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A point of view.
MARKET COMMENTARY:
Friday's Action:
A mixed bag of corporate reports weighed on Blue Chips Friday and the
Dow was unable to sustain a late foray into positive territory. The
Nasdaq managed modest gains as investors snapped up semiconductor and
wireless stocks. Volume eased, with 1.27 billion shares traded on the
NYSE and 1.49 billion shares traded on the NASD. NYSE breadth was
positive, with advancing issues over declining issues by a ratio of
1.30, but down volume came in over down volume by a 1.08 ratio. Nasdaq
breadth was positive, with advancing issues over declining issues by a
ratio of 1.37, and up volume beat down volume by a 2.15 ratio. Leading
sectors were semiconductors, +6.4%, internets, +4.0% and airlines,
+3.8%. Laggards were forest products, -3.2%, gold/silver, -2.2% and
oil
services, -2.0%. Nasdaq 100 futures closed 6.50 pts higher to settle
at
995.50, while the S&P's settled down 2.50 pts at 928.50.
Weekly Recap:
Trading last week was dominated by Tuesday's FOMC meeting and
corporate
America's certification of their financial statements on Wednesday. It
all went according to script. After a lackluster Monday, the market
rallied ahead of the FOMC announcement and then sold off when the Fed
did nothing as expected. The bond market soared and interest rates hit
their lowest levels in decades before finishing the week essentially
unchanged. Institutional buy programs kicked in Wednesday afternoon
as
the smart money rallied the market into the end of the week. The
media
was once again baffled by the market's reaction, decrying the Fed's
inaction on Tuesday and attributing Wednesday's rally to the change in
the Fed's bias and the fact that corporate CEO's were certifying their
financials. Come on now. What CEO in his/her right mind would
knowingly
sign off on a fraudulent financial statement? The market managed to
post
another positive week, with the Dow edging up 0.4%, the S&P 500 up
2.2% and the Nasdaq ahead +4.2%. Next week, the economic calendar is
on
the light side. Companies due to report earnings include Home Depot
(HD), Lowes (LOW), Toys R Us (TOY), Staples (SPLS), Sycamore Systems
(SCMR) and Medtronic (MDT), among others.
Is the Market Cheap Yet?:
The current price-to-earnings ratio of the S&P500 index is
approximately 37, almost exactly the same as it was at the market peak
in March of 2000. But the S&P has lost roughly 39% of its value
during the same period. So what gives? Is the market over or under
valued? How will we know when the market has bottomed based on
historical PE ratios? The problem is that PE ratios become useless as
an indicator for the overall market or for any stock index during a
period when there is a sharp decline in profits. The last time we saw
this happen was in the early 1930's. Corporations as a whole made a
loss
in 1932 and as a result, PE ratios were approaching infinity.
We are being told almost constantly however, that stocks are now cheap
and that they will turn out to be great investments if bought today
with
the aim of holding for the long-term. Many analysts, portfolio
managers,
financial journalists and strategists, not just the perma-bulls,
contend
that stocks are now at bargain sale levels. Their case is based on the
assumptions of much higher normalized profits, low inflation and
interest rates, and some kind of earnings discount model. Because of
the
perceived shortcomings of most traditional valuation measures, bullish
investors claim that shares are cheap without supporting statistical
evidence. This time it's different.
A more meaningful gauge of valuation in a collapsing profits
environment
is the price-to-sales ratio. The large-cap S&P400 index has traded
around 140% of sales at bull market peaks and around 40% of sales at
bear market troughs. That is, until the bubble of 1998-2000. Then it
traded up to 235% of sales, far surpassing any prior bull market
level.
Despite the vicious bear market of the last 2 1/2 years, the S&P400
still trades north of 125% of sales. Over the past 75 years, this
valuation level has been more closely associated with bull market tops
rather than bear market bottoms.
The dividend yield of the S&P500 Index is currently only about 1.73%,
about 4.2% less than the yield on a T-bond. The fact that investors
are
prepared to accept a dividend yield that is substantially below
the "risk
free yield" means that they are confident that the total return on
stocks
(dividends plus capital gains) is going to be much higher than the
bond
yield over the next few years. This is not the attitude we would
expect
to see if the market was near a major bottom.
The S&P500 recently traded as low as 775, but the capitulation phase
of this bear market is yet to come. Once mutual fund investors
capitulate en masse, it is not hard to imagine that the market will
fall
another 30%-50%. Since it is now apparent that the capitulation phase
won't begin until the S&P500 falls to at least 750, a target bottom
for the index of around 450-500 seems reasonable. This target might
not
be bearish enough however, since it would simply bring the dividend
yield up to around 4%, near its long-term average, and the price-to-
sales
ratio down to levels seen at other major bear market bottoms over the
past 75 years.
