A weekly newsletter based on the fact that stock market sectors are made up of industries, that industries are made up of individual stocks, and that individual stocks in the same industries and sectors move as a group. The proven best way to profit from the stock market is to keep your funds invested in the stocks of top performing sectors/industries at all times, and the best measurement of performance of these sectors/industries is their price movement over the previous six months. Below you will find commentary of Sectors, Industries, and Stocks based on the most recent 6-month period as well as updates on the past week’s action...

October 20, 2006

Two Spheres, Four Spheres, Six Spheres...A Dollar 

There are more than four hemispheres in our world. In addition to the Eastern and Western, separated by the Prime Meridian, and the Northern and Southern, separated by the Equator,  we have two more spheres -  the Financial Sphere and the Economic Sphere, separated by... who knows what.

The Economic Sphere is the making and distributing of stuff, and things. The Financial Sphere is the grease that enables the Economic Sphere to work. The two are co-joined in an uneasy symbiotic relationship that is constantly shifting with one endlessly threatening the other, but both having to work together for either to survive and prosper.

Throughout modern history, the Economy has represented the Economic Sphere, while the stock and bond markets have comprised the Financial Sphere. Financiers and economists have argued long and hard over which controls which. 

People who hate markets like to chide them for false moves and misallocation of resources. For them, the market is useless other than as a form of speculation. But market advocates love to deliver up reams and reams of data proving that if you just read the signs correctly, you'd see how accurately securities prices predict and facilitate future economic activity.

That leaves us stuck in mid-October, 2006, with the Dow Jones Industrial Average making daily new highs, pleasing the bulls and confounding the bears. The bulls say things are great; the bears say things are about to crash. To understand the world we live in today, we need to understand what the new century has wrought, if anything, when it comes to finance and economics.

We have three choices when it comes to analyzing and understanding what's happening right now.
     1) It's different this time.
     2) It's worse than we think.
     3) It's just the same old business cycle playing out as usual, with most people not recognizing the nose on their faces.
     

1)"It's different this time." 
This is the mantra of the "New Economy" folks. Yes, we've had a "New Economy" before, and it has always reverted back to the business cycle, or worse, each time reality sets in. But the "New Agers" have a convincing argument today. They say that the Internet and the information society that it has created has changed forever the role of finance and economics in our lives. Globalization, a direct result of free trade and instantaneous information, is credited with pushing all of us into a new world, where old political boundaries no longer separate consumer from producer. Feedback is credited with enabling both producer and consumer to adjust their actions quickly, and with a minimum of waste or redundancy, making for a much more attentive and profitable company structure. Risk has been reduced through a myriad of  derivatives that most people can't understand, but benefit handsomely from greater and easier access to credit. Volatility should continue to decrease as supply and demand morph into a smoother transitioning as we move effortlessly from bubble to bubble, creating endless progress as we go. 

If we choose to believe this theory, then the markets are well on their way to much higher levels, and the Economic Sphere has literally bonded with the Financial Sphere, creating something truly new that most of us can't comprehend yet. In this new world, Simplespreading will produce easy profits as sectors and stocks rally and fall with regularity as bubbles expand and deflate.

2) It's worse than we think.
Apocalypse now! Armageddon is just around the corner. We're living on borrowed time. The Financial Sphere has run wild, creating minefields of derivatives totally disconnected from the Economic Sphere. Everything will blow up when...real estate crashes, the  the trade deficit causes foreigners to cash in their US IOUs all at once and the dollar crashes, the bond market crashes, the stock market crashes, etc. The economic foundation we now stand upon is cracking under the weight of Financial imbalances which cannot ever be brought under control. All the government officials can do is try to stave off Reckoning Day by continually pumping more and more liquidity (money) into the system while we clueless consumers borrow and borrow our way into oblivion. 
(Hint: Learn Chinese.)

It's not a pretty picture they paint. Because they have been right in the past (like a stopped clock that's right twice a day), they continually see threats to our economic wellbeing. 1929 did happen. So did Japan's 1989, which they're still trying to get out from under. And nobody has forgotten 1974, 1987, 1998, or 2002.

So, it can and does happen. The timing is the thing. The Economic Sphere has cracked and the Financial Sphere has collapsed more than once in our lifetimes. Blame gets passed around. Finger pointing never ends. We know that the Financial Sphere can get overheated, and underheated (we know that's not a word, but it fits). And, so goes the Financial Sphere, so goes the Economic Sphere.

Nobody wants to get caught in a train wreck. But nobody wants to forego all the plentiful profits over the past four years while waiting for the other shoe to drop, either.  

If and when it happens...then Simplespreading will become an arduous chore. Picking our way through the minefield of a downward shift in security prices will take talent and craft. But it can be done because it has been done. Strong industries always drift to the top, offering opportunities for the nimble. As always, we seek to take what the market has to offer, even if it's crumbs. A snack is better than nothing.

