Bizarre Wall Street Analysis

October 14, 1999

Technical, fundamental and monetary factors . . . are all the primary environmental indicators that help investors and analysts interpret conditions that exist in the equity and debt arenas, and thus may impact the direction of future policy and price changes. All these areas, which includes "valuation" criteria (which is fundamental, as are earnings) have been correctly assessed here as negative or deteriorating overall commencing in April, this year. Interestingly, even when bullish without qualification within 24 hours of the low almost at this point last year, we emphasized that the odds favored only a move-up into early 1999 before risk, on a rotational basis, would return.

In the process, we've done our best (often nailing both short-term highs and also some lows), to shepherd investor thinking in a way that would maximize opportunity when clear, and protect the core of their hard-earned work for years establishing their asset-base. The variables for a further upside never existed significantly this year; and we said so, though given the mania of moments of course, not everyone wanted to remember that "preservation of capital" is first and foremost a requirement for investors (and we would argue money managers as well), with speculation very far down on the list, other than for whom it is a normal pursuit of their daily-basis activities. (Also, not tempted to get excited into extreme weakness, which is a reward for shorting the rebound as forecast last Monday, we're contemplating a spot to nail-down huge daily-basis short-sale gains from 1350 S&P levels, possibly buying for a rebound, and then short-sales anew as determined.)

Bull market psychology was (is?) deeply entrenched in a way that provoked one of our regular readers to observe yesterday that we give the majority of investors too much credit, in assuming that they have the capacity to interrelate markets and understand the shifting interrelating factors that can impact stock and bond prices. Well, we would hope our readers do have the capacity for understanding these aspects (we know most do in fact, as our appeal is not typically pedestrian), and we genuinely grieve for the public majority of investors at large, who got hoodwinked by the Street's absurdly high projections or naively believing one could in all climates easily look beyond short-term problems on assumptions stocks will always deliver vast superior gains. That's one-decision structuring; great when it works, disastrous when it doesn't. The good news is a climax would washout the downside in the ones that haven't tanked; the bad news is everyone's views are migrating this way, which could mean that the first such automatic turn won't hold very long.

We have thought for much of the year, that masked by firmness in Oils or a few other leadership stocks, that the Senior Averages would mask the internal deterioration and distribution which has been evident to anyone with even a rudimentary understanding of the interrelationships existing. As they "held up" sentiment, we projected not only the way the "generals" would catch-down with the "troops" (rather than the other way around some were expecting, for which there isn't much in the way of empirical precedent), but what would be the actual factor capable of breaking stock prices: that was seen to be not so much monetary policy, though that's a factor; not so much this ongoing internal deterioration, though that's a factor; not so much technical analysis, though it is helpful in understanding where a market is relatively, not so much where it will go; and not at all so much the hype about strong earnings; because a peaking of profits & growth were the key.

It is shocking that so many don't understand that even if earnings hold up or fluctuate modestly, the market (as we forewarned since April and reemphasized when nailing the July 1428 high of the S&P, which denoted our macro-short-sale at that time with regard to the major S&P trend) is not going to put such high multiples on simply stable earnings. That is the heart of the argument which has been already validated, even if ultimate low were to occur tomorrow, which it won't.

The point, is that the Senior Averages held up for months in the fact of higher interest rates that started last year (remember, the T-Bondswere briefly over 130 when we noted how they would be leading the Averages by many months, before the realizations broadly took-hold). The result at the end, can be either inflationary, or a conventional slowdown preceding an easier monetary policy. The problem in this case is the "stoking of the monetary aggregates" we've often warned of, in a way that hypes the situation almost in opposition to the Fed's stated policy directives.

The risk, of course, is that it promulgates a mild stagflation environment, at least for some very short periods of time. And there is a downside risk to money managers that understand these things, but haven't sold anything yet, because they think they can "bridge the gap" until the next upward cycle. The risk is that they're now essentially stuck, and aren't interested in liquidating into weakness, which of course means they'll be doing a sort of tough-love holding, which means they'll be selling potentially just where they don't want to do so, if push comes to shove, which it's likely to do, since noone's worrying about it. But not on this particular thrust down (at least not in an uninterrupted way, quite likely). And that, is exactly how you find the market not looking so far forward as some will argue it should regarding profits (why they tell the stock market what to do, we have no ideas about, and this generation will learn), and adjusting to a more normal growth rate at best, and something a bit more negative, at worst. We don't think any important low is at hand; while we are absolutely prepared to try to catch a daily-basis (albeit desperate) recovery.

