Peter Dag & Friends: May 2007

5/27/07

PE and bond yields

There is a non-linear relationship between bond yields and the market PE (see enclosed graph -- click on the graph to enlarge).

The PE for the S&P 500 is now 18. A PE of 18 reflects a relatively inexpensive market with yields on the 10-year bonds at less than 5%.

Interest rates are bullish for stocks

The enclosed chart (click on chart to enlarge) shows that the PE ratio rises (and stocks are strong) when short-term interest rates are stable or declining.

The PE ratio declines, and stocks are weak, when short-term interest rates rise.

The bottom line is that it pays to be bullish when short-term interest rates are stable or decline as it is happening now.

5/23/07

Consumers are spending less

The growth of retail sales after inflation is declining rapidly (see enclosed chart; click on graphs to enlarge).

Consumers are making less money because of rising inflation. The outcome is slower retail sales.

The trend is bad news for the economy. It may have good news for stocks and bonds.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

5/19/07

Is the market heading for a near term correction?

This near term indicator (click on graph to enlarge) anticipates the direction of the market over a few weeks.

You can expect a market correction when the red line moves below the blue line.

This gauge points to a rally when the red line moves above the blue line.

This indicator is saying the market should pause for a few days or weeks. Or, to put it in a different way, this is not a good time to start buying. It is wiser to wait for this gauge to turn around and move higher.

More on http://www.peterdag.com/.

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

5/10/07

The making of another bubble?

Commodities (in US$) and short-term interest rates have the same cyclical turning points (see above graphs).

Their historical relationship says the Fed is too easy. In 2002-2004 commodities were rising and the Fed was pushing short-term interest rates down to 1%. The housing bubble and a strong equity market were born!

Now, we have the same situation. Commodities are soaring (click on the graph to enlarge) and the Fed is keeping short-term interest at 5.25%. The trend in commodities is saying (as in 2002-2004) that the Fed is too easy and creating excesses in hard assets and equities. It is no surprise the money supply in the US is expanding at an above average pace (see blog below).

You can rest assured the markets always win. Let's enjoy the current financial feast as long as it lasts. But the markets will respond the way they always do. Short-term interest rates will eventually have to rise to keep commodities and money supply at bay.

More on http://www.peterdag.com/.

George Dagnino, PhD, Editor The Peter Dag Portfolio

Since 1977

5/9/07

Are we looking in the wrong place?

Wall Street is looking for a slowdown. Some well known economists are predicting a deep recession.

The enclosed graph (click on the graph to enlarge) shows the growth of the money supply. Its trend tells a totally different story.

The money supply is up more than 10% at annual rate in the past six months. This is very strong growth. There is a lot of liquidity in the system coming from the global markets.

What does it mean? The growth of the money supply started increasing in the fall of 2006. It is predicting strong economic growth in the US in the coming months. Growth will be robust toward the end of the year.

If the trend of the money supply is correct, investors will need to change their investment strategy.

Stock sectors that are strong when the economy slows down (such as financials and bonds) do not perform well when the economy grows at a rapid pace.

It is is going to be interesting to see if the money supply is going to be right in spite of all the worries about subprime and housing crises. Time will tell.

More on http://www.peterdag.com/.

George Dagnino, PhD,

Editor, The Peter Dag Portfolio,

Since 1977

5/8/07

A different idea

Lee Kuan Lew, minister mentor of Singapore, created a prosperous city nation. He is recognized as a major statesman.

I read excerpts of a speech on Foreign Affairs and he made interesting points. Given his standing as a global statesman, I thought to share with you some of his ideas. Very different from what you read in today’s press.

He compares Iraq to Vietnam, but not in the usual way. He noted that conventional wisdom in the 1970s saw the war in Vietnam as an unmitigated disaster. But that has been proven wrong. These are his words.

“The war had collateral benefits, buying the time and creating the conditions that enabled non communist East Asia to follow Japan’s path and develop into the four dragons (Hong Kong, Singapore, South Korea, and Taiwan) and, later, the four tigers (Indonesia, Malaysia, the Philippines, and Thailand).” [Ed. note: by stopping the spreading of communism].

The conventional wisdom now is that the war in Iraq is also an unmitigated disaster. However, he suggests, a stabilized, less repressive Iraq can be a liberating influence in the Middle East.
He concludes that this overall new order can only be achieved by bringing all of Iraq’s neighbors into the process of achieving this objective. The latest diplomatic efforts of Dr. Rice seem to follow this direction.

I would like to add another dimension. The awakening of China is engaging the world politically, economically, and diplomatically.

Its power around the world is astounding through its financial commitments, which include a plant in South Carolina and Oklahoma and a $500 million loan to Pakistan. India is feeling the pressure and is mimicking the successful Chinese model of enterprise zones.

China is moving west. The Middle East and Islam will find themselves sandwiched between a successful Europe and burgeoning Asia. History will probably say that the war in Iraq was an unmitigated disaster. But Mr. Lee Kuan Lew may be right. Time will tell.

More on http://www.peterdag.com/

George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977

5/6/07

Bad news and good news

Average weekly hours worked are slowing down in a worrisome way (click on the chart to enlarge. The slowdown reflects continued weakness in the economy.

One of the main ideas behind this blog is to monitor the behavior of the business cycle and determine its impact on the financial markets.

This information is another element suggesting the Fed will stay on hold.

This is good news for the financial markets.

Good news and bad news

The good news: growth in wages is declining (click on the graph to enlarge). Inflationary pressures are decreasing as the economy keeps downshifting.

The bad news: consumers' purchasing power is slowing down. This trend will cause sales to slowdown even further.

Bottom line. Economic growth will be sluggish. Inflation will decline. The Fed will stay on hold. Bonds and stocks will keep performing well.

Question: which stock sectors will perform well in this environment?

More on http://www.peterdag.com/.

George Dagnino, PhD

Editor, The Peter Dag Portfolio on http://www.peterdag.com/

Since 1977