Stopped Clocks?
Yes, careful, it could be that time on
Wall Street when the proverbial watch that doesn't work actually gives
the correct time… bring out the bananas, it's gonna be a party... a short
one, but maybe it'll be fun.
We're here for a good time... not a
long time (Trooper).
Joe Kernen,
one of CNBC's more rebellious henchmen, admitted today he didn't know
there was a "deep throat" (alias for the informer that helped
the press blow Watergate open and whose identity only one person knows,
to this day I think), and in the same breath wondered why we're still
talking about scandals 30 years old. I wonder why. The world must be a
better place otherwise the free press, which is freer today than ever,
would tell us it wasn't.
An upbeat earnings forecast from McDonald's
sent the bulls racing during a lull in the bad news on Monday, or so it
was reported. McDonald's said the weaker dollar is helping its foreign
currency earnings. That was important for the bulls because they have
been looking for a reason to get bullish on a weak dollar.
The bulls worked themselves into a lather
over the spin they could potentially attach to all of the various stocks
or sectors ahead of the second quarter. They agreed the market was oversold,
after falling for four straight weeks, and also that there was a ton of
money in money market funds on the sidelines (they have been in agreement
on those issues for some time - sort of like a stopped clock actually)
waiting to invest in shares. So they went on to bid almost everything
up except for gold and tobacco shares, which suffered on the excitement
that even spread to the bank shares.
US averages finished at their highs for
the day. The Dow was up 213 points, or 2.25%, while the S&P 500 closed
up 2.9% in a surprise bull raid. Advancers outpaced decliners almost 4:1.
Volume on the big board was 1.4 billion, which was lighter than Friday's
volume.
Citigroup, JP Morgan, and American Express
were the Dow's best performers Monday after a crack of key bullish support
in the Dow on Friday. In the rest of the market, it was the software,
biotech, insurance, and semiconductor (Intel) sectors that led the way
higher. What we're seeing here, I
think, are the bulls punching back after being pinned on the ropes for
four straight rounds.
Fly butterfly, fly.
A recovery in bank shares is bearish for
gold markets. On Friday we felt that the Dow's recovery fell short of
the kind that would lead to more gains this week, barring a swift one
or two day respite (correction in sentiment). Perhaps that is all Monday's
rally was.
If it is more than that, we'll need to
see it extend through 9800 for the Dow; for the Nasdaq composite that
resistance is at 1600, and 1048 for the S&P 500. These are short-term
resistance points that ought to help us determine the significance of
this rally, and guide our perspective. Technically we have to take it
day by day. So far, there's nothing to suggest it can't be just a good
round for the bulls before the knock out punch finally ends the match
tomorrow or the next day.
For fundamentally, this argument is about
valuation, specifically whether stocks are cheap relative to how they
will be valued in the future.
For two years the bulls have not been able
to buck the interest rate hurdle, but now, at 40 times earnings for the
S&P 500 they're going to attempt a rally on stronger commodity values,
higher rates, as well as a weak dollar. Good luck.
It's a sucker's play, because the bulls
want to bid up stock values ahead of a quarter that could turn out to
be disastrous if McDonald's is the only one to report good news (that's
a joke sort of). By disastrous I don't mean that earnings will be lower
than expected. I don't know. I would bet they will be, but current equity
valuations still reflect high expectations for earnings. Whatever those
expectations are, I doubt they've fully accounted for the impact on profits
as well as on the valuation process from the confluence of macro events,
whose upside has perhaps already been discounted today.
To get stock values to sustain these levels
or to expand, the bulls need to come up with an argument that can overcome
both the prospects for a weak dollar as well as the prospects for rising
interest rates.
In other words, a weak dollar, higher interest
rates, and higher commodity values are ingredients that can affect not
only profits for most participants in the economy as we know it, but also
alter the way that the market values financial assets relative to other
assets, commodities, and money. The equity risk premium as it stands today
continues to suggest that stocks are at or near the top of the individual's
subjective value list. The bearish argument is that this premium should
rise to better reflect the uncertainty in corporate earnings streams.
Bears (at least we do) argue that the factors that have contributed to
the low ERP are not sustainable despite ongoing policy efforts to extend
their influence. Such an outlook means that shares are still overvalued
today.
If, for instance, the market is valuing
yesterday's earnings at 40 times, which we all know is a historical extreme,
in a benign interest rate and price environment, what will it value tomorrow's
earnings at (per share) if prices and interest rates rise tomorrow? Those
earnings better come in good, that's all we can say, speaking for the
bears.
Before the bull market peaked visibly in
2000, the averages would often run up ahead of the start of earnings season
(after the end of each quarter). When they did they would often correct
during or after the end of the profit announcements. However, each pre
season run up ended at higher levels than the prior quarter's run because
it was a bull market. Consequently, the risk to playing this game of betting
on earnings was low, at the time, and so confidence grew and grew, quarter
in and quarter out. Every future bet would take into account prior bullish
outcomes before being assessed and laid.
