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USA: Strong Sell - SAMPLE REPORT

Monday, 22 May 2006
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Summary

Investors have been buying in the illusion that the Fed's tightening cycle is close to the top. We are not close to the top yet. The Economic Clock™ tells us to do exactly the opposite: sell at the top of the rate cycle. Once growth slows, profits have to get slammed by slower turnover as well as by slimmer margins - so why buy stocks if profits must weaken?

The Economic Time™

Monetary Economy:

Inflation is rising 3.4x faster than at the bottom of the cycle in June 2002. Core inflation is running 6x faster than when it bottomed in September 2003. Because of rising core inflation, the Fed wants the monetary aggregates to contract. Growth in reserve money is growing 25% less quickly when compared to its July 2004 peak. Growth in M1 is the weakest of all the aggregates, what with demand and checkable deposits contracting. M2 growth is steady, what with savings deposits growth decelerating while money market funds growth has been accelerating since September 2004 – shortly after the Fed started its tightening cycle in June 2004. Growth in M3 is accelerating with more RP liabilities of depository institutions, and with more institutional money market funds; however, a weaker dollar exchange rate outlook is depressing the Eurodollar component of this aggregate. Lending is growing at 77% of its peak rate last August. Within this, securities and consumer lending is decelerating rapidly, while loans for commercial, industrial and real estate purposes are at a cyclical top. Within real estate loans, those for homes peaked at 45% in October 2004 and have shriveled since to 3.8% per annum! The Fed started its tightening interest rates in June 2004. The yield curve has flattened considerably since then: short rates have risen fivefold while long rates have stayed flat. Inflation is rising, inter alia because the dollar’s exchange rate peaked last December, especially against the Euro, what with Central Banks diversifying their reserves more into Euros and people perceiving higher Euro rates. If Fed Funds do rise more than the market perceives, we remain of the view that the dollar will rebound especially against the yen, but also against the Euro, for some time. On a three month monetary policy view, expect the Fed to raise Fed Funds even more – peaking at around 6% by 3Q06.

Real Economy:

Growth is robust partly because one chunk of the policy mix remains growth-friendly. The Fed's monetary policy is one of tightening; however, fiscal policy is expansionary: outlays contracted by 10% annually in November 2003 and were racing by +14% this March! Although slower since the peak at 1Q04, GDP remains robust due to strong government consumption, private consumption (reflected in robust retail sales, esp. in cars and home-related), fixed capital formation, inventories and exports and imports. That inventories are contracting by an annual 63% lends more credence to our view that Fed Funds have much further to rise. Industrial production has been accelerating since last September, especially in equipment as well as in materials. On a three month macro profits view, things have peaked: ever higher Fed Funds and slower housing activity will slow domestic demand - i.e. turnover - as of 3Q06. Also, productivity is rising at half its peak rate of 4.9% in September 2003 while wages are rising 50% faster since then, so unit labour costs are rising sharply. So, with turnover slowing, margins have to narrow.

Sectors

Strong Buy Sectors

  • Health Care Services

Buy Sectors

  • Telecoms
  • Technology
  • Insurance
  • Finance & Securities
  • Energy
  • Electrical Products & Computer
  • Banking

Strong Sell Sectors

  • Transportation Equipment
  • Transportation & Logistics

Sell Sectors

Hold Sectors

 
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