Is It Really Different This Time?
Tim W. Wood
In April 2003 Louis Rukeyser announced, "The bear market has ended." More recently the June 16, 2003 issue of Barron's reports, "This rally is for real." Barron's goes on to say, "Even if the summer lull sets in, stocks are likely to be 10% higher by year end." It also seems that most everyone on CNBC has now officially declared the new bull market. I have heard the comments about the new "post war economic boom" and Dow projections of 12,000. Has a new bull market begun that has been so timely announced and accepted? This has never happened in the past, but could it be different this time?
A look at Sentiment
I want to look at the facts surrounding the recent bullish sentiment that this rally has produced. On June 11, 2003 Investors Intelligence reported 58.7% bulls and only 16.3% bears. This is a ratio of 3.60:1. We have to go back 16 years, to April 2, 1987 in order to see the ratio at these extremes. On April 2, 1987 the Dow Jones Industrial Average closed at 2,320.45. Over the next 13 years the bull market advanced 9,402.55 points and never saw this kind of bullishness. This single fact is beyond profound. Think about it, 13 years of the greatest bull market in history never produced this kind of bullishness! On June 18, 2003 Investors Intelligence reported 60.20% bulls and 16.10% bears. This drives the ratio up to 3.74:1. I think it was Mr. Dow himself who coined the phrase "Wall of Worry." It is clear to see from the sentiment numbers that this market is not climbing the "Wall of Worry" which makes this rally very, very dangerous.
To further illustrate the "Wall of Worry," the 1974 bear market bottom was marked with the percentage of bears at 69.60. This is the highest level of bears ever seen on the Investors Intelligence data. The 1974 low was also marked with a mere 23.3% bulls. With current readings at 60.20% bulls and 16.10% bears, we are now approaching the exact opposite end of the sentiment spectrum from what was seen in the 1974 bear market bottom. Now, I know that many people are questioning if things could be different this time. I have read enough Dow theory and market history to understand that people always think, "this time is different." This time is not likely to be different. We are dealing with human behavior and from all my reading of market history, humans respond in very similar fashion to similar events time after time. Technical analysis really is nothing more than the study of patterns in human behavior and for this reason I believe that market history is our best guide.
In looking at the Investor Intelligence readings going back to 1969, I found that we have only had a dozen occurrences where the ratio of bulls to bears has been at the recent levels or greater. I based this study on the June 11, 2003 ratio of 3.60:1. My conclusion on sentiment is that it is a great tool at helping you to understand when the market is at dangerous extremes, but it should not be used as a timing tool. It is best to use other technical indicators, cyclical break downs and Dow theory for timing. The reason I say this is that it is my observation that sentiment readings can remain at extremes for weeks or even months before the technical conditions of the market turn.
The first occurrence of the bull to bear ratio at 3.6 or greater was in 1971. The ratio oscillated above and below 3.6 for some 28 weeks before the market sold off into the seasonal cycle low in November of that year. The market did not top until the 7th week after the ratio first penetrated 3.6.
In early 1972 the ratio bounced back and forth around this level for 13 weeks. It was 17 weeks from the time the market first crossed the 3.6 level until the actual market top. Then, later in 1972 the ratio spiked above 3.6 for one week. A few weeks, later the ratio rose above 3.6 again and basically remained there for some 7 weeks. This time it was 5 weeks until the market reached the 4-year cycle top. I might add that this was also a bear market rally and the two year decline that followed carried the market down into the 1974 bear market low.
In February 1975 the ratio rose above 3.6 for 1 week and quickly retreated as the market proved to climb a "Wall of Worry" while the 4-year cycle advanced. In December of 1975 the ratio again penetrated the 3.6 level and this time it oscillated above and below this level for 66 weeks. The market top came 41 weeks after the ratio first penetrated the 3.6 level. This too, was a 4-year cycle top.
In 1978 we saw a one week push above the 3.6 level. The market top occurred 4 weeks later and the market began declining into the seasonal cycle low.
In March of 1983 the ratio oscillated for some 19 weeks above the 3.6 level. In this case, the seasonal cycle top came 15 weeks after the 3.6 level was violated. Then in November 1983 the ratio again violated the 3.6 level. This time the ratio remained above 3.6 for 4 weeks and the market topped 2 weeks after the ratio's rise above 3.6. The decline that followed was into a seasonal cycle low.
In January 1985 the ratio again found itself above 3.6 and this time it remained there for 6 weeks. The seasonal cycle and market top did not come until some 25 weeks after the ratio violated the 3.6 level.
In February of 1986 the ratio rose above 3.6 and remained there for some 16 weeks before the final break. This time it was 28 weeks before the market top was seen from the initial break above 3.6 on the ratio. The decline was into a seasonal cycle bottom.
And finally we get to the last occurrence where we saw a ratio of bulls to bears that was greater than 3.6:1. This last occurred in January 1987 and it took 11 weeks before the final break below 3.6 occurred. This time the market top came some 32 weeks after the initial push through the 3.6 level. We all remember 1987 and the decline was into a 4-year cycle low.
So, I now think you can see that sentiment readings can remain extreme for extended periods of time. This does not mean that sentiment readings no longer work as I have recently heard so many say. It is my view that we have to look at history and understand that these extremes take time to correct themselves. Each one of the extreme sentiment readings above occurred at either seasonal or 4-year cycle tops. Coincidentally, we are now moving into a seasonal cycle top and we may not have a 4-year bottom in place. No, this time is not likely going to be different. History tells me that we are now setting up exactly like numerous other times from the past.
