first majestic silver

Bear Market is Like Being Sandpapered to Death

November 29, 2000

A true bear market is like being sandpapered to death. It takes at least one step up for every three steps down. And so far, this bear is pretty much following that precedent. In 1969-70, seven of the eighteen months were up-months where the DJIA closed higher. In 1973-74, eight of the twenty-three months were up-months for almost exactly a 1:3 ratio. So far, since the DJIA peak in January, three of the past nine months have been up-months - matching that 1:3 ratio.

There are values starting to appear in this market, and we've given a preliminary review of some of them in recent issues, including Teleflex, Diebold, and Washington Mutual. But for the most part, such "value" is being shunned and ignored. That will persist until the depths of the bear and, along the way, blood is already running in the street for companies like Xerox (featured on page 6). We're not enamored with the stock, but strongly believe the gloom and doom has been deeply overdone. Yes, the company has debt problems - $11 billion of which will be eliminated if Xerox sells its financing business. Meanwhile though, with revenues rivaling those of Microsoft, Xerox is selling at a depressed total valuation equal to just 3 months of revenues.

Don't judge our view of this company from the near-term...but looking back a couple years from now. And keep the contrarian lesson of Union Carbide forever in the back of your mind: Crippled by debt in the early 80s, and culminating in the Bhopal accident of December 1984, Union Carbide stock clawed its way out of that despair by rising 4-fold over the next thirty months:

Waiting For The Bull [watching ice melt]

We can only make objective guesstimates of the course this bear market will take. However, we do know the ingredients that characteristically mark the birth of a new bull market. And almost none are present yet.

Summarized in Table [7] below, only one of the seven blocks has dropped into place. Our MEP Monetary Model (not shown), which measures Federal Reserve policy, remains in the negative region. And even though ECRI's Future Inflation Gauge fell for the 5th straight month in September, this past week's upside surprises in the PPI (+0.9%) and CPI (+0.5%) should keep the Federal Reserve on the sidelines for the foreseeable future. In other words, don't look for any positive shift in monetary policy, or a bullish signal from our MEP, until well into the new year.

The one block that has dropped into place is Condition #2 with >6 months of "DISTRIBUTION" (*2) in our Negative Leadership Composite [8] at the bottom of page 5. Of course, that in itself is bearish as it denotes bear market distribution is underway. But at some point next year, we expect this model to turn around and form a bullish "SELLING VACUUM" (*1) to appear in the upper half of this graph.

In Condition #3, bond models are on the verge of a bullish reversal but have taken a decisively bearish kick in the past couple weeks. For Condition #4, the Coppock Guide [9] is slowly and methodically inching toward the "0" level where the next upturn would signal a low-risk buying opportunity, but that turning point appears to be at least 6 months or more in the future.

We believe Condition #5 will be one of the decisive factors in Federal Reserve policy and in marking the starting point of the next bull market. Figure 10 shows the 33 years of Consumer Confidence data, along with all the "1st Discount Rate cuts" made by the Federal Reserve (after a series of hikes). Note that in most cases, the Fed will wait for proof-positive that the economy is sinking (Consumer Confidence is falling) before jumping in with an aggressive easing. After making the "easy money" mistake following the Asian Crisis, we don't think Greenspan is about to cut interest rates with Consumer Confidence hovering less than 3 points from its record high of early this year.

Conditions #6 and #7 are simply contrarian guidelines. The "Best Buy" opportunities always come in the depths of arecession (usually just as the media headlines recognize it), and after there's been a healthy washout in investor exuberance - in other words a bear market. Although the Nasdaq's 39% decline certainly qualifies as a bear market, it would be hard to argue -with the DJIA and S&P 500 off only 16%-that there's been much of a washout. There certainly hasn't been in the Margin Debt and Nasdaq valuation shown on page 2.

So for now, the best strategy is one focused on safety and patience... waiting and watching as the bear slowly does its work.

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