Analyst Louise Yamada on Why Share Prices are Lagging Behind the Underlying Commodities
Source: Jay Taylor/Richard Russell/Gold-Eagle (7/8/08)
Acclaimed analyst Louise Yamada provides a framework and some answers as to why, in spite of rising gold and energy prices, the shares and especially the junior shares have lagged behind the underlying commodities.
Following are Ms Yamada’s most recent take on the markets.
As I read the views of Louise, I found myself agreeing almost 100% with her vision. However, as a technical analyst who has taken a long-term view of the markets, she has provided a framework and I think some answers as to why, in spite of rising gold and energy prices, the shares and especially the junior shares have lagged behind the underlying commodities. In bullet-point form, here are some of the major points Louise made that I think need to be stressed because they help us understand why our Model Portfolio is struggling to get into positive territory, despite substantial price rises in the underlying commodities. And I think her vision of what is really going on helps us understand why we need to stay with our current strategy.
—Most stocks are in a structural bear market and as such will be in decline for some time to come. In fact, she makes the case that we could have another three years of gut-wrenching declines for some of the biggest and bluest blue-chip names in corporate America as economic power shifts from the West to the East. Some of the big-time companies that are in a significant decline are major household names like Citicorp, Pfizer, General Motors, Eli Lilly, Dupont, General Electric, and United Health Groups. In general, Louise thinks consumer cyclical stocks will continue to have a hard time, with the possible exception of deep-discount outfits like Wal-Mart and Costco. She also likes the railroads and utilities, and thinks Caterpillar might not be bad as it continues to participate in the global wealth-creating story.
—Ms. Yamada is comparing the U.S. equity markets now to that of the latter part of the 1930s. Most specifically, she thinks we have at least another three years of really difficult markets to struggle through, during which time, many of the former big names will not survive. This kind of structural bear market usually takes 10, 12, or even 15 years to end. She marks the start of this bear market at 2000, which means it could last beyond 2010.
—Energy and metal stocks are in a cyclical correction, not a structural bear market. Louise points out that the structural shift we are seeing is taking place due to global economic dynamics, owing to large populations now having spending power, and that this structural shift is resulting in a transfer of wealth away from financial stocks back to companies that produce “stuff.” For example, she points out that in 1980, which was the end of the last commodity bull market, financial stocks comprised 6% of the S&P 500, while energy companies comprised 27% of that index. By contrast, in 2007, financial stocks made up 27% of the S&P 500, and as recently as 2003, energy stocks were just 6% of that index. Now energy stocks have climbed to 14%. Louise thinks we could see upward to 30% composition of energy stocks before this bull market is over.
—Only 25% of China’s exports are to the U.S. and Europe. Louise has picked up on what I think is one of the most important drivers of change in the global economy—the emerging-market wealth that is essentially gaining at the expense of the western economies who have chosen to consume and not save. Thanks again, John Maynard Keynes! In essence, we have chosen to consume or seed corn rather than to save and invest for a better future, and we are now starting to pay for it as indebtedness to foreigners is starting to wreak havoc on our currency, which in turn is one of the main reasons the price of oil and other commodities is in such a steep rise. But the fact that not only the U.S. but also Europe combined comprises only 25% of Chinese exports is astounding evidence that decoupling is, in fact, in process, and why energy and copper prices are continuing to rise, even as the U.S. is in a recession! As Louise notes, this is why energy, metals, and agricultural stocks are in a cyclical correction and not part of the bigger and much more dangerous structural bear market.
—Oil stocks have earnings—not a bubble. NASDAQ—no earnings=bubble. In the interview, Louise was asked about a recent Barron’s article suggesting that oil was in a bubble market. A chart compared the upswing in the NASDAQ with the upswing in oil stocks. Louise noted that oil is not in a bubble because unlike the NASDAQ during its rise, oil has earnings. The NASDAQ did not!
—Most Americans will keep their heads in the sand. Because many mutual funds have a mandate to stay virtually 100% invested in stocks and because most Americans continue to hope that these old bellwether stocks will bounce back, it may take a few more years for this bear market to end. But clearly, her message to anyone who will listen is to get out of most U.S. stocks because they are heading much lower. For starters, Louise is looking at a 10,000 Dow.
KEEP YOUR EYES ON THE DOW/GOLD RATIO?
The comparisons Louise Yamada is making with the 1980s and 1930s reminded us to revisit the Dow Jones Industrial to Gold Ratio because when those ratios approached 1:1, it more or less marked the bottom of those equity bear markets. In essence, we are not measuring the Dow in terms of funny fiat money but in terms of real money with real intrinsic value, namely, gold.
The chart above provides Dow/Gold data points only at year-end, with the exception of the most recent calculation, which was carried out at 10:30 a.m. on Thursday, July 3. Accordingly, neither extreme high or low is displayed on this chart. However, a 1:1 ratio did occur in 1926, during the 1930s, and again in 1980 when gold rose to $850 and the Dow fell into the 800s. As of 10:30 a.m. on July 3, 2008, the Dow was at 11,287.08 and gold was at 930.40. If Ms. Yamada’s target of a 10,000 Dow makes the bottom of the bear market in stocks, we would need to see the price of gold rise by more than tenfold to hit our 1:1 ratio. Is that a realistic target? We think it could be, given the inclination of politicians and bankers to keep on printing money to try to avert an overall deflationary depression. In other words, the cost of living could (and we expect will) continue to rise dramatically while equities trend lower or, at best, tread water for at least the next several years. From a practical point of view, we think the current environment, in which the sectors in our Model Portfolio are in a “cyclical correction,” provides investors with a major buying opportunity at bargain prices before the next major move in gold and other commodities gets under way.
Many thanks both to Jay and Louise and to the Gold-Eagle site on which this piece appeared.