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Market Insights is a free market newsletter posted on the 28th of each month. |
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30-December-2002
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It's the end of the year and time for a look back to review what the markets did and how well we reacted to them.
The winners this year were the bond market and the gold market. The Fed dropped short-term interest rates 100 basis points [editor's note: the Fed reduced rates 50 basis points during 2002, not 100 basis points], driving the 90 day T-Bill yield from 1.75% to 1.22%. Longer maturities responded likewise with the 30-year T-Bond yield easing 71 basis points to 4.77% and the 10-year falling 125 basis points to 3.78%.
Lower interest rates reduced the opportunity cost for holding gold and the precious metal appreciated 20 percent on the year. The Philadelphia Gold & Silver Index (ticker symbol XAU) climbed more than twice that amount with a 41 percent gain.
For the third consecutive year, equities were among the losers as the benchmark S&P 500 index slid 24 percent. Once again, those following the recently popularized "buy-and-hold" strategy were punished for their passive approach to investing.
Portfolios with a technology bias fared even worse than average as evidenced by a 31 percent sell-off in the NASDAQ Composite, while those who played it safer by holding Blue Chip stocks were rewarded with a smaller loss as the Dow Industrials backed off 17 percent.
Foreign holders of U.S. securities really felt the pinch as the dollar tumbled 14 percent on the year. That was enough to just about erase any gains in fixed income investments and worsened any equity woes.
A year ago, we were recommending a long-term asset allocation (for those who choose to minimize portfolio adjustments) of 50% stocks, 20% bonds, and 30% cash. In October, with bond prices at their high of the year, we cashed out of bonds and moved to a 50% stocks/50% cash allocation. Those who followed this system were able to beat the market with a 5-10 percent loss on the year.
Our intermediate-term asset allocation (for those who prefer a moderate number of portfolio adjustments) back in December 2001 called for 20% bonds/80% cash. That allocation moved to 50% bonds/50% cash in April and then 50% stocks/50% cash in October just as stocks bottomed and bonds peaked. Followers of this strategy were rewarded with a 10-15 percent gain for the year.
Subscribers to our weekly wall street lemmings newsletter should have done even better through more frequent and more aggressive trading. By following our own advice, we were able to realize a remarkable 42 percent appreciation in our company-managed portfolio -- not bad in the worst year in nearly three decades for the stock market averages.
In the coming year, we see recent trends continuing. As long as short-term interest rates are held below the rate of inflation, gold should continue to be a profitable investment. Even though it may not look like it now, we believe the long bond price has topped out with yields headed higher over the next few months. Confirmation of this view requires that the 30-year T-Bond yield close above 5.21%.
Stocks, which entered a secular bear market in 2000, should continue their relentless decline. We don't expect to see a significant cyclical bull market develop until the S&P 500 index has sold off at least 70 percent and the NASDAQ declines at least 85 percent off their respective all-time highs.
The S&P 500 index is in a five year long head-and-shoulders topping pattern that projects prices down to around 475. The left shoulder developed in 1998, the right in 2001-2002, and the head peaked in 2000. The neckline at 960 is in the process of being tested and should provide insurmountable upper resistance for this index.
If prices are headed for the 475 area this year, we believe it will follow the projection we laid out earlier in the year. This forecast was derived assuming the rate of price decline in the current post-bubble market will closely resemble that of the 1929-32 post-bubble decline.
Over the near term, we see the S&P 500 moving in a trading range between a low of 868 and a high of 960 until the 30-year T-Bond yield moves above 5.50% and triggers the next leg of the decline. We also expect the XAU Gold & Siver Index to push above its recent 90 price peak and climb to 108 or higher.
The U.S. Dollar Index is headed lower. A declining dollar is likely to be accompanied by a slowing economy, higher inflation, and slower money supply growth. These should drive our proprietary liquidity indicator, RPCM2, below its seven-year moving average, marking the beginning of the end for this cyclical bear market (but not the secular one).
For those of you who like to keep your finger on the short term pulse of the markets, and particularly if you enjoy a more humorous and satirical slant, we offer the subscription based wall street lemmings weekly newsletter (formerly Weekly Insights) for a very reasonable $8 per month.
Both our long term and intermediate-term models are currently recommending a maximum of 50 percent stocks. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
| Market Statistics | |
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| DJIA 8332.85 | S&P500 879.39 |
| DJTA 2302.83 | Nasdaq 1339.54 |
| DJUA 214.79 | 30 YR BOND 4.77% |
29-November-2002
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Since hitting bottom on October 10, the S&P 500 index has rebounded a solid 21.7 percent while the Dow Industrials have climbed an even more impressive 23.6 percent and the NASDAQ Composite is up an incredible 33.4 percent. For the first time since 1998, the Dow has finished higher for eight consecutive weeks.
Little has changed in our outlook for the markets since last month. We believe that stocks are in a counter-trend rally within a cyclical and secular bear market similar to the 235 point April-May 2001 and the 232 point September-December 2001 rallies. That makes for an upside target in the S&P 500 of right around 1000 sometime in the coming month -- just a little above the 200-day moving average which is currently at 983. The NASDAQ is already pushing its 200-day MA and we believe that 1600 is a reasonable target for this average. In the two prior rallies the NASDAQ climbed around 650 points so a target of 1750 cannot be ruled out.
Both the S&P 500 and Dow are on track to retest important long-term overhead resistance. In the case of the S&P, it is moving toward the neckline of its five year long head-and-shoulders pattern at 960. The Dow is tracing toward the lower band of the secular bull market channel it had been trading in for over twenty years before it broke down through bottom support earlier this year.
In the third week of October our BullBear Index sank as low as -14.8, a clear BUY signal. In record short order it catapulted all the way to a +24.7 reading last week, a mere 3.3 points from registering a SELL signal. This week the index backed off to a +23.0 reading, leaving the rally intact. A short-term pullback in share prices may be just what the doctor ordered to temper investment enthusiasm a bit, and from a contrarian point of view, give the markets that needed boost for a run to our targets.
The long bond yield appears to have put in a significant bottom in late September that survived a retest in early November. A close above 5.21% is needed to confirm that the intermediate-term trend in rates is higher. Once that level falls, however, a top in stocks and the beginning of the next decline will not be too far off. If recent history is a useful guide, stocks will not fall in earnest until the 30-year T-Bond yield exceeds 5.50%. A run up to the 6.00% level will be enough to trigger a SELL signal in our Intermediate-term Model.
The XAU Gold & Silver Index still looks as though it is headed down to test its two year long uptrend line. That would take prices down to the 57-58 range and present what we believe will be a buying opportunity since our Gold Model is still in BUY mode.
For those of you who like to keep your finger on the short term pulse of the markets, and particularly if you enjoy a more humorous and satirical slant, we offer the subscription based wall street lemmings weekly newsletter (formerly Weekly Insights) for a very reasonable $8 per month.
Both our long term and intermediate-term models are currently recommending a maximum of 50 percent stocks. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
| Market Statistics | |
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| DJIA 8896.09 | S&P500 936.31 |
| DJTA 2360.62 | Nasdaq 1478.78 |
| DJUA 203.29 | 30 YR BOND 5.05% |
28-October-2002
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On Tuesday, October 9 we began covering our short positions and shifting funds out of Treasury Bonds and into cash. By Friday, October 11 we had completed our transition into 50 percent stocks and 50 percent cash. The low point in the stock market for the year so far arrived on Thursday, October 10 on the same day that the 10-year Treasury yield bottomed out at 3.56%. Twelve trading days later, the S&P 500 index is 16 percent higher and long-term yields are about 50 basis points higher.
