Signs of the Bear: Ned Davis

Friday, July 07, 2006 | 09:45 AM

I pulled a few key lines from an interview in Barrons last week with Ned Davis, a technician and quant wonk whose institutional service is top notch.

Here's the relevant excerpt:

Barron's: Is this simply a "stiff correction," as you have said, or a new bear market?

Davis: I'm concentrating on the downside risk. We are in a pretty defensive position, and in our investment strategy we are underweight stocks at 45%, market weight bonds at 35% and overweight cash. In my hotline trading strategy, I have a market-neutral stance currently, which I define as about as many shorts as longs.

How related is this market performance to the second year of the four-year cycle?

In the case of the four-year cycle, we plotted it against stimulus from the Federal Reserve and the federal government budget deficits and money-supply growth, and we found they correspond very well. Problems in a mid-term election year are generally because the Fed is tightening, and so the fundamentals fit with the cycle. As you get closer to the election, you know, there is uncertainty that is going to weigh on the market. As we get closer to October, it will become clearer. This is going to be a particularly bitter election with a lot of divisiveness. The country is as polarized as I have ever seen it. One of the unusual aspects of this period is how quiet labor has been. Job growth has been okay, but wage rates have not been good and the spread between the rich and the poor has gotten bigger and bigger.

If rates aren't too high, what's the problem?

When you look at the historical averages, they're not. But when you look at it versus $42 trillion in debt and wonder how we are going to service all that debt, then you get a little different feeling about it. In the last year the federal government is paying 21% more in net interest then it did a year ago. They have to keep rolling it over and are running deficits on top of that. That tends to be more deflationary than not.

How much downside risk to the market could there be if the economy stays strong?

There have been a lot of bear markets when earnings kept rising. In the 1973-74 bear market, earnings rose the entire period. A lot of that was inflationary, but a lot of the earnings today are coming from energy and other sectors that are inflationary. In 1946 we had a big crash and a bear market and yet earnings exploded. In 1962 we had a crash while earnings exploded. In 1987 we had a crash and earnings did very well. Just because we don't see a recession on the horizon doesn't mean there is not risk in the stock market.

What about profit margins?

High profit margins tend not to be bullish. They tend not to be bearish, though. High profit margins tend to translate into a flat market.

What's your view on the dollar here?

My view on the dollar is that it is structurally very, very weak. Even though currency depreciation really does not solve the trade-deficit problem, it has to be part of the solution. There will be a tendency for the dollar to go down. The problem is that it is in nobody's interest for the dollar to go down. It is not in the Fed's interest because of inflation. It is not in Europe's or Japan's interest because those economies are growing more slowly than ours. All the central banks in the world maybe want the dollar to go down, but only very slightly and very slowly. It will be a controlled slide. Right now, our economy is running particularly strong. The Fed is still tightening. Our rates at 5¼% are way above global rates at about 2½%. The dollar has a lot going for it, and it has been rallying a little bit. But the trend is down.

Is it for that reason you have been bullish on gold?

Yes. When you consider alternatives to the dollar, one of them is gold. Gold is such a small market, it doesn't take much to push it up. I'm pretty bullish on gold even after its unbelievable run. We've had a big correction here after it got beyond its fair value of about $540 an ounce. Being bullish on bonds and gold is a strange combination because one is deflationary and one is inflationary, but I think gold is acting now as a currency replacement and, in that light, it looks pretty bullish.

Good stuff from Barron's.

Signs of the Bear
Interview with Ned Davis, President and senior investment strategist, Ned Davis Research
Monday, July 3, 2006

Friday, July 07, 2006 | 09:45 AM | Permalink | Comments (46) | TrackBack (1) add to | digg digg this! | technorati add to technorati | email email this post



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Tracked on Jul 7, 2006 10:14:51 AM


The sad fact is that we're living in a debt fueled economy as opposed to an income fueled economy.

The largest buyers of goods and services, the American consumer and the Federal Government, have been financing their purchases without any real plan for re-payment.

Neither the American Consumer, nor the Federal Government has spent the borrowed money on new income generating assets. In the case of the consumer, the borrowed money has been used to drive the savings rate negative and in the case of the government, the borrowed money has been spent with shocking in-efficiency.

Where does this leave us?

The answer is really out of our control. Given our druthers, our fine system of borrow-and-spend would continue forever.

The real control lies in the hands of our largest lenders: the foreign central banks. These lenders are setting our market rates. Everyone else is just following in their slipstream.

So the question comes down to this: when will foreign central banks wake up and realize that the 5% treasuries they've been buying can't make up for inflation or more-importantly currecy risk.

Of course, the answer is that foreign central banks have not been making rational economic decisions. They have been making political decisions.

And there you have it: we in the economic world are errantly trying to determine our fate through data and numbers, when we would do ourselves a lot more good by learning to read the political signals coming out of China and Japan.

I would dare say that a good 1/3 of our time should be spent in decoding the intent of the Chinese and the Japanese. When their economic & political intentions shift, we will see tidal changes in our economies.

Posted by: Mr. Beach | Jul 7, 2006 11:36:20 AM

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