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The Money Map Advantage
Friday, October 7, 2005
By Horacio Marquez
Email – #12
STOP and GO: The energy profit-taking season is here – keep your powder dry to take advantage of an excellent buying opportunity.
The STOP case:
September ended with an unimpressive window-dressing mini-rally. Armed with the excuse of a hawkish inflation outlook from a number of Fed members, and a European Central Bank that is signaling maybe a couple of tightening moves for next year, October kicked off with market players deciding to book very significant paper profits achieved in cyclical stocks: energy, natural resources, basic materials, chemical, emerging market and selected tech stocks.
The weakness of energy lies in the seasonal phenomena that I described in my August 18 e-mail (#5) and was delayed by both Katrina and Rita. Basically, it’s the end of the U.S. driving season, European vacation and refrigeration season, and although the heating season has not yet kicked in, its all been reinforced by the self-rationing in personal gasoline demand due to the exorbitant Katrina/Rita gas prices.
At the head of the line in the profit-booking frenzy stand the highly leveraged hedge funds and Wall Street proprietary trading accounts. They are joined by the day-traders, who lately open their day with the question: What will I short today? And then proceed to close their shorts at the end of the day (and especially on Fridays). These fast-money accounts, abiding by the “never fight the Fed” mantra, and which today are very large, are amplifying the smaller seasonal reductions in their allocations to these sectors by longer-term investment funds.
The Fed members’ inflation warning is traditional verbal intervention. They are signaling to the markets that they will not provide a short-term stimulus to counteract the short term negative impact of wealth and activity destruction caused by Katrina and Rita, as I and others expected. In addition, they might hike rates a couple more times beyond their pre-Katrina/Rita private target, to compensate for the inflationary effects of the rebuilding spending.
Finally, the U.S. dollar repatriation by U.S. multinationals is being bolstered by the closing of the tax advantage window this December 31. These flows into the dollar, supported by the strength of the U.S. economy, and the expectation of higher short term rates, also conspire against U.S. dollar pricing of commodities, including energy, in the short term.
Ceteris paribus (by itself), all of this warrants a one-time, short-term downward adjustment in global stock valuations, which we are seeing.
The GO case:
As usual, in their endless search for equilibrium, markets will overreact in the short term. The hawkish Fed-speak, coupled with October’s traditional profit-taking season and the short-term strength in the U.S. dollar, will create an excellent buying opportunity this month for cyclicals.
Why? Profit-taking will abate soon, since it is usually sharp and fast. There is plenty of cash on the sidelines waiting to grab equities at the right price. The global economy is very strong and in the midst of a multi-year expansion. U.S. inflation is very well behaved and being pre-empted by the Fed, which will allow it to stop raising rates early next year. Early next year, the New Orleans rebuilding will be at full speed.
Also, Japan is restructuring and accelerating, and China and emerging markets keep growing fast. Finally, Germany’s market-friendly Merkel will likely reach a deal for a joint coalition government with Schroeder this Sunday, and become the first female leader of Germany. Any change toward more openness and reform is positive for Germany. All of this favors renewed dollar weakness in 2006 and continued global corporate profit expansion, which supports higher global stock prices. This is especially true for our preferred plays in global cyclicals, emerging markets and Japan (we’ll see about Germany).
What to do?
“Never grab a falling knife.” We are going to keep our powder dry to avoid costly trading mistakes in this very volatile environment, being patient and selective in looking for our opportunity to buy low into this short-lived profit-taking season.
In the meantime, our last pick, Mitsubishi Tokyo Financial, changed its symbol to from MTF to MTU, and its name to Mitsubishi UFJ Financial Group as it acquired lower-ranked UFJ Holdings to become the world’s largest bank. The market, as usual, penalized the acquirer immediately for the premium paid. Having adjusted for this, the bank vowed to concentrate in improving profitability and setting its target in the superior U.S. and European peers’ metrics.
The acquisition will enjoy unequalled local power to capitalize in the restructuring and accelerating growth of the Japanese economy, plus the added benefit of very significant cost savings from consolidation of both structures. Also, the weaker loan portfolio and positioning of UFJ is expected to benefit more than proportionally from an expanding Japanese economy, therefore adding more potential profit improvement to the combined entity. So we continue to be very bullish on Japan and especially their local companies, led by banks, steel and companies related to the local economy. Exporters are suffering temporarily from the U.S. growth scare.
Regardless of short-term oil prices, the demand for seamless pipes will keep increasing as winter will strongly remind us of our limited supply of natural gas and oil. Therefore, the question in our pick Tenaris (NYSE: TS) is when to buy some more.
Enjoy and profit, Horacio Marquez
Market Watch
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