Subscribers to the wall street lemmings were kept abreast of our moves on a daily basis. Users of our FREE proprietary HIPPO Portfolio Optimizer were informed of the final allocation shift on Saturday, October 12.
Now it looks to us like stocks are ready to embark on a pretty strong bear market rally. Based on the August economic data, our Intermediate-term Model moved from SELL to BUY much as it did in March 2001 just prior to a 235 point rally in the S&P 500. Then on October 11, our BullBear Index followed suit by falling below the -8.0 level and triggering a BUY signal much as it did at the September 2001 bottom when stocks rallied 232 points. Each time, prices moved up into the area of the 200-day moving average before heading south again.
A similar move this time around would take prices from the 769 low up to around 1000, with the 200-day MA currently at 1007. A rally of this magnitude would bring the S&P 500 all the way back up in a retest of the neckline resistance of the five-year head-and-shoulders pattern based on weekly closing prices. At the same time, the Dow Industrials would once again be bumping up against the lower support of the two decade long secular bull market channel it broke down out of earlier this year. The markets love to tease and it looks as though the hopes and dreams of the battered bulls are about be raised only to be dashed once again.
Two weeks ago, the BullBear Index, which is calculated from Investor Intelligence's sentiment data on investment newsletter writers, reached its lowest level since early 1995 when the great technology bubble was just getting underway. At a reading of -14.8, this sentiment indicator leaves little doubt that the traditional May-October ugly season is coming to a close and that the November-April silly season is getting its footing. It's only a matter of months before all of Wall Street is celebrating the end of the bear market and the resumption of the boom economy.
When the silliness becomes nearly universal, when Wall Street analysts are declaring that stocks are fairly valued and stockbrokers are pumping overpriced shares into the greedy hands of individual investors who are fearful of being left behind, reality will once again assert itself. The worst bear market of our lifetime will show just how relentless and ferocious it is.
Markets never move in a straight line and stocks are due for a retracement of the recent rally before climbing to their ultimate target. That's because investors and analysts wasted no time in shaking off their pessimism. Last week the BullBear Index made the largest one week jump this indicator has ever made since we began tracking it in 1993. Too much optimism too quickly means that this contrary indicator is forecasting trouble in the near term.
Looking a little further out, we suspect that some very important new trends are about to develop over the next six months. We believe that inflation is in the process of putting in a cycle bottom that could take rates above 3.5 percent. Historically, stocks have performed well when inflation is between 1.5 and 3.5 percent. Major declines often begin when inflation breaks out of this Sweet Spot, on either side.
The latest bubble that appears to be in the process of bursting is the bond market bubble. While stocks have been getting hammered, investors have been flocking to bond mutual funds. Falling long-term yields have in turn been fueling the real estate market. We believe that the bottom in stock prices coincided with a bottom in bond yields as well.
Obviously, if the bond bubble is in the process of bursting, the higher interest rates it brings will have a very negative impact on consumer borrowing. Once the consumer stops borrowing, spending will fall, the economy will slow further, and money supply will contract. This will feed on itself until all the economic distortions are completely wrung out of the economy.
Meanwhile, rising inflation rates and shrinking M2 will deflate our RPCM2 liquidity indicator, driving it below its crucial seven-year moving average, and signaling to us that the beginning of the end of the cyclical bear market is underway. The latest data show that this trend is already in progress.
The XAU Gold & Silver Index has been in decline for five months. It appears to be headed down to test its two year long up trendline. That should take price down to around 57, at which time we will be considering shifting some funds into the SCGDX gold mutual fund because our Gold Model is still in BUY mode.
For those of you who like to keep your finger on the short term pulse of the markets, and particularly if you enjoy a more humorous and satirical slant, we offer the subscription based wall street lemmings weekly newsletter (formerly Weekly Insights) for a very reasonable $8 per month.
Both our long term and intermediate-term models are currently recommending a maximum of 50 percent stocks. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
| Market Statistics | |
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| DJIA 8368.04 | S&P500 890.22 |
| DJTA 2279.48 | Nasdaq 1315.83 |
| DJUA 194.50 | 30 YR BOND 5.11% |
28-September-2002
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It's been a pretty good run.
Since we made the statement back in the March issue of Market Insights "We believe it will take nothing short of an economic boom to accelerate stocks higher from here" and "it is not a matter of IF stocks are headed to new lows, but WHEN", the S&P 500 index and Dow Jones Industrial Average have fallen nearly 30 percent, while the NASDAQ Composite is down more than 35 percent.
Throughout that stretch, we have recommended that you, our readers, should be invested between 0 percent (Intermediate Model) and 50 percent (Long Term Model) in equities. Last week, subscribers to the wall street lemmings were instructed to consider shorting this market for the second time since the bear market began in 2000 [editor's note: that was three weeks ago we recommended going short].
Unfortunately for many investors, most of the so-called experts on Wall Street (or as we like to call them in wall street lemmings, over-priced analus wallstreetus) were on the wrong side of this tough decline, as evidenced in Barron's September 9 issue.
That was the issue where a panel of Wall Street's Best came out with their 2003 forecasts and 11 of 12 expect the S&P 500 to be higher a year from now. That's very comforting to us because we expect the market to be down a record four years straight and this is the same bunch who last year collectively forecast the S&P 500 to be at 1294 by the end of 2002. Not bad...they'll probably only miss it by three or four hundred points -- 500 on the outside.
Panel member Ed Kerschner, chief global strategist for UBS Warburg, actually predicted a year ago that the S&P 500 would finish 2002 at 1570. That was a post-9/11 revision down from an earlier forecast of 1835 -- more than double the index's current level. "I've been doing this for 27 years and the market has never been where I thought it belonged," he offers as explanation. Not much we can add to that, Ed.
Abby Joseph Cohen, with computer precision, arrived at a year-end 2002 forecast of 1363 -- not 1350, not 1400, not even 1360 or 1365 -- but 1363. "We thought investors would be more accepting of risk this year," was her excuse. That's right. If those pusillanimous stockholders would have just blindly pushed their life savings into a tumbling stock market like she was recommending, her target would have been right on.
Had we made a prognostication like that, we would have probably been forced to close up shop. Abby, however, stubbornly insists that stocks will rally more than 44 percent over the next 12 months. "Those investors with a longer-term view are approaching the market with enthusiasm," she sputters. Apparently because stocks are the best investment on record in "the long run", investors should be enthusiastically throwing good money after bad in today's market.
We don't know about you folks, but we prefer real market analysis around here.
Between now and October 11, we expect to see share prices a fare bit lower than they are today. We have set as price objectives 725 for the S&P 500, 7300 for the Dow, and around 1000 for the NASDAQ Composite. Maybe they'll get there, maybe they won't. But however low they go, we are looking for a very significant bottom in equities followed by a substantial counter-trend rally of 25 to 30 percent for the S&P 500 and 40 to 50 percent for the NASDAQ.
That's because not only is the ugly season coming to a close, the traditionally weak six months for equities between May and October, but more importantly our Intermediate Model based on August data has registered its first BUY signal since March 2001 when it forecast the April-May rally. We will switch from bonds and cash to stocks and gold shares once the bottom is in.
Look for the 30-year bond yield to bottom out at about the same time stocks do in a blow-off top (in price). Yields are currently trapped between support at 4.66% and resistance by the 20-day moving average at 4.77%. Yields have trended below their 20-day MA the better part of four months and should continue to do so this week as yields slice through support.
The XAU Gold & Silver Index is trapped between support at the 50-day MA and resistance at the 20-day moving average. It successfully tested support on the long term trendline as we had anticipated last month. A close below 67.3 would be negative while a gap-up day and a close above 72 would leave a very bullish island bottom reversal pattern on the chart and prompt a shift of funds into gold shares.
