in so doing, likely end up giving a downside projection all the way back down to the 2002 major bear market lows. In Elliott terms, we believe that is exactly what lies ahead, as the NASDAQ secular bear market is likely tracing out a very large (A) – (B) – (C) structure. Wave (A) within this pattern was the enormous bear market decline that ended in 2002/2003 near 1100, with the rally of the last few years tracing out and upward A-B-C of one lower degree. That rally peaked last October at 2850 with NASDAQ completing an expanding wedge which has since yielded to a Wave 1 decline and Wave 2 snap back recovery rally. These are likely part of a much larger five wave declining structure, which when complete will embody the larger Wave (C) decline. My judgment at the moment is that NASDAQ will end up revisiting 1100 over the next 18 to 24 months along with most of the other major market averages.
Above: the GST Unweighted Index of the Four Horsemen of Tech (AMZN, RIMM, GOOG, AAPL)
For the Four Horsemen of Tech, the outlook going forward is very likely at a minimum a 50% retracement of the entire advance seen during the last four years. In our view, the index is now making a failing Double Top with prices all but ready to begin a steady sell off in the weeks ahead. Tomorrow, the street will be watching a key report from RIMM, which could well be the trigger for a more extended decline in tech related shares. To be sure, at these levels, the risk-reward ratio is preposterous, and unless one is a particular glutton for punishment, or likes losing sleep, the recipe for tech investors is to switch horses and start following precious metals.
Elsewhere we continue to see more signs of trouble ahead brewing in Europe with the Aegean countries. On the charts, the Spanish stock market has traced out and broken down from a classic Edwards and McGee Broadening Top formation over the last 12 months.
Above: Spain close up view. The Broadening Top formation 14872.90 2/19/07, 13602.40 3/14/07 15372.50 6/4/07, 13519 .10 9/17/07 15868 11/06/07 12625 1/21/08 11937.20 1/22/08
To form a broadening top, prices must record three higher highs separated by two intervening lower lows. The pattern is then activated once prices close at a third lower low. In the case of the Spanish IBEX Index, the first high was seen on 2/19/07 at a reading of 14,872. This was then followed by a decline into a low on 3/14/07 at 13,602. From there, prices pushed to a higher high (the 1st higher high) at 15,372 on 6/4/07. This was then followed by a lower low on 9/16/07 with a close of 13,519. Rounding out the pattern was the 2nd higher high on 11/6/07 at 15,868 which was then followed by the 2nd lower low on 1/22/08 at 11,938. In the classic broadening top pattern, after recording the third lower low of the mega-phone style pattern, prices often retrace 50% of the prior decline.
Again, this happened right on queue with a rally into a 50% retracement high in mid-May. Following this advance, the text book pattern then reverses into a very long and painful decline. In our view, the strong Euro is hurting export volumes in these countries, and with exports receding, earnings and profits will follow. The stock markets of southern Europe are right now in the process of discounting this fact with both Spain and Italy in full break down mode. In my view, it is not too far a stretch that one or more of these countries, along with potentially one or two Eastern European countries, may bolt from the Euro before this down cycle is complete as the pressure of not inflating imposed by the ECB will likely prove too much. Already Libor bond spreads for Spain and Italy and widening out over Germany and ECB paper, a major warning that cracks are developing underneath the surface.
Above: Spanish Stock Market, the IBEX-35 about to make new lows for the entire move.
This Elliott Wave structure for the Spanish and Italian stock markets agree with the bearish chart formations, wherein for the Spanish stock market, a decline toward the 9,300 to 9,600 range – a major third wave decline looks to be dead ahead.
Above: the Spanish stock market coming out of a broadening top and heading into a likely massive third wave decline. Watch out below!
Above: Milan the MBI Index about to break down into another extended decline.
In the case of the Italian stock market, the MBI Index last quoted at 23,879 is likely to break support at 23,000 and could then decline rapidly toward the 17,000 to 18,000 price level in the months just ahead. These patterns agree with other charts we have featured in this column showing Hong Kong and Paris in recent weeks. The message in our view is universal: global equity markets of all stripes are in for a lot of difficulty as 2008 wears on and investors should be looking to sidestep what appears to be an approaching decline of very large proportions.
At the close, stocks ended with a loss of 34.93 index points on the DJIA, with the Dow closing at 11,807.43 ending with a loss of 0.29%. For the S&P, Tuesday saw the index end with a loss of 10.64 index points to finish at 1314.29, while NASDAQ closed lower with a loss of 17.46 index points at 2368.28. The 10 Year Bond ended with a yield of 4.105%, down 6.3 basis points while nearby Gold ended at $889.55, up $5.75 per ounce.
That's all for now,
© 2008 Frank Barbera