A Melman Minute
By: Leonard Melman
We are all familiar with the story that one of the
most dangerous moments in boxing comes when you throw your Sunday punch at your
opponent, hit him squarely on the jaw - and he just smiles back at you. Well,
the United States Federal Reserve Board must feel the same way. After the stock
market debacles in January and March of this year, the Fed did virtually
everything it could to stimulate both economic growth and confidence in the
economy.
They flooded the market with money, moved to bail out the banks, worked hard to
pass laws to resolve the mortgage and credit crisis and, most recently, have
relentlessly 'talked up' the value of the U.S. Dollar. They have worked
mountains, but, as far as securities markets are concerned, have they have not
only failed to produce the proverbial 'molehill', they have accomplished nothing
at all, except to use up a great number of potential financial weapons.
One look at the chart of the Dow Jones Industrial Average illustrates our point.
The Fed was able to give the securities markets a boost each time they acted
decisively in January and March, but it can be readily seen that the DJIA has
given back all those gains and is once more trading close to the yearly lows.
Not only that, but the BKX average based on bank share prices, the one group
that was supposed to have benefited the most from the Fed's actions, has
actually been plunging to new low prices almost every day of late.
Although the picture for the financial markets is indeed taking on a negative
appearance, in an effort to be objective, it is important to point out that
there is one widely-regarded concept that remains in a bullish mode and that is
the concept of "non-confirmation". Simply stated, most market averages tend to
confirm one another, meaning that they move in relative tandem. However, when
they diverge with one average making new lows, but another important average
remaining relatively close to their highs, a "non-confirmation" is clearly
taking place.
One of the most famous theories regarding this concept is the "Dow Theory".
Originally posited by famous market analyst Charles Dow, who was also one of the
founders of Dow, Jones & Co., and described thoroughly in Robert Rhea's book,
"The Dow Theory" published in 1932, one of the hallmarks of that theory is that
movements to new highs or lows in the Dow Jones Industrial Average are not
confirmed until the Dow Jones Transportation Average also makes new highs and
lows.
In the present circumstances, we have a startling divergence. The Industrials
bottomed near 11,500 in January 2008, rose to near 13,800 and have now retreated
back to the 11,700 zone, threatening to give a 'sell' signal if they break under
the previous low levels. However, the Transportation Average is nowhere near a
new relative low. After bottoming near 4,000 in January, the 'Transports' rose
sharply to about 5,500 at their recent highs and, as of this morning, have
returned only to the 5,000 level - a full 25% above their January lows.
According to the Dow Theory, a new bear market will not be confirmed until the
Transports join the Industrials by falling below their last important lows.
We mention this because the Dow Theory, while hardly infallible, has actually
been a valuable tool of market analysis through the decades and it has many
believers. Until the theory confirms the existence of a new primary bear market,
a serious doubt will exist in the minds of many Dow Theory adherents.
For ourselves, we believe that the actions of the Industrials, combined with
serious weakness in the bank shares, the S&P 500 Average and continuing
fundamental information that points toward further economic troubles all combine
to demonstrate the potential for serious economic upheavals. However, there is
another side to that question and we would be remiss not to take note of that
alternative view.
Speaking of fundamental information, another devastatingly weak report on the
state of American Real Estate came out this morning with information that the
Case-Shiller Index of home prices suffered through another huge decline during
the month of April, 2008. Twenty metropolitan areas are included in the index
and, for the first time ever, all twenty areas are in simultaneous decline when
year-to-year price comparisons are made.
The cumulative effect of month after month of declines is now beginning to be
felt widely. From 2003 through 2006, home prices in America moved up by an
average of 52%, but fully one-half of those gains have now been lost on average.
As Rex Nutting of website "MarketWatch" observed, "Falling prices have eroded
Americans' wealth, cutting into their ability to borrow against their home,
refinance, or to sell for a profit. Millions of Americans now owe more on their
home than it is worth." (our emphasis)
Declines of a serious nature have been spread across America from the Pacific to
the Atlantic as well as from north to south, evidenced by the list of those
cities where real estate values have fallen by more than fifteen percent in the
past year, a list which includes Minneapolis, Detroit, Tampa, San Francisco, San
Diego, Los Angeles, Phoenix and Miami.
Although some respected analysts are now offering the opinion that this may
indeed be the time to start investing in those depressed markets, we would
suggest two concerns which lead us to believe that the worst may still lie
ahead.
First, as many of those millions of homeowners encounter severe difficulties in
making their monthly mortgage payments, it seems likely that they are turning to
credit card lines of credit to obtain the cash to continue those home
installments. When those lines of credit run out and the enormously high
interest payments on credit card balances are added to their high mortgage
payments, it appears likely that another wave of defaults will be the result.
That could further depress the market.
Second, we offer the opinion that tens of millions of middle age or older
homeowners have watched the price on their homes, purchased decades ago for a
comparative pittance; explode upward during the boom times. They undoubtedly
have formulated plans to use the huge increments of real estate net worth to
fund their retirements. Now they are watching those plans crumble in front of
their very eyes. We believe that a tidal wave of selling awaits, brought about
by older homeowners desperate to sell while they are still able to recover any
meaningful profits left to salvage.
As long as real estate values continue to decline, an ominous threat hangs over
the entire American consumer-driven economy, a threat which bears close
watching.
In today's markets, as of 8:30 AM PDT, the Dow Industrials have recovered from
earlier selling and are now close to unchanged, with the TSX down about 90
points. Gold has continued to recover from early selling Monday and spot gold is
now above $890 (all prices US$) while the other precious metals including
silver, platinum and palladium are close to unchanged. Base metals continue to
show weakness this morning with nickel and zinc encountering particularly heavy
selling. Crude is once again above the $137 per barrel level while the U.S.
Dollar is down moderately.
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