Stocks are on a tear, with the Dow Jones up a thousand points in two months and advancing in 24 out of 27 sessions during one stretch, tying an 80-year-old record. This despite the concerns and anxiety of some of Wall Street's most seasoned strategists, not to mention a skeptical public, judging by the net out-flows from equity mutual funds during April -- a month that turned out to be one of the best for stocks in recent memory. With recent sluggishness in housing and retail sales, what is to explain this dramatic climb?
As an analogue consider the sport of stockcar racing. The race doesn't always go to the fastest car. Driver skills and tactics are key and one of the most important tactics is drafting. In drafting a trail car tucks close behind a lead car greatly reducing the air resistance it faces. At 150+ mph the aerodynamics of stockcars are such that drafting actually benefits both cars -- the trail from less air resistance, the lead from less drag as the trail car displaces the vacuum that is created when a car rockets through the atmosphere at such high speeds. NASCAR fans will also point out that drafting, sets up the dramatic slingshot maneuver, which comes...but enough about racing.
Global economics is a type of race. For most of the past 50 years the U.S. has performed the function of lead car in the world economy. That was good for the rest of the world, which struggled to keep pace, but benefited nonetheless from the more powerful and better performing U.S. economy. Times are different now. For the past several years the overseas economies have been growing faster than the U.S. In fact, global growth is booming like no time in the past half century. China, India, Brazil, et al. with two billion plus people are racing to transform themselves, from developing to developed countries. That type growth enjoys the advantage of not having to invent the future but just the necessity of replicating what is already in place in the developed world.
Look inside the major market indexes and you see some interesting divergences that support a thesis of global industrialization on a massive scale. There are ten Sectors in the S&P 500. This is how they fared for the 5 years ending 5/11/07:
S&P 500 +39%
Information technology +34%
Consumer Discretion +19%
Health Care +19%
Consumer Staples +15%.
Wall Street's conventional macro-economic view focuses on the consumer as the primary engine of economic growth. This myopic demand-driven perspective is poorly suited to capture the dynamism of the current production-driven global expansion. And it is clear from the list above that an investment outlook focused on the consumer has missed out on much of the action over the past five years.
Drill down further through the sectors to the 140 industry and sub-industry groups as defined by Thomson Financial and you find more of the same. The top five performing industries for the past 5 years (5/11/07):
Diverse Metal/Mining +521%
Oil & Gas Refining +386%
Consumer Electronics +312%
Agriculture Chemicals and Fertilizer +307%
Four of the five industries are big beneficiaries of global growth that outstripped worldwide capacity in their arenas -- the result great pricing power and exploding earnings. The words of the great 19th century economist, Jean-Baptiste Say come to mind, "Supply creates its own demand."
The message of the market's recent action may be that we have passed through a discontinuity. Or to use NASCAR parlance; a slingshot maneuver has taken place and the U.S. economy now finds itself tucked snuggly behind the developing economies and for the most part enjoying the ride.
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