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Richard Russell on the Markets

October 15, 2002

I've been doing a lot of thinking (what else is new?). In fact, I woke up at 2AM Saturday morning, and I realized that something was bothering me. What could be bothering me? You guessed it, the stock market and the action of the market last week.

Here are some of my thoughts.

It's now (finally) conceded that this is a bear market. Not only is it a bear market, but it's widely conceded that this is a BIG bear market, and the most costly bear market since the 1930s. Even CNBC now refers to "the bear market."

I noted that on Friday the CNBC reporters, despite two big rallies on Thursday and Friday, were very careful to label the rallies as bear market rallies that might not carry much further. In other words, these former cheerleaders for the bull market were becoming careful, even skeptical. The bear market had beaten the perma-bull attitude out of them. The CNBC reporters, I thought, even had a beaten look about them. The were tired of appearing stupid in the face of the bear.

Next, I note that business is turning "iffy." The business news is not awful, but it's not that great either. Consumers are slowing down. There's a lot of talk about people ("friends") losing their jobs. Corporate earnings have caved in. Corruption is turning up everywhere. "Who can trust these greedy, corrupt CEOs?"

Anyway, what I'm saying is that the bullish sentiment is fading. People are noticing "that something different is going on."

The Financial Times last week saw fit to run a piece about my friend, Bob Prechter, who has been talking about the Dow ultimately breaking below 1000. The article didn't make fun of Robert, the article took him seriously -- even including a picture of Robert along with the article.

Bond maven Bill Gross of Pimco (widely quoted now and accepted as a very wise man) recently warned that the Dow was worth about 5000. Nobody laughed at Gross. I had the feeling that his "5000" forecast was generally taken very seriously.

To sum it all up, the general sentiment toward the market and the economy has changed. The bear market is accepted. And I have to wonder -- is it time for the bear market to give the world some hope? Is it time for the bulls to cross-up the bears? I think there's at least a chance that that may be where we are.

Last Wednesday, we had a really rotten day on the market -- down volume on the NYSE was 85.7% of the total of upside + downside volume. Six stocks on the NYSE declined on that day for every one stock that rallied. It was a pretty bad day.

Then Thursday, the next day, we had a good rally day and upside volume was 80% of the total of upside + downside volume. On Thursday my Most Active Stock Index (NYSE) rose by 13. That was a strong showing for this indicator -- for a change.

On Friday we had an even stronger day with upside volume being an impressive 89.7% of upside + downside volume. Mmmm. Again I got a plus 13 on my Most Active Stock Index.

Last week the Transports, after resisting for months, finally confirmed the Industrials by breaking to new lows below their September lows. Last week my PTI broke below its preceding July low.

Yet there was no follow through on the downside. Only the two strong days of last Thursday and Friday.

The McClellan Oscillator has been severely oversold. Lowry's short-term indicators are very oversold. My Big Money Breadth Index (an advance-decline line of the 10 largest-cap stocks in the S&P) has totally collapsed.

The market has been down for six consecutive months. For six out of the last seven weeks the market has been down.

And I wondered -- is it time for the bear to do a bit of double-crossing? My answer -- it could be, it just could be.

There are thousands of hedge funds now operating. They haven't done well this year. I understand that the average hedge fund is down around 1.5% this year, their first rotten year in a while.

Volatility has been sky-high at around 50. The option-writers are charging big money to protect themselves against this wild market that can run 200 Dow points or more (up or down) day after day.

OK, here's what I'm thinking. For my average subscriber, you're probably better off sitting tight. I presented all the reasons why it makes sense not to try to "beat the bear." Part of it is for tax reasons. Part of it is for psychological reasons. And part of it is that most speculators end up as losers. This is particularly true when volatility is running this high. A high-volatility stock market can keep you awake at night -- even if you are right.

But I have a certain number of subscribers who have lots of money, and they will always be "playing" the market. For those people, and I assume you are pretty much OUT of the market now as per my advice, this is not a bad time to speculate.

Here's my suggestion. The Dow has actually been weaker than the S&P of late. But it's hard to imagine any rally going anywhere without the Dow. So my suggestion is to buy a Diamond (DIA) or so (how many depends on you) on the Amex at the opening and one or more at the close of Monday's trading. And put a stop roughly 8% below your buy price. A DIA is a proxy for the Dow.

I call that, "getting your toe in the water." If the market continues higher, you can always add to your initial position. If the market comes back to test last week's close, there's a good chance you'll get stopped out, but that's part of the game, and you don't play this game unless you have the stomach to take small losses.

My personal problem is this. I don't gamble, and I rarely speculate. When I see real values, I'll take a BIG position. The last big position I've personally taken is when I put probably 80% of my liquid assets into top-grade municipal bonds about two years ago. That proved to be one of the best investments I've ever made.

When I bought those bonds I considered the upside and the downside. The downside was that if I was wrong, if the bonds went down, at least I would be receiving attractive tax-free interest. For me, that interest was worth 8-9% in taxable return. I thought it was a good deal. On top of that, I was convinced that my Dow Theory interpretation was correct -- that we were in a primary bear market. Because we were in a bear market, I thought that the Fed would want to drive interest rates down.

That's what the Fed did, the bond market took off on a huge rally, and everything worked out fine. I avoided the disaster that befell common stocks, and I had a great ride with the bonds. And I got paid for riding via tax-free interest.

All along, I made no secret of what I was doing. I told my subscribers over and over again to buy bonds.

