Navarro’s Big Economic Picture – Readi-Whip Market

Three headlines on the front page of the IBD 02/06/06 issue pretty much capture the microcosm of the macro moment: “Nasdaq Reverses Lower in Brisk Trade,” “10-Year Yield Rises to 18-Month High on Int’l Rate Hikes,” “Alternative-Energy Stocks Shine As High Oil Costs Here to Stay.”

Regarding headline #1, while it is true that the market is showing surprising resilience in the face of increasingly mixed economic news, it is equally true that the change in the type of market action we are witnessing is far more suggestive of topping action than a nice leg up the bullish ladder.   Failing to hold higher highs and disquieting distribution days cannot really be ignored.  If higher interest rates and higher oil costs are really “here to stay,” it’s now only a matter of time before the short sellers gain the upper hand.  And I shall repeat one observation that keeps coming back to me: This looks a lot like the first quarter of 2000 when most economic forecasters were projecting robust growth and the market was blithely unaware that its Waterloo was just around the Fed rate hike corner.

Hedging Your Bets With Matt Davio:  The Haves and Have Nots

I want to discuss the big picture of the consumer as it relates to inflation, savings rates, and spending.  What first catches my eye, and is of paramount concern, is the true negative savings rates employed by the American consumer.  Encouraged by an aggressive Fed who lowered rates to 1% over the past three years, the consumer has ratcheted up debt and spent and speculated in real estate as well as goods and services.

Yet the recent retail numbers that came out yesterday were pretty uninspiring, save for a few isolated specialty retailers. You can see the consumer’s momentum waning in products like AAPL and DELL, which are trendy, and the stock prices of these names along with the flailing of WMT indicate the consumer is tired.

The homebuilding index put in a top last July and as interest rates continue to rise, it seems that further highs will be difficult to procure.   The Bush administration, all the while beating the drum for an ownership society, has successfully employed an easy money policy to get home ownership rates in this country to all time highs.  Over 71% of the nation “owns” their home. With home ownership levels about 10-15% above normal, supply and demand has driven the market to its top. Who is left to own a home?  Why speculate with prices so high, unless you are betting on every family owning multiple homes.  I just don’t buy it. And as a lessor, who’s is left to rent your rental property if 71% of the population owns their own home?  Talking to lessors I know, it has been difficult for the owners of rental properties to find quality renters even with prices being forced lower over the past few years.  They are selling their real estate at current prices because it doesn’t make sense to own anymore at current market prices versus rental prices and acceptable pool of renters.

Which brings us to this heady juncture.  With the combination of easy money becoming more expensive and consumers having to service their debt coupled with the  negative savings over the past 3 years, I am willing to bet that retail is not the place to be for big upside in the near-term.  Homebuilders, DELL, AAPL, WMT are already showing the writing on the wall. GOOG, the darling of momentum America, is now seeing tougher times as its stock price has come off nearly 1/3 from its all-time high.  There will be tougher times ahead for GOOG as they learn the lessons MSFT learned years ago – that super-mega-cap companies with slow growing, established revenue streams eventually lose their forward-looking premiums and plod along with the rest of their blue chip brethren.

Inflation is real for the average consumer.  Haven’t you seen it?  Look around….the rise in energy costs at home and for the car, increasing insurance costs, painfully expensive education for our children (who need it more than ever in this global economy)…heck, even stamps have risen 5.4% of late!   Couple that with increasing mortgage debt and interest rates and a negative savings rate and you’ve got a consumer that isn’t set to spend like he has the past few years.  With that being said, I am willing to sell retail stocks that have performed very well over the past few years and even consider shorting the broader index over the rest 06 and into 07.  I think there is a nice risk/reward setup on RTH the retail holders. I would expect the old high in July of 05 on RTH to hold as the high. I think there is a potential of 5-10% downside on the retailers. Here is the chart:

This Week’s Macroeconomic Calendar: Another Week of Volatility Ahead

This will be another big data week with a lot of chances for renewed market volatility.

On Monday, the quarterly bankruptcy filing come out.  Last quarter’s spike was blamed on new legislation that filers would rushing to avoid.  Let’s see if that was the only driver.  Factory orders and consumer credit will likewise be of some interest.

On Tuesday, we’ll get a revised look at productivity, crucial to holding down wage inflation.  It fell unexpectedly last quarter but the fall was again blamed on a one-time event (Katrina).  Me thinks there is more to the story.

My first big market mover of the week is the trade report on Thursday.  We keep hitting records – last month we got to $66 billion – and if that deficit worsens further, it is going to roil the bond and currency markets, with some spillover to stocks.

Of course, everyone on Wall Street will be waiting with bated breath for the jobs report on Friday.  Last month likewise hit the under number but the bulls spun it as a story about less pressure on the Fed to raise rates rather than a sign of any underlying weakness.  It’s amazing what the longs will convince themselves of.

Stock Picks and Pans: Land of the Rising Inflationary Sun

My big add of the week was MTU, Mitsubishi UFJ Financial.  It is showing very strong technicals and leverages the Japanese recovery and end of deflation in the land of the Rising Sun.  I trimmed QMCI, I’m scaling into DVSA, a biotech play, and added to my QQQQ short.  I closed ARTX without gain and most of my PPHM with a nice gain and will likely close the rest of the position on any sign of weakness.  I will cut AKSY after the market open on any sign of weakness with a small loss.  Holding HEPH, HIT, PFSW, PPHM, SVA, TMTA, VION, and XOMA, which I kept on some renewed strength.  

Peter Navarro is a business professor at the University of California-Irvine, and can be contacted at pn@peternavarro.com. Matt Davio is a managing partner at the hedge fund, Red Rock Capital Fund, and be contacted for hedge fund services at redrock@peternavarro.com.

DISCLAIMER: This newsletter is written for educational purposes only.  By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever.  Trading and investing involves high levels of risk.  The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader.  The authors may or may not have positions in the financial instruments discussed in this newsletter.  Future results can be dramatically different from the opinions expressed herein.  Past performance does not guarantee future performance.