Global Market Bearish Call

[David Randolph]

I don't want to make a long text explaining why I'm turning bearish on the general market, so I'll tell you why by topics:

1) I believe there were two fundamental reasons behind the medium term bull market that we've had since March 2003:
- Monetary policy gave the first push up (SPX up from 770 to about 1000 points), when a famous article written by Ben Bernanke said the FED would prevent deflation by printing money.
- The second push, from 1000 to 1240, was made by a believe in global growth led specifically by China. I was bullish in global markets because two major players were coming to the global scene, India and specially China.

2) Those two fundamental reasons are no longer in place
- The FED now is rising rates every chance he gets.
- China is hot only in the talk, but the money shows a different story, take a look at this:



China's stock market is in a bear market since May 2004. There's no more reliable bearish divergence than the world being bullish on a country that's going down.

The FED is no longer our friend and China's growth is no motive to buy stocks as we've seen. So there's no bullish fundamental factor to keep on buying. If there's no motive to buy, there are a lot of motives to sell (FED tightening, China may enter into a cyclical recession after more than a decade of an average GDP growth of 10%), and that's what investors are starting to do:



The S&P 500 Index broke two important supports yesterday.

The general market trend is bearish now, so one should be under invested. We have 66.6% equities and 33.4% cash in the 3 Stocks on Fire Portfolio. I want to raise the cash portion of the portfolio to more than 50%, looking just for individual strong stories.

(This article was made by David Randolph from 3 Stocks on Fire. 3 Stocks on Fire is a Community of stock traders and investors. Our 3030 members exchange trading ideas and strategies on our message boards everyday. We welcome you as a new member of the 3 Stocks on Fire Community, please take 10 seconds to register and receive our free newsletter)

[shawFund]

Hi, David:

   I basically agree with your assessment on the current market condition:
the US market will enter a correction period after three months of bull run. The correction is needed for the end-year rally.

   But for China, two things I have some different opinion:

China stock market:

   1. China's stock market has been in Bear market since 2001 not from last year. During the last 4 years, the market value lost 60% (index), the actual value lost 80% or more (just like our NASDAQ from 2000-2002);

   2. Since this May, the China's market has bottomed out and bounced back 20% from its low (1000->1200 and now is around 1400);

   3. But the bounce back is short lived. China market will not turn to Bull in the near future. The reason: China's government has decided to convert all the non-tradable shares (60% of total outstanding and all owned by government) into tradable shares starting from next year.
That is, the government wants money by selling those shares but I doubt there is enough buying power to digest those huge amount of shares.

China's economy:

   China's economy will not enter a recession, will continue growing with a slower pace (6%-7% annually compred with 8%-9%).

   China's economy was over-heated during the first 6 months of this year. The government took many hard steps to cool down the economy and the result is good (9% first half of this year)

   What is the future drive for China's continue growth:

   1. Housing: Demand for housing is huge. The problem for China's housing market is high price (bubble). Once the price is under control, no problem to find buyers.

   2. New growth engine: HDTV, 3G will drive big demand in the next few years. China has the world biggest population on Internet and Cellar phone use, bigger than US.

   3. Highway construction will continue in fast pace.

   ....

   China will hold 2008 Olympic and this will be another engine to drive its economy.

   I don't have time to talk more about it. I may provide some link later for your reference.

[Irishman]

FWIW-
Have to agee with both your assessments, but for me the greatest fear is that which we already know, and that is this: Alan Greenspan will OVERDO the rate hikes, thus putting a lid on the equity markets. He's done it several times in the past, and you can rest assured he will do it again Thank God the man is set to retire! Also, the high price of oil will soon start to be felt, not only by the consumer, but by companies bottom lines. On that score we have been very fortunate so far, but make no mistake, that chicken will soon come home to roost. So, our job will become a little harder but not impossible. I've always found in the past that when the market slows, stocks with particularly strong fundamentals rise to the top and I'm sure that will be the case again. All the best.
Irish

