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Saturday, Dec. 3, 2005

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Wilkinson's Edge
The Cutting Edge of Financial Analysis

Global Equities

Much has been written about the prospect for the year-end rally in equity markets.

The so-called "Santa Claus rally" is already here. And it is fueled by declining energy prices that have helped to take the burden off of the consumer.

That much is evident, judging from exceptionally strong retail spending for the first weekend of the holiday season.

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This year's $27.8 billion in sales at the malls over the Black Friday weekend was the second-strongest result since 1999. And the 22% increase in online spending and the 29% rise in Web site traffic are set to mark fresh records for Cyber Monday sales.

But take a look at the state of the top 10 largest world economies and how their stock markets have fared this year.

 
The chart is skewed by the oversized gains in the Russian stock market, which is up a whopping 77%. The only loser on the year is the Chinese stock market, which has lost 13%.

But the other eight leading nations are showing solid 10-30% gains. Only the United States has a less-than-10% gain for the year-to-date, with a paltry 4%.

To my mind, it's almost as if the American investor is still suffering from a hangover after the recent bear market.

As more experienced investors look overseas and recognize this underperformance, they find it easier to buy equities as we are stonewalled by 4-1/2-year highs.

If the rest of December brings decent economic news, the potential "Santa Claus rally" might become a reality.

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U.S. Growth Upgraded

During the week there was a strong jump in consumer confidence as measured by the Conference Board. The index jumped from 85.2 to 98.9, which was the strongest gain in two years.

"Coming after the energy shocks and Katrina, it's a remarkable spring-back," said Ethan Harris, chief U.S. economist at Lehman Brothers Inc. in New York.

"The economy seems to have an underlying resilience."

The drop in energy prices is undoubtedly a boost to retailers, and we have to consider the broader ramifications of both a sudden drop in the cost of gasoline and lower-than-expected home-heating costs.

I wouldn't be surprised if these factors were partially responsible for the boost to growth as forecast by investment bank Morgan Stanley. This week, the firm raised its forth-quarter GDP forecast from 3.1 to 3.8%.

Consumer confidence has risen back above its five-year average of 96. Before the hurricane devastation, it was at 105.

So now that the economy has gotten over the shock, and refineries are gradually getting back on track, growth can resume. It's almost back to business as usual.

And with this week's announcements of a strong durable-goods report and further strengthening in new-home sales, it's easy to see why that might happen.

The chart below shows the recent 11.4% annualized growth in machinery and longer-lasting-goods orders. Indeed, the March slump in orders was quite clearly an aberration and is well behind us.

The lean level of inventories - coupled with strong pent-up demand for machinery, as evident in unfinished orders within the durable goods report - will likely fuel growth over the next six months.

That much is evident within the GDP report for the July-September quarter. This data shocked the market to the upside with a 4.3% growth rate, which is racy whichever way you slice it.

It was the healthiest clip of growth since the first quarter of 2004.

Consumer spending grew at 4.2% and accounts for 70% of the overall economy. Given what was going on with gas prices during the quarter, that means there was a healthy dose of momentum behind the scenes.

More importantly, the impetus for growth came from investment by businesses, which grew for the second consecutive quarter at an 8.8% pace.

Commodities Corner

With growth outpacing expectations, let's take a look at a technical perspective on some energy products.

We have a two-year chart of crude oil above (blue line), along with a 200-day moving average (green line).

Technical analysts use moving averages as benchmarks to determine whether any given market is bullish or bearish.

When price is above the long-term average price, the market is bullish. Conversely, when prices are below the moving average, the market is in bear mode.

The chart depicts a perfect bull run for oil throughout the two-year period.

Notice how in December 2004 and May of this year, prices fell only as far as the moving average - then found support and an army of willing buyers. On both occasions, prices raged back to the upside in the aftermath.

We have just witnessed a similar retreat to the average.

Now I'm compelled to ask: "What comes next for crude oil?"

Will this decline spur a fresh round of buying from patient bulls who have sat out of the fray in recent weeks?

Or will it mark a change in the overall trend from bullish to bearish?

The technical situation is the same in both heating oil and unleaded gasoline, where prices have sliced right through their 200-day averages. Only in natural gas are we yet to stretch lower for support at that point.

When the CEO of a major oil producer stands up and declares that crude oil prices above $55 per barrel are "unsustainable," you have to question whether the bull market may have run its course.

Have a great week! 

Andrew Wilkinson
Senior Newsletter Editor