Then around a year-and-a-half ago (or was it longer?) I told subscribers to buy some gold shares. I told them that some of the shares were so cheap that they could be considered "perpetual warrants." I hope you guys and gals are holding those "cheapie" golds. You put 'em away and forget about them. In fact, there are still some cheap little gold shares around, stocks like KGC, BGO, GSS. Some of these sell for around a buck.

Maybe it's time for the PTI to move up and test its moving average. Maybe it's time for the market to make mince-meat out of a large portion of shorts that are in this market. Maybe it's time for the bear to give the battered bulls a little hope. Maybe it's time for Mr. Bear to bring in a fresh batch of "investors" who believe that we've seen the end of the bear market.

At any rate, we may have enough evidence now (sprinkled with a bit of intuition) to believe that we're on the edge of a decent bear market rally. But what do I know. I'm just a writer wrestling with the toughest opponent in the world -- that monster that we call "the stock market."

Items written Saturday morning after I've gathered the newspapers --

From the London Financial Times' front page -- "Brokerage Group Hit by $250 million Damages Verdict. Award against Prudential by Ohio jury signals Middle America's growing hostility to Wall Street." Russell comment -- the anger is building, people tend to get angry when they lose their money, and they usually want to blame somebody else, not their own stupidity. Typical bear market reactions.

From last week's NY Times -- "Results Are Glum at Dow Jones, and Outlook Is Gloomy. Dow Jones, publisher of the Wall Street Journal and Barron's, reported third quarter net income yesterday of $2.4 million, a drop of about 85% from the $16.7 million in the quarter a year ago." Russell Comment -- And you wonder why the Journal and particularlyBarron's, have continued to print bullish articles in the face of the worst bear market since the 1930s? It could be your job, dummy, so stay bullish.

From today's headline in Investor's Business Daily -- "2nd Great Up Session Raises Investor Hopes That the Worst is Over." Russell Comment -- It could be your job, dummy, so stay bullish.

Headline from a major article in today's Barron's -- "Torn and Frayed. Beaten-down financial stocks may be ready for a turn -- and with them the market as a whole." Russell Comment -- It could be your job, dummy, so stay bullish.

OK, enough nonsense. It's obvious that the bear market is beginning to gnaw at the guts of these publications, and it's obvious that the editors, reporters and writers have every reason to want the bull to return.

It's all very interesting, but I don't know whether it has much to do with whether the market is ready to rally.

One item in Barron's does bother me, and it bothers me a lot. It's the Confidence Index, which is a good indication of where bond-buyers are voting with their money. When the bond crowd turns bearish, they move from lesser-grade bonds to the highest-grade bonds. The Confidence Index is the ratio of the yields of the two groups. A declining Confidence Index means that the bond crowd is moving out of the medium-grade bonds to the highest grade bonds (and thereby sacrificing yield as they make the move to safety).

The CI dropped from last week's low reading of 68.0 to this week's scary low of 66.4 I gasped when I saw this figure.

This is the lowest reading since the 1940s! I may be the last person on earth who follows the CI, but back in the '60s when the CI had a big following we used to say that the CI preceded the trend of the market by two to four months. That sticks in my mind. And it bothers me no end to realize that the CI is saying that the bond market IS VERY FRIGHTENED BY THE CREDIT PICTURE AHEAD. THE BOND MARKET CONTINUES TO MOVE TOWARD INCREASING SAFETY.

Again, how does this affect the stock market? How does this affect the possibility of a good rally ahead? My guess is that if we get this rally, it's not going to be a long-lived rally. There's too much potential trouble ahead. The plunging Confidence Index suggests it.

So yeah, the market can rally. The market could well be ready to rally. The bear is drooling to pull in more suckers and in the process wipe out some of that army of wise-ass short sellers. But I'd be very limited as how big a money-pot I'd risk as far as playing the upside. That plunging Confidence Index bothers me.

The true (common stocks only) advance-decline ratio figures for last week were -- Oct. 7 minus 5.90; Oct. 87 minus 5.89; Oct. 9 minus 6.50; Oct. 10 minus 6.17; Oct. 11 minus 5.60.

The S&P was selling last week at 31.25 times trailing earnings while yielding 1.90%. That P/E of 31.25 could only be justified by a massive surge in forthcoming earnings. I don't think there's a chance of that happening.

Conclusion -- stocks continue to be flagrantly overpriced. But the adjustment doesn't happen overnight. It generally takes a big bear market to bring about the required adjustment. Which is what has been happening.

Note -- in bear markets the "adjustment" usually goes too far on the downside, which is what gives us P/Es of 5 or 6 or 7 at the bear market bottom.

One more item -- on the Lab page of Barron's under Federal Reserve Date Bank there's an item labeled "Foreign Holdings of US Debt." I've been watching these figures. This week the figure was minus $4.665 billion. A year ago for the same week it was plus $76.290 billion. In other words, a year ago foreigners were increasing their holdings of US debt. They are now beginning to unload US debt. This could be trouble if it continues, and it looks like the trend towards unloading US debt is continuing.

Last item --according to today's NY Times' front page headline -- IRAQ, IN RESPONSE, FAILS TO APPROVE INSPECTION TERMS. It demands more talks. Baghdad's Reluctance on UN Conditions Is Said to Annoy Russia and France."

I don't know what in hell Saddam is thinking about -- but I believe I can hear a strange muffled boom-boom sound coming from the Bush White House. What could it be? Oh, I know what that sound is -- I've heard it before. That muffled boom-boom is the sound of the drums of war.


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