[don]

let me throw in a viewpoint from SE Asia. Thailand has a tiny market capitalization, corruption,
bombings in the Muslim south. A real basket case. right? But, it's economy is fairly representative of the region. And, I posit, that it is this region (all of Asia) which will provide the growth for the forseeable future. Huge infrastructure is being built, for the first time, all across this region, with the exception of 'wealth concentrations' such as HK, S/pore. I mean; airports, irrigations systems, dams, rural developments, wireless communication systems, highways, pipelines, refineries.  The local economies are healthy and adaptable. It is laughable here, to consider the tax implications of a business. We have so much growth to cover, before we get to that point. There are so many people, here, striving for a better life and prepared to work for it. okay, education and mgt skills are lacking. But, so what? when I was managing a team of trainees fresh out of university (North Amer), I used to groan at their inability to craft a simple letter. India has 150 million people who have risen to the middle class category. China is only a few years behind. You will have a brand new, yuppy wave, of 300 million. That is the entire population of the States! Seven Elevens are popping up like mushrooms (that is one of my fav. stocks to buy for my retirement, except I never seem to  retire).This post is all over the place - I have so much data to pull in, I would need a book to do it. So, let me pull it all together; David, I think your call is correct.But I would limit it to the significant portion of the developed world (USA, EU). overheated property markets, underachieving economies, non-maintainable spending, excessive taxation, underfunded pensions, aging populations. What impact should this have on 3SOF  investing/trading philosophy? Zero, I suggest.  Don't let the big picture spoil your enthusiasm.  Keep doing what you do! You do it well!. Fox.

[shawFund]

As expected, bio and energy sectors are hot today.

More about China:

China's growth is real, of course problems are also real.

During the last 20 years, the average salary in big cities has gained more than 3,000% from 40 yuan to 1500 yuan. Living standard has improved greatly.  But still much lower than industrial countries. It will continue its rapid pace in the near future.

Of course risk is also quite high.

[tommyt]

No disrespect to your ecomonic call, but I see things a bit differently. Markets move up and then down, and I think this is just reversion to the mean(April uptrendline in the S&P). I think yesterday's action was simlpy hard earned profit taking, which is a healthy market reaction after a three month rally. We should bounce of the trendline again, which will take us to the holidays.
Additionally, the Fed's monetary policy can be seen as reflective of the underlying strength of the economy. Rates would not go up if they were not supported by something. I would get use to it increasing for years to come, we are still at forty year lows. The real problem is the oil bubble, and interests rate hikes help keep it's inflationary effects low. Speculators in oil will move on(Cramer did last week), and a return to $50/barrel will have a positive effect on the markets.

Some hopeful news:

http://www.nytimes.com/2005/08/21/business/yourmoney/21stra.html

http://today.reuters.com/news/newsarticle.aspx?type=domesticNews&summit=&storyid=2005-08-25T171756Z_01_HO546049_RTRIDST_0_USREPORT-ECONOMY-DC.XML

And the Oil bubble:

http://www.nytimes.com/2005/08/21/business/yourmoney/21energy.html

[agatto2]

Humm so am i a bear    or a bull only the ticker will tell, but to be sure , folks will buy any think they think is going up , tells me the tinkers will be selling down. imho.   tonyg

[REALDEALS21]

Oil will stay above $60 throughout the YEAR !

[rpccpa]

The following chart is amazingly bullish when you think about how strong the small stocks have been and how we have actually expected them to start underperforming at some point this year. The Volume Oscillator for the Russell 2000 is saying that buying pressure is building up under that sector during the very mild correction. In fact, the oscillator is almost back to the zero line, meaning buying pressure is only slightly lower than selling pressure:



We may have to reallocate a larger percentage of our funds back into the sector. Ideally, we would get a final selloff as the 20-week cycle bottoms in the next couple of weeks. But, the main point here is that with this kind of buying pressure building up, we certainly do not want to miss the next rally.


As you know, the 10- and 20-week trading cycles are due to bottom right at the end of August. Up until Wednesday afternoon, the market was slowly easing down the hill toward the low. Then, a powerful geomagnetic storm, a result of two massive coronal mass ejections from the sun on Monday, hit, sending readings to official storm levels (our geomagnetic storm image on the Trading Page went to red early Wednesday morning). The market shrugged it off early, but continued high levels of magnetic disturbance had their effect as traders sold stocks in the afternoon.

