March 12, 2004 -- Question -- OK, Russell, the stock market has backed off following its uncorrected rise from its March 2003 low. So why do you think this is such a serious reversal, rather than just a long overdue correction?
Answer -- At the October low of 2002. the S&P was selling at slightly over 30 times earnings while yielding 1.90%.
The Dow Theory puts emphasis on values above all else, including price movements. Bull markets start with stocks at great values. Bear markets start with stocks at overvalued levels.
Bear markets typically end with the Dow and the S&P selling at 5 to 10 times earnings while yielding 5% to 6%. At the lows of 2002, the valuation level were ridiculously high, higher than what we've seen at previous bull market tops. For this reason, I'm of the opinion that the bear market did not end at the 2002 lows. No bear market in history ever ended with stocks at overvalued levels.
If that's the case, then the rise from the September 2002 was simply an upward correction or interruption in a continuing bear market. As I see it, the recent new highs in the Dow unconfirmed by the Transports have called the top for this upward correction in a continuing bear market. If the top is indeed in place, then it stands to reason that the forces of the bear are currently in the process of taking over again.
Question -- Earnings have expanded greatly here in 2004 over 2003. Even if earnings level off some, wouldn't this suggest a higher stock market or at worst a level stock market?
Answer -- First, the stock market is a discounting mechanism, and all estimates of future earnings are simply guesses -- and very often wrong guesses. Furthermore, the major factor in the major swings in stock prices is not earnings, it's price/earnings ratios -- or what investors are willing to pay for earnings.
At previous bull market peaks, investors were very bullish and were willing to pay up to 20 times earnings for the S&P. At previous bear market lows, investors turned very bearish, and have paid as little at 5 to 7 times earnings.
The history of markets is a history of the broad, multi-year swings from extreme optimism to extreme pessimism and then back to extreme optimism again. In my studies over 50 years, these are the only guaranteed "cycle" that I have ever subscribed to. All other cycles are "iffy," or to put it more cynically, and I've said this many times before, "Cycles, where are they when you need them?"
Right now the S&P is selling at slightly above 23 times earnings. Sooner or later, one way or the other, today's extreme bullishness will give way to extreme bearishness. When this happens, my guess is that price/earnings on the S&P will decline to 5 to 8. If, for the sake of argument, this bear market ends at 8 times S&P earnings, then even if earnings hold at the current level (which is extremely doubtful), the S&P could lose two-thirds of its current value.
It's my guess that some time over the coming ten years we will see investor sentiment swing from today's current extreme optimism to a period of extreme pessimism. This alone suggests that holding stocks here is a long-term LOSING proposition. This leaves us with two reasonable choices -- become an expert trader, or sit with cash and gold until this bear market ends.
Question -- Russell, that is one very boring scenario.
Answer -- Are you in this business for excitement or for handling your money intelligently. If you want excitement, my suggestion is -- go to the nearest Indian casino or to Las Vegas. There you can lose your money in a few hours or less. My job is to offer investment advice, not excitement. But wait -- it can be exciting. It's sad but exciting to see a great bear market wipe out trillions of dollar of assets -- particularly if what's being wiped out is not your own assets.
Question -- I'm writing this in the morning half an hour after the opening, and the Dow is up 64 points already. What do you make of this? Is the decline over?
Answer -- Five trading days ago on March 5 the Dow closed at 10595. Yesterday the Dow closed at 10128. That a loss of 467 points in four days. At that rate of decline, the Dow WOULD DISAPPEAR in a little over 80 days. I don't think that is going to happen. Which is why we have upward corrections in primary bear markets. Bear markets don't go down in straight lines, they go down deceptively and erratically. Of course, bull markets rise in the same way.
This, by the way, is why I've said that the single hardest thing to do is to buy early in a bull market and ride the bull market all the way to somewhere near the top. By the same token, its extremely hard to get out of a bull market near the top and then stay out of the bear market that follows -- until somewhere near the bottom.
Question -- OK, the McClellan Oscillator plunged to minus 202 yesterday, and the market is severely oversold. Now a rally is on. What will you be watching?
Answer -- I'll be watching my PTI, my Big Money Breadth Index, my Most Active Stock Index, the histograms on the various averages, and obviously I'll be watching for any discrepancies and divergences. In other words, I want to judge the strength of the rally compared with the strength of the preceding decline.
You'll note in my reports over recent weeks that I didn't say that the market is now ready to collapse. I said that I believe "the top is in," meaning that we've seen the best of the upside. The market should now enter a broad decline -- while taking the most number of people with it. To do that, the market must somehow keep people hoping. The bear is expert at keeping investors hoping.
