Macro Trends And Timing
In my first column
of 2002, I
identified a number of sectors and stocks to watch for the year. I’d like to amplify upon that idea within the context of a quote from
the cover story from this week’s Barron’s.
“Memory-chip prices have been increasing. Fourth
quarter personal computer sales were better than anticipated. DVD players, digital cameras and game consoles…enjoyed robust sales. And there’s growing buzz about wireless computer networking,
next-generation cell phones and digital media…Security has taken center stage in the wake of the
Sept. 11 terror
attacks…Disaster recovery
planning should also get a boost…Another hot theme is Web integration — the
push to provide web links to big corporate software applications (e.g., B2B)…Another hot sector
is data storage.â€
Now here are the sectors I identified several weeks
ago: Internet Security, DVDs, Wireless, Banking (for risk diversification),
Video Games, Storage, B2B and Internet Infrastructure. Note that there is a decent overlap with the
Barron’s analysis — but
I’m not bragging. Most of the
stocks I put on my watch list have fallen — but I don’t care.
Therein lies the point of this column. Those stocks that I identified have fallen
along with the broader
market. I wouldn’t expect it
to be any other way. Indeed, those
stocks won’t get off the deck without a strong up move from the market. And that won’t happen until there is clear confirmation of an economic
turnaround.
Sure, most analysts predict a turnaround, but there
is great uncertainty about when it will be. The only consensus seems to be that
the sectors I’ve noted above
will be some of the strongest once the economy and the markets get off their
back. In the meantime, a lot of
people are going to lose a lot of money betting on those sectors BEFORE there is
confirmation of an upward market trend.
That’s why the very best traders find it
absolutely critical to start with an assessment of the market and sector trends
BEFORE implementing any strategy — and allocate more heavily to cash in the
presence of high uncertainty.
Here, then, are three possible macroeconomic
scenarios that I believe will ultimately determine the market and sector trends:
#1: A Gradually
Building Boom
In the “boom scenario,â€
monetary policy — repeat interest rate reductions by the Federal Reserve —
provides an adequate stimulus even as a stalemate over fiscal policy moderates
any fiscal stimulus. This keeps
both inflationary pressures and interest rates down. The
economy gradually builds up steam for a sustained expansion. It does so without igniting inflation, and all is well with the world. Bull market city.
#2: Double-Dip
Recession Gloom
In the “gloom scenario,†we
suffer a “double dip†recession. After
a weak recovery, something shocks us back off the expansion path. It could be another terrorist attack or a disruption in the oil markets. Most likely, it will be an external global shock brought about by a war
between India and Pakistan, a dramatic escalation of the Israel-Palestinian
crisis, a U.S. military incursion into a terrorist state like Iraq or Yemen, a
meltdown over the Argentina peso crisis, and so on.
Monetary policy becomes
ineffective because you “can’t push on a stringâ€:
Gloomy business executives refuse to invest even with very low interest
rates. The fiscal policy stalemate
now becomes a vice rather than a virtue and seals our recessionary fate. The downturn continues for
four to eight quarters instead of two or three. Bear market metropolis.
#3: A
Stagflationary Doom
Both monetary and fiscal policy
become highly over-expansionary. In
a sharp “V”-shaped recovery, we see dramatically rising budget deficits
that put upward demand-side pressure on interest rates and inflation and start
to choke off recovery. On the
supply side, both the substitution of guns for butter and the diversion of
productive capital investment for “protective capital†like guards and
fences severely stifle productivity. This
breeds “cost push†inflation and contributes to rising unemployment.
Finally, escalation of the war on
terrorism disrupts world oil markets and sends oil prices soaring. The result is an extended period of simultaneous inflation and recession
much like we experienced in the stagflationary era of the 1970s.
This last scenario should be most
feared because it cannot readily be fixed by discretionary monetary or fiscal
policy. It will also be bear market
world.
So stay tuned. I will keep you apprised of which scenario is emerging as the most
probable. In the meantime, in the
absence of a clear market trend, tight stops and conservative scaling into
trades may help keep any losses small.
And remember, I want to hear from
you. Send me an e-mail at pnavarro@uci.edu,
or go directly to my web site https://www.peternavarro.com.