Final High!
We have oft wondered what Alan Greenspan's legacy will be. Throughout the 1990's the Fed Chairman was hailed as a saviour and a genius. Indeed if you had mentioned God and Greenspan in the same breath it probably would have been Greenspan that would have been on top. On the other hand we have oft referred to Mr. Greenspan as the "Wizard of Oz". All sleight of hand and illusion.
While we agree we are being irreverent we also believe it is with just cause. Since the bursting of the stock market bubble in 2000 there have been numerous articles taking shots at Mr. Greenspan. Clearly he is not viewed in the same favourable light that shone his way during the bubble run up in the late 1990's. The fact that he has managed to hang on to the second most powerful job in the world (some say the most powerful) when many others his age are happy to the take the retirement cheque and saunter off into the sunset is testimony to his stamina and determination. Or, it may be a testimony to an immense ego.
Let's examine the record. We centered on monetary growth (M3), GDP and debt growth for corporations and consumers. Alan Greenspan was appointed Fed Chairman on August 11, 1987. The record is from 1988 onward.
The two periods 1988-1994 and 1995-2000 are quite a contrast. The period 1998-1994 was characterized by sluggish growth, slow monetary growth and slow debt growth except for the consumer. By contrast the period 1995-2000 was characterized by rapid monetary growth, rapid debt growth and while GDP was up from the previous period it was generally only about half the growth of money and debt. The rapid monetary and debt growth in the latter period contributed in no small manner to the resulting stock market bubble. The spurt in money and debt growth was aided by the elimination of banking reserves (as well it was also here in Canada). The rapid monetary and debt growth in the latter part of the 1990's was also part of the effort to rescue the US bond market and US dollar that were both in a downward spiral particularly in 1994 and in serious risk of collapse.
Since the market topped out in 2000 and following the September 11, 2001 attacks the Fed has generally maintained a loose monetary stance and the debt growth has continued although it has slowed considerably for corporations. Slower monetary growth in the early part of the year as the economy improved and a need to sop up excess liquidity from the September 11 fallout has picked up again in response to some economic weakness. We suspect that the recent stock market rally in the stock market is being aided once again by some rapid monetary growth that is picking up from slowness in the early part of the year.
Looking at all these numbers I am harkened once again to an alleged quote to Mr. Greenspan that I read in an interview with Ian Gordon of Canaccord Capital, a noted Kondratieff Wave Cycle analyst, that Mr. Greenspan "would love to be Fed Chairman when the Kondratieff Winter comes because I think I could override it by dropping interest rates and printing enough money that it would overcome all the deflationary aspects of the economy".
Mr. Greenspan (aka "Easy Al") is getting his wish and so far one could argue that it has prevented an outright collapse. But intervention of this magnitude may work for a while but ultimately it is doomed to failure as there is a presumption here that in the face of an easy money policy that people will act rationally. Given the levels of both corporate and consumer debt growth it was and is anything but rational as they have gone out and borrowed like drunken sailors. Trouble is now they can't stop the need for the fix unless something happens that forces them to. And this is the real vulnerability we could soon be facing. Mr. Greenspan walks a tightrope in trying to balance things to prevent a collapse.
Ned Davis in a recent musing said, "Greenspan feels that once the bubble bursts the Fed can put the party back together again. He feels this way because of what happened after the crash of 1987. But the stock market is much, much bigger now relative to GDP than in 1987 and savings are less and debt is higher. I am skeptical how easy it will be to put Humpty Dumpty back together again. My game plan is to increase liquidity currently, so the likely upcoming bear market will not hurt me ………"
I quoted it verbatim to emphasize the enormity of the situation. Now the Fed keeps pumping money and all we get are short sharp up moves as we are currently witnessing. But is it sustainable? And the answer is a definitive no! Banks are belatedly now tightening standards and credit spreads are widening. Bankruptcies are at record levels and foreclosures are at record levels. So the Fed can pump the money and lower interest rates but its impact will only be minimal. This is as Ned Davis describes the "liquidity trap". And we have yet to feel its full impact.
