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What's the Long-Term Outlook for Stocks and The Economy?
9/12/2011 1:17:00 PM
SAN DIEGO (ETFguide.com) The stock market's summer performance has been nothing but stunning. Seeing daily swings in excess of 4% has become as common as American fast food in China.
Sometimes it's helpful to step back and shift the focus from day-to-day changes to multi-decade trends. This kind of big picture evaluation shows whether events like this summer's meltdown are just a hiccup or confirmation of a long-term trend (change).
More than just a Multi-Decade Fluke
Gradual changes are often so subtle that they are nearly invisible to the naked eye or novice observer. But, just because a change is gradual doesn't mean it's insignificant.
Let's take a look at the basic make up of the U.S. economy. A few decades ago, sweat-trenched U.S. manufacturing facilities were the most fertile, growth-producing environment on the planet. This growth was fueled by 'Made in America' products. The growth was organic and it was real.
The first red box in the chart below captures this period of powerful organic growth. It lasted from 1947 - 1966. During this period, GDP growth averaged 4.18%.
The second red box captures a period of growth fueled by low interest and financial engineering. During this period - from 1975 - 2000 - GDP growth averaged only 3.4%.
(The above chart was featured in the March 2011 ETF Profit Strategy Newsletter)
The Only Original Dow Component, Not some Hot Tech Stock
General Electric ( GE ), a company that prospered during both phases, aptly illustrates the difference between both periods.
Until the late 1960s, GE was known for manufacturing quality, American-made products like refrigerators, washing machines, stoves, light bulbs, and jet engines. GE manufactured real products, provided real jobs, and made real profits.
Starting in the 1980s GE changed its focus from blue collar manufacturing to white collar alchemy. GE ventured into television and high finance. GE's focus shifted from building quality products to financing purchases of competitor products. Ultimately, it went from manufacturing real products to building a financial house of cards.
In August 2000, GE traded as high as $60.5 a share. In 2009 it was as low as $5.73 - a 90% drop. Today, it's hovering around $15. As you ponder this change in valuation, keep in mind that GE is the only original Dow Jones Industrial Average (DJI: ^DJI) component, not some hot today cold tomorrow tech stock.
A New Trend is Born ... and Killed
Financially engineered (artificial) profits appeared to be the best new thing since sliced bread. However, GDP growth since 2000 has dropped dramatically, now only 1.71%. The post-2007 meltdown shows that an economy cannot be built on the financial (NYSEArca: XLF) and banking (NYSEArca: KBE) sectors.
It also shows that an artificial bull market is much more receptive to huge corrections. We've had the 2000 tech bust (NYSEArca: XLK), the 2005 real estate (NYSEArca: IYR) debacle, the 2007/2008 deflation of the financial sector, and most recently the summer 2011 meltdown.
If you think financially engineered profits are bad, brace yourself for what lies ahead. The hopes for economic prosperity (perhaps even survival) rest on Facebook, Twitter, Groupon, LinkedIn, Netflix, and the like.
Social networking isn't a proven business model, yet Facebook has an estimated market cap larger than those of Boeing, Home Depot, Walt Disney, Dell, Hewlett Packard, Costco, or even Goldman Sachs.
Hewlett-Packard employs 325,000 people, Home Depot 300,000, Boeing 160,000. However, Facebook cuts pay checks to only about 1,000 lucky employees. Welcome to the future of high corporate profit margins and even higher unemployment.
Groupon has an estimated value of $6-9 billion, but its recipe of success is to coax businesses into providing discounts of 50 - 90%. Groupon is a classic economic leach that benefits by sucking the profits out of its client base and teaching its subscribers to buy only at discount prices. Welcome to a future of shrinking small business profits.
The Stock Market Agrees
The big picture fundamental outlook appears less than confidence inspiring. What about the big picture technical outlook?
The chart below (although small in size due to upload limitations) was featured in the March ETF Profit Strategy Newsletter and provides a big picture technical forecast. In fact, it's about as 'big picture' as it gets.
What you see is a giant bearish M pattern, it could even be considered a head and shoulders pattern. The neckline is formed by the 2002 and 2009 lows.
To determine an upside price target, we drew a parallel channel that connects the 2002 and 2009 lows with the 2000 high. The April 3 ETF Profit Strategy update said the following about this trend channel and other resistance levels:
'For the month of April this trend line will traverse through 1,377. The 78.6% Fibonacci retracement is at 1,381.5. There is a fairly strong Fibonacci projection resistance at 1,369. In terms of resistance levels, the 1,369 - 1,382 range is a strong candidate for a reversal of potentially historic proportions.'
The S&P (SNP: ^GSPC) peaked on May 2 at 1,370.58 and has since lost as much as 269 points or 19%. The Nasdaq (Nasdaq: ^IXIC) has held up slightly better, but no matter how you slice it, the stock market has given up more than a year's worth of gains within a matter of weeks. The VIX (Chicago Options: ^VIX) spiked to the highest level in over a year.
In addition, all major U.S. indexes broke below a trend line that has provided support on nine different occasions since the March 2009 lows.
This doesn't prevent rallies. In fact, based on our research, we should see a sizeable rally soon. However, odds favor that the stock market's trend has changed from up to down.
The ETF Profit Strategy Newsletter provides a detailed forecast for the remainder of 2011. This includes the target for the trending bottom and the up side target for the ensuing counter trend rally.