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In the last several months we have attempted to provide a cautious but
sensible guide for what to expect in the markets. We had been calling for a
short-term low in October, to be followed by a 20-25% rally into 1999, then
the likelihood of a further selloff in the March-April 1999 timeframe to
lower lows. that the action of Oct. 8th was climactic on our
Index, that a short-term low was in, and wrote on Oct.11th that I was
trading the market from the long side going into the next week.
Since June 1998, we have been advocating that portfolio managers should
sharpen their pencils and use a "Ben Graham–style" approach to determine
the fair prices they'd be willing to pay for stocks on their wish list. The
overall concept was that there would be great bargains amidst the chaos in
the markets, and that rather than wait for a particular index to hit a
particular number, one should stick to stock picking given the uncertainty.
Many of the stocks we had highlighted, such as APCC, MO, BUD, COX and a
slew of Utilities have gone on to make new highs. Now, I am not going to
claim that prior to Greenspan's action I expected the rally to come after
the Fed move to be so robust. I was hoping the rally would be strong enough
to turn a few bears bullish. We were prepared to sell again in the
projected rally level of 8100-8200 in the absence of any extraordinary
events. It seems clear that Mr. Greenspan was well aware that moving as he
did with the major indexes just below major resistance would allow the
market the opportunity to blast through with the help of buying from
scorched short-sellers. It is known that for many years Mr. Greenspan has
helped design financial analysis software. It appears that he is also a
pretty good technician - another endorsement for my under-appreciated
technical pals!
Although confessing one's errors is unfashionable, I am also willing to
admit that however short-term climactic Oct. 8th was for our favorite
Index, we did not get the kind of public capitulation we were hoping to see
to end this phase of the bear market. That seems to be staved off for the
moment ( until next Spring?). As mentioned previously, the Fed action gives
the market a new complexion, and to be a survivor one has to be able to
adjust. But does it change things dramatically? Are the ostrich's that hid
their heads in the sand going to be bailed out again? Were p.m.'s that got
into high cash levels in the Aug.-Sept. period wrong? What about the recent
contractions in major investment banks? Because of the baby boomers, are
lengthy bear markets a thing of the past? Is the market holding in because
of the pending election, or just month-end squaring of positions? (Is this
too many questions?!).
First of all, anyone that froze and did nothing since July may appear to
have been right, but analysis of their portfolio performance on an absolute
basis will prove that they've suffered terribly even if the indexes don't
appear too bad off. I think that the p.m.'s that took action to defend
their client's portfolios did the right thing, even if they might have left
some on the table. After all, caution was, and is, clearly called for.
There still are other shoes to drop. It would be imprudent to be fully
invested with all the recent uncertainty.
Second, the Fed's action may have stimulated commercial banks to lend more
freely, but Banks and savings institutions now account for only 30% of
lending to non-financial companies in America. This credit crunch we're in,
as indicated by not only the junk bond market, but also even in commercial
paper, is a capital-markets phenomena. Sentiment has improved, but the
markets need more time to evaluate new conditions. Also, the market is now
expecting a series of further rate cuts, and the Fed needs to keep it going
on Nov. 17th and beyond. Short-term this may be o.k., but longer-term (6-9
months out?) it is clearly inflationary. So is recent money supply growth.
That the Fed is willing to in essence re-inflate already over-valued
markets has done nothing but increase the risk of later downside action.
Many people perceive that the Fed has now taken on responsibility to be the
World's central banker. That indicates the predicament we're in, too.
This week's Economist warns that China may be on the brink of financial
catastrophe. Europe's new financial union now consists mainly of Socialist
governments. The US is facing a horrendous trade deficit. There still is a
possibility of recession at home in 1999. So, an analyst still has to be
careful about earnings expectations for next year. The market seems to have
factored in all the good news, leaving it vulnerable to disappointment
again.
Short-term we called for the market to run out of upside steam in the 8700
area, and it hit 8652 on Oct. 20th. Fibonacci fans will note that the DJIA
had a 62.3% retracement, for the SPX it was 60.2%. The last few days showed
the kind of range contraction notable at turning points. Since we're so
overbought, bounced off resistance and nearly run out of upside targets, I
expect that we should go back towards 8100-8200 to prove that the break
above this level was for real ( 1035-1045 on the Dec. S&P). We are
currently short the S&P from Friday. This dip will probably be bought, and
then you'd look for a rally to then test this last week's highs. Either it
makes a higher high and keeps going, in which case it just gets us back
into the same problem we had in July. Or, the test of last week's high is
successful and we have to go back down for a further test of the lows, in a
retracement that could be surprisingly severe. The best case for the bulls
would be if the market could build a nice wide trading range for a while.
This would help build up a count to go further, and would buy us some time
to re-evaluate the environment.
Robert Rhea's seminal work on the Dow Theory principles stated that bear
market rallies can last from three weeks to three months and that the
beginnings of bull markets are virtually indistinguishable from reactions
within a bear market. One way to distinguish the difference is through the
study of accumulation/distribution. I don't show any significant
re-accumulation overall yet to embolden those with cash to spend
indiscriminately. All one can do is stick to the discipline of buying
stocks that have bottomed and show renewed enthusiasm on the part of
institutions. Caution is still in order. It's too early to call an end to
the bear market.
T.R. Peterson
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