Another measure of sentiment, or really fear, can be seen in the Volatility Index, known as the VIX. The VIX has also recently hit very important levels and once again we are hearing, "This time is different." On May 16, 2003 the VIX recorded an intra-day low of 20.57. Since the bull market top in 2000, the VIX has reached this level only three times. The first time was on September 7, 2000. On September 6, 2000 the DJIA hit a 22-week cycle high at 11,401.20. Six weeks later the DJIA had declined 15% in reaching the cycle low at 9,651.68. From this weekly cycle low the market rallied for two weeks, then worked side ways for some 13 weeks as the VIX moved back down to 22.05 on February 1, 2001. On February 6, 2001 the market hit an intra-day high of 11,035.61. This marked the high for the weekly cycle and from this point the market quickly began to slide into the seasonal cycle low, which was recorded on March 22, 2001 at 9,106.54. This time the drop was 17.48%.
The second VIX reading below 20.57 came on July 2, 2001 at 20.26. The DJIA hit both a 22-week and seasonal cycle high a few months earlier on May 22, 2001 at 11,350.00. From this high, the market fell 29% into the September 2001 seasonal cycle low.
The third VIX reading below 20.57 came on March 28, 2002. A few days earlier on March 19, 2002 the DJIA recorded both a weekly and seasonal cycle high at 10,673.10. On July 24, 2002 the DJIA hit an intra-day low of 7,532.66. This was also a 29% decline.
Now we have the forth VIX reading of 20.57 or less since the birth of this great bear market. In addition to the recent low VIX reading itself, I ran a 14-day RSI on the daily VIX. I found that on April 24, 2003 the RSI hit a low at 25.25. I then began looking at historical RSI readings on the VIX. I had to go back to July 14, 1987 to find the last time that we had a reading this low. On July 14, 1987 the RSI reading on the VIX was 25.21. It has been 16 years since we have had an RSI reading on the VIX this low. The daily RSI has been diverging and warning of a bottom in the VIX since the April 24, 2003 low. All indications are that the VIX has or is bottoming and as it starts up, the market should to begin weaken.
Quotes from the Masters of Dow theory
George Schaefer stated: "There are three principle phases of a bear market: the first represents the abandonment of the hopes upon which stocks were purchased at inflated prices; the second reflects selling due to decreased business and earnings, and the third is caused by distressed selling of sound securities, regardless of their value, by those who must find a cash market for at least a portion of their assets."
Robert Rhea described the three phases of the bear market in a very similar way. More importantly, Rhea goes on and states: Each of theses phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market." Does this sound familiar or what? Rhea also states: " Such secondary movements seldom prove perplexing to those who understand the Dow theory."
Rhea says that these secondary reactions (bear market rallies) seldom prove perplexing to those who understand the Dow theory because the Dow theory student is a student of history. It now seems that the only bears left standing are all students of market history. I suspect that the market historians will likely prove once again to be right in this case as well.
A look at Value
Another longer-term historical fact that I would like to discuss is dividend yields and price earnings ratios. Historically, price earnings ratios and dividend yields have been roughly equal at bear market bottoms. When the bear market ended in 1932, price earnings ratios had fallen to less than 9:1 and dividend yields hit a high at 10.55%. In 1942, as the '42 to '66 bull market began, price earnings ratios were roughly 8:1 while dividend yields hit 8.71%. At the 1974 bear market low, price earnings ratios had fallen below 7:1 and dividend yields fell just short of 6%. As of June 24, 2003 the GAAP price earnings ratios for the S&P 500 is at 32.85. I have recently seen reports that are showing "core" earnings are as high as 39. As of June 24, 2003, Pinnacle Data reports the S&P dividend yield to be 1.67%. It's obvious that the price earning ratios and dividend yields are at extremes as well. Unfortunately, they are at bull market extremes. Based on today's earnings, the S&P 500 would have to sell at 303 in order to have a price earnings ratio of 10:1. Let me emphasize that this is based on today's earnings. This assumes that earnings will remain constant as the market falls. This is not going to be the case. When the market starts to fall and the consumer begins to pull back I can almost assure you that earnings will fall. No bull market has ever begun at current valuations. Based on this simple fundamental fact, how can anyone suggest that a new bull market has begun?
Summary
My long-term outlook for the market has not changed. We are in a "Primary" bear market and the recent rally is nothing more than a bear market rally. My long-term objective for this bear market calls for the Dow to move into the 3,000 range. I look for this to occur as early as 2006 but it could be as late as 2010. For more information on my long-term projections please see go to www.cyclesman.com/Articles.htm and click on the article "Has a New Bull Market Begun?"
It is my opinion that we are likely still in the first stage of this great bear market. This rally has served to suck the hopeful and uninformed back into the market. The optimism, which is seen in the sentiment numbers, goes to show that the public has not yet abandoned the hopes upon which stocks were purchased at inflated prices. Given that we are now seeing sentiment numbers not seen during the largest bull market advance in history, the over extended technical indicators and the cyclical structure that is now unfolding, I would argue that this market is now at very very dangerous levels. The seasonal cycle top is due very soon. Once this top is in place, the seasonal low will follow. The seasonal low is due later this year and the decline into this low could prove to be more of a surprise than most people can presently imagine.
It is by way of my newsletter, Cycles News & Views, that I try to help people understand and time these important turning points. In the July issue of Cycles News & Views I have examined the current cyclical setup and the potential meaning. For more information on myself, the newsletter, subscriptions, other articles, interviews, subscriber reviews, etc. please go to www.cyclesman.com or call 318-342-9038.
25 June 2003
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