For those of you who like to keep your finger on the short term pulse of the markets, and particularly if you enjoy a more humorous and satirical slant, we offer the subscription based wall street lemmings weekly newsletter (formerly Weekly Insights) for a very reasonable $8 per month.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
| Market Statistics | |
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| DJIA 7701.45 | S&P500 827.37 |
| DJTA 2185.17 | Nasdaq 1199.16 |
| DJUA 213.77 | 30 YR BOND 4.69% |
28-August-2002
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For the most part, our outlook on the markets remains unchanged from last month.
We were looking for a rally to take equities up through mid-month and that's what we go with all the major averages posting very strong gains from the July 24 lows to the (thus far) August 22 highs. The S&P 500 led the pack with a 24 percent gain while the Dow Industrials and the NASDAQ Composite each rallied up around 20 percent. Because we are of the opinion that all the averages are tracing out an Elliott Wave 4 counter-trend rally we would anticipate each of them to stall out after retracing 38 to 62 percent of their May-July Wave 3 declines.
The NASDAQ has been the weakest index throughout the bear market that began over two years ago so our experience suggests that it will be limited to a smaller 38 to 50 percent retracement. As of August 22, the NASDAQ had made its way back 41 percent. In the days since, the price action has signalled to us that the intermediate rally is probably over and that any up moves will be contained beneath the recent high.
We would look for the S&P 500 to retrace a larger 50 to 62 percent of its May-July decline, while the Dow is more likely to hit the high number of 62 percent. To date, the S&P 500 has climbed to 57 percent, the Dow to 55 percent. Since August 22, both these averages have been in a decline that appears at this time to be no more than a pullback within an intermediate advance. We anticipate that both will move to the 62 percent retracement levels at 981 and 9281 before continuing the long-term decline.
As of today, both the Dow and the S&P 500 are testing support at their 20-day moving averages. The picture turns decidedly negative for stocks if both of these averages fail support and close below their 20-day MA on strong volume. Confirmation that stocks are headed for a retest of the July lows would be for the U.S. Dollar Index to close below its August 14 low of 106.18. Stock price movements have correlated well with swings in the dollar since it peaked against foreign currencies in July 2001.
From a longer term perspective, the Dow Industrials have rallied all the way back to the secular bull market channel that contained its price action for over two decades until just recently. Rallying back up to what used to serve as long-term support and now acts as long-term resistance is not wholly unexpected price behavior. It's the last hope for those stubborn secular bulls who believe that the recent spike down out of the channel is an anomoly. Not until the rally fails to carry prices back into the channel will these perennial bulls give up the ghost.
At the same time the Dow is in the process of retesting its secular bull market channel, the S&P 500 has been retesting the neckline of its 5-year head-and-shoulders topping formation . The left shoulder of that configuration formed in 1998, the head in 2000, and the right shoulder earlier this year. It is quite common for prices to retest the neckline of a head-and-shoulders pattern after a breakdown occurs. In some cases, prices can even poke a little way above the neckline before turning south for good and that, in fact, is what the S&P 500 did this past week, as this chart demonstrates.
When the Dow Industrials and S&P 500 recently broke down through historic support levels, they did so with increasing volume and considerable downside momentum. To convince us that a move back above resistance is significant, both price momentum and volume would have to be equally impressive. Without these, we would have to conclude that any penetration of resistance was a fleeting event and that prices would in short order resume the long-term decline.
If stocks make new lows in the Fall as we believe they will, it is very likely that the bottom will mark the beginning of a substantial cyclical bull market in stocks within the larger secular bear market. That is because both our BullBear Index and our Intermediate-term timing model are very near BUY signals, and another decline in stocks would likely trigger those BUYs.
Furthermore, since 1998 important stock market bottoms have developed while the long bond yield was below 5.60% while important tops formed when yields were above this level. At present, yields are very near 5.00% and appear to be heading for major resistance around the 4.80% area. We would anticipate a bottom in stocks to coincide with a bottom in 30-year bond yields much as it did in October 1998.
The Philadelphia Gold & Silver Index (XAU) has been in a long-term uptrend since October 2000. This past month, the XAU has been locked in a trading range between its 50-day MA as resistance and the uptrend line that connects the lows of the last two years as support. It looks as though prices could move up to resistance at 70 but then we would expect a decline back to the uptrend line.
A break above 70 and especially above 73.5 would be very bullish while a break below the uptrend line should be viewed as bearish. Our gold timing model is still in BUY mode so we are leaning toward a bullish resolution.
For those of you who like to keep your finger on the short term pulse of the markets, and particularly if you enjoy a more humorous and satirical slant, we offer the subscription based wall street lemmings weekly newsletter (formerly Weekly Insights) for a very reasonable $8 per month. Come on over and have some fun with us.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
| Market Statistics | |
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| DJIA 8694.09 | S&P500 917.87 |
| DJTA 2313.38 | Nasdaq 1314.38 |
| DJUA 249.63 | 30 YR BOND 5.01% |
28-July-2002
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Another myth is laid to waste.
Bear markets expose myths for the fantasies they are. This particular bear market has exploded its share. There was the New Economy myth that had people believing that 18 percent annual returns were permanent fixtures. There was the "buy the dips" myth that taught investors to throw hard-earned money at stocks each and every time they took a breather. Never mind no one ever knows for certain where the bottom is -- in a market that prospers 18 percent per year no bull can be wrong for very long.
There's the "buy and hold" myth that insists that as long as you own "good companies" and you are in the market for the long haul, the market always treats you right. When this one explodes, investors will learn that two decades is a very long time to break even. Many will also learn that owning stocks for the long haul is a lot easier to do in a friendly secular bull market than it is after years and years of being brutalized by a secular bear market. Try saying those words when most people believe that the stock market is a playground for fools and gamblers.
The mantra that was beat into the noggins of the small investor during the stock mania of the 1990s -- that stocks are a safe long-term investment -- has yet to be shaken to any significant degree. Not until the average Joe and Jane abandons this belief and moves into safe, boring fixed income investments will the current bear market find a solid bottom.
The latest myth to be exposed is the "Don't fight the Fed" fantasy. It grew up in a market that is very different from the one investors now face. One year ago today we made the following forecast: "even though the Fed has aggressively cut rates six times, the stock market is likely to FALL 30 percent over the next 12 months...the S&P 500 will be in the 850 neighborhood...by June 2002." It was based on an analysis we presented in our posted article, Fight the Fed.
We believe that our historical approach to market analysis has been vindicated now that our forecast turned out to be so prescient. It was also a boon to both our reputation and our pocketbook. But the point we were really trying to drive home is that you can't make a living by following shibboleths. Sometimes it does pay to fight the Fed. Oversimplified systems that fail to take account of history's lessons are a certain road to ruin.
In the process of meeting our year-long target, the stock market has sustained considerable technical damage. All three major stock market averages that we follow -- the S&P 500, Dow Industrials, and NASDAQ Composite -- have broken down out of secular bull market channels that go back at least two decades. That means that equities are now officially in a secular bear market, which historically means that it will be a long, long time before the averages move to new record highs.
In the process of breaking down, these averages formed very large head-and-shoulders patterns over a span of five years. The left shoulder peaked in 1998, the head in 2000, and the right shoulder in 2002. The neckline that connects all the low points of the formation was decisively violated to the down side this past month. A head-and-shoulders is one of the oldest, most reliable reversal pattern known to technicians. The neckline is generally considered to be the halfway mark for the overall price decline.
