Bull's Rebuttal
So what if the Dow goes up by 15% over
the next three to four months. That's no consolation to anyone that watched
it drop 30% in the past four months. To recover losses like that the average
would have to rise 40% off its recent bottom, near 7600. Besides, a fifteen
percent move off that bottom means an 8740 target, which is only 40 points
away. In less than a week the bulls erased one third of their prior 4
months worth of losses; it is a feral display of volatility. The gains
were broad during Monday's dash of usual end of the month momentum, or
at least 'usual' during the bull market. The Dow average gained 447 points.
All
the major US stock market averages gained more than five percent save
the Dow Utility Average, which gained only 1.4% on Monday. Advancers led
decliners 9:2, and nearly 2 billion shares changed hands on the big board.
It was a solid bullish romp. Technically,
the move was significant provided it was not related to month end nonsense,
but even so, the significance was minor.
What I mean is that bears still have control
over the short term down trend, defined by 925 on the S&P 500, 1420 for
the Nasdaq composite, 490 in the NYSE composite, and 8700 for the Dow
Jones Industrials, which closed just above resistance at 8712 Monday.
The rest of the major US market averages closed below nearby resistance,
despite the bullish four-day affair so far.
Still, the surprising nature of the momentum
should be disturbing to the bears. If so they may find solace in the sentiment
data. The S&P 500 Call-Put ratio reveals just about the same amount of
bullish sentiment today as it did at May's bullish levels - at the tail
end of a small two week rising wedge in the average that represented the
bullish rebuttal to an early May break down from a (intermediate) double
top.
The CBOE put-call ratio registers a less
bullish reading than it did in May, but infers as much bullish sentiment
as at any time since May. A reading in this statistic below 0.60 has proven
to be a reliable sell signal so far this year.
The
current reading below the 200 day moving average (blue line in the chart)
only means to us that the indicator is closer to giving us a sell signal
than a buy signal, and this while the bulls have hardly put a dent in
the bearish technical arguments.
Keep 'em bullish boys. One or two more
days of this could do it. Or we could get a turn around for the bulls
that results in a bear market rally, sort of like the summer rally everyone's
been expecting, only from far lower levels. Or we could get a brand new
bull market.
But I don't think this is much more than
a bullish rebuttal while the market makes its invariable transition from
the Tech sector to the mighty Dow for its bearish leadership.
We've argued for almost a year that the
Dow is likely to take over the bear market's leadership job as we enter
into the next phase of the bear market, where the broad market's losses
tend to accelerate. What better time for this transition than when these
averages fall through their 9-11 lows to new four and five year lows,
signaling an extension to the two year primary bear market?
The bulls of course still largely insist
the transition will never happen, and also that the worst of the bear
market be behind us.
From a technical standpoint I think it's
almost necessary to see the Dow capitulate, meaning relative to the broad
market, before we can legitimately call for the end of a bear market.
I labor under the impression that the Dow Industrials fall last in a bear
market (primary), but normally lead us out of it also.
Stocks such as IBM for instance were able
to resist the technology bear until April of this year. It just broke
down, as did the rest of the market soon afterward - in July (this month)
all the averages sent us another primary bear market signal, but only
the Dow had recovered it since.
When something breaks out or breaks down,
usually we look for confirmation, which often means an assessment of the
rebuttal. The current stock market rally is thus a rebuttal to July's
primary sell signal, in our view. The challenge facing the bulls is for
them to take back all of July's losses in order to show us that they weren't
real. But it's going to be tough to sell us on the idea that the bear
market is over, particularly to the extent the argument is premised on
the idea the Dow never participated in the bubble in the first place.
Fallacious Bubbleheads
With religious fervor, Wall Street media henchmen (and women) have been
applying Mr. Greenspan's bubble model to the markets. The model was first
developed after his "irrational exuberance" speech in 1996 in which he
forecast a major market top boosted him into top spot for the lame duck
economic forecaster of the year award yet again (perhaps the award is
a prerequisite for the transition to a dove). In 1996 you see, the Dow
was hovering around 5500. His speech resulted in one last dip to near
5300 then the market was never going to see those levels again, to this
day.
From that day forward, a bubble definition
was only to be applied in hindsight, for if the Mighty Quinn couldn't
tell the difference ahead of time, no one could. From that day forward,
millions of individual investors making investment decisions throughout
the land could not be wrong collectively. In other words, markets were
always going to be right, just like it says in the textbooks.
The markets have become so efficient that
it is irrelevant whether any or all of these individual investors understand
the way that inflation works itself through the system because collectively
they do understand. It doesn't matter that inflation affects the individual's
valuation judgment, or that it breeds irrational exuberance and manifests
as malinvestment and debased currency. None of that matters because the
markets work just like they say in the textbooks, efficiently. They're
never wrong.
