FSO Editorials: "Is Weakness in Dow Components Signaling a Nasty Fall?" by Dr. Joe Duarte 08/28/2005

FSO Editorials

Is Weakness in Dow Components
Signaling a Nasty Fall?
by Joe Duarte, MD
Joe-Duarte.com & IntelligentForecasts.com
August 28, 2005

The bears are having a good time inside the Dow Jones Industrial Average.

While the market is marveling at Chinese IPOs, there is a huge erosion of market value ongoing in the bellwether of bellwethers. Whether this is merely a sign of the times, or a sign of something dark and sinister coming down the pike, is well worth exploring.

General Electric (GE) is almost a mutual fund unto itself. The company's well-diversified set of businesses includes a financial services unit that caters to a wide array of investors, and clients. The plastics unit is often seen as a bellwether of future economic trends. And the company's broadcasting arm includes some of the crown jewels of the media business.

But the stock is sending a very negative message. GE is off over 10% since December, as of August 26, when it broke to a marginal new low. At 20 times earnings, with a 16.8% return on equity, a 2.6% dividend, stout management, and very steady earnings, the stock should be doing well, assuming that the fundamentals of a world class conglomerate matter.

Wal-Mart (WMT) is another example of a dog of the Dow that's getting its bark trimmed.

Charts Courtesy of StockCharts.com

The stock is off 24% from its November 2004 peak, as of August 26. Under the hood, it's the same kind of story: solid fundamentals, featuring a slightly below average 18 P/E along with a 26% R.O.E., and a slightly wimpy 1.3% dividend yield. No trouble here making money either.

SBC (SBC), 3-M (MMM) and Exxon (XOM) are similar stories, with dismal charts and fairly good stuff under the hood, including dividends, reasonable sales, and fairly good value, especially when compared to stocks like Genentech (DNA) and even the market's current darling, Google (GOOG) .

So what gives? The answer is likely to be multifaceted.

Technically, the U.S. stock market is not doing well. The Dow Jones Industrial Average is now trading below its 200-day moving average, often an ominous sign for stocks, if it remains unchecked, as it can signal that a bear market is under way.

The U.S. dollar is trying to stabilize, and may have stopped falling over the long term, even if it doesn't rally from current levels for some time. A rising or steady dollar could eat into some of the profits that the big conglomerates make overseas.

But, there might be a much simpler story behind the weakness in the Dow.

Interest rates are on the rise, and oil prices may be reaching that point at which economic growth starts to slow. Already Wal-Mart is complaining that its clients, "working class" Americans, are having a hard time making their way to their stores due to high gasoline prices.

The combination of higher rates, and higher oil prices could well be what has the entire market worried.

Outgoing Federal Reserve Chairman Alan Greenspan noted on August 26, that the housing market is in a state of "imbalance."

In April I described a scenario that included several different variables with one conclusion: an economic crash. See earlier column.

The conclusion then:

1) "Assuming that the Chinese economy hits what is an inevitable bump in the road, that would mean that somewhere later this year, perhaps in July or August, the traditional time for financial markets to start stumbling and churning, we could be in for another Asian meltdown, as in 1997's Thai Bhat debacle."

2) "That could mean that by October, the usual bad month in the markets, things could be fully underway."

3) "If U.S. households find themselves in a cash flow crunch, as a result of rising mortgage rates, and the Chinese economy is suddenly drained of foreign cash, being repatriated to the United States due to the lure of rising interest rates, a significant change of scenario in the markets is not just likely, but inevitable. The shift could start suddenly, and progress quickly, fueled by fiberoptic communications and the flow of information at the speed of light."

In recent days the Hong Kong stock market has logged a series of significant declines.

The Chinese government has recently reported that foreign direct investment has flattened out.

Over the last few days, we've seen, haphazard statistics from the housing market, accompanied by the acceleration of the down trend in housing stocks, despite good earnings and happy talk from company CEOs.

And U.S. households, may be in the early stages of having cash flow problems due to high oil prices, and the effects of higher interest rates that may be starting to bite the housing market.

I'm not a prophet of doom, but, I am a trader. And to me, it looks as if the stealth bear markets in key components of the Dow Jones Industrial Average, as well as the mostly unnoticed slippage of the whole index below a key technical gauge, may be trying to tell us all something.

If I'm wrong, then we might be looking at some nice bargains inside the Dow.

But I'll be watching very carefully over the next few days and weeks. After all, October is getting closer.

joe duarte Joe Duarte M.D. is founder and Editor in Chief of Joe-Duarte.com. Dr. Duarte is a board certified anesthesiologist, a registered investment advisor, and President of River Willow Capital Management, where he manages individual client accounts. duarte iq His latest books "Successful Energy Sector Investing" and "Successful Biotech Investing" (Prima/Random House) are available on line at amazon.com, barnesandnoble.com, borders.com, Traders Press, and all major online and brick and mortar bookstores in the U.S., U.K. Europe, and Australia.

Dr. Joe Duarte's Daily Market I.Q. is a subscriber service that provides daily intelligence, trading strategies, and technical analysis at www.joe-duarte.com.