Our interpretation is that these formations support our view that stocks are headed to their 1994 price levels. When we first started saying this two years ago, people thought we had stepped off the curb. Now forecasting that the S&P 500 is on its way to 475, the Dow to 4000, and the NASDAQ to 750 may sound depressing, but it is no longer an absurdity.
For the record, we think these levels will be broached by October 2003, as this projection indicates. The above forecast was made by lining up the September 2001 low with the November 1929 low and assuming that the slope of the current decline will approximate the slope of the 1930s bear market.
In the near-term, we are looking for stocks to retest last week's bottom in the coming week then bounce until mid-August in a counter-trend rally. After that look for stocks to make their final lows for the year in October. Just because we say so doesn't mean that it will happen. That's our opinion today, next week it could be different.
Between now and October expect the chorus of analysts singing that stocks are "fairly" valued to get louder and louder. That way there will be plenty of justification to pile into the next significant rally -- not unlike the one from September 2001 to January 2002. This concept of "fair value" will be shoved down investor's throats until they are convinced that a new bull market is in place.
That's when the next myth will be tossed into the dustbin of history. The one that tells investors that it is safe to be in stocks as long as the market is "fairly" valued. Forget that history warns us that what gets overdone on the up side always gets overdone on the down side. Stock prices move up and down within broad long-term channels. Markets are not in the habit of streaking off to the upper band of the channel and then settling down at mid-channel, where they are today. They tend to sell off until the bottom end of the channel is reached. In other words, another 50 percent decline from here -- give or take a few.
There is a lot of talk right now about how the Fed's valuation model shows that stocks are undervalued. This model presumes that the correct valuation of the stock market can be determined from the 10-year Treasury bond yield. Take the reciprocal of the yield and that is where the S&P 500 index price-earnings ratio should be. Statistically, over time, this relationship works pretty well. At any given point in time, however, it would be a mistake to use this as a guide.
For example, from 1929 to 1932, with the 10-year yield in the 3 to 4% range, this formula would have justified P-Es around 30. Yet the P-E during the worst bear market in U.S. history bounced around between 13 and 17. In other words, stocks were "undervalued" as they fell an astounding 89 percent in three years.
On the economic front, the longer this bear market pounds away at investor psyches, the more folks will realize that the stock market is not going to make up for record low savings rates. To bolster those sagging retirement and education accounts, savings rates will climb back toward historical norms. The more money that moves into savings, the less that will be pumped into the consumer economy. A slowing economy is a lead-pipe cinch and there's nothing the Fed will be able to do to stem the tide.
The flight to gold and gold stocks came to an abrupt end once our target level of 90 dollars per share was met by the Philadelphia Gold & Silver index (ticker symbol XAU) over a month ago. The correction has already met and exceeded our lower target of 64 which is not a very encouraging sign, and the recent decline has been so ferocious it is hard to imagine it will be able to reverse from here
A break below the current price level of 55 would scream for investors to stay away from this market for some time to come. On the other hand, our gold timing model is still in BUY mode and a gap up from current levels would leave an island bottom reversal pattern on the XAU chart and entice us to enter a long position.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
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| DJIA 8264.39 | S&P500 852.84 |
| DJTA 2254.79 | Nasdaq 1262.12 |
| DJUA 216.99 | 30 YR BOND 5.31% |
28-June-2002
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Today marks the halfway point on the year and the scorecard for the equity markets shows that a lot of damage has been done thus far in 2002. For starters, the NASDAQ Composite index just completed its worst six month period in its 30 year history. Since NASDAQ's bear market began in March 2000, this stock average is down 72 percent. The S&P 500 Composite index had its worst opening six-month period since 1970 and is now off 36 percent from its all-time highs.
We have been saying for several months that 2002 would be a negative year for stocks and fewer and fewer in the investment community are willing to debate that contention. A down year this year would set a mark that we haven't seen for many years -- three consecutive years of negative performance by the S&P 500 index. The last time that occurred was before most of us were born back in 1939-41.
This is a market environment that virtually no one has first hand knowledge of and that is why very few people have been properly prepared for it. Unlike most investors, readers of this column are neither shocked nor rattled by these events as they unfold. Indeed, many of you who have followed our lead are profiting quite handsomely from the worst bear market since the 1970s.
What separates us here at Market Innovations from most other market analysts out there is the extent to which we rely on historical market analysis. Our research goes back way beyond the beginning of the secular bull market that began twenty years ago. In our view, long-term historical research provides the only path to financial success in a history making market like the one we find ourselves in.
It is becoming obvious that the stock market and the economy have lost their traditional link. Wall Street analysts and commentators are scrambling to explain why it is that the economy has performed surprisingly well in the face of a very powerful bear market. Some have made the case that the unending Wall Street scandals and the unstable global political environment are depressing stocks values. So, they reason, all will return to normal just as soon as we can get the bad news behind us.
Certainly all these things are compounding the stock market's problems but very few grasp the nature of the abyss we are staring into. History tells us that the late 1990s were a once-in-a-lifetime stock market mania, a bubble. History also tells us that once-in-a-lifetime manias are followed by once-in-a-lifetime panics. The markets were not reflecting reality when share prices were defying gravity so now it is time for them to come back down to Earth.
While many companies and the investors who gobbled them up have since been punished for their indiscretions, price-earnings levels for the market as a whole are just beginning to approach historical norms. As one scandal after another reveals that the earnings side of that ratio needs to be adjusted downward, prices must also adjust downward to keep pace -- to reflect reality.
Unfortunately, history also tells us that stock prices don't usually drop to historical norms after they have been hugging the stratosphere for a period of time. They tend to overshoot to the downside and not just by a little. The last major bear market drove price-earnings ratio to around 7, about half of the historical average. Don't be surprised if it happens again over the next year or so -- we won't.
Our own research suggests that bubbles like we just experienced, like U.S. markets saw in 1835 and 1929, and like Japan went through in 1989, usually take stock prices down at least 70 percent. If you think folks are confused and anxious about today's market, just imagine what it will be like if the S&P 500 settles into the 400s after four back-to-back years of negative performance. The last time a cyclical bear market lasted that long was during the Great Depression.
In the near-term, it appears that the stock market has a very good shot at meeting the target we set a year ago. When we published our online article entitled Fight the Fed in June 2001, we believed there was a good chance that the S&P 500 index would be some 30 percent lower one year hence. At the time the average was in the 1240 neighborhood based on daily closing prices. A 30 percent decline would take the S&P 500 down to an 867 close which would correspond to roughly an 850 intraday low.
The intraday low for the month of June 2002 just past was 952, which is a 23 percent decline for the 12-month period. While that in itself is probably near enough to our target to give ourselves a little pat on the back, we have reason to believe that the 850 level is a real possibility by mid-July. One reason we believe this might happen is that we are expecting a 13-week inflection point in the first week of July, +/- one week. With the market in such a strong downtrend, that inflection point will most assuredly be a low.
A second reason is a pattern we discussed in some detail in last month's newsletter. We noted then that the March-May price action in the S&P 500 was developing in a manner very similar to the May-September 2001 pattern. Since then the similarity has persisted to the point that the parallels are nothing short of uncanny, as this chart demonstrates.
Notice in that chart that where we currently stand relative to the 2001 cycle is in the post-9/11 period when the markets were closed for four days. Obviously, since no trades transpired, prices were flat during that period. Similarly, prices today were also essentially unchanged from where they were a week ago. If the parallels continue, we are a mere seven trading days away from a tradable bottom right at 850 for the S&P 500.