So why are they so volatile if they're
so efficient? To which the devout bull would probably answer they
weren't volatile until the recent crisis of confidence, commonly attributed
to the corporate crime wave, as if it didn't exist on the way up.
The aggressive accounting tactics, I'll
say it again hoping someone will hear, were clearly visible during the
bull market. But the collective brilliance of the market failed to see
them for what they were: a consequence of the bubble, which resulted from
the inflation that the Fed is supposed to monitor. So of course, if the
Greenspan Fed can't see a bubble forming right under its collective feet
while their "pedal is to the metal" at the local printing presses how
on earth could anyone else see one? Or so goes the parable.
In true form, one analyst after another
says it. At first, it's absurdity gets a shake of the head, the next time
it is heard, it gets a twitch of the lip, the third time it's heard it
gets a turn of the head combined with the wonder of how these people can
say it over and over again. It must be that nobody has questioned it.
So we will.
The nineties stock market bubble was not
simply isolated to the technology sector!!
It's just that you'll never get 150 P/E
ratios out of the blue chips until they're profits disappear altogether.
Even the 1929 stock market bubble resulted in only a P/E ratio just above
20. It wasn't until after the crash that the ratio spiked up to over 200
on several occasions in the early thirties. During the late fifties, according
to data from the chart above (just ahead of the go-go era for tech stocks)
the Dow Industrials got up to about a 25 times trailing earnings multiple.
I'm sure it was cheap with respect to earnings outlooks. Excluding the
spikes in this ratio usually attributable to profits depressions, the
only other time the Dow Industrials were priced as high during their boom
phase was just before the 1987 crash, during the late nineties, and now.
There are two ways to argue against us.
The first is that many Dow stocks are also technology stocks and they
heavily influence the multiple on the Dow average. The second is that
the P/E ratio is a far too rudimentary measure of value to be useful in
today's world of high finance.
Indeed there are seven Dow components we
would call pure technology plays. They are Hewlett Packard, IBM, Intel,
Microsoft, SBC Communications, AT&T, and United Technologies. These stocks
were priced at between 30 and 60 times earnings during the best part of
the nineties boom in 1999.
But these aren't fly by night operations.
To imply that the impact on the rest of the economy, and other markets,
from the valuation distortions reminiscent in only these stocks was neutral
is a bullishly biased inference today.
Moreover, stocks like Du Pont went for
50 times earnings in 1998. American Express went for 30 times earnings
in 1999; Disney went for better than 70 times earnings in early 2000;
GE went for 45 times earnings by mid 2000; Home Depot went for 60 times
earnings in early 2000; Johnson & Johnson traded at almost 40 times earnings
during early 1999; Coca Cola traded at 50 times earnings from 1998 to
2000 then it traded up to almost 90 times earnings in 2000 when earnings
began to fall; McDonald's traded up to about 38 times earnings in early
1999; Merck traded just higher than 35 times earnings in 1999; Wal-Mart
traded for 50 times earnings in 1999. Should we continue?
Reuters-Bridge
The list is long, and the bubble permeated
the entire stock market, not just the tech sector. Mostly the tech sector,
but not "just." Even 3M, the epitome of old economy stocks in the Dow,
traded for 28 times earnings in 1999, and today trades for almost 30 times
earnings. Clearly then, it wasn't only the technology sector that influenced
the Dow's multiple during the height of the boom, or even now.
To say that the bubble is isolated to the
technology sector is a fallacy. What's more, it's probably damage control
by our economic managers to promote that fallacy, as if the inflation
was still under control.
But even if it isn't that, it is the rudimentary
application of the Greenspan model for a bubble, which the world's blue
chip analysts are blindly applying to the markets that have now come down
the most. Since the tech sector has given up most of its gains, that is
where the bubble must have been, right? The Dow has been dropping less
quickly so therefore it can't be a bubble yet. This application of hindsight
bubble-o-nomics is going to acknowledge a bubble only if and when the
blue chips fall much further.
Of course, there are better measures of
value than the simple P/E ratio. But they'll all show similar results
in hindsight. In our view, value is subjective anyway, so it is not the
actual number that matters, but which way it's likely to go that does.
Nonetheless, this is a big topic and one we'll leave for subscribers in
a future issue.
It is our view at the moment that the price
of gold & gold shares have discounted a material bounce in the Dow as
well the US dollar, both of which are underway. We don't share the enthusiasm
for Wall Street assets that the 4-day bullish affair implies that others
have at the moment.
Until Monday, the bond markets were able
to hold on to their gains. But Treasuries were knocked back a few notches
as confidence did in fact grow in a stock market recovery on Monday.
Further losses in the bond are likely to
first signal a rise in this confidence, but then it is likely that their
rising yields will also lower the equity risk premium yet again.
The persistent decoupling of these two
assets will continue until the bear market has run its course. The sticky
bond yield has been an efficient primary controlling variable for equity
values, and we expect it to continue so.
Well, who needs the Fed anyway?
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
July 31, 2002
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