Cole's Market Insights - June 1, 1997

Economy Still Robust

The economy remains strong. First quarter real GDP growth was upward revised to 5.8% last week, April durable goods orders came in above expectations, and consumer confidence hit a 28-year high.

This torrid growth pace should slow somewhat. Much of the strong first quarter growth represented inventory accumulation as production and imports outpaced final demand. Auto sales apparently softened in May and personal bankruptcies are running at very high levels. Fed officials have indicated they anticipate a slow up; this undoubtedly was a key factor behind the recent FOMC decision not to hike rates. But with cyclical stocks still very strong, any slowing is likely to be modest.

Focusing on aggregate economic statistics can be very misleading in today's economy. With the stock market continuing to surge and executive and professional compensation in a strong uptrend, the upper 20% of the income distribution is doing better than ever before. This group's financial well being will be further enhanced if capital gains and estate taxes are cut as contemplated in the latest budget agreement.

The middle and lower classes are having a much harder time. Despite very low unemployment, real wages have increased little if at all for most working Americans. Corporate downsizing continues at a strong pace. Most downsized employees are able to find new jobs, but many of them can only do so by accepting substantial cuts in wages and benefits.

Stock Market May Peak This Summer

The current powerful stock market runnup probably represents the third and final leg of the great bull. The first leg ran from November 1994 through May 1996, or 18 months. The second leg ran from July 1996 to March 1997 -- about half as long as the first. If the current leg lasts half as long as the second, the market can be expected to peak late this summer, probably in the Dow 8000 area.

After many months of dismal relative performance, market leadership is shifting to the small cap sector. The Russell 2000 small cap index surged 11% in May. This was well above the 4.8% gain for the Dow Industrials and the 5.9% rise for the S&P 500. This change in leadership is expected to continue. The fact that the laggard small cap sector finally is starting to catch up with the larger cap issues is another sign that the bull market has entered its final blowoff phase. The writer would not be surprised to see the Russell 200 surge as much as 20% more over the next few months before this bull is put to rest.

Gold Still Basing

Nearby gold futures rose $2 to $344.80 last week but bullion remains technically weak, having long been unable to get above its 200 day moving average. Reaction to news remains dismal with gold unable to hold its modest gains following the dollar's recent sharp decline against the yen. Among gold stocks, Canadian juniors have again come under pressure following reports of Bre-X style tampering at two small exploration companies. South African golds also are soft. Many of these companies have elevated cost structures making them particularly vulnerable to further declines in the bullion price.

In retrospect, the gold sector's failure to rally significantly during the March stock market correction signalled that this sell off was not the start of a bear market. If the writer's expectation of a major stock market peak this summer is correct, the next secular gold bull should begin at that time.

The decisive victory of the French left in this weekend's parliamentary elections probably will not have much immediate impact on the bullion price, but is potentially very bullish. Rising resistance to government austerity programs in Europe could signal that the shift to the political right in the advanced capitalist counties that began in 1979 is coming to an end. Long-term this would be very bullish for the noble metal.