(THURSDAY 7TH JULY - 08.15 - JAMES GERRISH)...There was once again plenty of reasons for traders to sell last night with a negative lead from Europe, China hiking rates by 0.25% and weaker than expected data on the US service industry - but once again resilience was the play of the day. The DOW JONES added +56pts while the S&P 500 was up +0.1%. Locally, our market added +6pts yesterday on a session of very light volume (probably be the same today as we await employment data from the States Friday) while the FUTURES market is pricing a drop of -8pts when trading kicks off this morning.
One of the sectors I like to look at in the US as a leading indicator of economic activity is the transportation sector. It shows the amount of goods moving in, around and out of the worlds largest economy. The DOW TRANSPORTS is one of the oldest indices available and is shown below.
Some of you may have heard about the DOW THEORY. The logic for the theory is pretty simple. If the Industrial stocks are rallying (Dow Jones Industrials), its because business is good, but there is no point in the Industrial companies making products unless the transport companies are shipping those products.
So essentially, the theory suggested that both indices need to confirm each other. If the Industrials average makes a new high but the Transports don't, it's a sign products are being made but not shipped...i.e. business is slowing and inventory is mounting. Similarly, if the Transports makes a new high but the Industrials don't, it's a sign products are being shipped but the industrials are cutting back on production, and this also warns the economy is slowing. If all is going well, the indices move in gentle harmony with one another and the economy sings along! We'll that was the theory anyway.
I think the relevance of looking at the indices together has lost some of its appeal, mainly because the industrials no longer just encompass truly industrial companies. You;'got the likes of McDonalds, Citigroup, AIG, American Express, Disney etc etc.
What we find now however is that the Transports can be a good leading indicator. The chart below probably doesn't show it as accurately as it should but it gives you the idea.
The point here is that the chart of the DOW TRANSPORTS, looks anything but bearish. Its juts broken out to a new high after coming back and re-testing the longer term (200 Day) moving average. So if the transport stocks are performing well in America, its probably a good thing... Right?
CHINA RATE HIKE
The Chinese Central Bank raised rates yesterday for the third time this year. Inflation that peaked at 5.5% is clearly a concern and the move yesterday probably pre-empted a strong June inflation number + data that shows GDP remains pretty robust.
The move increases the one year lending rate to 6.56% and its benchmark on year deposit rate to 3.5%.. so you're still actually losing purchasing power by sitting your money in the bank!
There are lot of different views about Chinese inflation and speed at which the economy is growing/slowing. I'm of the belief that we're starting to signs that inflation is peaking - that price pressures are starting to subside as growth cools.
Recent surveys of purchasing managers showed the weakest pace in 28 months in June while the Chinese PMI came in below expectations.
I think the PBOC is also conscious that if they raise interest rates too far, they're likely to get a flow of international investment given the interest rates differential between the US (0-0.25%) and China.
We're actually seeing this in the Aussie Dollar at the moment which has become the classic carry trade. (Borrow in a low interest rate environment to buy a high yielding currency and lock in the rate differential).
Back in January, I wrote a short note about my view for 2011. Here is a excerpt: (VIEW FULL REPORT HERE)
China has been growing at near 10% in 2010 with greater Asia clocking growth rates of 8%. This incredible growth in China (and Asia) has led to inflationary pressures which have prompted moves to tighten policy. This will be a major theme in 2011 and I'd expect that further measures will be used including interest rates rises and increasing capital requirements for banks. Will this have a significant impact on Chinese growth? In short, no.
Why?
1. Chinese policy makers don't want their economy to slow significantly. I think at times we view China's status as the emerging super power though rose coloured glasses. The fact is there is still a high degree of poverty in China and the growth of the middle class is still a work in progress. If China slows dramatically, the social implications would be dramatic.
2. The speed and scale of industrialisation and urbanisation is unprecedented. At no other time in history have we seen such rapid expansion on such a significant scale.
MY MODEL PORTFOLIOS
We were active in the model portfolios yesterday adding a couple of new positions and building on some existing ones.
In the EMERGING GROWTH, we build on our existing positions in Hunnu Coal (HUN), Woodside (WPL) and Starpharma (SPL). I noticed the other day Charlie Aiken has started to push SPL with a $1.90 price target. We've been there for a while now so its obviously a positive that SPL is coming on the radar of others.
We also started to accumulate Incitec Pivot (IPL) - a fertilizer and explosives manufacturer and distributor. The recent pullback + signs of some upside momentum look appealing.
In the BUY WRITE portfolio, we bought Com Bank (CBA) and wrote $52 August calls against it.
As a SHORT TERM TRADE, we have also added Incitec Pivot (IPL) as a buy.
Visit www.mymarjetview.com.au to see updates
STOCKS TRADING OVERSEAS
In New York, News Corp fell by US$0.60 to US$17.94, equivalent to A$16.77, A$0.40 below its last close on the ASX.
ResMed fell by US$0.04 to US$30.99, equivalent to A$2.90, A$0.01 above its last close on the ASX.
In London, Rio Tinto rose 15.5 pence to £44.94, A$0.23 higher in Australian currency terms.
BHP-Billiton rose 11.5 pence to £24.71, A$0.17 higher in Australian currency terms.
Henderson Group Plc was unchanged at £1.56