Today
we're in reverse. Since mid 2000, the S&P 500 rallied into earnings season
4 times (out of the past seven quarters): the summer rally of 2000, the
May/June rally in 2001, the post 9-11 rally that ended once 4th quarter
profits for 2002 were being announced, and the February/March 2002 blue
chip rally we dubbed the "Wind Up" at the time. While the correction
in stock prices after the fourth quarter ended did not force the bulls
to give back all of their profits from the post 9-11 bubble, the Wind
Up that began ahead of the last quarter culminated in lower lows, as did
all the others since 2000.
The point is that confidence in this betting
game is probably increasingly impaired as a consequence of poor betting
outcomes in the recent past. I think it will take more than McDonald's
to bring confidence in this game back, at today's valuations. The purpose
of assessing this is for short term players wondering whether or not the
bulls are going to be able to sustain a rally into July.
Foreign currency
profits! That's the new line. To be sure, bank stocks probably saw impetus
from a bounce in the tech sector as well as the overall market. Stocks
that had been trashed in recent sessions bounced the most, leaving McDonald's,
or one of the Dow's few better performers this year, in fifteenth place
(of the 30 Industrials) on Monday.
Although we can rarely tell how far these
kinds of rallies will extend when they start, the bears haven't relinquished
the reigns quite yet, fundamentally or technically.
The only damage that has been done to the
bearish case is that the Dow recovered key bullish support at 9529, after
closing below it on Friday for the first time in seven months. That was
the technical significance of Monday's action. If bulls can hold that
fort, they can neutralize the bearish momentum for the time being. Note
that we're not saying they could or can't. We're just stating a supposition.
I think they'll (the bulls) fail at that,
but will be on watch to reassess that judgment if needs be.
For the moment we can suggest that matching
or beating expectations in the 2nd quarter is likely to be a moot case
for the bulls at this point.
At any rate,
the enthusiasm on Wall Street for the better earnings outlook in connection
with the weaker dollar resulted in a stronger dollar Monday.
The dollar's biggest support came from gains against the Rand and Australian
dollar.
Otherwise the dollar index was up only
marginally - hardly enough to count for much so far. But Wall Street's
rally was enough to splash some cold water on gold bulls.
I felt it first thing in the morning. For,
we know that any convincing bull run on Wall Street is likely to drag
the dollar up with it. That's the correct ball to keep your eyes on if
they're not already there - in our opinion.
Gold prices finished a touch lower at about
$318, while most gold indexes gave up from three to five percent on Monday.
All the gold indexes finished near last week's lows but (gold) bulls were
able to hold those lows for now.
The
rally in US shares closed at its highs on Monday, leaving the global share
merry-go-round to bid up enthusiasm further overnight. Japan was off more
than 2% Monday morning as well, and barring typical bear market news to
spoil the moment the Dow rally could put that slide sharply in reverse
in Tokyo by morning.
If Tuesday's
open looks strong in New York it is possible the correction in gold shares
could deepen. The short-term patterns in these charts appear to have a
bearish bias developing at the moment, and if last week's lows are taken
out, these shares could drop by another 10 to 20 percent before the swoon
ends.
If that kind of drop in value would hurt
then it would be prudent to sell some shares sooner than later. We are
increasingly confident of the inverse relationship between gold shares
and the Dow, but any investor must realize that if the Dow were to crash
tomorrow the equity risk premium could rise across the board so that the
gold stocks would get it too.
It's important to be in a position where
one can be comfortable with corrections like that at times when the outlook
is not entirely clear. Our outlook discounts (as in forget about it) a
significant Dow recovery, and portends a further rout after the indexes
tap nearby resistance levels, plus or minus. There is no reason to reduce
our 30% allocation in gold shares unless our outlook for the Dow and/or
dollar changed in the near or long term.
One thing to watch out for is dollar intervention,
despite the controversy surrounding dollar policy in recent months. Nobody
expects it, perhaps because of that.
The fact is that the stakes are high, if
only because the Plunge Protection Team must increasingly have a lot of
paper to get off. Anything could happen, and anything might be tried.
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
June 19, 2002
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Goldenbar Report: is not a registered
advisory service and does not give investment advice. Our comments are an
expression of opinion only and should not be construed in any manner whatsoever
as recommendations to buy or sell a stock, option, future, bond, commodity
or any other financial instrument at any time. While we believe our statements
to be true, they always depend on the reliability of our own credible sources.
Of course, we recommend that you consult with a qualified investment advisor,
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before making any investment decisions, and barring that, we encourage you
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