But there are other reasons why one may be upon us and none of it has anything to do with the regular array of bad news that drips on us day by day. It may have more to do with the traditional buy in November, sell in May type of thinking that comes upon this time of year. It is certainly not because we believe suddenly the valuations have become attractive. They haven't. The S&P 500 price earnings ratio (P/E) is still just over 30 (see http://tal.marketgauge.com).
That is still a long way from traditional bear market bottoms around 8-10. To believe that it will never reach those levels one only has to understand that there were few who ever believed that the S&P 500 P/E ratio would ever go over 30. It has been at or above those levels since 1999. An over reaction in one direction often begets an overreaction in the opposite direction to regain balance.
First the bad news and there has been plenty of it. Leaving aside ongoing terrorist bombings that threaten to completely finish off the waning tourist travel and the airlines with it and as well the threat of war with Iraq the most potentially devastating bomb that could hit the market is a possible major bank collapse. The Japanese banks of course have been a sitting time bomb for years. Ditto for their insurance companies. But more recently two banks names are getting bandied about. One of course is J.P. Morgan Chase (JPM-NYSE) he of the $23 trillion derivatives book. The other is Commerzbank A G (CBK-DAX, CBRZY-OTCBB) the huge German bank holding company.
J.P. Morgan Chase has fallen roughly 70% from its highs of January 2001 and is even down 37% from its most recent August 2002 highs. JPM has been put on credit watch by Standard & Poor's and Moodies and has had its ratings cut recently. Commerzbank A G is down fully 85% from its March 2000 highs and even down 44% from its August 2002 highs. Like JPM, CBK has had its ratings cut by both Standard & Poor's and Moodies and placed on credit watch with negative implications.
The market implications for these two giants of the banking industry in both America and Germany are of course unknown. But the fact that it has reached this stage for these two esteemed old line banking companies says quite a bit about of the shape of the world banking industry and the implications going forward for the world's financial system. The downgrades compromise their ability to deal in the market , participate in loan syndications, borrow money and it especially compromises JPM's derivatives portfolio. We recognize that neither institution has been reduced to B level credit status yet but certainly these type of events send all financial institutions and corporations to reassess further their lending practices and exposures.
Credit spreads between top credits (governments) and others (primarily corporations and financial institutions) have been widening for months. Banking and financial collapse is a prime characteristic of the Kondratieff winter. This onward march we are seeing unfolding is a force in progress that has not as yet played out the final act. Once these forces are in play it is extremely difficult to prevent the inevitable outcome.
As credit is contracted the money supply growth that has been growing at rates of 6-8% in the US and debt growth that has also been rising at similar rates will begin to contract. Contraction in money and debt growth will inevitably lead to more problems in the financial sector and as well to negative economic growth. Debt collapse, which already appears to be underway, will lead the economy downward in a deflationary spiral. The Fed, as the Bank of Japan (BOJ) has already discovered, will find itself unable to be able to stimulate as they did in the past as all of the funds will be going to just trying to prevent a collapse rather than actually doing anything.
We have always been struck by the ongoing comparison of the NASDAQ of 2000-2002 and the Dow Jones Industrials 1929-1932. While the Dow Jones Industrials has not followed the same pattern most of the other markets such as the S&P 500 and even the TSX have tracked that famous collapse somewhat. The top in the 1929 market was made on September 3, 1929 while the market bottom was seen on July 8, 1932 for a total of 1039 days. The NASDAQ topped on March 10, 2000 and the S&P topped on March 24, 2000. This bear market is now anywhere from 935 to 949 days old (to October 15, 2002). If the same time count is in play we might be looking for a significant bottom in the market anywhere from January 13 to January 24, 2003.
We have also been looking for our four-year cycle low. The last four-year cycle low was made in October 1998. It is clear now that the low seen in September 2001 was not it. It of course remains to be seen whether recent lows in July 2002 and again in October 2002 are it. We believe they are not the low but it is possible. But once again in the interim we could see another bear market rally that may have begun with the sharp two day rally seen on October 10-11, 2002.
We are showing two weekly charts. One is once again the famous 1929-1932 Dow Jones Industrials bear market. Note the clear 13-wave (a fibonnaci number used in Elliott wave counts) collapse to the July 1932 lows. We have attempted to provide a similar count for the S&P 500. Here we have been able to discern thus far 11 waves down (assuming the bottom is currently in). This would suggest to us that two more waves should unfold. One, which may be beginning to get underway now, should top out no later than around the US Thanksgiving (November 25) but certainly absolutely no later than mid-December (December 15). The final down wave should occur through December 2002 and January 2003 and should be in place no later than February 2003.
Since this will be nothing more than another tradeable bear market rally one should stick to quality names. Oversold stocks that may be poised for a good rebound that could easily be anywhere from 10-30% are (symbols only all TSX), A, BMO, BBD.B, BCE, BVF, CAE, CM, CNR, CLS, DTC, HSE, NXY, MG.A, NCX, PCA, TEK.B, RCI.B, TD and ZL. There are of course others.
October 17, 2002
Charts and technical commentary by David Chapman of Union Securities Ltd. 69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email david@davidchapman.com
The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.