Geomagnetic levels are forecast to stay at storm level through Thursday and then begin a process of subsidence. According to the Federal Reserve, the effects could last up to a week after the actual storm.

This comes as a catalyst for the landing of the 20-week cycle on the 31st of August. Note on the Dow chart, that would correspond to the intersection of the short term polytrendline, which rolled over at the recent trading high, with the rising support line, the lower triangle line:



Needless to say, we are getting an ideal trading setup. This wave E to the downside would end the triangle and allow the pre-existing trend to reassert itself to the upside in a thrust rally. If that rally fulfills its maximum potential, it would carry the Dow to 11,600 by mid-January 2006.

[David Randolph]

Hello, I will answer the posts on this thread one by one when I have the time ... these are all big posts and thoughts so expect this thread to get really, really big 

Discussing the general market is one of my favorites, I've done it actively since 1999.

Actually, I'm much more used to the general market analysis than to individual stock analysis, and I'm very pleased of learning about a new game (well, not new, but individual stocks are a rediscovery for me).

So I'll start by the first answer and then move on to the next ... thanks for all your posts on this subject, keep them coming 

Hi, David:

   I basically agree with your assessment on the current market condition:
the US market will enter a correction period after three months of bull run. The correction is needed for the end-year rally.

   But for China, two things I have some different opinion:

China stock market:

   1. China's stock market has been in Bear market since 2001 not from last year. During the last 4 years, the market value lost 60% (index), the actual value lost 80% or more (just like our NASDAQ from 2000-2002);

   2. Since this May, the China's market has bottomed out and bounced back 20% from its low (1000->1200 and now is around 1400);

   3. But the bounce back is short lived. China market will not turn to Bull in the near future. The reason: China's government has decided to convert all the non-tradable shares (60% of total outstanding and all owned by government) into tradable shares starting from next year.
That is, the government wants money by selling those shares but I doubt there is enough buying power to digest those huge amount of shares.

China's economy:

   China's economy will not enter a recession, will continue growing with a slower pace (6%-7% annually compred with 8%-9%).

   China's economy was over-heated during the first 6 months of this year. The government took many hard steps to cool down the economy and the result is good (9% first half of this year)

   What is the future drive for China's continue growth:

   1. Housing: Demand for housing is huge. The problem for China's housing market is high price (bubble). Once the price is under control, no problem to find buyers.

   2. New growth engine: HDTV, 3G will drive big demand in the next few years. China has the world biggest population on Internet and Cellar phone use, bigger than US.

   3. Highway construction will continue in fast pace.

   ....

   China will hold 2008 Olympic and this will be another engine to drive its economy.

   I don't have time to talk more about it. I may provide some link later for your reference.

Great post Shawfund, let me give you my take in topics:

«I basically agree with your assessment on the current market condition:
the US market will enter a correction period after three months of bull run. The correction is needed for the end-year rally.»

Possibly it is just a correction, but it can be the beginning of something bigger. Many bear market factors are occurring at this moment.

Considering China, you seem to forget that's still a communist country. They still have many government controlled prices and the fiscal deficit is huge, some economists talk it is 80% of the GNP  There are rumors that the Chinese government asks for bank loans and never pays, well, it doesn't ask, banks are obliged to lend to the government, they rule everything.

Remember Russia? When that country left communism the economy grew fast, but then a sudden and pretty strong recession kicked in. The same thing can happen in China.

I believe China may be the great economic miracle of the 21th century, but before that it can and will probably have a crisis that will take that communist government down !

Besides this, I agree with all your assessments, but I like to be a contrarian on these things, the world is bullish on China (everyone I talk to only thinks about China, it is on the news everyday), so I'm inclined to be medium term bearish on that country.

And a crisis in China will take the world equity markets down with it, since that's the major source of speculative fuel. Watch the Indonesian Rupiah ... it crashed a few days ago ... that was the beginning of the asian crisis in 1997.

I have an article at home with interesting economic data about China, I'll write some more about this in the next few days ... thanks Shawfund 

[shawFund]

Hi, David:

   We all would like to know your more through analysis on the global market. I am specially interested in the article you mentioned about China's economy and the possibilities of entering a long term bear market for the US stock market.

