Pete Kendall's Socio Times: A Socionomic Commentary

December 3, 2006
Stocks Seen Volatile Amid Manufacturing, Jobs Data
U.S. stocks are expected to remain choppy next week as investors look to key employment and manufacturing reports to determine whether the economy is headed for a recession next year.

"Volatility is...going to be one of the hallmarks," of the coming trading sessions, said John Caldwell, investment strategist at McDonald Financial Group.

The market's tone has been set by this week's reports of the first contraction in the manufacturing sector since April 2003. The Institute for Supply Management's November manufacturing index and the Chicago Purchasing Managers Index took on greater-than-usual importance because they raise concerns about the whether the economy is headed for a so-called hard or soft landing.

The central bank is expected to leave rates unchanged when it meets on Dec. 12.
Mike Holland, manager of the Holland Balanced Fund, expects stocks to gain ground next week and through the end of the year. He said he's taking his cue from the many large multinational companies that have been describing their business bookings as "robust" through year's end.

"We're not adverse to taking money off the table in the near term...and using the market volatility to our advantage."
CBS MarketWatch

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Anything-But-Bearish Factory Fall Is Exactly That
By: Pete Kendall, December 4, 2006

[The 1929-1933 experience] came with a kind of surrealistic slowness...so gradually that, on the one hand, it was possible to live through a good part of it without realizing that it was happening, and, on the other hand, it was possible to believe one had experienced and survived it when in fact it had no more than just begun.
At The Crest of the Tidal Wave quoting historian John Brooks

The use of the word “volatility” has a familiar ring. Another example is this comment from another senior analyst: “The release of a lot of economic data has the potential to induce further volatility.” At another point in the same story, the author says that the same analyst believes the market will “probably open about 15 to 20 points lower today following bad news on the state of the US manufacturing sector.” So when he says volatile he means down. It reminds us of this comment from The Elliott Wave Financial Forecast in February 2003, when the stock market was flat on its back Wall Street still hadn’t adjusted to reality: “A good example is the use of the word ‘uncertainty’ as a euphemism for falling prices. Even though the S&P has already experienced its biggest and longest decline in more than 50 years, many insist the markets are in a ‘period of uncertainty’ rather than a bear market.”

The market usually leads the economy lower, but that’s not always the case. In 1929, for instance, the downturn was well advanced and actually made a clear reversal coincident with the downturn in stocks. Recent issues of EWFF, have discussed several signs of an economic contraction including the inverted yield curve, demand for help wanted advertising and a negative reading in the Philadelphia  Fed’s index of economic activity (see October EWFF entry in Additional References below). Now comes word that the Institute for Supply Management's factory index of national manufacturing activity fell to 49.5, from 51.2 in the prior month. A reading below 50 signals contraction. The figure and the analysts' use the word “volatility” in place of “a decline” or “falling prices” hint that this may be one of those rare cases when the economy and stocks swing lower in tandem. Another possible sign of it is that instead of focusing on the obvious signs of a slowing economy, analysts are using recent highs in the stock market to suggest that the economy is in no danger.  This is true, but it will remain so only as long as stocks stay up. Once they reverse, the advanced state of economic deterioration suggests a contraction that is as hard as they come.

Additional References

October 2006, EWFF
One of EWFF’s most important forecasts for 2006 was this one from January’s Bottom Line:
The yield curve inversion relative to bullish market expectations implies trouble ahead for the economy.

The news is starting to appear. In addition to the sustained inversion of the yield curve, whereby short term interest rates are higher than long term rates, some clear indicators of an economic contraction are: the first negative reading in the Philadelphia Federal Reserve’s general activity index since April 2003; a plunge in housing sales and the first nationwide housing price decline since 1993; and a seven-month long decline in the Index of Leading Economic Indicators. Since 1980, seven months of a LEI decline have never failed to precede or accompany economic recessions.
The advertising environment also bears a striking resemblance to its condition in late 2000 and early 2001, when EWFF used a series of early setbacks in the ad market to tip readers off to the onset of the last recession. After struggling to recover from the downtrend, newspapers are once again fighting for their lives. The New York Times, Knight Ridder and The Tribune Co. are selling off operations, slashing pay and doing whatever it takes to stay viable. “Everything is on the table,” says the chairman of the Tribune Co. A readership transition to the Internet is greatly responsible. The industry’s troubles are clearly mounting. For recent quarters, total ad revenue was down 2.3% at The Dallas Morning News, 1.1% at The Providence Journal and 1.7% at the Press-Enterprise in Riverside, California. Meanwhile, The New York Times and Dow Jones & Company forecast sharply lower third-quarter earnings because of a “challenging” print advertising market.

Historically, the Help Wanted Advertising Index has been a reliable economic barometer. In February 2001, EWFF cited the index’s collapse from 90 to 75 and noted, “Similar plunges started before each of the last five recessions.” The effectiveness of the index may now be suspect because of the transition to Internet classifieds, but the renewed plunge in August to the lowest level in more than 40 years suggests that the dearth of help wanted ads is probably saying the same thing it said the last six times: recession is on the way. The reason that the newspaper industry has managed to stave off the inevitable move by readers to the Internet is the stubborn influence of the old uptrend. “At the end of the great bull market, the mood is so elevated that both the new and the old economy coexist,” EWFF noted in December. But we have also noted that part and parcel of a deflationary downswing is the wholesale adoption of more efficient technologies created during the boom. The urgency of this crash in ad revenue means that the happy coexistence between old and new economies is over.

Also, keep in mind that high flyers tend to get rocked by the slightest bit of turbulence. Most people don’t remember that the original dot-com bust was accompanied by an online advertising shakeout. Here’s what EWFF had to say about it right before the start of the 2001 recession:
Another clue to advertising’s suddenly perilous future is the pivotal role it came to play in the virtual economy. In the dream that was the New Economy, the promise of future ad revenue justified countless web vendors’ lack of profitability. Once the top was in, studies came out showing that Internet advertising did not even work. Three days after the NASDAQ’s March 10 peak, for instance, InternetWeek reported, “The notion that web users would be steered to e-commerce sites” was “a fairy tale.”

Online advertising has begun to work quite well, but the latest retrenchment again includes a sudden wave of apprehension and setbacks. On Tuesday, Yahoo warned that auto and financial advertising would be weaker than expected. Internet ad monitors EMarketer and the Internet Advertising Bureau both report slowing Internet ad growth in recent months. EMarketer also lowered its annual growth rate for Google’s online sales from 80% to 65%. This may not seem like much, but with expectations primed for astronomical growth, such a hiccup is likely to be problematic. This Business Week cover about “The Dark Side of Online Advertising” is another signal that seems to be torn right out of EWFF at the onset of the economic recession in 2001. The article is about a “slipping confidence” in online advertising. As we keep saying, confidence, an ephemeral mental state, is the fundamental building block upon which the economy rests. In an economy that is maxed out on debt and consumption, it won’t take much slippage in investors’ and consumers’ minds to speed the reversal.

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