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From the final week of August through the week of 10/17/2005, M1 actually decreased $41.2 billion. The decline in M1 may spell trouble for the economy and the stock market. The last time M1 declined was in 2000 (see red arrow). The S&P dropped more than 121 points to end the year and was followed by another 148-point plunge in 2001.
The rising short-term interest rates may have caused some money to be "swept" from the NOW (Negotiable Order of Withdrawal) accounts into the MMDAs (Money Market Deposit Account) which are not included in M1. Incidentally, this might've contributed to the recent surge of M2 - 12% increase since the final week of August. Nonetheless, one obvious reason for M1's decline may be attributed to the decline in the real DPI (Disposable Personal Income). Even though Friday's GDP report stated that the third quarter GDP was an "acceleration in real GDP growth", the DPI had fallen once again into the negative territory for the 2nd time this year - see Chart 2 below. This third quarter also marked the first time since 2003 the real DPI declined from the 2nd quarter (see gold bars). Yes, this recent decline partly reflected the impacts of Hurricane Katrina and Rita. But even without the impacts of the hurricanes, the real DPI would still have to increase more than 1.5% in order to surpass the 2nd quarter and more than 2.8% in order to surpass the same quarter a year ago. Failing to rise above the 2004 third quarter growth rate of 2.8% has resulted in a declining DPI trend that forms lower highs. And, remember last year, there's Hurricane Ivan that also caused widespread damages. No one knows for certain the actual impacts of Hurricane Katrina and Rita, but the preliminary consensus seems to be a 0.2% subtraction form the third quarter GDP. And, since DPI is approx. 0.5% of the GDP, it's mathematically impossible for this quarter's DPI to exceed the same quarter of the past 2 years.
Same rationale applies to the real GDP data (Chart 3). Even if we added that 0.2% hurricane factor to this quarter's GDP growth rate of 3.8%, it still wouldn't have been higher than the same quarters in the previous 2 years (aqua bars). Since the PCE (Personal Consumption Expenditures) represents 70.22% of the GDP, we can't analyze GDP without analyzing the PCE data. Again, you can see that the 3rd quarter PCE has also been in a downtrend since 2003 (green bars on Chart 4). It wouldn't have made any difference even if we added the 0.1544 hurricane factor (0.2% x 77.22%) back to this third quarter's PCE.
The market allegedly rallied on Friday in celebration of this "acceleration in real GDP growth", but the facts contradict such claim. If anything, the huge swings of the market action in the past few days were more likely due to short-covering and momentum trading. Bear Sterns, Merrill Lunch, and Goldman Sachs' trading desks were all said to have covered their large short positions during the week. This is becoming a common practice in the earnings report months. Hedge funds and short-term traders are known to have their short bets covered ahead of earnings reports to avoid getting burned by unexpected earnings results. Regardless of the reason for the recent market volatility, the market continues to stay in a downtrend since August 3, 2005. One way to keep a clear view of the market and to avoid confusion is to keep an eye on the Retail Sector. Remember the Consumption represents more than 70% of our economy. All the earnings reports, the past GDP reports, and the new Fed's chairman, etc. mean nothing if the Consumption slows down. Chart 5 shows RTH (Amex Retail Holders) started its last uptrend from the April intraday low of 84.93 to the July intraday high of 102.72. At 92.15 close on Friday, RTH is now skating on thin ice and staying slightly above the 38.2% Fibonacci Retracement. If it falls below this level, it could challenge the April low. RTH has been trading in the 50%-38.2% Fibonacci Retracement range since September. Sooner or later it's going to have to decide which way to go. And, it's most likely to go down. The black buying volume bars that help keep RTH floating above the 38.2% Fibonacci Retracement have been forming lower highs (black circles). This means diminishing buying pressure. The Stochastic indicator had also just crossed below its trigger line (red line) and broken the recent uptrend trendline (thick redline). Meanwhile, the MACD continues to stay in the negative territory after its recent failed attempt to climb above 0 (red circle). These are all clear signs of a weakening sector. And, when the retail segment sneezes, the rest of the economy catches cold.
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