3) It's just the same old business cycle playing out as usual, with most people not recognizing the nose on their faces.
Economists, financiers, academics, politicians - most like to think the cycle works. They just want the cycle to work for them and not their competitors. The Fed is in its heaven and all's right with the world. The Economic Sphere is supposed to keep turning out product while the Financial Sphere is supposed to keep financing it. Imbalances can be cured. Trends can be smoothed. It's the same old game they and their predecessors have been playing since the modern economy began. The unlucky few get caught when the music inadvertently stops...momentarily, but that's the way the world works. Grin and bear it. Tomorrow is another day. Don't worry; be happy.

If we had to make a choice (and we do each time we venture into any market), we'd have to go with #3. We're too old and have seen too many markets to believe that "it's different this time," or "that it's the end of the world." Well, it could be, we guess, but it's usually somewhere in between. We know it takes the two competing mindsets to make a market. Optimists have to have exuberance in order to take that risk of building (the "build-it-and-they-will-come" syndrome); pessimists always serve the role of keeping some type of a lid on "irrational exuberance" before we self-destruct with excitement. And somehow, we muddle through. 

To get into a Simplespreading position, someone has to sell us stock and buy our calls. To get out of a Simplespreading position, someone has to buy our stock and sell our calls. Buyers and sellers; sellers and buyers. It makes a market.

Simplespreading will continue on its path of expecting 3 - 6 good market opportunities a year. The up years and the sideways years will be easy; the down years will be a little harder. But the plan is always the same because the market is always the same. Only the directions of the trends are changed.

Basic material commodities have had their run. Stocks are having their run. Foodstuff commodities appear to be beginning their run. Perhaps bubbles do build our world. Maybe the ideal economy is a rolling bubblemania where hot money flies from one industry to the other. In the meantime, we continue to look for strong stocks in strong industries retreating back to support, and  await the March publication of Daniel Gross's Pop: Why Bubbles are Good For the Economy. He just might be on to something. Or, maybe that stopped clock is just about to be right again. Whichever it will be, it will be a market of one sphere feeding off the other, and vice versa.

FOR THE WEEK...Don't Stop Believin'

Working hard to get my fill,
Everybody wants a thrill
Payin' anything to roll the dice,
Just one more time
Some will win, some will lose
Some were born to sing the blues
Oh, the movie never ends
It goes on and on and on and on

                                                        - Journey
                                                                   

We haven't stopped believing. Yet. But we never believe very strongly, anyway. Our opinion is always "data dependent." The crowds are cheering the Dow onward as it climbs, point by point, to new daily highs. Leadership rests firmly in the big capitalization stocks - the Dow-type stocks. Emerging overseas markets are still trailing the more established European indexes. Thus, the Generals are leading and the Soldiers are still lagging. 

Real Estate vaulted into the coveted #1 spot for the first time in over two years. That pushed Tobacco down into the #2 position, but it's having near-term problems with that role. The #3 spot went to Utilities, also having troubles holding onto recent strength. Media, on the other hand, had no problem maintaining its grip on the #4 position. It's a strong industry with some good-looking stocks. The Military-Industrial Complex kept its Top Ten streak going by residing firmly in the #5 spot. That's 26 straight weeks near the top of the list for the Aerospace/Defense sector.

Insurance enjoyed its 6th straight week in the Top Ten, coming in at #6. The Dow Jones Industrial Average checked in at the #7 spot, tacking on almost 1% for the week. Defensive sector Food & Beverage continued its drop, stopping this week at the #8 spot. This is the lowest rank it's experienced since the first of July. Drugs stayed put at the #9 spot, barely budging in price this week. Specialty Retail's move into the #10 position is the first time since April it's seen a Top Ten ranking.

Analysts, who expected a September massacre, are now predicting the worst is over and that the last quarter of the mid-election year is nothing but up and up, historically speaking. Nobody has evidently mentioned to them that if the market didn't go according to history for September, that doesn't mean it can't go against history in October, November, or December.

As mentioned above, these are confusing times. Much economic data points to a recession just around the bend. Yet, the market doesn't see it. Maybe it is different this time. That would be nice. We've been held hostage to the brutal business cycle for hundreds of years. But we have to interject here that the ups and downs of the market are just as much psychological as they are economic or financial. How else can you explain the expansion and contraction of PEs on an almost regular basis? Stocks alternately sell at 10, 20, 30, and 40 times earnings, based more on how the investing public views its own future than on how well the companies themselves are doing. And, the last time we looked, emotional outbreaks are alive and well - just check out the latest news from inside the Beltway or down in Silicon Valley. Humans will be human. 
What else can we be...until the cyborg gets here?

THE BEST...