That would mean that the S&P would join the NASDAQ in setting a new bear market low. The Dow Industrials, on the other hand, would likely be right around their September 2001 low of 8062 and perhaps be setting up a double bottom market low. It is not necessary that another terrorist attack or some other earth-shattering event takes the markets lower. There have been a number of times in the recent past when stocks sold off a similar amount in a short period of time with very little provocation. Examples are October 1987, August 1998, and March 2000 [Editor's note: April 2000, not March].
If the above scenario unfolds as we describe it, the final leg of the stool will have been knocked out from under the secular bulls. Since the early 1980s, all three major averages have been climbing higher in secular bull market channels. The NASDAQ Composite broke down out of its channel in April, retested the lower support line in May, and failed that test and declined further in June (so what, it's just the "New Economy" NASDAQ stocks that are getting beat up ... the reliable "Old Economy" stocks are still in a secular bull market, right?).
Wrong. This past month, the S&P 500 index which represents the 500 largest companies in the U.S. economy, followed suit and also melted down (yeah but those solid blue chippers in the Dow Industrials are still hanging tough, aren't they?). So far they are. But if prices collapse the way we are expecting them to, the Dow will join the others in waving farewell to one of the great bull markets of all time.
In other markets, gold is in an intermediate-term correction and everyone who followed our advice has taken profits by now. Next downside targets on the Philadelphia Gold & Silver Index (ticker symbol XAU) are 69 and then 64. The U.S. dollar is clearly in a bear market now, and famous currency trader George Soros believes that a 30 percent decline for the currency is in the cards. This is bad news for both stock and bond prices because foreign investors will be motivated to withdraw funds from U.S. financial markets since their profits will be eroded by the currency swap (or in many cases their losses will be made worse).
Bonds are in a tug-of-war. With inflation below 1.5 percent, bond prices want to move opposite stock prices. Since equities are trending lower, there is pressure on bond prices to move up and for bond yields to move lower. However, as we just pointed out, the falling U.S. dollar has precisely the opposite effect. The deciding vote may be cast by the U.S. economy since a slowing economy would lower bond yields and a strengthening economy would raise them as long as inflation remains in the "zero" range (+/- 1.5 percent).
The record shows that a bear market as powerful as the one we believe is upon us is always accompanied by a weaker economy than we have experienced to this point. Our hunch is that the economy will once again fall into recession with a backdrop of a rising inflation rate and falling equity values. Under that scenario bond yields will rise to keep pace with both inflation and an expansion of government borrowing.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
|---|---|
| DJIA 9243.26 | S&P500 989.82 |
| DJTA 2730.32 | Nasdaq 1463.21 |
| DJUA 273.88 | 30 YR BOND 5.52% |
28-May-2002
| Long Term Model asset allocation: | |||
|---|---|---|---|
| Intermediate Model asset allocation: | |||
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The equity markets are little changed from where they were a month ago. More importantly, our general outlook has changed very little as well -- only the specifics need modifying.
In our last newsletter we were of the opinion that the S&P 500 index was in the early stages of forming an Elliott Wave 3 to the downside, which typically is the most severe of the declining waves. In retrospect, it now appears that the index was completing a Wave 1 of the decline and has since moved up in a Wave 2 counter-trend rally.
Today, all three major averages broke down out of their short-term uptrends. Should the S&P 500 close below its May 7 low of 1049, it will most assuredly be in the early stages of that powerful Wave 3 decline we were looking for. Confirmation of this conclusion would come from a close beneath 1560 by the NASDAQ Composite and below 9808 for the Dow Industrials.
Today was an interesting day in the market. For the first time in some time, the Dow Industrials look to be the weakest average of the three. The last time the Dow showed itself to be relatively weak was in the August-September months of 2001. The other interesting thing about today was that the CBOE put/call ratio registered a 1.08, a very high number. When the put/call ratio is above 1.0 it normally accompanies at least a short-term bottom in share prices. But it is a reliable bottoming indicator only when it coincides with above average trading volume.
Volume on the NYSE today was below 1.0 billion share which is well below average these days. NASDAQ shares exchanged hands at an anemic 1.3 billion shares. The last time the CBOE put/call ratio was above 1.0 while volume was this weak was on August 17, 2001. By September 21, a little over a month later, the S&P 500 had shed some 19 percent of its value.
Granted that a most unusual event bridged those two dates. The ensuing decline was not strictly related to the attacks on American soil, however. On September 9, with the S&P 500 at 1086, we warned our Weekly Insights subscribers that the S&P 500 was headed for its October 8, 1998 low over the "next few weeks." Less than two weeks later the S&P 500 fell to an intraday low of 945 -- just 22 points shy of that target. It had become apparent to us that an important decline was at hand. We believe a similar situation is very possibly just ahead.
No two cycles are exactly the same but the recent decline beginning in March bares striking similarity to the May-September 2001 slide. For starters, an Elliott Wave 1 unfolded between May 22 and July 11 (34 trading days) that took share prices down 11 percent. We believe that the March 19 to May 7, 2002 correction was also an Elliott Wave 1. In 34 trading days it reduced share prices by the same 11 percent.
From July 11 to August 3, 2001 equity values retraced about 1/2 of the decline in an Elliott Wave 2 counter-trend rally. The recent May 7 to May 17 rally also appears to be an Elliott Wave 2 that retraced about 1/2 of the way back to the March 19 peak. With the Dow beginning to show weakness, we would not be surprised to find the S&P 500 down around our target level of 850 sometime this summer.
Gold went on a tear this past month, with the Philadelphia Gold & Silver Index (ticker symbol XAU) now challenging highs that go all the way back to October 1999. Those who took intermediate positions in gold mutual funds in mid-March when we felt the time was right, are now reaping 40+ percent rewards. While it appears to us that gold is ready to take a breather here, we think new highs are eventually in the offing as long as our gold timing model remains in the BUY mode.
Meanwhile, the U.S. dollar violated a multi-year uptrend line and is making a retest of its September 2001 low. If it closes below that level, it will be in an unmistakable bear market that began with the July 5, 2001 high.
Rallying gold and a falling dollar traditionally portend a negative outlook for stocks. Add to that SELL signals from both our short-term and intermediate-term (not to mention our long-term) timing models, and there should be little doubt in your mind where we believe equity prices are headed. As we mentioned earlier, the May 6-7 lows are critical to determining the direction of the markets.
Those early May lows serve as very important milestones -- much more important than simply indicators of the intermediate direction of stocks. Should the S&P 500 index breach in a significant way the 1049 closing low it made on May 7, it will mean lights out for the long-term bulls. The party will be over. The fat lady will have sung. As Yogi Berra once so eloquently stated, "It ain't over 'til it's over." It will be over.
That's because a close below that all-important mark will drive prices out of a two decade old bull market channel that traces all the way back to the beginning of the Mother of All Bull Markets that found its origin in August 1982. Some of those Bullest of the Bulls, like Harry S. Dent, Jr. (The Roaring 2000s) and David Elias (Dow 40,000), are hanging ther reputations on the S&P 500 and the Dow Industrials remaining within their respective bull market channels over the remainder of the decade.
We, on the other hand, are well positioned for quite a different outcome.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
|---|---|
| DJIA 9981.58 | S&P500 1074.58 |
| DJTA 2728.13 | Nasdaq 1652.17 |
| DJUA 297.81 | 30 YR BOND 5.13% |
29-April-2002
| Long Term Model asset allocation: | |||
|---|---|---|---|
| Intermediate Model asset allocation: | |||
|---|---|---|---|
In July of 2001, with the S&P 500 index trading above 1200, we fearlessly (some would argue "foolishly") forecast a 30 percent depreciation in stock prices one year hence. To meet that projection, the S&P 500 would have to fall to 850 by July 2002. With the price action in the markets this past week we are feeling more and more comfortable with our prediction, although at this juncture we would like to substitute 'summer' for 'July'.
