Where the economy and markets might be heading

I’d like to reflect this week on a couple of
stories that caught my eye the last week or so — each of which gives us a
different, but interesting, take on where the economy and markets might be
heading. As a reference point, let’s start with the observation that the brief
August rally we had bit the dust last week — and likely was more of a short
squeeze rally as opined in last week’s missive. Now for the stories:

The first story appeared in the Wall Street Journal and pretty much wrote the
obituary on Bill Gross as a credible prognosticator. Gross is, of course,
Pimco’s bond king and oft-quoted market pundit. Seems like its been almost four
years now that Gross has been getting the markets’ direction wrong, he’s not
sleeping at night or eating well, and, most importantly, his investors have been
taking a pretty good haircut.

I can see how Gross has gotten into so much trouble. For several years now, the
bad economic news has been mounting; and a reasonable speculator like Gross
could easily jump to the conclusion that the bear is nigh. His own problems
started in September of 2002 when he projected a value of 4,000 for the Dow.
That was pretty radical at the time; and anybody who had jumped on that advice
on the short side, would have lost his shirt. The question is how an ultra-brain
like Gross can get everything so wrong — particularly the bond market which he
has hitherto owned.

One answer appears in the second story that caught my eye. Seems like most of
the profits that U.S. corporations are raking in these days are going to stock
buybacks. There’s no more efficient way to keep stock prices propped up than
that — particularly since the flood of money is now more than offsetting all
the new stock options these companies are awarding.

The third story of interest has to do with how consumers are — finally! —
responding to higher gas prices, higher rates on their adjustable rate
mortgages, and the declining use of home refinancing to serve as an ATM.
Consumers are cutting back — oh duh — on at least some of their consumer
spending — and the retailing sector is taking a hit. That story confirms the
insight that oil price shocks and rate hikes are contractionary — but again,
Gross’s timing has been wrong. Call in premature Bearitis.

I think that Gross is eventually going to be right about the stock market bear
— a sustained oil price shock, a long-term budget deficit, a non-coincidentally
weakening dollar bringing inflation, the loss of U.S. manufacturing jobs and
declining per capita income, and a thousand other unkind economic cuts are
taking their toll on Goliath. Still, yet a fourth story that caught my eye made
me start thinking about domestic stock markets — whether in Germany, the U.S.
or elsewhere — in a different way.

This story focused on how the German stock market was outperforming the domestic
economy by leaps and bounds. The reason: a lot of German companies are
conducting operations — both production and sales and distribution — outside
the Fatherland. So even as Germans cry in their beer over a stagnant economy and
high unemployment, the shareholders in German companies — from Riyadh to
Toronto — are toasting their good fortune.

The broader point here — and I think it may be at least semi-profound — is
that we can no longer view domestic stock markets as leading indicators of
domestic economies. Instead, we as forecasters must look at the whole web of
exchanges around the world and parse their effects region by region and country
by country. This is a whole lot harder than it used to be — which is why folks
like Gross uncharacteristically have been losing their way.

This Week’s Market Movers — Visions of GDP Revisions

While a lot of big players will be heading for the beaches this week, there will
be some interesting reports vying for investor attention. We get a double dose
of consumer confidence — The Conference Board’s on Monday and U-Mich’s on
Friday. Both should signal a gloomier consumer — so any upside surprise would
be bullish. My big market mover of the week bet is on the revision to 2nd
quarter GDP. There’s talk that it will be ratcheted up to over 3%, which would
be bearish as it signals more inflation than previously thought.

Portfolio Shorts and Longs

Let’s start with my poodle (i.e., small dog) of the summer — the Brazilian
exchange-traded fund
(
EWZ |
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Chart |
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PowerRating). I bought in at $40ish, scale in a bit more at
$41ish and last week lost a couple of points in a Brazilian downdraft and cut my
losses quick. Licking my wounds, I sought answers. Here’s two: First, the
Brazilian economy has been lifted on a sea of commodity price hikes — from
soybeans to metals — and those markets may be softening. Second, Brazilian
elections are soon and the Socialist leader Lulu, who looked to be in big
trouble just months ago, is now pulling away with the race — putting Brazilian
entrepreneurs in a deep funk.

Now let’s turn to
(
EPIXD |
Quote |
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PowerRating). This was my hot August stock — right out of
Vaino’s biotech corner. Well, last week, the technicals turned South. I promptly
cut my position by 75% and took some nice gains off the table. If the stock
breaks through the $7 support level, I will take the rest of it off the table —
but keep it high on my watch list for a reload.

Meanwhile, I’m sitting tight on three biotechs —
(
ABAX |
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PowerRating),
(
AXCA |
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PowerRating), and
(
HTI |
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PowerRating). Plus, my big buys of the week were two of my favorite stem cell plays
—
(
ASTM |
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PowerRating) and
(
STEM |
Quote |
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PowerRating). Both seem stable at the low end of their ranges
so downside risk is minimal. With the Republicans getting beat up on their
opposition to stem cell research, the political tide should soon turn. And there
has been some nice good news on the science front. These are, however, long term
plays.

Peter Navarro is a business
professor at the University of California and the author of the best-selling
investment book

“If It’s Raining in Brazil, Buy Starbucks” and the business shelf bestseller

The Well-Timed Strategy.” His latest book is “The
Coming China Wars.”