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Today's WrapUp by Chris Puplava 11.23.2005 Mon Tue Wed Thu Fri Archive

ECONOMIC AND MARKET PULSE

General Motors Corp. announced Monday that they will be closing 12 facilities in North America and cutting 30,000 jobs by 2008 due to declining sales and rising health care costs. This move would cut more than a fourth of its North American manufacturing jobs, which is 17% of its 173,000 hourly workforce (the average hourly worker is around 49 years old), with the move being called “devastating” by the United Auto Workers. GM is not alone as Ford Motor Co. announced last week that it plans to eliminate about 4,000 jobs in North America early next year in its own restructuring plan.

GM has been under pressure from Asian rivals as its US market share has fallen from 33% ten years ago to 26.2% currently. Moreover, GM has lost nearly $4 billion in the first three quarters of the year. Toyota could be passing GM in worldwide production as Toyota expects to produce 8.1 million vehicles this year while GM expects to produce 9 million.

GM is trying to cut costs and improve efficiency and said the plant closings will cut $7 billion off its $42 billion annual operations budget by the end of next year. The plant closings will decrease the number of vehicles made by GM in North America by 1 million a year by the end of 2008, down 30% from 2002. GM Chairman and Chief Executive Rick Wagoner said the plan would improve North American plants to run at 100% of their capacity compared to the current 85%.

To put things into perspective, it’s no wonder Toyota has been soaring while GM has been falling with Toyota having the most productive plants in North America, operating at 107% capacity in 2004 according to Greg Gardner of Harbour Consulting, which measures manufacturing productivity.

These aren’t the only troubling economic news coming out lately. The International Council of Shopping Centers (ICSC-UBS), which reports a weekly tally of store sales, said in a special consumer question that 59% of those polled said high gasoline prices are reducing their discretionary spending. Interestingly, this percentage is greater than the 54% level in late September when consumers were faced with gas prices at $3. High gas prices, shaky consumer confidence, and an uncertain jobs market are clouding the outlook for holiday sales.

Looking at leading economic indicators also points to an economic slowdown, troubling news for the stock market which typically peaks before the business cycle does. The October job growth proved disappointing as non-farm payrolls rose a much smaller-than-expected 56,000. The overall weakness was centered in service-producing jobs, which rose only 7,000. Retail trade declined 5,000 with a sharp 8,000 decline at auto dealers whose sales suffered badly in the month. Leisure jobs were especially hit hard, down 18,000.

The Labor Department said the weak growth was probably not tied to Katrina, and that job growth outside the Gulf Area was below trend. It did note that high gas prices could have dampened the jobs market including hiring in vacation industries, confirming the ICSC’s special consumer question mentioned above. Surprisingly the Labor Department said Hurricane Rita had only a minimal impact and that Wilma hit too late in the month to be included in the data.

Source: Econoday >http://(www.econoday.com)

When looking at the graph above, a clear correlation can be seen with non-farm payrolls and the S&P 500. The bottom of the recent bear market was in October 2002 followed by a sharp rally that began in mid-2003 before slowing down in 2004 and 2005. As 2005 has seen a relative flat market, the non-farm payrolls have shown a broad top which peaked on a year over year % increase in January of this year and appear to be rolling over.

Another recessionary indicator, new jobless claims, which has a significant inverse correlation with the stock market, also shows a concerning trend. The chart below shows the inverse correlation between the S&P 500 and new jobless claims

Notice the bottoming seen in 2000 over a period of a few months then the about face continuing on a sharp incline before slowing in 2002. The broad peak seen in new jobless claims corresponded with the broad bottoming in the S&P 500 in 2002-2003 followed be a decline in jobless claims and the beginning of the current bull market.

I plotted jobless claims over a shorter time frame alone to include the jobless claims bottom in 2000 to November 2005 seen below.

What can be seen in the above chart is that jobless claims fell from early to mid 2003 to January 2004 at a sharp pace, but since then have been falling at a decreasing pace. With the recent news from GM and Ford mentioned above, an increase in new jobless claims could be putting in another bottom and possible reversal, bad news for the markets.

Challenger, Gray & Christmas Inc., an employment consulting firm, said that the 30,000 GM job cuts combined with Ford’s 4,000 job cut puts the auto industry on track to meet, or possibly surpass the 2001 record of 133,686 job cuts in one year. The Challenger report said that the auto industry, which includes car manufacturers, suppliers, and auto dealers, announced 89,016 job cuts through October 2005, 123% higher than the 39,921 job cuts through October of 2004.

Michael Gregory, senior economist at BMO Nesbitt Burns said that “Everyone understands the old adage that ‘What’s good for GM is good for the U.S. economy,’ and if GM, the bellwether, is struggling, it very clearly affects confidence.” He further added that “From a manufacturing standpoint, it’s going to have ripple effects into the parts industry as well – adding to the headwind on the manufacturing side.”

