Dent: The Road Ahead

05/26/2006 12:00 am EST


Harry Dent

Author, The Demographic Cliff

"When will the commodity bubble burst?" asks Harry Dent. Here, the author and advisor, who focuses on very long-term cyclical market patterns, looks at the state of the financial markets to provide an assessment of the road ahead for investors.

"The markets are the most confused we've seen them in a long time. First, stocks edged up despite new highs in oil and extreme moves in gold and copper. Now, as oil and gold prices back off significantly, stocks are correcting and showing little ability to bounce. When the markets are this screwy, it is obvious that the traders have taken over. Is this just a quick scare before stock prices take off and commodity prices finally fall? Or do we have more of a sell-off ahead and one more spike in commodity prices?

"Stocks are going to have to wait for the commodity bubble to fizzle before we will see a stronger increase. And the charts suggest that the parabolic move, especially in gold, is not sustainable for much longer. Oil appears to be in a final wave up for now. With stocks showing strong earnings and little downside risk due to undervaluation, investors should hold their positions in stocks and continue to add on any temporary weakness.

"At this point, the markets would appreciate some slowing in the economy, as it would more clearly signal an end to Fed rate hikes. It is logical to expect that the economy will finally slow a bit in the coming months with rising interest rates and oil prices. But there should be no doubt that the Baby Boom spending wave did not peak with the stock market crash of 2000-2002. We continue to be in an unprecedented boom, which the Fed and oil prices are doing their best to slow with little impact.

"It's a very good thing for the new economy that energy prices make up only around 5% of corporate costs, with all other commodities making up another 5%. Wages account for 70%, and that's where this era of very high productivity is keeping earnings and stock prices strong while inflation remains mild. However, such extreme speculation in commodities takes its toll.

"Long-term interest rates are finally rising in line with short-term hikes by the Fed. The bond market fell to very low rates last June, but long-term rates have now risen a full percentage point on the ten-year and 30-year Treasuries. This trend strongly suggests that interest rates will ultimately move higher in the years ahead, which means that bonds will not be as attractive to investors given that such investors will be penalized as rates continue to edge up in a strong economy. This factor is another that favors stocks.

"With real estate now slowing and interest rates rising (hurting bonds), stocks and commodities are the only places left to be. And once the commodity bubble collapses, then stocks will be the only place. Earnings have continued to be stronger than expected, as companies take advantage of new technologies and business processes. We see double-digit earnings gains for the next four to five years as the technology cycle comes back stronger than ever.

"With venture capital booming again, we still see a bubble in stocks and tech as inevitable. If commodity prices remain high or rising for most of 2006, then it may be 2007 before we see more bubble-like action in the stock markets. But we still think it is likely that stocks will accelerate by the summer. The year 2007 is almost certain to be a strong year in stocks, as it will represent the strongest year in the four-year presidential cycle, where stock gains near 50% are typical (like in 2003, 1999, 1995, 1991, 1987, and 1983).

"We are going to have to wait and see if commodity prices back off in the next month or so to see how strong stocks can be. But with strong earnings and major undervaluation, we continue to see stocks as the place to be and the commodities bubble as the next to burst and create large downside risk. It's too late in the commodity cycle to be chasing sectors like gold and oil. Signs of a mild slowing ahead would be the best news for the stock market, as it would cool the commodity surge and the Fed.

"As small caps keep outperforming, large caps look more and more undervalued, which makes large caps the place to be with the lowest risks. The markets are finally getting very oversold and are approaching very strong buy targets at 11,040 on the Dow, 1,253 on the S&P 500, 2,150-2,160 on the NASDAQ, and 710-715 on the Russell 2000. We recommend buying near these targets on the next substantial decline, especially in the technology, small cap, and Asia sectors."

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