21-Dec-97

The Consumer Price Index (CPI) for November fell from the previous month for the first time since December 1995. If it continues this pattern, red lights will be flashing for the stock market by January. To understand the reason for this, and how stocks can decline while bonds rise, read our November letter.

The long bond has fallen below the 6.00% mark as we expected. The outlook for interest rates is still very positive with gold having fallen below $300 per ounce (which we anticipated in the July letter).

Both the S&P 500 index and the DJIA have retested previous highs and failed to penetrate them. The Dow's high was set on August 6th at 8218.34, the S&P on October 7 at 983.12. The Dow is currently 6 percent below that level, the S&P 4 percent lower.

In spite of the failed retests, it appears that one or both of these averages will soon set new highs. Should this occur, the number of bullish newsletter writers should be quite high. A reading above 60 percent would confirm our belief that the large cap stocks are peaking. That indicator is currently at 52.5 percent.

The Nasdaq is another story. Our bet is that the smaller stocks have already begun a bear market decline. The 1650 level is important resistance for this average.

23-Nov-97

The market corrected just as we expected in our last letter, although the bottom that was established on October 28 was nearer 15 percent than the 10 percent we were expecting. And as we also anticipated, the correction occurred while the long bond yield trended lower. The outlook is still favorable for the long bond and we expect to see it break through the 6.00% barrier soon.

The individual investor appears to have treated this sell-off as another in a long series of great buying opportunities. This belief is now well established among amateur investors, insuring that they will be eager recipients as the insiders and professionals distribute their overvalued shares.

We believe the odds are now 50/50 that the August 6 peak in the DJIA of 8340 marked the beginning of a bear market in that average. Expect the S&P500 to retest its October 7 intraday high of 983.12 sometime in December. If the Dow is in a bear market then the retest will fail and the October 7 high will prove to be the beginning of a bear market in the S&P 500. The NASDAQ peaked the following day on October 8 and is behaving like it may stall out here at the 1650 mark.

How is it that stocks could be in a bear market while bonds are moving higher in value (lower in yields)? If our intermediate timing model flashes a sell signal in the next month or two, it will be triggered by falling inflation - not by rising interest rates.

Prior to WWII, it was not uncommon for stock prices to fall at the same time bond prices were rising. It requires that inflation no longer be perceived as a pricing factor by bond investors. This normally occurs when inflation is near 0% per year and bond prices react only to supply and demand for loans. Under that scenario, falling bond prices mean the economy is slowing - a negative for stocks. The CPI inflation rate is currently 2.08% and falling.

15-Oct-97

Since our last letter, all the major market indices made new record highs. The exception is the DJIA which was unable to exceed its August 6 peak of 8340.

Things have turned negative over the past week. We suspect the market will retest its recent lows (903.8 on August 27 for the S&P 500 index), and probably dip slightly below. That would mean about a 10 percent correction.

The reason for this is a sharp increase in the bull minus bear index to 19.1 from its recent low below zero. NYSE volume is behaving rather poorly as well, and the 30 year bond has shown some weakness after making a 52 week low in interest rates at 6.24%.

Long-term interest rates are merely taking a breather here. With gold still languishing at the $320 per ounce level, it appears the trend toward lower rates is still intact. Small and intermediate capitalization stocks are poised for high relative strength over the near term. We still expect them to rally strongly as the market makes a final move up before an important top occurs.

21-Sep-97

As we expected, the market corrected in August (about 7 percent on the S&P 500 index), and then staged a rally in September. The S&P 500 now stands just about where it was at our last writing.

Gold is still languishing at $320 per ounce and may move lower. The outlook for bonds is still quite positive. The 30 year government bond is about to test its recent low of 6.30% and our guess is that it will break through and head lower in yield. This undoubtedly will lead stocks into record highs. The newsletter bulls minus bears indicator dipped below zero recently which is also quite bullish for stocks.

The NASDAQ and Russell 2000 are already in record territory with the S&P 500 very close. The DJIA is lagging. What may be happening here is that small stocks, in classic fashion, are about to lead us into the final highs before a bear market correction sets in.

Our intermediate timing model is still in the BUY zone and probably couldn't flash a SELL before December. So in our opinion a major correction is not imminent. But what we do find troublesome is the tremendous amount of insider selling since July this year. As reported in Barron's this week, company directors and officers sold shares in their firms more frequently than they bought by a ratio of 2-to-1 in July. This just prior to the market selloff in August. Not a big deal, right? Wrong.

During the 10 percent correction in April of this year, insiders scooped up shares in their firms at a 2-to-1 rate. That was immediately followed by a spectacular 32 percent rally in just four months.

So what did these same insiders do during the August correction? They increased their selling to 3 sells to every buy! And worse yet, the volume of shares sold exceeded the volume of shares bought buy more than a 14-to-1 margin in the large cap stocks. This is not good news and more than likely means the rally from here will be suspect.

7-Aug-97

Since our last letter, the 30 year bond yield fell to a 16 month low of 6.30% and has climbed back up to 6.52%. Gold is still languishing at $320 an ounce. In the meantime, stocks appreciated another 5 percent.

Unfortunately, our short term timing model has just flashed a SELL signal. This combined with a 5th wave diagonal triangle formation in the S&P500 and DJIA charts is pointing toward a very sharp correction ahead. With the subdued optimism among newsletter writers (bulls minus bears is currently at 17 points) and our intermediate model still positive, it is not likely to be very deep. Our best guess is about 10 percent by month's end.

