Whoever Figures This Out Stands To Make A Lot Of Money On The Downside

• July 5, 2005
• Peter Navarro

Navarro’s Broad Market Outlook: A No-Profit
Rally

This market will continue to hold little
trading interest for me until Chairman Greenspan’s bond market conundrum is
fully resolved.   Right now, the Fed is acting like the economy is growing
robustly with some inflationary pressure but the bond market continues to keep
the long end of the curve suppressed while a relatively flat curve suggests a
sluggish economy. 

Of course, if the Chinese and Koreans and
Japanese are actually buying enough bonds to keep the long end down, that would
resolve the conundrum in favor of the Fed’s view and make a continued stock
market rally more plausible.

I just don’t have any evidence to support
this view and while many say you “can’t fight the Fed,” you don’t want be going
long out on a limb while fighting a flattening yield curve too.

This Week’s Market Movers

It will be a quiet week on Wall Street
until Friday when the Jobs Report turboprop hits the investor fan.  There’s some
buzz on that it could surprise to the upside, which would tank the bond market
but goose stocks.  Maybe, but it seems more of a gamble than a speculation so
why bother betting on that?

The only other item of note will be
factory orders on Tuesday.  With the ISM surprising to the upside and consumer
confidence now moving back up a bit, a bullish factory orders report could lend
some credence to the Fed’s view.

Portfolio Musing

With slim pickins’ out there, I opened up a
couple of positions in some penny stocks.  One is VION, which has some drugs in
clinical development for cancer.  The stock is currently under accumulation and
a lot closer to its year low than high.  Ergo, the risk to reward seems
decent.   Another is IBIS, which has a small niche in the semiconductor biz. 
This likewise is a strong technical play, although the volume is a lot lighter.

Meanwhile, I doubled down on my losing
position in ZILA.  It seems to have reformed a base and is under accumulation. 
Looking to do the same for my losing position in ARDI as soon as it firms up a
bit more.  Both companies have products that logic says should make some nice
bucks down the road.

Holding both GERN and ASTM as long term stem cell plays.   

Hedging Your Bets With Matt Davio:  Pox
Americana

I want to address two themes this week. 
One is the American as a consumer and homeowner.  The other is the American as
an investor.

The American Investor

Let’s start with the investing skill — or
lack thereof — of the typical individual investors.  According to Dalbar, Inc.,
“individuals have historically underperformed the markets, earning just 2.6% vs.
the S&P 500 gain of 12.2% between 1984 and the end of 2002*. Research in the
U.S. has shown that this dramatic underperformance comes as a direct result of
client behavior, or more specifically, the attempt to avoid bad performance
while seeking out better returns.“ 

What’s the more exact cause of this
underperformance?  In a word, it is EMOTION — as illustrated in
this char of the classic cycle of investor sentiment:

 

My question to you is whether your
behavior would seem to comport with this chart.  Or, alternatively, have you
been a contrarian able to countercyclically exploit opportunities that have
presented themselves?

In this regard, the major emotional risks
equity investors face include: • Herd mentality, • Likely investment at the top
(Buy High), • Likely withdrawals at the bottom (Sell Low), and last by not
least, a deviation from one’s long-term strategy and discipline when times get
tough.

The American Consumer
and Homeowner

Housing, in my mind, has seen its best
days of growth.  That’s not to say prices can’t go higher.  However, if 70% of
Americans already own mortgages and houses, is there really that many 2nd, 3rd,
and 4th home buyers still out there for people to be chasing “values” at these
prices? I don’t have the answer but circumstantially there are many signs
pointing to a nearing of a relative top anyways. 

Prior to July 2003, mortgage refinancing
activity seemed to track movements in interest rates fairly closely. Since then,
however, homeowners have been less than responsive.

 

Have we hit the limits to growth in the
refi market? If so, it may be another hint that the home-as-ATM phenomenon has
come to an end.  The real question is whether homeowners are scaling back of
their own accord — or whether circumstances have forced them to

Of course, over the last few years,
betting against the US consumer has been a losing wager. And yet when we look at
the parabolic rise of non-mortgage household debt in the chart below, one cannot
help but imagine that it eventually will be problematic.

 

 

Note first the exponential acceleration of
the curve.  This is a true geometric gain that is clearly outstripping
population growth.  In fact, you can draw at least 3 separate trend lines on
that chart — 1960-80; 1985-96 1999-2005 — each running at a higher rate than
the prior trend.

This can’t go on forever, and whoever does
figure out exactly when the U.S. consumer gives up the ghost — within a
quarter or so — stands to make a lot of money betting on the downside —
shorting retailers, banks and consumer cyclicals to name but a few. 

Peter Navarro is a business professor at the University
of California-Irvine (www.peternavarro.com). 
Matt Davio is a managing partner at the hedge fund, Red Rock Capital Fund.   

For investment management services, contact Matt at

redrock@peternavaro.com .  

Contact Peter at

peter@peternavarro.com

  

DISCLAIMER:
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only.  By no means do any of its contents recommend, advocate or urge the
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