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Sept 18 Peaked Peaks?
By Brady Willett & Todd Alway
"The real losses occur in the second stage down, after investors who bought stocks on reflex get discouraged. That's when liquidity dries up and there's a lack of interest." Farrell of Merrill Lynch
When observing the markets it is easy to become consumed with analytical predictions and the daily
bombardment of economic statistics; each trading session a new story breaks, an economic statistic is
unveiled or reassessed, and sectors thrash in opposite directions seemingly without rhyme or reason. It is
in this way that many financial fortunes have been made and lost. Simply put, short-term leveraging of
assets makes one subject to the incalculable short-term fluctuations of daily market life. A storm off the
coast of Florida, a strike in Europe over rising oil prices, or even a slow news day are enough to trigger the
market in unpredictable directions. In fact, what the daily activity and static quantitative figures can not
comment upon is the long-term psychological state of the market. Certainly one can proffer an opinion on
market psychology based upon the daily flows, but this opinion is transient; it must change once a new
report is wired or a new opinion is learned and appreciated. Accordingly, it offers little to guide the investor
interested in long-term market movements and, presumably, long-term portfolio gains. That said, based
upon the long-term flows, what the present equity environment may be telling us is that regardless of the
daily plays, the grand scheme of the game may already have been altered.
Looking At The Peaks
Both of the major markets have reached record highs this year. Nevertheless, they are currently in a holding
pattern in which lower lows and lower highs have become definitive of the parameters of market movement; a
typical bear market by most definitions.
High investor expectations heading into 2000 are themselves a significant indicator of a latent climate of
unfulfilled expectations in which investor impatience with a lack of growth in paper wealth threatens to turn
the current drying-up in the liquidity stream entering the market into a raging torrent of capital exiting the
market for other venues. It doesn't help the situation when these investors are forced to stare up at market
peaks which in all likelihood will not be re-attainable by years end. Add to this a decline in earnings growth
estimated to last until the second quarter of 2001 and the situation for the investor may seem dire indeed.
The average investor expected 20% market gains in 2000 and is now staring at, in many cases, a 20+% rally
just to break even.
The peaks are flickering out of reach as investors grow more and more impatient...
Two other statistics whose peaks may have been met in 2000 are turnover rates and margin debt. Each
comments on the state of the market; turnover rates by displaying periods of intense or flaccid trade and
margin rates by commenting on investor leveraging tolerances. For instance, after the 1987 crash it took
more than a decade for turnover rates to reach their pre-crash levels, and margin debt, if it suffers another fall
by January 2001, will have fallen year over year for the first time in more than a decade.
More possible peaks to consider include mutual fund assets and the creation of equity funds. Mutual fund
assets reached a concurrent peak with the Nasdaq back in March, yet the creation of equity funds continues
at a torrid pace. This equity fund creation, needed to feed demand, reflects the long-term behavior of the
market more gradually; hence a long downturn after maximum girth is reached is typical. Such was the
case back in 1929 (investment trusts) and in the 1960s (gogo mutual funds).
It is easy to become pre-occupied with the daily statistics and short-term commentary immediately
impacting the markets, but the larger part of the story can be told in the long-term flows; in the peaks and
what each represents to long-term investor sentiment. As the markets reflex towards a more habitual trading
atmosphere the most important thing to consider is how the majority of investors will perceive the future state
of equity growth. My guess is that this perception will not be very optimistic. That being the case, rather
than representing a temporary slow-down in the growth of equity valuations, current market conditions
threaten to make temporary bearish sentiments into an entrenched bearish reality.
