USA Corporate Profits & Dow Jones ForecastBusiness Cycle InvestorDJIA QUARTERLY FORECAST - AUGUST 31, 2008 |
AUGUST 31,
2008 RECOMMENDATION: S
T A Y I N
We
recommend to stay invested in the Dow Jones Industrial Average Index
(DJIA) until the next quarterly update at the end of November 2008.
Review of the past 3 months
The Second Quarter’s 2008 US NIPA Corporate Profits announced in August 2008 by the USA Government at www.bea.gov Table 6.16.D fell slightly while the so far most depressed financial sector’s Corporate Profits continued a solid recovery from its Q4 2007 bottom. The final Corporate Profits results will be known in 3 years as they will be a subject to more revisions to ensure consistent quality of the long term time-series.
The USA Government revised in July 08 many macroeconomic numbers for the 2005-2008 period including Corporate Profits hence the change in the shape of the blue line on the above charts.
The most interesting revision was to Real GDP growth numbers that were previously all reported in a positive territory. The 4Q 2007 was retrospectively adjusted down to a negative -0.2% followed by a positive +0.9% for Q1 2008 and the latest unexpectedly strong +3.3% growth in Q2 2008 (see table 1.5.1 at bea.gov). It seems, we came close to a recession in Q1 2008, defined as two consecutive negative GDP growth quarters and it can also mean the bottom of the GDP cycle is behind us. Our last Buy signal in Q1 2008 coincided with the GDP bottom.
Dow Jones and S&P500 underperformed during the last 3 months after a bumpy period and significant early falls despite the beginning of historically positive for the stock market IN PERIOD as defined by our methodology and more companies reporting better than expected earnings.
The subdued market performance was primarily due to a sudden jump in the price of oil touching the all time record of $150 per barrel as a result of aggressive speculative buying and strong comments by politicians related to the threat of a use of nuclear weapons in the middle-east. Such negative for the stock market events are unpredictable and can in the short term overwrite any macro-economic fundamentals. Speculators control significant 70% majority of the future oil contracts trade and can move the short term market in any direction.
Falling oil and commodities prices together with a strengthening US Dollar and better than expected GDP growth in Q2 helped the stock market recovery in August 08.
Interestingly, the small cap sector represented by Russell 2000 index performed relatively much better probably because of a lesser exposure to the struggling housing and finance sectors.
The housing sector in the US is still in a deep recession with falling house prices and rising mortgage delinquencies rates especially in the boom & bust states of California, Florida and Nevada. Tighter credit and rising mortgage interest rates are making it difficult to refinance and take new loans. The struggling banks and Freddie Mac & Fannie Mae are reluctant or unable to ease the rates charged on prime mortgages despite reduction in official interest rates charged by the Central Bank.
Subprime delinquencies are dominating at about 37% of loans originated in 2006 while prime mortgages are just at 1.7% but that rate is increasing at a faster pace for prime mortgages while subprimes delinquencies are beginning to plateau (source: Credit Suisse). That suggests the credit crisis has been spilling over to the core prime mortgages that are only ”prime” for as long as the house prices are steady or rising which is not currently the case.
Freddie Mac (FRE) and Fannie Mae (FNM), the Government sponsored mortgage providers established in the 1930s that control 50% of the USA housing loans market are on a verge of collapse having lost 95% of its market value over the last year.
When this credit crisis is over, commercial banks should emerge in a stronger position than non-bank lenders to capture a large part of the US mortgage market. Freddie & Fannie and other non-bank mortgage providers - if they survive - will be weakened by the crisis and new bank capital regulations (so called “Basel II”). At the same time, commercial banks will benefit from the access to cheap Fed discount window and a wider use of Covered Bonds promoted by Treasury Secretary Paulson. New post-crisis mortgages are likely to be covered or backed by banks’ balance sheets and hence be more credible and attractive in the eyes of new investors.
A strong Private Equity lobby has been also pushing for new legislation to allow them significantly increase equity stakes in the banks without adding to the disclosure requirements.
Some observes think the commodities/resources boom is coming to an end considering that all commodities including the soft/agricultural began to fall simultaneously. If this was true the “commodities” currencies such as Canadian and Australian dollar would depreciate.
A few analysts pointed to the evidence of recovery in the Corporate Profits of the US Financial Sector over the last three quarters together with slowing delinquencies in the subprime mortgages may signal the bottom of the current financial crisis in the USA and the stock market should start reflecting a brighter future ahead.
International markets may still need to finish their downturns which would attract more capital inflows to the USA resulting in appreciation of the US dollar and US equities and further fall in commodities.
The next 3 months Outlook:
The updated value of our proprietary Business Cycle Index (green line on the charts above) points to a favorable environment for the USA Corporate Profits and stock market over the next few months and we recommend to "Stay In" the market.
The “IN PERIODS” identified by the proprietary formula have been historically characterized by solid and consistent returns underpinned by favorable macroeconomic fundamentals such as stronger Corporate Profits growth.
The methodology delivered average 27% ungeared return per 15 months average "In Period" or 20% annualized over 60 years history, including last 4 years of actual results (see Performance record).
The Charts above illustrate recent performance until August 31, 2008.
Next quarterly update is planned for end of November 2008.
Sincerely
The
Business Cycle Investor
August 31, 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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