Insurance Is looking like a good Idea going into elections....
FROM VECTOR VEST
THE TRUTH CHART. (Back in MARCH 2003 So OLD but USEFUL)
Geopolitical concerns have dominated investor's attention for the last few months, causing stock prices to wither and, more recently, soar on expectations of a quick victory in Iraq. The primary benefit of an easy win over Iraq is that it would eliminate a major factor inflicting pain on the market. Unfortunately, it will not solve the market's problems. That's up to the economy.
As you know, stock value is driven by earnings, inflation and interest rates. Value rises when earnings go up and inflation and interest rates decline. Typically, a strong economy leads to rising earnings, which is good, and rising inflation and interest rates, which are bad. So investors are constantly balancing these factors against each other.
With three factors, each of which can move up or down, there are eight combinations. This array of combinations is called the "Truth Chart." It appears as follows:
Case/// Earnings///Inflation///Interest///Prices///Comments
1. Up Up Down Up Bull Market Begins
2. Up Down Down Up Bull Market Thrives
3. Up Down Up Up Rarely Happens
4. Up Up Up Up Bull Market Ends
5. Down Up Up Down Bear Market Begins
6. Down Down Up Down Rarely Happens
7. Down Down Down Down Bear Market Prevails
8. Down Up Down Down Bear Market Ends
Case (2) reflects the best of all worlds, a rare combination of a strong economy with rising earnings, falling inflation and interest rates. This is the so called "Goldie Locks" scenario. It prevailed from January 1995 to October 1997.
This happy scene was rudely interrupted in October 1997 by the "Asian Currency Crisis," which sent earnings, inflation and interest rates tumbling and created the Case (7) scenario. Case (7) did not last long, however, since inflation began to rise from extremely low levels in July 1998. Enter Case (8).
Dr. Greenspan lowered interest rates in rapid succession in October 1998, giving the market a tremendous boost. The world economies began to recover shortly thereafter, causing short-term interest rates to begin rising. Earnings also began to turn North in January 1999, enter Case (3).
Case (1), one in which earnings and inflation are rising while interest rates are falling, is the usual combination of factors which fosters Bull markets. Case (3) rarely happens. Although Dr. Greenspan said he was fighting "supply-demand imbalances," he began raising interest rates in August 1999, bringing rise to Case (4).
Investors, flush with success from the Bull Market, continued to push stock prices higher and higher, even though Dr. Greenspan continued to raise interest rates. The Fed always wins this battle. Case (4) prevailed from mid-1999 to October 2000, when earnings peaked. Enter Case (5).
Case (5) lasted from October 2000 until January 2001 when Dr. Greenspan began lowering interest rates. The economy went into recession in March 2001, and Case (6) never happened. Once the economy weakened and earnings started to go down, Case (7) occurred again.
In 2001, Sir Alan lowered interest rates again and again. He ignited an auto and housing buying spree, although the economy remained weak. Inflation has been rising for several months now and earnings are not. We are in a Case (8) scenario and looking for the end of the Bear market. The war rally is nice, but the new Bull market will not get rolling until earnings begin to rise again. Yes, we have heard it over and over that earnings are rising. But are they? Next week, I'll tell you more about the Truth Chart.
FROM VECTOR VEST TODAY 4/13/2006
THE CASE 4 WALL OF WORRY.
The Case 4 Bull Market Scenario, as described in the Truth Chart, (see my essays of 03/21/03 and 03/28/03), is one in which earnings, inflation and interest rates are all rising. It is by far the most challenging of the eight market scenarios shown in the Truth Chart. In this scenario, the economy is strong, earnings are great, but the day of reckoning is on the horizon. While it is described as the scenario which marks the end of bull markets, Case 4 scenarios can go on for a long time. This one started on May 7, 2004 or 23 months ago. When will it end?
To answer this question, let's examine each of its key factors: Earnings, Inflation and Interest Rates. First quarter corporate profits are expected to rise more than 10% Y-O-Y. Therefore, it seems reasonable to expect stock prices to continue to go up if earnings have been going up. But that's not the way the game is played. Investors worry because they discount the future, not the past. They constantly look for things that may affect future profits and start selling stocks even before earnings actually start turning downward. They want to get out at the top of the earnings cycle and often give false alarms.
That's why we need to be very watchful of earnings data. Our Investment Climate graph of S&P 500 earnings continues to show a steady rise in earnings, but its trend indicator has been essentially flat since last November. This suggests a decrease in earnings momentum, and that's not good. But it's too early to hit the panic button.
Inflation and interest rates have been hitting multi-year highs lately and this has given many investors the jitters. Generally speaking, CPI inflation is not considered to be a serious problem until it reaches 5% or more. It hit a ten plus year high of 4.70% last October, but came down to 3.60% last month. So inflation is getting dicey, but is not dangerous just yet. I'm amazed that high oil prices haven't impacted the CPI more than reported so far, but I have a deep suspicion the number is rigged anyway.
Here's a number that isn't rigged, the Fed Funds rate. It will be a problem if it goes above 5%. It's at 4.75% now and is virtually certain to be raised to 5% at the next FOMC meeting. However, the 90 Day T-Bill, which we track, closed at 4.58% today. The Fed doesn't usually get ahead of T-Bills too often, so they may, just may, stop at 5% for a while. This would be terrific news for stock investors, but one never knows what the Fed will do. My observation has been that they tend to raise interest rates too high and cause recessions. Now that's something to worry about.
If you follow the news, there are a million other things to worry about, but don't pay too much attention to them. Keep your eye on earnings, inflation and interest rates, especially inflation. It will determine what the Fed does with interest rates. This, in turn, will determine the fate of the economy and earnings. Knowing where we're at in this mad scramble is the challenge of climbing The Case 4 Wall of Worry.
I hope this helps for the years of investing ahead us all!!!!!