One side-effect of a "no fear" market . . such as discussed in last night's Daily Briefing, can be the absence of the very key perception so many falsely hold in this marketplace; ample liquidity. We've warned in any number of reports in recent months how this was a "hollow argument" by all making it, because that meant they had scant evidence to justify buying equity leaders; such as any argument about valuation. Because they could only point to liquidity as a bullish factor, we said that emboldened expectations for market implosions; because liquidity is very ephemeral.

As liquidity flees (one of the fastest evidences of retrenchments; so never was a big market plus as bullish trends all creates liquidity if people are willing, or daring, to put that to use in strength), it has to have a reason to reappear. Besides that, it's eroding, as prices decline. That's because a ton of investors remain fully invested (or worse, leveraged) in this market environment, against every common sense suggestion we've made over the course of so much of this year; a time of major-trend distribution, which was patently evident by most activities in the market all this year.

Pie-in-the-sky

The downside damage to the Senior Averages (not necessarily the already downtrodden that did not participate in the final upward phases) can be greater because of the lack of cash reserves in so many funds or elsewhere; compounded by a fleeing of capital "parked" in Dollar-denominated assets. You may recall that both in April and July we argued that those advocating fully invested postures were going to add to the carnage once the market broke; whereas those of us with (for us the highest cash reserves of 75% in history, since April, besides nailing the July 1428 highs) ample buying power simply have to pick the spot to start reallocations into the market during this gradually increasing duress, almost irrespective of where final bottom are for both of the Senior big-cap Averages. We are not willing to do so yet; but are watching the action in a host of stocks that have come down, and monitoring particularly to see what fails to decline in the maelstroms.

Bizarre thinking on the Street. . . was one topic here last night, involving curiosity that many of the "sages" cautioning a lack of concern during this particular downside phase, never foresaw or acknowledged the decline in the first place; in some cases since Spring. It's also interesting how the so-called "quality" companies are not reporting quality earnings, or if they are, it's being sold into fairly rapidly. We've warned of this for the past few months as the causal factor breaking the market (fundamentally, as that's what technicals reflect, whether in advance or otherwise).

In this case, besides the multiple contraction we thought reasonable (that's not so extraordinarily bearish either), we made a few remarks about the overall consensus estimates and even about the "estimators". That's because we thought a number of analysts and firms that focus on these things, were hiking expectations based not on business or realistic conditions but rather just faith in the future. To us they were advising investors essentially to hold-on, based on pie-in-the-sky bits of hope; not factual evidence. That was very disconcerting, as it didn't dovetail with our views of the world, which saw at least some modicum of slowing in the final parts of this year and even into early next. And, knowing how far ahead the market doesn't look, we thought that merited the caution we embraced. Now, with even premier stocks disappointing, contractions of multiples levels is almost a given, which is very much what this decline presently is about. Even the most conservative money managers and analysts (or most reckless, holding with abandon, depending on your viewpoint) can't miss this; now forced-to-reckon with the markets half-year of messages.

Does that matter besides the fact we did foresee it? Yes; because it means most managers and lots of analysts did "handhold" investors with their fully-invested unjustifiably-aggressive postures throughout one feisty, but nevertheless clear-cut, drubbing across a broad list of securities. That means there is danger, noted last night again, and it means periods of time to restore confidence in analysts who've apparently shaded the numbers excessively optimistically, just to try keeping stock prices propped-up beyond anything warranted by fundamental or even technical analysis.

It's Party Time!

Sentiment remains pretty bleak, and is amazing as analysts start talking about Dow 10,000 party time; only coming from the other directionthis time around. Will we break it? Of course we will; as something in the order of 9800 is the minimum (bare minimum) downside expectation here for the entire period dating from above 11,000 in early July. The key though isn't the Dow; but how a once-hardy S&P behaves. It doesn't have to do this quite so procedurally as it has this week, in harmony with our single-trade guideline; that being the short-sale from theDec. S&P 1350 level; so now let's take a look at this daily-basis action, and the meaning of a first short-term downside goal being achieved intraday yesterday, and then the second phase being reached during today.

Daily action . . . reveals an extremely orderly decline, which is essentially progressive in nature. Orderly declines are normally bearish, especially when the volume expansion's not extreme. We suspect that more-meaningful snapback behavior is forthcoming soon; and may or may not still occur in front of this week's nominal Expiration. (portions reserved)

It would be helpful if we could get some "irrational-style" selling, which hasn't occurred at all yet. That could help wash this out on a daily basis, and give traders a reason to bump up stocks for at least a daily-basis rally. That it's not happening tells you that traders aren't worried about it (of course that means they should be), or that institutional types are using every rebound to exit out of stock as best they can (many, in the retail mutual fund sector, have little or no available cash, and this time of year, would have to sell in the open market to raise money to meet redemption's, a topic which is almost verboten to talk about in the industry; so we just thought we'd mention it.