I want to included two charts on this site. The first is the Wilshire 5000 Index which will give us an overall view of the entire market since the Wilshire is made up of actually 6000 stocks on the NYSE, the Nasdaq and the Amex.
Below we see the Wilshire. I analyze the action as a "triple top," and then a sharp break below two previous lows and below the 50-day moving average (blue line). Note that each peak was accompanied by a lower peak in the RSI. MACD at the bottom of the chart shows the same three declining peaks. The Wilshire has topped out.
The second chart is a very important one -- here we see the Morgan Stanley Consumer Index. As you know, consumer buying has been the backbone of the so-called "recovery" in the stock market. On that basis, we have to take the action of this chart seriously. The Consumer Index has now dived below its 50-day MA, and the Index looks to me as though it's in trouble. Note how far the Index is above its 200-day MA (the rising red line). I'd be surprised if this Index could work its way back to the highs. The last thing Greenspan wants is US consumers pulling back on the excessive buying. This chart says that's just what consumers may be doing.
TODAY'S MARKET ACTION -- I said yesterday that with the McClellan Oscillator at minus 202, the market was severely oversold, and that turned out to be the case. Result -- a rally today. I should have remembered that when the downside pressure is strong enough to push my PTI into it bearish mode, the market is usually oversold -- thus, PTI "sell signals" often tend to be followed by rallies -- which was the case today. Next week we'll see just how good the rebound turns out to be.
My PTI was up 6 today to 5401, which takes it 1 point above its moving average. I call the PTI neutral to negative (negative because of yesterday's sell signal).
The Dow rebounded up 111.70 to 10240.08. Only two Dow stocks were down today, one of which was MO down 2.01.
April crude was down .59 to 36.19.
Transports surged 67.09 to 2863.09.
Utilities were up 1.90 to 274.83.
There were 2405 advances and 918 declines. Up volume was 83.1% of up + down volume, a good upside day, but with volume shrinking.
There were 68 new highs and 18 new lows. When new lows outnumber new highs, we'll know that this market is really rolling over. Watch the new lows. Today's 18 new lows was the highest number since August 25 of last year!
Total NYSE volume slipped to 1.31 billion shares.
S&P was up 13.82 to 1120.60.
Nasdaq was up 40.82 to 1984.71 on a sliding 1.66 billion shares.
My Big Money Breadth Index was up 8 to 48437,
June Dollar Index was up .69 to 89.60. June euro was down .99 121.8. June yen was up .04 to 90.47.
German DAX was up 10 to 3915. June Nikkei was up 225 to 11300.
Bonds were lower. June 30 year T-bond was down 8 ticks to 114.30 to yield 4.71%. June 10 year T-note was down 2 ticks to 115.26 to yield 3.76%.
April gold was down 5.40 to 395.60. May silver was down 13 to 7.06. April platinum was up 4.30 to 907.10. June palladium was up .70 to 278.85.
Gold/Dollar Index was down 9.40 to 441.
One share of the Dow buys 25.88 ounces of gold.
Gold advance-decline line was down 2 to 1334.
XAU was down .35 to 98.53. HUI was down .94 to 222.04.
AEM up. 20, AU down .32, CDE up .11, GG up .01, GLG up .27, GSS down .01, KGC down .04, NEM down .06, RGLD u .12, SSRI up .38.
Gold stocks gave very little despite the 5.40 drop in April gold.
STOCKS -- My Most Active Stock Index was up 11 to 410.
The five most active stocks on the NYSE were -- NT up .02, LU up .10, GE up.11, PFE down .08, MO down 2.15.
VIX dropped a surprisingly large 2.46 to 18.21. I take this as a sign that the desire for downside protection has fallen away very rapidly, and this is not a bullish indication.
McClellan Oscillator was up 27 to minus 29 and still negative but also still oversold.
CONCLUSION -- There were obviously a lot of shorts in this market all playing for a continuation of last week's slide. When it didn't happened, there was short covering -- and particularly short covering to be OUT of the market over the weekend. I continue to believe that the top is IN for this market, but we could have a few more days of rally to erase the severely oversold condition.
I thought the two most significant items today were the drop-off in volume and the plunge in the VIX.
That should wind up the week.
Richard Russell
Editor-in-chief - DOW THEORY LETTERS
www.dowtheoryletters.com/dtlol.nsfMarch 12, 2004
The inimitable and venerable Mr. Russell gained wide recognition via a series of over 30 Dow Theory and technical articles that he wrote for Barron's during the late-'50s through the '90s. Through Barron's and via word of mouth, he gained a wide following. Russell was the first (in 1960) to recommend gold stocks. He called the top of the 1949-'66 bull market. And almost to the day he called the bottom of the great 1972-'74 bear market, and the beginning of the great bull market which started in December 1974.