This past Friday the S&P 500 broke down through very important resistance at 1074 which was the February 22 low. While we would expect to see prices bounce off of minor support at 1053, probably tomorrow, there is every reason to believe that the S&P 500 is on its way down to test the September 2001 low of 945. And every reason to believe that low will fall as well. If we are reading the charts correctly, the S&P 500 is in the early stages of an Elliott Wave 3, the most destructive of three down waves (Waves 1, 3, 5 are down; Waves 2, 4 are up).
The NASDAQ Composite index also broke down through its February 22 pivot low of 1697 on Friday. As we suspected, the NASDAQ has retained its leadership role and will now likely drag even the Dow Jones Industrial Average, which has been the strongest index, below its September 2001 low sometime this summer. Looking at monthly averages of daily closing prices, the NASDAQ peaked in January while both the Dow and the S&P 500 topped in March. We believe that those levels will set the high water marks for year 2002.
In retrospect, the catalyst for the decline was the Enron accounting scandal. All signs point in the direction of accounting games being responsible for overstated earnings for the last several years by companies of all shapes and sizes across a variety of industries. If earnings have been overstated, then historically bloated price-earnings ratios get even more bloated once those accounting gimmicks are corrected. That has investors worried and rightly so.
There is more to this decline than meets the eye, however. Liquidity, or we should say the lack thereof, is also playing an important role in recent stock market behavior. Our proprietary liquidity index, RPCM2, topped out in December last year and has begun to accelerate to the downside. The relationship between RPCM2 and stock prices the last two years is reminiscent of the 1968 to 1982 secular bear market period.
Back in October 1967, the year-over-year change in RPCM2 put in a cycle high and began a slide that took it deep into negative territory. Fourteen months later in December 1968, stocks moved into the first leg of the secular bear market that would need 18 months to find bottom. RPCM2 recovered to new highs and made its next peak in December 1972. Just one month later stocks began the second and nastier leg of the secular decline that hit bottom two years after. By then equity values had fallen more than 55 percent in real terms.
When the S&P 500 made its recent record high in September 2000, RPCM2 had been in decline for 20 months. The first leg of today's secular bear market ended 13 months later. As RPCM2 recovered to new highs, share prices rallied (though far less than they did back in the 1970s). When RPCM2 peaked the second time in December 2001, it took just three months for stocks to respond to the downside. We expect the overall damage to be closer to 70 percent this time around.
As if scandals and falling liquidity were not enough, we believe investors are sensing a whiff of deflation in the air. Since November 2001, the CPI inflation rate has been averaging just under 1.50 percent. If we assume for the moment that the economy is in the early stages of recovery from recession, history tells us that the inflation rate will fall further before it begins to climb. CPI inflation rates below 1.00 percent are a real possibility, then. If our view that the recovery will stall and that the economy will take a second dip down is correct, inflation could actually go negative.
This whole deflation thing is important for two reasons. First, as we pointed out in our February 2002 issue, history shows that stock prices perform best when inflation is in the range of 1.00 to 3.00 percent. Some of the most severe declines in history coincided with inflation breaking out of this comfort zone. Major tops in 1937, 1946, 1968, and 2000 saw inflation break above 3.00 percent while the 1929 peak coincided with inflation breaking below 1.00 percent.
Second, once inflation moves into the "zero" range (let's say between +1.50 and -1.50), bond yields and bond prices behave differently vis-a-vis stock prices and the economy than they do when inflation is either positive (above 1.50) or negative (below -1.50). For a detailed discussion of this phenomenon, visit our article entitled Goldilocks Meets the Bear.
In a nutshell, when inflation is not "zero" stocks retreat if long bond yields move higher and advance if these rates fall. However, in a "zero" inflation environment the opposite is true -- stocks like it when long rates move up and head for the hills when they decline. So with inflation at its current levels, bonds of longer maturities (greater than 10 years) are a safe haven when stocks are in decline which is why we have shifted more money from cash into bonds in both our intermediate and long-term portfolios (see top of page).
From the standpoint of our intermediate-term stock market timing model, a "zero" inflation environment poses a problem. One important component of that model is the long bond yield. When real long term yields are above 3.40% as they currently are (about 4.00%), our research indicates that gold peaks first, Treasury bonds next, and then stocks follow suit. Falling gold and bond prices trigger a SELL for stocks but the implicit assumption in the model is that stocks don't like rising interest rates.
Now that stocks are following interest rates rather than running away from them, our intermediate model is no longer valid. Unfortunately, there just isn't enough historical data available to develop a credible timing model in a "zero" inflation environment. Out of curiosity, though, we inverted the bond yield component in our model for the recent low inflation period just to see what would happen. With this new rule added, the model generates a SELL signal in February 2002 just one month prior to what we believe to be the year's high for the S&P 500 in March.
It's not as though a SELL signal in February would have made any impact on our portfolio asset allocation. For the record, we have been completely out of stocks since the Wednesday before the World Trade Center attack when the S&P 500 was trading at 1132. Indeed, we announced at that time that we were moving half of our cash into the Rydex Ursa Fund (ticker symbol RYURX), a hedge fund that moves inversely to the S&P 500. We first began moving out of stocks in July of 2000 with prices near all-time record highs. The following chart summarizes our recommended positions since the beginning of the bear market.
We have already given you two alternatives to investing in stocks that we like at this time (long-term bonds and the RYURX fund). Now we would like to discuss two other alternatives: real estate and gold.
Many economists and investment advisors, Barron's among them, are warning that real estate could be the next bubble to burst. Certainly prices have been booming of late due primarily to historically low mortgage rates. Our own research indicates that real estate will outperform stocks over the next few years but because we believe that the stock market is in a secular bear market, that's not exactly an endorsement of real estate. With deflation a real possibility in the near term, we would steer clear of real estate for now.
Our gold timing model moved to BUY mode in the fall of last year. This was triggered by the Federal Reserve's aggressive rate cuts that drove real short-term interest rates into negative territory. In early March we suggested that it was time for those who were interested in owning gold shares to make their move. The Philadelphia Gold & Silver Index (ticker symbol XAU) at that time was in the low 60s. It is now in the upper 70s and looks to us that it will eventually reach 90. The Scudder gold fund (ticker symbol SCGDX) we recommended is up nearly 30 percent since mid March, while the normally more aggressive Tocqueville gold fund (ticker symbol TGLDX) is up just over 20 percent.
Bare in mind that gold will move into a secular bull market only when inflation exceeds 5 percent. With inflation as low as it is, the latest rally in gold should be viewed as a cyclical bull market within a secular bear decline. A deflationary economy is not the time to buy-and-hold gold or gold stocks. We recommend that all intermediate-term investors in gold keep a trailing SELL STOP just below the up trendline that can be drawn by connecting the November 2001 and March 2002 lows. Currently that line is at the 67 dollar level for the XAU. Alternatively, a SELL STOP could be placed below the 50-day moving average of your particular gold stock or gold stock fund.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
|---|---|
| DJIA 9819.87 | S&P500 1065.18 |
| DJTA 2694.84 | Nasdaq 1656.93 |
| DJUA 302.55 | 30 YR BOND 5.62% |
28-March-2002
| Long Term Model asset allocation: | |||
|---|---|---|---|
| Intermediate Model asset allocation: | |||
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Six months ago, in our September 28, 2001 newsletter, we ventured that the September 21 low of a week earlier would be an important bottom. "How high markets will climb is hard to say but expect the rally to be explosive, not unlike the April/May move," we wrote. "That one was somewhere around 2000 points on the Dow, 200 on the S&P 500, and 600 on the NAS. That would bring all three indices back up to what we consider to be insurmountable resistance levels -- 10000 Dow, 1180 S&P, and 2000 NASDAQ."
