The Market's Battle of Midway

June 4, 1999

With Alice Rivlin unchained. . . from the Federal Reserve Board, one more "dove" has flown the coup of those inclined to believe the "this time is different" scenario regarding business cycles. A risk of inflation (versus deflation; pervasive risk explanation reserved, as well as IMF comments in Friday night's DB), is diminished in a sense, though we all believe the Fed Chairman controls the outcome much more than a simple "vote" of the Board. And now, the opportunity to debate or select a new Vice Chairman takes center stage there; and probably it will be someone with more of a "hawkish" bias. It won't be the retiring Treasury Secretary Robert Rubin (even if the Board's interested), as he's most likely only potentially willing to consider the top job, down the road a bit.

What does this mean for the markets? Little different, but in a strange sense is more bullish for a recovery in the 2000-02 vicinity. That's because a Fed that gets a grip on the current situation is likely to then find itself in the enviable position of being able to reduce rates down the road, and not have to engage in a series of aggressive hikes if this economy overheats significantly. It has crossed our minds (as noted the other day), that there is a different way this can flow; which is why we mentioned that an FOMC meeting that doesn't hike rates isn't automatically bullish, of course beyond the requisite knee-jerk reaction. (explanatory reasons & forecast are reserved)

The "Rough Riders"

Again, and this we do have some conviction about: this has been a market priced for a perfect -if stressed- world. And this is not a perfect world, despite the great "patriots" proclaiming it as so. If you view a great patriot, not as someone who constantly extols American investors to ride-out all market scenarios, but as someone who helps investors navigate the treacherous market waters; in all humility it would be those of us cautioning against extending leverage and cutting holdings to a minimalist exposure (only into rallies), that are doing the American populace the best favor.

It's funny how this bull-bear debate continues to be argued, as we've already been proven right, just by virtue of the projected low last Fall, the rally into early this year, and the very specific call for the PC & Internet sectors to again implode this year, under cover of a strong DJ Average. It already happened, and what you're looking at now is a rebound from this previously forecast breakdown. So, the debaters about the outlook are already fighting the last war. It's sort of like a squadron of pathetically-trained Kamikaze pilots attacking the American Naval Fleets in 1944, a year or more beyond the definitive battle that most Admirals already knew sealed the fate of their Imperial Japanese Navy. Their planes attacked, occasionally scoring a few hits unfortunately, but the battle was not in doubt, even before they scraped together what aircraft they could, for all those missions in vain. That's the modern equivalent of putting good money against bad, while a host of indicators told us months ago what the likely outcome of the War will be, and in fact are calling (as you know) for sporadic battles that may be played-out, enroute to the final victory.

The Battle of Midway. . . which occurred on this date (June 4) in 1942, was a pivotal fight early in America's involvement in the Pacific Theatre of War. It marked the defeat of the Imperial Navy of Japan; and though many didn't realize it, and much fighting remained, was theturning point. It may be similar in markets, as we had the downside attack, but the bulls are complacent. We need them to suffer a loss and then gradually retreat to their home islands, which means back in the Dow 9000's, at a minimum. Stay tuned, as one battle doesn't necessarily end the whole war.

Therefore; most rallies will generally be cast much as the fruitless Kamikaze attacks in WWII; so only temporarily they will appear to be interesting. Much as the "Rough Riders" attacked those Spanish forces in Cuba, in another battle, without knowing for sure what's over San Juan Hill, there was never any doubt who would then prevail in the final analysis either. But you didn't want to be a casualty on the way to that victory, even if you knew there was a deep valley over that hill (viewing it as a false rally within a downtrend). Also no more than the valiant crew of the first U.S. Torpedo Squadron from Admiral Nimitz's flotilla, who of course knew they caught Yamamoto with his pants down, but that didn't help those flyers, if they crashed, and then got lost at sea awaiting rescue. It could be mighty chilly waiting for the PBY's, and "holding for the long-term" can be just as chilling, when an investor isn't sure if his hundred dollar 'net stock, now in half in some cases, is going to rally, or down more first, or ever hit the old highs. (We didn't know how high was high but simply that we had to take some chips off the table early this year; as you never go broke in the pursuit of at least partial profits, so as to play with no more than profits; if that much. While the holders are worried about what's this skids next; we're cruising along, anticipating bargains.)

