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January 09, 2006
Yield Curve Theories, Electronics Sizzle and Dow Theorists Diverge
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Dan Luskin of SmartMoney.com reports: According to the bears, an inverted yield curve is an indication that a recession is coming. They point to the inversion that started in 1978 and ushered in the back-to-back recessions of 1979 and 1981. The inversion that began in 1988 presaged the recession of 1991. And the inversion of 1999 foretold the recession of 2000. On the face of it, all that makes it appear like the bears have an open-and-shut case. It seems that recessions follow yield-curve inversions like sunrise follows the rooster's crow. And, of course, that's the bleak version of reality that the relentlessly negative media has been pushing. But take a deep breath and count to 10. Things aren't as bad as they seem. One thing the bears don't tell you is that the yield curve's track record as an economic crystal ball isn't perfect. It inverted in mid-1998, yet no recession followed. In fact, the years following that inversion were an amazing boom. Don't tell me you've forgotten those wild couple of years leading up to Nasdaq 5000?
This charts shows the 10-year Note Yield less the 13-week Tbill Yield. The 10-year T-Note Yield should be higher and it current is higher. But not by much. The 10-year T-Note Yield is only .0247% higher than the 13-week T-Bill Yield. That is not much of a premium for taking an extra 9 years and 39 weeks of risk! One thing is for sure, the Fed is tightening as long as the red trendline holds and this yield spread narrows. The blue horizontal line marks zero and a move into negative territory would create an inverted yield curve. While this is not always bearish for stocks, it can hardly be considered a positive.
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Dow Jones report: Hot sales of MP3 players and accessories powered strong gains at both Best Buy Co. and Circuit City Stores Inc. in December, sending shares of both higher in pre-market trading Friday. Best Buy(BBY), the nation's largest consumer-electronics retailer, said December sales shot up 12% to $5.7 billion last month, while sales at stores open longer than a year - a key industry metric - climbed 5.8%.
Clothes will come and go, but Electronics will remain hot for some time. BBY gapped higher and formed an island reversal over the last five weeks. Notice that there were no trades at 46 from early December to 6-January. This means that all those with shorts established in the green oval are holding losses and getting the squeeze.
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Dow Theory Buy Signal!
The Dow Industrials broke falling flag resistance and CLOSED at a four year high. According to Dow Theory, this is one piece of the bullish puzzle.
The Dow Transports form the other half of the puzzle and this Average reached a new all time high in late December. Technically, the new reaction highs did not coincide with one and other. However, both reached new reaction highs within two weeks of each other and this should qualify as a Dow Theory buy signal or bullish confirmation.
Mark Hulbert of CBSMarketWatch reports: Does this mean that Dow Theorists are unanimous in believing that happy days are here again? The answer is yes at least for two of the three investment newsletters I monitor that refer to the Dow Theory: Dow Theory Forecasts, edited by Richard Moroney, and TheDowTheory.com, edited by Jack Schannep. Moroney, for example, says that he is inclined to use the DJIA's close above the 10940.55 level as the occasion to increase his equity exposure. And Schannep says that the DJIA's rally on Friday means that "we are 'in the clear' according to the Dow Theory." Richard Russell, however, editor of Dow Theory Letters, is an exception. He is not inclined to make a big deal of the DJIA's confirmation, for at least two reasons. First, he thinks it is worrisome that the DJIA took so long - nearly three months - to confirm the DJTA's strength. Secondly, Russell believes that the Dow Theory also is about values, and stocks' valuations today are far from cheap.
For some strange reason that is what I expected from Russell. Peter Brimelow refers to Russell as one of the “geezers”. He has been in this business for a long time and has certainly paid his dues. However, I think Russell’s bias’ may be getting in the way of his chart interpretations. Either the Dow reaches a new high or it doesn’t. Yes, it did take a long time. However, new highs are signs of strength, not weakness and should be interpreted as such. Russell has been bearish for a long time and yet the markets are hitting new highs. The market tells a different story.
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Posted by Arthur B. Hill at January 9, 2006 08:19 AM