Every year at this time we mention the January barometer, a somewhat flawed indicator. The signal is that what happens in January is indicative for the year.
There are those who take it a stage further and say that what happens on the first trading day in January is indicative for January. Hence, they would logically argue that market behaviour on 2nd January sets the course for the next twelve months.
As it happens, not for reasons of the January barometer, but more because of our fundamental view, we think that this year is very likely to be an extension of the first negative trading day.
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For fullCircle Asset Management, the year's first trading day was truly extraordinary, every component of the model portfolio benefited remarkable!
We constantly review the stock markets of the world a condition now exists that is rarely seen. Almost every stock market in the world is in the early stage of forming a decisive top from which significant declines are very likely.
The exceptions are few. Not surprisingly, on the back of the strong oil price, Middle Eastern markets remain positive, that is about the only good region, even the Chinese stock market is in the early stages of a top formation. Certain markets, e.g., Ireland, have completed very decisive tops.
Bill Gross, of PIMCO, the largest bond fund manager in the world, says that the US is in recession already. He obviously knows something nobody else does because technically a recession occurs following two consecutive quarters of negative growth. But we kind of know what he means: the economic conditions are extreme and unremitting and who knows, he may be at least half right.
Economists have estimated that in the fourth quarter 2007, US gross domestic product grew by a measly 1%, following the third quarter's 4.9%. We expect their estimates are tinged with a certain amount of optimism. They wouldn't have to be that wrong for the fourth quarter 2007 to be one of negative growth. We will soon know.
If there is going to be a recession in 2008 - and the likelihood of that gets greater by the day - then 2008 will be a very poor year for stock market returns, especially in the developed world. No matter what action Central Banks take, and there will be plenty of it, we are only in the early stages of what will turn out to be the worst credit contraction in living memory.
We contend that it is quite wrong to optimistically expect Central Banks to remedy matters. We cannot see, under any circumstances, how banks and other lenders will return to the loose lending policies prevalent only months ago.
As their continued unwillingness to lend continues, so will defaults and insolvencies accelerate. As defaults and insolvencies in both the consumer and the commercial world gather momentum, so banks' willingness to lend will become less. As bad debts accumulate negatively in banks' balance sheets, their main focus will be the recapitalisation of their balance sheets not making new loans.
Events are certainly moving on quite rapidly. One of the triggers for Wednesday's stock market decline in the US was the Institute for Supply Management's Index of National Factory Activity in December which was 47.5 compared to 50.8 in November, much worse than expected and the worst number since April 2003. A figure below 50 means economic contraction. Worse still was the gauge of future business activity which registered a bleak 45.7. Optimistically, analysts had predicted a figure above 50 for December.
In the immediate short term, exposure to the negative side of stock markets makes admirable sense whilst we wait for the inevitable opportunity, possibly late 2008 more likely 2009, when those same stock markets will represent a once-in-a-lifetime opportunity. The last time such a massive opportunity presented itself was in 1975 when the UK stock market yielded 12% having just fallen 75%. Today the dividend yield is just over 3%.
Two issues ago, in issue number 559 dated 6th December, we commented upon the Norwich Union Property Fund, the biggest out there. At that point, it had fallen precipitously to its August 2005 level. We commented then "Investors can't escape and it will get worse". The fund price then was 160, it is now worse, down to 153, back to where it was in March 2005 and still it will get worse and still investors can't escape.
In the last issue number 560, there was insufficient room for our Four Horses of the Financial Apocalypse. We welcome them back.
The white horse - false peace - the Volatility Index (VIX)
As we have explained in previous issues, the whole nature of this index dramatically changed in early 2007 when the thirty-week moving average changed from suppressing to supporting the price action. The uptrend throughout 2007 has been maintained, this all suggests an ever increasing level of anxiousness as major investors seek insurance by buying put options in order to protect portfolios, vulnerable to stock market weakness.
In November 2007 UK investment funds suffered net withdrawals for the first time since 1992. How nervous is that?
The red horse war and destruction the Philadelphia House Market Index
There is overwhelming bad news as far as the US housing market is concerned.
The Standard and Poor's/Case-Shiller Index of twenty metropolitan areas, for October, fell 6.1%, the biggest fall ever since this Index was created. The Index has fallen every month in 2007.
According to the Commerce Department, November sales of new homes fell 9% to an annual level of 647,000, a twelve year low. At the same time, the October sales were revised lower. So far this year new home sales are down 25.4%, heading for the biggest yearly fall since 1993.
Existing home sales surprisingly rose 0.4% in November to an annual rate of 4.98 million. The first rise since February 2007.
The median price of previously owned homes fell 3.3% to $210,200 compared to twelve months ago.
It's getting worse!
The black horse famine and unfair trade Dow Theory
On 21st November last year, Dow Theory delivered a primary bear market signal when both the Industrials and Transports closed below the 16th August closing price. This signal was decisive. What followed was a strongish rally which would seem now to have failed, with the prices now not a lot higher than 21st November see the charts.
If the first signal was correct, and we think it was, then it is only a matter of time before those November lows are exceeded.
The pale horse sickness and death the Inverted Yield Curve
Long-term interest rates remain very low. In America the thirty-year treasury yield is 4.34% almost as low as it has been at any time in living memory and in the UK, the forty eight year yield is at 4.19%.
Although the US Fed Fund's Rate is slightly higher than the thirty-year yield at 4.25%, as we say repeatedly, when long-term yields are this low, the outlook for the economy in the medium term is not good.
By John Robson & Andrew Selsby at fullCircle Asset Management, as published in threesixty, a fortnightly newsletter that gives insight into the investment markets.
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