Again, the more gradualist this remains, the more dramatic it will complete. There is basically not going to be a pattern where everyone just says "ho hum", we'll wait it out and be fine, and not get a sufficient catharsis to spook their thinking, challenge their wisdom, and probably compel if not force, stock out of their portfolios. That might not be an enduring low, but would trigger a little bit of buying interest around here, we suspect. However, it hasn't happened as yet, with tomorrow giving us the retail sales numbers (worrisome for the bonds) and then Friday the PPI data, with the CPI next week. It's probable that worries regarding these factors at least limit (or temper) any rallies in the interim, though they should occur from time-to-time, and be measured in at least an hour or two's duration, as opposed to just a few minutes such as seen yesterday or again today.

Yes; it's fascinating that the Street's praying for a few hours of rallying now, whereas days would have been a given not so long ago. (Partial analysis reserved for subscribers). We are absolutely watching for it, while still short in a very successful trade from the 1350 level of Dec. S&P. This trade was maintained all day for the second day (it was initiated late Monday in a very quiet, but hugely important session, mostly for the horrible behavior of financials in the absence of T-bond trading during the Columbus Day hiatus). We continue short the guideline trade on the hotline (900.933.GENE) into at least the early going Thursday and then we'll see. For now there is no particular stop on this homerun guideline trade, ahead theoretically around 6000 points or more.

Psychologically . . . in the last two weeks, many bears scrambled to the bullish side of things or at least withdrew from looking for the downside. As they frantically figure out why they essentially were bamboozled into modestly going for the bait of the "orthodox" resistance, giving way to the forecast run-up we speculated for several days about; that being the low 1350's of the December S&P, they should temper their zeal with regards to getting back to the bearish side of things.

In the interim; discretion continues to remain the better part of valor; the burden of proof will remain on the bulls shoulders; and there's no particular rushing to catch falling safes, or bail-out other investors troubles from their greedy profligacy on the upside. Monday was an extremely quiet Columbus Day session, and in our stated view revealed the risks for Tuesday's markets as well. As you know, hardly anyone noticed reverberations to Chairman Greenspan's Monday talk about basic net capital requirements and bank mergers; nor did they key on the Chairman's very clear statement regarding how these ventures risk "undermined oversight" in some aspects. It was our view that the immediately ensuing pressure in the financials, such as the Bank stocks (BKX), was clearly ominous for Tuesday's T-Bond activity, and Treasuries dutifully fell into line, early Tuesday, which is exactly why we maintained the overnight Monday S&P daily-basis short. As this action (in bonds and stocks) prevailed through Wednesday, we just did exactly the same.

What happened this week continues to be, as noted: a) a desired deflection from the 1350 S&P area, b) some impact from the Oil price rise, though that's comparatively minor, c) a response to the Pakistani military coup (which impacts the non-existent perfect world order argument mostly), d) continued responses to earnings expectations, and responses to those disappointments in the lack of quality results from many so-called quality companies, and certainly their being a good bit weaker than the "hopes" expressed by most money managers (which rewarded the skepticism or if you prefer independent thinking about these matters for months now), and e) some weakness in the Dollar particularly yesterday, which got everyone's attention at a time that Dollar strength would normally be looked-for by all those who understand the interactions of money sloshing, or capital flows, across the big oceans to and from the Port of New York.

In Summary . . . we continue our march towards (reserved). Anyway, more importantly (not) the McClellan Oscillator reading on Monday of +39 was indeed a nominal -2 change that often is interpreted as negative, with which we had no problem interpreting it thusly, but didn't overdo the emphasis, since Monday was a semi-holiday session, and we had shorted the December S&P at 1350 anyway, because we saw any number of very disconcerting factors developing. Monday was seen as a boring, but very important environmental preparation day. For a week we've been emphasizing the evident tension on the tape, which was occurring despite an Expiration week. The Tuesday "Mc" reading was below the zero-line at -16, and on Wednesday the posting's -64.

Caution remains the main watchword here; which is why we went into last weekend suggesting discretion the better part of valor. There is no change in that view, though we're looking for an hourly washout and rebound, within what should then become a vacuum to the downside later. (Pattern call is reserved, and as of midday on Thursday, has appropriately nailed the action.)

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