The COT Report:
The latest Commitments of Traders report shows that Commercial Hedgers
sold roughly 600 S&P futures contracts short to bring their net
short position down to -47,918 contracts. Large Traders are also net
short -40,576 contracts, with the entire offsetting net long position
of
+88,494 contracts being held by Small Traders, the so-called "weak
hands". Over in the Nasdaq pit, Commercials covered some 1,000 ND
contracts to bring their net short position to -8,051 contracts.
Commercial action in Dow futures was little changed this past week,
with
Commercials remaining net long the Dow by +9004 contracts.
After three weeks and short covering some 28,000 contracts, Commercial
Hedgers became net sellers of the S&P's again this past week. Six
hundred contracts is not much of a one week change, but it does break
the recent trend of aggressive short covering, which no doubt
contributed to the rally off the July lows. Now that Commercial short
covering appears to have abated, there is one less reason to be
aggressive on the long side. Over the longer term, the outlook remains
bearish, with Small Traders net long a near record 88,000 contracts.
Needless to say, large traders didn't become large by being on the
wrong
side of the market.
Market Sentiment:
The AAII sentiment index of bullish individual investors was unchanged
at 38%, while the bearish percentage rose to 41% from 39% last week.
The
fact that the small investor bearish percentage rose while the market
was rallying last week is a positive sign, indicating a healthy amount
of fear still exists. In fact, looking at previous instances in which
the AAII Bearish Consensus rose to 40% or higher during a week when
the
S&P500 closed higher has historically led to a higher S&P500
close the following week a high pecentage of the time. The Market Vane
weekly consensus of bullish S&P commodity advisors rose to 28% this
week from 24% last week. The Investors Intelligence survey of bullish
newsletter writers came in at 38.5%, up from 35.5% last week, while
the
bearish percentage slipped to 37.4%, down from 39.8% last week. With
the
bearish consensus little changed this past week, it suggests there is
still a healthy amount of pessimism among newsletter writers. Until
this
number falls below 35%, the market should continue to find support on
pullbacks and trend higher over the intermediate term.
The Short Term Outlook:
We said in Thursday night's column that the odds were better than 80%
that we would make higher highs on Friday, which we did. The SPX
managed to squeak out a 2 pt higher high before closing slightly
lower,
while the NDX exceeded Thursday's high by 18 pts before closing 15 pts
higher on the day. For Monday, the odds are 78% that the NDX will
make a
higher high, but only 60% for the SPX. On a weekly basis, both the SPX
and the NDX trends have reversed to bullish, with both making higher
highs and higher lows and closing in the upper half of their
respective
weekly ranges. This price action argues for higher prices over the
intermediate term. On a short term basis, we're ready for a pullback
or
consolidation, as the market has gotten a little ahead of itself. As
we
mentioned Thursday night, Nasdaq volatility remains statistically
"out-of-bounds" for a second day now and should revert higher soon,
meaning that the NDX should fall in concert. However, when volatility
fails to rebound when it should, it can often lead to a sharp drop in
volatility coinciding with an explosive market rally. Those occasions
are rare, but they do happen. There were a number of indications
Friday
that the market is topping out. The equity put-to-call ratio came in
at
0.38, the second lowest level in the last two years. The option
premium
ratio surged to 0.92, the highest reading so far this year. The NYSE
McClellan Oscillator edged up to +184, the highest reading in the past
three years. The previous high this year was back on March 6th and
the
SPX topped out three session later. We have nearby Fibonacci
resistance
for the NDX at the 1007-13 level and support at 975-82. For the SPX,
those zones come in at 936-39 resistance and 918-23 support. Both
indexes have Fibonacci time cycle clusters of 8/19-8/22 for a
potential
short-term trend reversal. This time frame coincides with our next
Pivot
Point, which is 8/19, plus or minus 2 days. For our Day Traders, we
have
a predicted daily high and low for the S&P E-mini of 936.50 and
921.00 for Monday. This is one of the lowest daily range predictions
for
the last month, suggesting that the market is ready for a pullback or
a
consolidation.
To summarize, we expect the market will make higher highs Monday
before
reversing lower or consolidating short term. The reversal could come
as
early as Monday. Over the intermediate term, we expect the market
will
work it's way higher for another few weeks. We remain bearish over
the
longer term however, and expect the market will make new lows later
this
year or early next year.
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