The rally certainly was explosive, reaching our targets in early January after just three months. This led us eventually to set new higher targets of 11300 Dow, 1250 S&P 500, and 2300 NASDAQ. Even with these higher targets, we have maintained a very defensive stance. Most of our portfolio is allocated to cash and has been since the summer of 2001 when share prices were much higher.
We are committed to maintaining this posture until equities show us a clear signal that they are headed higher. The most important single indicator that would tell us that it was time to shift our portfolio back toward equities would be for the S&P 500 index to break out above 1180. That event, however, is looking less and less likely.
That's because the big story behind this rally was the recovering economy. The economic news has been quite positive for several months yet all the major indices have been moving sideways in a trading range since early November. The S&P 500 has bounced between 1070 and 1180, the NASDAQ from 1700 to 2100, and the Dow Jones Industrial Average has been contained within 9500 and 10700.
We believe it will take nothing short of an economic boom to accelerate stocks higher from here. This past week exemplifies our position. Positive economic data were met with buying in the mornings and sell-offs in the afternoons. The stock market seems to be saying 'yeah, sure we know the economy is improving but now show us something REALLY good.'
Our own Slump Index will move above -2.0 for the month of March, indicating that the economy bottomed in October/November but has been expanding very slowly. We would look for a reading above -1.0 to tell us that the economy is truly out of the woods. That would require that either the S&P 500 convincingly breaks above 1180 or the Federal Reserve starts ratcheting rates higher without causing a free fall in share prices (good luck).
As you know, for us it is not a matter of IF stocks are headed to new lows, but WHEN. At this point, neither our short-term nor our intermediate models have given us bona fide SELL signals. Our short-term model has been on the verge of a SELL four times already this year. Tomorrow [Monday] the window will close on the fourth opportunity unless some unlikly activity occurs before the markets close.
Our intermediate model is perhaps a month or so from registering a SELL. In order to do so, it requires as a minimum that the 30-year bond yield, which closed today at 5.82%, move above 6.00%. That target is easily attainable sometime in the coming month of April.
What is helping push the long bond yield higher is the price of gold. We mentioned last month that we would be buyers of gold shares once the Philadelpia XAU index moved into the 59-61 range. On March 8 it fell to a low of 60.4 and from there launched higher to close at around 72 today, a 19 percent run that still looks like it has some legs left in it.
At some point we look for gold to take a breather if our intermediate stock market timing model is going to hand us a SELL signal. That model is based on the observation that first gold rallies, then long-term interest rates rally (bond prices fall), and then stock prices fall. But the last event usually occurs precisely when gold prices retreat after making a solid run.
No timing models are perfect and it may be that we will not get a short-term SELL signal at the market turn (the last signal from that model was a BUY on September 24, 2001), and perhaps not an intermediate SELL, either. But investor sentiment is telling us that such a turn is nigh. The CBOE Volatility Index (ticker symbol VIX) is looking very much like it did back in August 2001 just one week prior to the double top in the S&P 500 index and the beginning of a long slide in all the stock averages.
Back then the VIX reached a low of 18.06 on August 28 and stocks peaked on September 1. Today, the VIX went as low as 18.87 and is falling at the rate of 1.0 point every four days. That means that it could reach the low 18's by next Tuesday. Next week is when a 13-week inflection point is due (+/- one week) so that suggests to us that some kind of important top is at hand.
To bolster that view, our BullBear Index (formerly known as the index of Bullish Minus Bearish Newsletter Writers) has been acting very much as it did exactly two years ago when the S&P 500 made the first top of its double top formation on March 24. This year the BullBear index went negative in early January and stocks have gone nowhere since. At the present time, it would take a reading below -8 for this index to turn positive but last week's reading of 23.4 is a long, long way from there. Should this index move back above 28 over the next two weeks, that would be strong confirmation that a top was in place.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
|---|---|
| DJIA 10403.94 | S&P500 1147.21 |
| DJTA 2917.96 | Nasdaq 1845.35 |
| DJUA 305.73 | 30 YR BOND 5.82% |
28-February-2002
| Long Term Model asset allocation: | |||
|---|---|---|---|
| Intermediate Model asset allocation: | |||
|---|---|---|---|
A bifurcated market, where the major averages are trending in different directions, is symptomatic of a high level of confusion and indecision among investors. The Dow Jones Industrial Average has been in a month long uptrend that has taken it above its 200-day moving average and broken it out of its bear market channel, as the following Dow chart illustrates.
The NASDAQ Composite, on the other hand, continues to decline from its January 9 intraday high of 2099. As of today's close, it is now down 17.5 percent over the last seven weeks. Contrast that with the Dow which is less than 2 percent below its January 7 high. Where the markets are headed from here depends entirely on which of these two averages is in the lead.
The S&P 500 index, nestled between the two, is about 6 percent below its January 7 high of 1177. It is, however, in a downtrend which is a solid indication to us that the NASDAQ is still leading this market as it has done throughout most of the past eight years. Until proven otherwise, we will assume that a falling NASDAQ indicates that sooner or later the other major averages will follow suit.
Confirmation of our conviction would have to be provided by the future price action of the S&P 500 index. That average is in the process of building the right shoulder of a head-and-shoulders top formation. A breakdown through the downwardly sloping neckline would set up a price target down around 1000 and most assuredly would take the S&P 500 to new cycle lows below the September 21 bottom at 945.
If the bears win this battle, we could be witnessing some serious fireworks over the next five or six weeks. A 13-week inflection point is due the first week of April (+/- one week) and if it turns out to be a bottom, our projection would be for the S&P 500 to fall to the lower band of its long-term bear market channel. That would take it to the 850-900 neighborhood, a decline of more than 20 percent.
The bulls can claim a victory if the Dow can successfully take out its January 7 peak by closing above 10300 on strong volume. The S&P 500 would move into an intermediate uptrend by closing above 1125, which would likely mean a test of the 1177 high was in order. If these occur, look for a market top around the early April inflection point.
In that event, the July inflection point would in all likelihood be a bottom that would see the S&P 500 below 850 -- a forecast we made seven months ago in our July 28, 2001 newsletter. That prognostication was based primarily on conclusions drawn from our posted article Fight the Fed.
Either way, we are quite confident that the secular bear market is intact and that 2002 will not be kind to equities. We list no fewer than a dozen reasons for that conclusion:
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Speaking of gold, we would be buyers of gold shares with a retracement of the Philadelphia Gold & Silver Index (ticker symbol XAU) down to the 59-61 area. It has been taking a breather since powering up to a cycle high of 69.81 on February 8 when it formed a candlestick "shooting star" reversal pattern. This should be a temporary sell-off in a larger intermediate cycle move to the upside. We drew attention to the coming run in gold back in our November 28, 2001 newsletter after our model gave us a BUY signal.
We prefer investing in gold shares rather than the bullion itself because stocks pay dividends to holders while bullion charges storage fees to owners. As a matter of fact, since we ourselves are not stock pickers we prefer gold mutual funds over either vehicle. Two that we are considering are Scudder (ticker symbol SCGDX) and Tocqueville (ticker symbol TGLDX). The Scudder fund is a conservative medium-cap value fund in the no-load category. It gives you better than average performance for funds in this category at a very low cost to you. Tocqueville is a very different fund -- a high flyer that invests in small growth companies. It has an excellent performance track record but you give up some of the gains in high fees.
