Dow Transports raise warning flag
July 28, 2006 -- Opening observation -- Am I living in some never-never fantasy land? Since July 3, the Dow Jones Transportation Average has fallen 669.04 points, and I haven't read one damn thing about it in the Wall Street Journal, the New York Times, The LA Times, the San Diego Union, the International Herald Tribune, the Financial Times, or Investors Business Daily. Is this some kind of conspiracy of silence? Nah, it's just an absence of good reporting. It seems to me that some newspaper, somewhere, should alert the crowd regarding what's really going on? Aw, maybe times are so good that a little item like a crash in the Transportation Average doesn't really matter.
And now a little history -- the US economy grew at a slower 2.5% rate during the second quarter, slower than analysts had predicted. And now a little forecast -- Bennie and the Feds will not raise short rates on August 9th.
While all eyes are fixed on the Dow and the S&P, things have not been going well at the Nasdaq. The daily chart of the Nasdaq tells the story. From its April 19 peak of 237, the Nasdaq closed on July 21 at 201, a decline of 15% in three months. A little rally followed and the Nasdaq closed yesterday at 205, so there is some bounce in this index. However, note that the 50-day moving average has now crossed well below the 200-day MA, which tends to put a "roof" over the index.
The Nasdaq is the tech index, and tech has been having its problems. One thing that has always bothered me about the tech stocks is that they are so open to competition. You come up with a good idea for a product, and in no time five or ten companies are competing with you. Ah well, let me put it this way -- the Nasdaq is not a pretty sight. It never really recovered from its 2000-2002 collapse, and the action since 2002 has hardly been encouraging.
By this time, I guess subscribers have grasped the idea that I am not in love with this stock market. What about looking at the markets as one single entity that covers the whole market? The way to do that is with the Wilshire 5000, the index that includes roughly all the stocks on the NYSE, the Nasdaq and the Amex. Below we see a daily chart of the very broad Wilshire.
The interesting feature of this chart is that since its high which was recorded on May 5, the Wilshire had traced out a series of declining peaks. In other words, each rally was weaker than the preceding and each peak was below the preceding peak. There are four peaks on the chart (red arrows), count 'em, and we have a sort of "double bottom" at the 12,300 level. The 50-day moving average has now dropped below the 200-day MA, and the pressure is now to the downside.
The chart formation we see below is not "a pretty picture." The rallies are fading and we have a series of descending tops. When you see this kind of action, you know it's very difficult to generate profits in the stock market. A series of declining tops is almost always a bearish phenomenon.
The actions of my PTI together with the Wilshire and the Transportation Average represent a flashing yellow flag. It wouldn't take much to turn that yellow flag a bright red.
Countrywide Financial -- this is the nation's largest independent loan lender and mortgage company -- it's a stock that has a wide following. But suddenly, CFC has fallen out of bed. I don't know the story yet, but I do note the stock action. It's all part of the deteriorating real estate and loan picture. Notice the volume on yesterday's break. What's up, Countrywide?
Oh, you think Countrywide is just an isolated case? Then check out the chart of Capital One Financial Corp. below. This is a diversified company offering banking services, credit cards, auto loans, etc. I'd say something is unpleasant is going on in the loan business, wouldn't you?
I'm receiving a lot of mail regarding my warning about possible deflation. Yeah, I know, the Fed is worried about inflation, many analysts are worried about inflation, the newspapers are constantly talking about the "dangers of inflation." Me, I'm totally open-minded as to whether inflation, deflation or neutrality is coming up next. I'll leave it up to the markets to provide the answer.
I do think this -- if the US economy starts to act deflationary, Ben Bernanke will have a fit. Bernanke does not want to be in a position where he has to fight deflation. Halting inflation is easy; reversing deflation can be difficult, as the Bank of Japan will tell you.
Why am I even talking about deflation? My reasons are (1) world central banks are raising interest rates while sopping up liquidity. (2) Housing in the US is running into trouble, inventories are at record highs, mortgage rates have been rising, and too many people "own" their homes with thin equities and rising mortgage costs. (3) The world is producing too much in the way of cheap goods and services. (4) Massive amounts of debt are inherently deflationary since they must be financed, and financing eats up capital.
Under the above conditions, deflationary forces are definitely out there. As matters stands -- failing to inflate enough means giving into the underlying forces of deflation. It's the old story -- "Inflate or die."
The question I'm asked frequently is "How would gold stocks act in a deflationary atmosphere?" The better question would be, "What would the Fed do if deflation began to creep into the economy?"
My answer is that the Fed would bring down short rates, and do everything possible short of giving money away. Japan fought deflation for years, flooding the markets with yen that could be borrowed with literally zero interest rates. That would probably be the model if the US moved into a deflationary situation.
As I see it, the biggest threat to the US is a potential housing collapse, which would obviously be very deflationary. If that happened, we could even see a moratorium on mortgage payments. This government would do absolutely anything and everything to halt the forces of deflation.
Of course, the one guaranteed recipe for halting deflation and bringing back inflation -- is war. World War II ended the Great Depression during the early 1940s. And we always have that secret weapon -- the mighty military-industrial complex. Yes, that's the one that Eisenhower warned us about in his final speech. It's still here -- bigger than ever. In times like the present, US spending for "defense" is absolutely open-ended.
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