   Not all all people are bulish on China. Actually I have read many articles about the coming crash on China's economy and the fell of China's communism system from Los Angeles Times, Wall Street Journal, New Yorks Times, ... and online posts.

I will use this weekend to give some of my interpretation of the Index chart (Nasdaq, SP500 shanghai A share Index...

[Calvinurban]

Hi David,
I want to share my view against bearish on China Economy. While China's stock market has been in Bear, it does not reflect China's economy. This is because most of China's companies that have significant impact are actually listed overseas. To understand China's economy, we should look into Singapore (STI) and Hong Kong (HSI) stock market.
For taxation, capital transfer & liquidity and many regulatory reasons - that encourage the companies not to listed in China - except for state-owned or related - real estate, energy and etc companies. In fact the China stock market & its investors are still very undeveloped. In fact, it was too speculative that cause it to rise too fast couple years ago (like dot.com period). Now is adjusting 'reasonable' levels. But due to lack of firm accounting and transparency - most investors avoid investing there directly but in STI & HSI.

http://finance.yahoo.com/q/bc?t=2y&s=%5ESTI&l=on&z=m&q=l&c=%5EHSI

As you can see from the link that STI & HSI in past 2 years had been uptrend and there is no sign for slowing down. The China's economy is still booming so fast that Chinese government is trying to keep at 9% growth in prevent inflation. Again too many reasons to write, but in summary:
China is (still very) hungry. The Chinese people with rich heritage & once powerful are trying very hard to catch up. They (individuals) know what is like to be poor, rich, wealthy or educated. All around, they can see evidence/benefit of wealth & power & living standards just 100 years ago, so they are trying so very hard to achieve for themselves. With their gap so huge compared to the rest of the world, I can expect still a long way more before it slows down.

To understand China, read articles from people who is/had work within China, not with from outside. 

[ramlau]

I have commented on the economy lately:

http://www.amazon.com/gp/cdp/member-reviews/A2BYS3BBGD8KC3/ref=cm_cr_auth/103-9560337-2998234?%5Fencoding=UTF8

Dow Jones is still struggling to stay above 10000 and Nasdaq once again failed to break 2200. We are going through the peak of the second Hubbert curve in these years. (They even have a website dedicated to King Hubbert at HubbertPeak.com!) That's another reason why I think the market will continue to go sideway for a few years - just like what happened in 1970 when American oil production peaked, as Hubbert precisely predicted in 1956. The major indices were all flat throughout the decade, from Nixon to Carter.

Forget about buying and holding, the rest of the year will repeat what happened in Q1 and early Q2 of the year. I'd rather just keep shorting until the market conditions get better.

Ram

[usedcasting]

I of later have been trying to be optimistic about the future. First, I was trying very hard to believe that the unbelievable American financial engine would and will be able to sort itself out(a rather large task considering the overextended debt). And second, China, India and other small underdeveloped nations are pushing very hard for better living conditions. These things two accomplishments alone are monumental. My doom and gloom outlook is of course more directed toward another factor, energy and Hubberts peak. I hope i am wrong in what I forsee as being the biggest challenge of them all. We have only really harnessed oil and petroleum for two centuries and today most everything is a product of it. We are on the downslide with some big bumps coming in the not too distant future. It is obvious that nations are shoring up what oil is their's and protectionist game will/has started. Alternative energy sources on the scale required are far far away and what will happen in between is hard to imagine. We like to believe that technology and good policy making will save the day. I hope it can.

U.

[Calvinurban]

And a further comment to add for understanding China's "Stock Market" being in Hong Kong & Singapore. The significants of these 2 small cities is a bit historical. For 100 years before 1997, Hong Kong was always the gateway into & out of China, trading to the captalist world. Until China started to welcome investors in the 80's. That what helps Hong Kong to become the key Financial center in Asia after Japan. But comes 1997, China taking back of Hong Kong, many companies fled Hong Kong due to fear Chinese government especially if they supported opium trade or previous Chinese policies in the past. So many companies relocated their offices to Singapore, with operations still in Hong Kong or China. Singapore which traditionally have good Chinese relationship has now become another significant Financial center in Asia together with Hong Kong & Japan.

Cheers...Calvin