Index Round-Up for 2007

Includes: DIA, QQQ, SPY
by: Philip Davis

I wish I could say I was happy to put this year behind us but it’s been a fantastic year and I doubt we can expect the same from 2008. We have many burstable bubbles that may join the housing bubble in decline including oil and metals as well as Asian markets if we get a stall over there.

I continue to believe that US equities are the least sucky place for global investors to put their money in ‘08 for the same reasons I outlined in August, when we were still below 13,100 and we had just made our bottom call the week before. Although the Dow, Nasdaq and the NYSE are well up since then, we’ve lost ground on the Transports, S&P and SOX so our mission for January is clear - will the top three come down or will the bottom three come up (the Russell is our tiebreaker).

There you go, that’s everything you need to predict the markets in Q1. Now let’s take a closer look at our indices:

Dow - Weak dollar means strong International sales plus lots of dividends make for a fun "flight to quality play" (if you can call (NYSE:GM) quality that is). We are sitting exactly on the 200 dma at 13,350 with the 50 dma about to form a "Death Cross" and it will only take the smallest bit of bad news to push us to retest the 2007 lows around 12,500 which is how I agree, yet disagree with Stuart Freeman (BusinessWeek’s market forecast winner of ‘07) as he sees the Dow bottoming in the summer in the low 12,000’s but I see it going lower now and topping in the summer, perhaps close to 15,000 but we both see the year ending around 14,500.

Transports - This is the Achilles heel of the Dow as the energy sector must fall for the transports to prosper. $100 oil is now required for oil companies to grow into their values but it’s already murdering the consumers and driving up costs for the transports - their own private little stagflation spiral that no amount of Fed cutting is going to fix.

S&P - It’s very disturbing that the broader S&P should underperform the Dow by half in ‘07. You hear nothing of this in the MSM as they’d rather sit there with their heads in the sand and tell you how great everything is since bad news = bad ratings. I will remind these idiots of an ancient concept called "The Public Trust" that is important enough to be the subject of an initiative by the media in Europe but has gone so far out of vogue in the states that, like in many fascist regimes, most of the unvarnished truth you hear is presented under the guise of comedy programming like the Daily Show. Ignoring bad news makes by putting your head in the sand makes it far more likely that you are going to get kicked in the ass!

The S&P already made their death cross on Christmas eve and, if we don’t pull back over 1,500 soon, then we are probably heading for a retest of 1,400 before we can make any further headway. The best case scenario would be a commodity sell-off leading the index down while retail (probably consumer staples) and financials hold things together as that would address what’s wrong with the S&P at the moment. It’s up to our pals at OPEC, who can tank oil with the flip of a switch at their upcoming meeting but we may have to wait until they have a chance to buy more stocks as Arabian Sovereign Wealth Funds have lined up over $1.5T to "bail out" our beaten down financial stocks and now we’re softened up enough to take the money, unlike the Feb ‘06 Dubai Ports Debacle.

This is how these investment cycles go. We hated the Japanese invasion as they rose to prosperity in the 80s, auto workers and other unions picketed them and decried the loss of jobs but we sure took their money as our real estate market tanked, leaving that country holding the most expensive bag ever filled by Wall Street, until they figured out how to stick it to US homeowners in the first half of this decade…

With our Fed making all the same mistakes that the BOJ made in the ’90s, I’m not too confident that "this time will be different" for the US. So let’s watch the S&P 500 a lot more closely than the Dow 30 as they are 30 companies that are well-suited to prosper despite a US recession.

NYSE - There are 1,915 companies making up the NYSE and they’ve outperformed the S&P by almost the same wide margin as the Dow has. I think, to some extent, the S&P suffered this year due to overly optimistic expectations and tough comparisons while the NYSE had many up and coming mid-caps that carried the ball in what was, on the whole, a pretty good year. Now this group faces higher expectations and tougher comps - any tick below the 200 dma at 9,769 should be taken most seriously as a bad sign for the markets in general. If they can hold 9,400 on a dip (5% rule) it will be a good, healthy sell-off we can buy into.

Nasdaq - The poster child of 2007 with an 11% gain on the year. Doing it without their SOX on made it doubly impressive as the semis had a TERRIBLE year, mostly the last quarter where they went from + 5% to -10% for no reason in particular. 3,082 stocks populate the Nasdaq composite, which is still technically at 1/2 the highs it hit in 2,000 so if we’re going to get a breakout that can negate the broader downtrend, it needs to be here at 2,700 with a rally that takes us through 2,800 and keeps us there while the other indices play catch up. With companies like (NASDAQ:ADBE), (OTC:APPL), (NASDAQ:BIDU), (NASDAQ:CROX), (NASDAQ:CSCO), (NASDAQ:EBAY), (NASDAQ:GOOG), (NASDAQ:INTC), (NASDAQ:ISRG), (NASDAQ:MRVL), (NASDAQ:MSFT), (NASDAQ:QCOM), (SNDK) and (NASDAQ:TASR) leading the index, we’re just one small tech explosion away from greatness.

My upbeat theory on this: They are building all those office buildings in China, the next step is buying computers and networking them together, then those workers want cool stuff at home like home pcs, IPhones etc. Also, the Vista roll-out has been slow, which is disappointing but good for steady business increases in the year ahead. Biotech looms as one strand of DNA away from a $100B rally at any time and alternative energy is on fire with companies like (NASDAQ:SPWR) and (NASDAQ:PEIX) jockeying to become the standard oils of the 21st century. What a wonderful world it could be!

SOX - I still believe in Semis and for all the reasons I liked them last Jan at 460. We did really well up to 545 in July but, unlike the other indices, the SOX never came back. This is interesting with the rise of the solar plays as they tend to use a lot of semiconductors to make those things and the forward p/e of the solar industry indicates that the semiconductor manufacturers will be operating at 150% of capacity for the rest of the decade at least so either the semis are undervalued or we are about to have one mother of a crash in solar stocks!

Russell - "And a child shall lead them." It is the small caps that have to get us through this year. The Russell finished the year right about where it began, at 780. It was anything but flat though, with a high of 855 (up 10%) and a low of 750 (down 4%) the index held up pretty well considering all the things that were thrown at the economy this year. If we’re going to crack, it’s the Russell that will go first as tightening credit, consumer pullbacks, higher labor costs and spiraling inflation are kind of hard to shake off for the little guys, who death crossed in September and make a good case study for what you can expect from the others if things go south. Notice how they looked like they didn’t care in October but then, suddenly, they cared a lot!

I wrote an article after the mid-October market drop, discussing how we knew the market drop was coming and many of those elements are still at large today, albeit 800 points lower at the moment so there is less sense of urgency in the warning than there was back then at 14,200. Still, it behooves us to keep a very close eye on the index action - anything can happen and probably will in the year ahead and personally, I can’t wait!

Markets go up AND down and we certainly learned this year that we know how to make money in either direction so let’s just preparte ourselves by gettng our portfolios in shape and having our equipment ready so we can enjoy the wild ride that lies ahead. PSW is a team effort and we’ve got a really fine group assembled who I am very confident will be able to capitalize on whatever opportunities lie ahead. We’re not playing the markets because we wanted a quite paddle down the river - it’s rough going out there but oh man, what a rush it can be when we get to the other side a little older, a little wiser and hopefully a little richer than where we began.