Fast move but do you want to believe it?
If you are despairing that you have missed the rally that started on October 10, 2002 well then don't. Classic bear market rallies are those that effectively start out of nowhere and move extremely fast. In barely a week the market was up roughly 13%. On October 15 we jumped almost 5% alone. Indeed we have had numerous almost 5% and better up days since this bear market began in January/March 2000. Oddly enough we hardly had any days like that in the great bull market of 1995-2000.
Still the rally had its effect. The bulls came charging out of the woodwork. "It was the biggest four-day percentage gain since 1933". "The final bear market bottom". "Investor's are focusing on the positive economic news". "It's the largest four-day rally since 1974. That was a major bottom".
And fund managers, a host of analysts and some media pundits suddenly became market-timing wizards. They called it the end of the bear market. That valuations were the best investors were going to get in a long time. That the market had gone too far anyway. That there was no justification for the market to be this low in the first place. If suddenly all these "fundamental analysts" have become instant "market-timing" wizards when they always said market timing doesn't work then have I got some overvalued stocks for you. Of course one can suppose that this is the type of emotion one would expect when they are really "hoping" and "praying" that it is a bottom so they can get back to somewhere remotely where they bought in the first place.
I hate to disappoint them. But no October 10, 2002 was not the bottom. Sadly they said the same thing at the July 24, 2002 bottom, the September 21, 2001 bottom and the March 22, 2001 bottom. And they will probably say it again the next time we make a dramatic bottom. Real bear market bottoms pass without notice. At a real bear market bottom no one points it out, no one cares and no one even thinks it is a bottom. We have not reached that point yet.
Anyone that believes that price earnings ratios (P/E) on the S&P 500 still over 30 is great value is clearly dreaming. Coca Cola (KO-NYSE) at a P/E of 26 and Johnson & Johnson (JNJ-NYSE) at a P/E of 27 are just two of the Dow stocks with excessive P/E ratios. Earnings are looking better. But that has often been in relation to the dismal results of last year. As well analysts have been dropping their targets quite rapidly given that in past periods they kept coming in too high. Result is that the targets are easier to hit and or exceed. Certainly earnings growth is not at a level that one could call a new bull market. Nor are forecast earnings at levels that one could call it a new bull market. Some are just chicanery such as Microsoft (MSFT-NASDAQ) telling us that because they made an accounting change for subscription leasing software rather than selling it that it boosted their earnings probably on a one time basis.
Firms have other woes as well beyond accounting scandals. One of the latest is the growing gap in under funded pension plans. This is fairly serious and it could have serious ramifications for firms such as General Motors to name one and IBM to name another. And this has been in a period where car sales have remained robust thanks to 0% financing.
Loan losses continue to pile up at the banks. As the consumer is forced to cut back due to layoffs credit card delinquencies already starting to run at record levels will reach epidemic proportions. Foreclosures and bankruptcies have been moving at record levels this past year. And is there an airline company that is even remotely profitable. Profits and airline companies is an oxymoron. Why anyone would want to own or run an airline today is beyond my thinking. Finally McDonalds (MCD-NYSE) has reported declining earnings for the 7th time in 8 quarters. Either people are finally getting tired of eating McDonald's fast food or worse they just are not going out as much any more. Either way it bodes poorly for not only McDonalds but for just about everything else.
And recent economic numbers are anything but robust. Leading economic indicators have fallen for 4 months in a row. Is there any sector that is looking any where near robust except for housing. Industrial production is falling, non-residential spending is in a three-year downtrend, retail sales are softening, and even consumer debt growth that has fueled the economy is slowing. The only bright light anywhere is the threat of war. Here war is bullish for the economy. One has to wonder when the deaths of few hundred thousand people gets investors excited to buy the market. But recently it was the easing of war threats that helped spark the rally.
The mutual funds are hurting. In the US roughly $64 billion has been pulled out this year. So there is no new money coming in. Trouble is this amount while impressive is not even 2% of all the funds in the mutual fund market. The numbers here in Canada are comparable. So that tells us there is a lot more to come out before this over. And finally Abbey Joseph Cohen, she of Goldman Sachs recently said the market is "notably undervalued" and forecast that the DJI and the S&P 500 will rise 48% over the next 12 to 18 months. Trouble is Abbey Joseph Cohen's record in the past two years has probably been the worst of any analyst anywhere. She has become a classic contrarian indicator. And she still has a job.
But all this being said we are in the throes of bear market rally that could still have some more legs. We appear now to be finally getting the first overdue correction to the rally that started on October 10, 2002. The structure of this rally we suspect will be quite similar to the one that unfolded off of the July 24 low. Note how for the S&P 500 that one went up in a classic abc type of Elliott Wave pattern which we have called an A wave. The subsequent drop we suspect was probably a B wave as while we saw new lows the lows were not so far under the previous low to negate the possibility of a another C wave up. The B wave fell in five waves down.
The current rally has become overbought very quickly. We are also running into resistance in the form of the 100-day moving average. Some support lies below at the 50 day moving average but better support lies at the 20 day moving average near 840. We certainly would not want to see that level fall on any pullback. We have possible turns around the end of the month so if we are making a low that should be a secondary opportunity to buy for the final phase of the counter trend rally. Certainly we would not want to be short beyond November 2. All bets could be off, however, if we were to break below and close significantly below 840.
The rally could continue through until at least mid-November and possibly into the US Thanksgiving Day weekend. Beyond that point we are expecting a return to the bear market and new lows in the first quarter of 2003. Note that the US Treasury bonds have now broken down sharply from their recent high prices. We take that as a possible omen that the credit crunch we have been anticipating for some time may soon be upon us. In a credit crunch interest rates will rise not fall and the spike in yields could be significant. The recent rally in the stock market appears to be counter trend. It may be impressive but do you want to believe it?
October 25, 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.
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