Chief Executive John Challenger said that “Job cuts will not end with these announcements. Every town with a closing plant will see its local economy take a hit. Retailers, restaurants, real estate, home improvement stores…will all see business decline.”

Continuing the case for a possible economic slow down comes from looking at housing starts, a reliable economic indicator. The graph below overlays the direct relationship between housing starts and the S&P 500.

As seen above, housing starts peaked in early 1999 followed by a sharp decline and advancement to a lower high seen in early 2000. This lower peak turned around into a sharp decline that foretold of the S&P 500 decline just months later.

The current picture between housing starts continues to show the positive correlation between housing starts and the market. The graph below shows the 5 month housing starts average which appears to be peaking or at least leveling out, with the recent high just over 2070 units (th), the previous high.

Removing the 5 month average and plotting actual housing starts relative to the S&P 500 shows the first break in the increasing trend in housing starts where the peak occurred in February 2005 as seen in the chart below. The first lower peak in housing starts seen in April 2000 signaled the coming decline in the S&P 500. The current lower peak seen in October of this year could be telling the market what lies ahead in the near future, although a divergent pattern is seen presently with housing starts declining and the market rallying.

When looking at non-farm payrolls, new jobless claims and housing starts, all three appear to be showing weakness in the current economy and a possible declining period in the face of record oil and natural gas prices with winter knocking at our doors. These indications would also spell trouble for the stock market, and analysis of the internal strength of the market is in order.

The recent highs in both the NYSE and NASDAQ have not been confirmed by their respective Adv/Dec data. The NYSE put in a new high at the current 77135.35 value but has only regained roughly half of its Adv/Dec pullback from the high seen in September, with the NASDAQ showing a higher high with an even weaker Adv/Dec move since its recent bottom.

The recent move in the Dow Jones Transport Average has not been confirmed by the Dow Jones Industrial Average. Tim Wood pointed this out in his recent wrap up on 11/11/2005, “The Dow Report: Questions on Dow Theory.” His graph is pasted below.

Tim’s thoughts on the current market and Dow Theory from his wrap up are given below:

In the interim, yes, the “Secondary Trend” is currently bullish. But, this non-confirmation is a serious warning that the Secondary Trend is in jeopardy. Also, think about this; the Primary Trend remains bearish and the Primary sell signal according to Dow Theory still stands today. If the Dow Theory was not relevant, then why is it that this giant bear market rally separating Phase I from Phase II of the bear market has not been able to carry the Industrials to new highs? Guys, we are still at the same levels on the DJIA as we were in 1999. That was 6 years ago. If this were a “new bull” market don’t you think we should have made a new high by now? I maintain that the advance out of the 2002 low was merely a Secondary Reaction separating Phase I from Phase II of the ongoing bear market. Furthermore, the sideways action that has been seen since January 2004 is part of the topping process associated with this giant bear market rally.

His views are further supported by Frank Barbera, a frequent guest on Financial Sense News hour (click here for a link to interviews). Frank’s recent work looks at the current market situation and he points out that the recent advance in the S&P 500 comes on the wings of the financial stocks, as the Philly Bank Index has posted a gain of 11.18% from the low on 10/12/05 while the S&P 500 has gained 6% over the same period. This is not surprising as financials make up 20.1% of the current S&P sector weight. Frank thinks that the recent rally in the financials (and subsequently the S&P 500) “appears to have been largely a rotational bet placed by large quantities of the nearly 9,000 hedge funds on a soon to be expected change in Fed Policy.”

He feels that, “The crowd is clearly betting on the idea that ‘Inflation’ for this cycle has peaked with the highs in Crude Oil and Unleaded Gasoline seen in late August, and that the Fed will soon begin to change its language toward a more accommodative stance.” He goes on further to say that, “In fact, it would be my view that based on the degree of conviction seen within the rally in financials over the last few weeks that the market is hoping for a change of language at the upcoming December meeting.”

Frank further adds, “In my view, there is great risk in this assumption, in that it is far from clear whether or not we have truly seen a peak in energy pricing for this cycle, and therefore a significant decline in inflation for the Federal Reserve to go on HOLD as soon as the market is currently expecting. Were the timing of a Fed policy change delayed by several months, the repercussions for the stock market would likely not be pretty.”

In Frank’s piece he included a graph on the S&P 500 using Elliot Wave Analysis with a bearish rising wedge formation, see below.

As the NYSE and the NASDAQ’s recent highs have not been confirmed by their respective Adv/Dec movements, bearish divergence is also seen in the S&P 500. Looking at the weekly chart over a 3-year period with the last three highs seen in early 2004, early 2005, and the recent October high shows non-confirmation by the RSI and MACD.