The stock market is up 21.3% (S&P 500) since the lows of October 10. This rise is slightly below the last two bear market rallies of roughly 24%. But 17% of that rally (or 78% of the entire rally to date) was accomplished in the first 8 trading days. This phenomenon is not unusual for bear market rallies that are oft defined as sudden rapid rallies out of nowhere. And ultimately they fail, as the end of the bear market will only come after some period of basing. It will also come quietly, not dramatically, as we have too often seen since this bear market began over two years ago.
We had noted in previous articles that we suspected we could see a rally into the US Thanksgiving. We are now in that time frame and we are making a high. Some cycle analysts we follow have noted the period as one where we could see a turn in the market. But this rally also fits with the seasonal and cyclical rallies that are oft seen in this period. And indeed we could if any pullback now is shallow still hang on until Christmas or New Years as we did last year. But the best part of the move is over with any further up move limited.
But odds are more in favour now that we are in the process of seeing the final high for the next few months. The market has rapidly become quite bullish again with numerous analysts proclaiming once again that the bear is over and we are in the throes of a new bull market. A real bull market will be advancing when these same analysts are proclaiming that it is merely another bear trap. The market is technically overbought on the dailies with negative divergences appearing on the indicators. Breadth and volume on the recent up move are generally lagging and recent numbers are diverging with levels seen at the end of October.
We are showing a chart of the S&P 500 weekly. Note what appears to be giant head & shoulders pattern. The neckline of this pattern is currently around 955. The left shoulder was formed with the top prior to the sharp 1998 sell off. The head was formed at the 2000 top and the right shoulder was formed with the rally following the 9/11 meltdown. The neckline was formed with the 1998 low at 923.32 and the post 9/11 crash at 944.75.
We expect the neckline should act as extremely stiff resistance as it did in the August rally. The high in the August rally was at 965. The rally could, however, easily reach up to the 40 week MA currently near 980 without violating the head & shoulders pattern. The head & shoulders pattern target is for drop to S&P 500 315. Since the pattern took roughly 4 years to form the drop could take at least two years or more to complete.
We have marked two possible Elliot Wave patterns of the current down move. One (in blue) is the more bearish scenario. Elliot waves correct in strings of ABC. In an ABC correction either the A wave or the C wave can descend in five waves. The bearish scenario has a five-wave collapse from the 2000 highs culminating in the post 9/11 mini crash. The B wave was the ensuing rally that carried is just into 2002. The C wave then should fall in three waves since the A wave fell in five waves. We have labeled the first wave or A wave as the October 10 lows. We are currently forming the B wave with the C wave to come. The C wave could carry us to the S&P 500 600 level. From there a more substantial correction could get underway.
The more bullish scenario (in red) has the S&P 500 falling in an ABCXABC zigzag pattern. The first ABC ended with the March 2001 lows. The X wave fit the pattern of a short sharp corrective wave typical of X waves. The second half of the zigzag ended with the lows on October 10. This then would only be the end of the A wave of a possible ABC long-term corrective wave down. The B wave currently underway could take several months to play itself out but still generally achieving no higher than roughly 1000 on the S&P 500 and testing the neckline of the head & shoulders pattern. It could play itself out in an Elliot five-wave ABCDE type of pattern, which suggests considerable up and down movements.
We should note one possible further bullish scenario. This scenario emanates from the first bearish scenario that suggests that the bottom on October was the culmination of an ABC collapse in itself and therefore is the end of the bear market. We put less stead on this one because the head & shoulders pattern certainly suggests much lower and this would say the bear market is over and done with. One need only remind that the S&P 500 price earnings ratio (P/E) remains at or around record levels near 30. Bear market bottoms suggest that the P/E ratio should fall to 10.
No matter how we look at it we are at the cusp of at least a short term high and possibly a final high for the next few months. We could as we earlier suggested hang on till Christmas or New Years if any current drop getting under way is shallow. Threats to the market remain in a weakening US Dollar, the ongoing threat to war in Iraq (remember the deadline for documenting WMD is December 8) and ongoing vulnerabilities to the economy. Time to batten down the hatches once again.
November 27, 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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