Gold may be putting in a base here. If the outlook for the metals continues to improve, bonds could be shaken even further and cause greater weakness in equities. Such a scenario would very likely unfold rather slowly, however, allowing stocks an opportunity to rally into September.

12-Jul-97

The stock market has achieved our objective of 900 to 930 laid out in the May letter, and it's not done yet.

Gold has made a precipitous drop, falling below the $340 per ounce support level to a 12 year low of $320. We wouldn't be surprised to see gold drop below $300 per ounce. The catalyst for this reaction in the gold pits was the announcement by the Australian government that they had been selling the metal for several months.

Falling gold prices have traditionally been very positive for the bond market. Rising bond prices in turn are almost always a prelude to higher stock prices. The meltdown of gold and the fall of commodity prices in general may be enough to propel the 30 year government bond below the 6.50% level. That would be extremely positive for stocks.

The contrarian in us is starting to smell euphoria in the equity markets. We hesitate to join the ranks of the doomsayers who see parallels between our current stock market and the market of the 1920s. However, there are lessons to be learned from that epic period. Stock prices accelerated higher in 1929, the final year of an 8 year bull market. Normally, large price gains begin from a severely oversold conditions, not in the latter stages of a bull run. The blowoff top (over 30% increase in 3 months) occured with both commodity prices and interest rates falling, normally a positive environment for equities.

While low inflation is very favorable for financial assets, deflation is not very kind. It can lead to the unusual combination of falling bond yields and a declining stock market.

10-Jun-97

In last months letter we predicted that the S&P 500 index would exceed 900 sometime this summer. With just eight trading days until the official beginning of summer, the index already achieved the 870 level today.

We still anticipate an S&P 500 composite of between 900 and 930 during the hot season.

Over the past month, the number of bullish minus bearish newsletter writers climbed from a -10 to a very strong +21.5 reading. This is the type of action that normally leads to a significant market selloff.

But with the long bond yield falling to 6.80% and with NYSE short interest once again at unusually high levels, the market is poised to move higher.

Expect either a significant decline that will bring sentiment back toward neutral, or a blow-off rally that raises bullish sentiment to extreme positive levels (+35 or more) and leads to a bear market.

2-May-97

A final bottom in the large cap markets occurred on April 14. The S&P corrected a full 10 percent and the Dow fell 12 percent from their respective all-time highs in February and March of this year. Those highs will be challenged in the coming weeks. The NASDAQ corrected 15 percent and has only made up half the loss.

Our short term model flashed a bona fide buy signal on April 11, the day of the closing low and one day before the intraday low on the S&P 500 index. The market for large cap stocks has been nothing short of spectacular since then. Even the small caps are beginning to show signs of strength.

The number of bullish minus bearish newsletter writers has fallen to a -10 reading. This is a very positive signal for stocks. The long bond yield has fallen below the 7% level after flirting with 7.20%. This too is a very positive sign. Anticipate a little backing and filling as the market challenges the previous all-time highs.

The market is just a tad overextended after the recent explosion. But we feel there is very little in the way of stocks advancing another 10 to 12% from here before any serious threat presents itself.

Once we reach those levels (sometime this summer) it will be very interesting to see what sentiment and interest rates look like. Judging from the article "Contrarians Beware" by Mark Hulbert, things could become a bit nasty. He points out that the top three market timers since 1980 are all negative on the market now.

Value Line Investment Survey, Growth Stock Outlook, and the Chartist have all turned bearish recently. Value Line expects stocks to be lower three to five years from now, Growth Stock Outlook is recommending no more than 20 percent stocks, and the Chartist model mutual fund portfolio is now 100% in cash.

You contrarians out there are well aware that when investment advisers in general are negative it is a good time to buy stocks. But when the best newsletters are negative, it is a time to be cautious.

Michael Burke, editor of Investors Intelligence, has been monitoring newsletters since 1963 and has a formidable track record himself. His interpretation of sentiment right now is that we are at an "important top".

6-Apr-97

As we anticipated in last months letter, a market rally in the first week of March led to a larger move down. We thought a bottom would be found in the third week of the month. Instead it looks like the correction may have ended on Thursday of last week, nearly five weeks later.

The S&P corrected over 9 percent, the Dow Industrials 10 percent, and the Nasdaq about 15 percent. But don't be surprised if we make some sort of retest of the recent lows next week.

We suggest the bottom has arrived with some trepidation. Our short term model still has not flashed a buy signal. We believe we will see one on a retest. The reason there has been no buy signal is that options traders have been much too complacent throughout this sell-off. Normally, the further the markets fall, the more pessimistic options traders become. This did not occur this time and may be signalling something larger is in the making.

The number of bullish minus bearish newsletter writers has again fallen significantly over the past several weeks, normally sinalling a strong move up in the averages will follow. And with the number of bullish newsletter writers now well below 60 percent and the long U.S. Treasury bond below 7.5%, a very positive market expectation would be justified here.

However, the long bond is now convincingly above the 7.0% barrier which raises the specter of a further move toward the very threatening 7.5% level. And don't take lightly the Fed's action two weeks ago. This in all likelihood will change the psychology of this market. We are firm believers that the market is more powerful than the Fed. But Fed reactions to market conditions normally are useful for telling us which way the tide is moving and in this case the tide is falling.

Add to this mix the unusual behavior of options traders and our suspicion is that the market has one last move up before a very significant correction (i.e., BEAR market) asserts itself. Once again, the key will be the price action of the long bond.