Sam Stovall, chief investment strategist for Standard & Poor’s, took a look at the bull markets since 1942 (click here for a link to the article). The data indicates that the bull markets have averaged 56 months in length with the first year’s advance averaging a 38% gain followed by a 12% gain seen in the 2nd year and a 3% gain seen in the 3rd.

Source: Standard & Poor’s Sam Stovall

The chart above indicates that the third year poses the biggest challenge to the markets, where 6 out of the 11 (54%) bull markets over the last 60 years (including the current bull market) have finished in the red. Of those who finished the 3rd year on a positive or flat note saw an average of 14% return in the fourth year. Note that of those bull markets that survived the 3rd year on a positive note, their average return in the 3rd year was 11.8%.

So how does the current bull market measure up? Taking the low as October 10th of 2002, the first year advance was 24.3% (below the 60 year average), the second year was up 8.1% (again, below the 60 year average), and the third year recently completed on October 10th of last month was up 5.8% (above the average).

What I would like to point out is that the bull markets that showed a strong gain in their fourth year showed a strong return in their third. Removing the 0% return seen in the bull market that began in 1962 and the current bull market, the third year advance was 16%, 1.75 fold greater (175%) than the current bull market’s 3rd year return. This observation, along with the divergence shown above in the NYSE, NASDAQ, and the S&P 500 shows the weak internal strength of the current bull market and its possible peaking.

As mentioned above, Frank feels the market is expecting an easing in the Fed on interest rate hikes and has positioned itself ahead of this move as seen by the move in financials. There bet is that inflation has seen its peak in the current cycle. If investors are wrong, Frank sees a nasty reaction by the market, which could spell the end of the current bull market.

As a gauge on inflation, one has only to look at how gold is doing. Does the yellow metal show signs of peaking? The simple answer is NO, and neither do gold and silver stocks as seen by the charts below.

Both the XAU and the HUI indexes have not broken through their trend lines and are even accelerating their advance as is gold, which is approaching $500!

Another look at inflation would be to see how oil and natural gas are doing, which have been pushing up headline inflation. See charts below:

Both the oil and natural gas indexes have taken a hit recently but are still holding above their long term trend lines and their 200-day moving average and have even accelerated their trend this year.

The current trend in natural gas and oil will likely continue due to anticipated cold weather this winter. The 30-day and 90-day weather outlook from AccuWeather given below is not encouraging (Source: AccuWeather).

National 30-Day Outlook:
-A dip in the upper-level steering currents will develop over the Mississippi Valley during much of December, generating an active winter storm track from the southern Plains to New England. Along this track, precipitation will be near to above normal.
-South Florida and California will have above-normal temperatures during December.
-The Southeast and the Middle Atlantic regions will experience near-normal temperatures, as will a broad region of the U.S. that stretches from the Pacific Northwest, southeast to Texas.
-The region from the central and northern Plains to New England will be colder than normal during December. Much of the precipitation that falls in this region will be in the form of snow or ice.
-Higher levels of precipitation over relatively warm waters will create more lake-effect snow than usual in the Great Lakes region.
-The Pacific Northwest should have near-normal precipitation in December, but the remainder of the western states, as well as the Rockies and the western Plains, will likely have below-normal precipitation

National 90-Day Outlook:
-December through February will be colder than normal over the eastern third of the nation. The only exception will be South Florida, which will experience near-normal temperatures.
-Much of the western half of the nation will be warmer than normal during the next 90 days, but Utah, southern Idaho and Nevada will experience near-normal temperatures.
-Precipitation will be above normal from the eastern Great Lakes to northern New England, and near normal from southern New England and the Middle Atlantic region to the central Gulf Coast.
-The Southeast coast will be drier than normal in the 90-day period, as will much of the western United States. Only the region from the Pacific Northwest to western Montana will have near-normal precipitation.
-This winter will likely be quite snowy from the Great Lakes to New England, where temperatures will be below normal and precipitation near to above normal.
-A developing drought in the southern Plains is likely to worsen this winter.

The Energy Department report on natural-gas storage data revealed a surprise decline in supplies of 8 billion cubic feet to 3.27 trillion cubic feet. Stocks were 32 billion cubic feet less than last year at this time, though still 195 billion cubic feet above the five-year average of 3.08 trillion cubic feet.

The projected cold winter by AccuWeather will likely cause an increase in demand for natural gas and heating oil, coupled with the recent declines in natural gas storage will likely push natural gas prices further. This in turn would put pressure on headline inflation and may then cause the Fed to delay their pause in raising interest rates. This action may then cause financials and the broader markets to enter into a corrective phase.

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Chris Puplava

© 2005 Chris Puplava
Puplava Financial Services, Inc.
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