With the latest CPI data release, the 12-month inflation rate dropped to 1.08%, its lowest level since 1964. Looking back over history we find that stocks tend to perform their strongest when inflation is between 1.00% and 3.00%. For some reason, some of the more significant market peaks have coincided with inflation moving out of this comfort zone. These include the 1929 crash when inflation fell out of the bottom of the zone, and the 1937, 1946, 1966, 1987, and 2000 tops which occured after inflation moved out of the top of that zone. Inflation has been falling precipitously since last September and seems more likely this time around to fall below 1.00% in imitation of the 1929 era.
It is becoming the majority view that the recession is nearly over. Alan Greenspan himself seems to have joined in the chorus. Could be... but our own Slump Index, which correctly called the beginning of the recession in March 2001 when the same pundits were of the mind that no recession was in sight, is giving us an ambivalent indication at present. It bottomed out at a -2.8 reading in October and November but has only managed to climb to a still dreary -2.5 by January. It has essentially gone flat since September of last year.
A solid indication that we are headed in the right direction would be a reading above -2.0, and anything over -1.0 would signal that we are definitely out of the woods. A move like that would need for the S&P 500 to rally above the January 7 high, or for the Fed to start raising interest rates (without triggering a free-fall in share prices). At the risk of sounding overly pessimistic, our own hunch is that we are in for a double dip recession. Some improvement for a few months followed by another down leg in the economy just fits better with our overall cycle analysis.
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Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
|---|---|
| DJIA 10106.13 | S&P500 1106.73 |
| DJTA 2810.93 | Nasdaq 1731.49 |
| DJUA 279.64 | 30 YR BOND 5.41% |
28-January-2002
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There can be no question now that the S&P 500 index has broken out of its long-term bear market channel that goes all the way back to the September 1, 2000 high. In doing so, the index closed above its 200-day moving average for the first time since October of 2000, some 16 months ago, and officially moved into a long-term uptrend. That uptrend lasted just one day.
On January 7, the day after closing above its 200-day average, the S&P embarked on a short-term decline that has now taken the average below its 200-day, not to mention its 20- and 50-day moving averages. Technically speaking, then, it is now in both long- and intermediate-term downtrends. Realistically, though, the charts show that what is really going on is that the S&P 500 has been moving in a sideways consolidation pattern since the middle of November last year.
In order to officially qualify as an intermediate downtrend, we would need to see this average close below its December 14 pivot low of 1114.5. And because the S&P 500 would also be below its 200-day moving average, it would be a safe bet that the long-term decline was resuming with a test of the September 21 low of 945 right around the corner. We got close to that December pivot low last week when the S&P reached 1117.4 and then bounced. Now it appears the index is on its way to test the 50-day moving average (currently at 1144.3).
The picture looks similar, but a little more negative, for the Dow Jones Industrial Average and the NASDAQ Composite. The Dow closed below its December 14 pivot low last week but remained above its November 29 pivot low. The NASDAQ closed below its December 21 pivot low for a single day but turned around the next day and closed above it. Both indices currently reside below their 50-day and 20-day moving averages and are right at (NAS) or below (Dow) their 200-day moving averages.
In retrospect, the September 21 low appears to have been the end of the first phase of the secular bear market. The S&P 500 very nearly followed the scenario we laid out way back in our October 2000 newsletter when we projected the market would fall to 950 by summertime. That projection was based on a large diagonal triangle formation in the charts that we believed would be followed by an Elliot Wave A-B-C correction. The S&P 500 reached 945 in September.
Because our ultimate target is for the S&P 500 to fall to around 450, that A-B-C formation would have to be followed by an "X" counter-trend rally and then another A-B-C bear market decline. We believe that the rally off of the September lows is part of that "X" leg. The question is, assuming we are correct, when will the "X" rally come to an end?
Recall that last month we suggested that the major averages are facing a very large overhead supply of stock at 1180 (S&P), 10300 (Dow), and 2300 (NASDAQ). Both the Dow and the S&P tested those levels in the first week of January, just in time to be turned away by the 13-week inflection point. The NASDAQ fell short, hitting overhead resistance at the 2100 level. Those January 7 levels stand as the high for this leg so far and could very well be its termination point.
That's because at the same time stocks are pushing up against very important resistance zones, investor sentiment has gotten overly optimistic. The Chicago Board Option Exchange's volatility index (ticker symbol VIX) closed at 21.77 today. There were only six days in all of last year that it closed lower than this -- all falling between early June and early July as the S&P 500 was tracing out a collapse from the 1300s in May to the 900s in September.
Also, in the week ending January 11, our index of Bullish Minus Bearish Newsletter Writers pushed above 29 for the first time since July of last year. We consider anything above 26 to be a SELL alert. Over the past four years there have been eight prior occasions when this index exceeded 29: April 3 1998, July 24 1998, January 15 1999, May 7 1999, March 24 2000, December 15 2000, February 2 2001, and July 20 2001. In every single case, the S&P 500 index was lower a month later -- sometimes much lower.
This is important precedent because we have good reason to believe that if a month later, on February 8, prices are lower than they were on January 11, the year 2002 will be a negative one for stocks. Our conclusion is based on analyzing eight years of data (1994-2001) on what is colloquially referred to as the Santa Claus Rally . Santa Claus begins in mid-December and carries share prices higher into January. We separated the data into bear years (1994, 2000, 2001) and bull years (the rest) and then averaged all the bear years together and all the bull years together.
What we found was that throughout most of January the bear years and the bull years tend to move together. Toward the end of the month, however, the bear years begin to diverge from the bull years as this chart illustrates (the chart shows the percent change in the S&P 500 index compared with the December 1 close). By the 5th trading day of February, all the bull years in the study were above the 3.00% level and all the bear years were below 2.00%.
This year the 5th trading day falls on Friday February 8. Because our index of Bullish Minus Bearish Newsletter Writers broke above 29 in the week ending January 11, we believe the S&P 500 index will close below 1145.6 on February 8, or no greater than 1.4% above the December 1 close. If that occurs, the S&P 500 will be on the bear market track in the above chart. Odds would then favor that stock prices will take out November-December pivot lows and challenge the September lows.
On the other hand, a close above the January 7 intraday highs would make it very likely that 2002 will be a positive year for stocks. We would, in that event, be forced to bias our portfolio allocations toward stocks and await SELL signals from either our short- or intermediate-term models (hopefully both).
If a continuation of the bear market decline is in the cards, the catalyst will in retrospect have been the Enron scandal. The largest ever corprorate bankruptcy took an ugly turn on Friday when whistleblower John Clifford Baxter, a former Enron Corp. vice chairman, was found dead in his car with an apparent self-inflicted gunshot to the head. The collapse of the 7th largest U.S. corporation in and of itself may not be enough to trigger a stock market slide. But if investors become concerned that other firms are hiding a mountain of debt the way Enron's accountants did, THAT could certainly warrant a stampede from equities.
The economy appears to be rebounding, based on consumer sentiment data from both the Conference Board's Consumer Confidence Index and the University of Michigan Consumer Sentiment Index. Our own Slump Index (see our article Be Careful What You Wish For for a description of this index) suggests that we are not yet out of the woods, though.
You may recall that the Slump Index moved below -1 in March of 2001, signalling the beginning of the recession. It currently stands at -2.8, the lowest level since the recession began. In the past, a bottom in the economy has coincided with a bottom in this index. We would have to see the index move higher from here before we begin to believe that the good times are back. A close back above -1 would provide even greater certainty.
Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.
For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.
| Market Statistics | |
|---|---|
| DJIA 9865.75 | S&P500 1133.06 |
| DJTA 2804.84 | Nasdaq 1943.91 |
| DJUA 288.77 | 30 YR BOND 5.47% |
