USA Corporate Profits & Dow Jones ForecastBusiness Cycle InvestorDJIA QUARTERLY FORECAST - MARCH 27, 2008 |
MARCH
27,
2008 RECOMMENDATION: B
U Y
We recommend to “Buy” the Dow Jones Industrial Average Index
(DJIA).
Review of the past 4 months
Fourth Quarter’s 2007 US NIPA Corporate Profits announced today by the USA Government at www.bea.gov Table 6.16.D fell -3.3% from previous quarter consistent with our November 2007 forecast.
The US and international equities markets fell heavily over the past few months. US Dow Jones Index has been in a down trend since Friday October 12, 2007. Dow Jones fell -14.6% since then and global markets fell even more, some by -40%. This is not a surprise as international markets usually drop more than the USA during major US corrections and bear markets disregarding local favorable macroeconomic environment (please refer to the asset allocation strategy for a historical evidence).
The stock market falls would have been much sharper and deeper if it was not for an unprecedented and rapid response by the US Federal Reserve Bank in concert with other central banks and governments of US/EU/Japan/UK on all fronts: monetary policy, fiscal policy and unorthodox ways of increasing liquidity and protecting financial system from a looming major disturbance.
Interest rates in the US have been reduced by 2%; from 4.25% down to current 2.25% while US Government approved $150b (or 1% of GDP) fiscal stimulus package targeting average American family. Moreover, FED and other central banks injected few hundred billions into the struggling financial system by reducing discount rates, providing additional emergency loans and even accepting low quality securities (mainly subprime securitized mortgages) as collateral for top rated and liquid Government notes.
US average house prices have fallen by nearly 9% - unheard of since the 1930s great depression. The drop wiped out $2 trillion dollars from the value of households balance sheet. Sales volumes, building approvals and new construction indicators have deteriorated to record low levels. The US families are under much pressure increasingly unable to service their mortgages. The reductions in the official interest rates by FED have not yet much helped the consumer. A typical 30 year mortgage rate is currently 5.72% - not much lower than 5.85% 3 months ago. Moreover, the rates paid on larger mortgages have actually risen. For instance, the so called US Jumbo Fixed 30 year mortgage rate is currently 7.23% Vs 6.74% 3 months ago before the FED reduced its target rate by 2%. It is apparent, the banks are trying to recover the subprime losses and pass on growing cost of funding in the wholesale credit market.
Credit is very tight at the moment. Highly leveraged entities are at risk: Private Equity - leveraged buyouts, Hedge Funds, banks, insurance bonds, derivative markets, financial companies in general, property sector, households etc. Here are some examples of the distressed market:
5-th largest 80-year old US investment bank Bear Stearns collapsed and only after FED guaranteed $30b of its debt it was bought by JP Morgan for a few percent of its last year's value. The price paid does not exceed the value of one of Bear Stearns buildings in New York;
Private Equity firms are suing banks for walking out on earlier agreed debt finance; banks are not interested in funding new buyout deals anymore; some Hedge Funds caught on the wrong side of a leveraged bet have closed on heavy losses;
Commercial and Investment Banks shares fell 10-80% around the world and they are increasingly relying on central banks for restoring their reserves and balance sheets.
Various analysts expect more bad debt write-offs as subprime mortgage crisis is spreading over to the other sectors of the financial system. As a result, the market sentiment is negative and bearish.
The market expects further interest rate reductions and FED indicated it is standing by to inject additional liquidity if and when required. The FED has practically unlimited balance sheet and is able to create as much money as is required by simply making an accounting entry in the books. That makes some observers worried about the impact of such approach on future inflation and exchange rates.
2 months outlook:
Our forecast and recommendation has changed: WE RECOMMEND TO BUY the Dow Jones Index in anticipation of bottoming out of the US market over the coming months. While the NIPA US Corporate Profits are likely to fall further in the first quarter of 2008 (they will be reported in May 2008), the turning point is already in the making according to our macroeconomic formula. We should start seeing bottoming out of the Corporate Profits during Q1-2008 followed by the recovery in Q2-2008.
Our proprietary Business Cycle Indicator is back above the average for the first time in 2 years triggering the BUY signal and beginning of the "In Period 15" (green line on the chart above).
The early stages of this new "IN Period 15" are likely to be volatile and more falls are possible given the current extremely bearish mood and uncertainty about the quality of risk disclosure by the financial sector. Most previous "In Periods" also experienced a 1-4% fall after the BUY signal (please refer to Max Fall in the "In Period" Performance Table).
Therefore more prudent and risk averse investors would be spreading the buying activity over the next month or two and aim to accumulate on bad news and market drops to reduce the risk.
The “IN PERIODS” identified by our proprietary formula have been historically characterized by solid and consistent returns underpinned by a strong Corporate Profits growth. A 50+years historical average ungeared profit achieved with the macroeconomic model was 27% per 8-15 months long average "In Period" or 20% annualized (see Performance record).
For the record, today's BUY signal marks the end of 2 years long OUT PERIOD 14-15(2) that returned 10.3% or approximately 5% annualized and was extremely volatile. During this time, investors who followed our recommendations and stayed out of the market in the safe capital protected cash on call made similar profits.
The Charts above illustrate recent performance until March 27, 2008.
Next quarterly update is planned for May 2008.
Sincerely
The
Business Cycle Investor
March 27, 2008
___________________________________________________________________
Individuals invest directly in the large USA market index Exchange Traded Funds (ETF) that trace Dow Jones Industrial Average or Standard & Poor's S&P 500 indexes or in an equivalent liquid USA market index mutual funds.
The ETF funds trade on the stock market just like normal stocks. One transaction in ETFs provide investors with diversified blue chip portfolio and solid dividends. Transaction and management costs are minimal.
The proprietary Business Cycle Index is an effective leading indicator of corporate profitability for the whole USA economy. The aggregate US Corporate Profits are calculated quarterly by the USA Government and published at www.bea.gov where subscribers may independently verify the forecast.
Corporate Profits have historically shown a high 93% correlation with moves in the major diversified USA stock market indexes: Dow Jones Industrial Average (DJIA) and S&P 500. Hence, the Business Cycle Index can be used as a leading indicator of the broad USA stock market.
The Corporate Profits for the whole US economy don't always move in the same direction or by the same magnitude as the profits reported by individual companies or even the DJIA or S&P 500.
More information about the research methodology can be found at www.businesscycleinvestor.com/methodology.htm
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