In the stock market. . . ultimate victory (as is always the case) will be to the bulls, of course. We are secular bulls for that reason (though secular risk has built as in no recent time). However, the trick to savoring that "patriotic" joy is to avoid the valley's and play for the peaks. You want to be a participant in the Victory celebrations, by having bought in the midst of an enemy attack. That's what we did last October, that's what we did in the late Summer of '96, and that's what we're very excited about doing later this Summer or Fall, as the patterns shall allow. In the interim, it isn't so patriotic to hear those who made the idea of selling anything earlier this year seem like sacrilege; and that's because too many fine Americans are having their investment portfolios emaciated. It is more severe for those who overstayed the Internet and PC sectors, ignoring our clear warning.

Meanwhile, our first "macro" short-sale in so many months; from the June S&P 1380 level, will remain in effect, coming out only per the guidelines we've explored previously here in these DB's as you know. We are of course well aware of the ability of markets to rally from daily oversold. In fact that's why we're flat with intraday scalping, after a number of mostly nice trades Thursday. It's because this market action is essentially a consolidation below support that we'd increasingly be suspicious of any knee-jerk positive response to the jobs numbers. In fact, what's surprising is that the market hasn't rebounded more than it has so far, and that's something worth pondering.

Technically. . . (parameters for an anticipated rebound are explored now; and thus are reserved for DB readers only; per the usual custom within these courtesy postings for non-subscribers).

Random Stupidity . . . for diehards believing that Index fund buy-and-hold approaches will work best for anyone who has time to watch the markets, or even who don't, is being trotted-out again. We hear this every time the stocks the Street has most-recently been in love with, get trounced. In this case, it was the PC's and Internet's, which we've done so great in over the years, but the very sector we particularlywarned-of early this year. You don't need inside-information to win in the markets with timing (though those who can't do it will claim so), but you do need a clue and a feel of where fundamentals are going in key industries, not just where a liquidity-driven trend is in fact heading (trends can outlive the facts, as we saw this year for awhile). The individual investor (not just traders), even in limited time outside of his or her career, can address markets with their determination to at least increase exposure into extreme weakness (when few will be so willing), or to scale-out into extreme strength (which is when you hear mostly about the great "liquidity").

If nothing else; doing so will avoid the pitfalls of going "over the hill" and finding out that the Army you expected to cover your flank, isn't there. If it is, great; but you can't conduct life in the market successfully believing it will always be there. That's the kernel of thought in the expression: "let the other guy get the last 10%". And that's what we meant a month ago saying that; questioning at the same time whether there would even be more than another "2%" (and there was not). The crowd that advocates consistent (or random) investing will not be heard from, once the confirmed demise of the old bull market is acknowledged. Many investors will (as was the case for so many last year) no longer be whole, and will be disinterested in buying stocks at the most opportune of times, going forward from there. The core of our strategy; to limit risk and reduce exposure early this year was not that the market (in some stocks) couldn't go higher. It usually does; that's life if one believes (as we do) that not everything tops concurrently, and that the Dow would benefit of course from sector rotation during many desperate efforts of the mutuals to keep the trend alive.

At the heart of our approach is to take a chunk out of a meaningful trend, and outside of scalping (at the risk of lacking humility; something we probably do in the S&P as well or better than most) the minor moves, trying to scale-out into excess optimism, and scale-into panic selling climaxes. The random crowd is not only nuts; but how is one to do so if one instead is fully-invested all the way down, and thus more concerned about old holdings, than the buying of great stocks on the cheap. And that in early May is what we again meant by emphasizing that if the Dow were to fall 20-40%, each investor ask themselves a question: would they be more upset about erosion in all the stocks (or portions thereof) they retained, or would they be more excited about the bargains that had become available in major stocks at low prices? If the answer was the former, they likely needed to sell more; if the answer was the latter, they were probably close to ideally positioned.

Chester Nimitz took a chance at the Battle of Midway going after that 4th Japanese Carrier. But he had the power of the United States behind him, and an already mortally wounded opponent. The normal American investor has worked years to build his "fleet" of shares. Leveraging those after an already-impressive feat (years of successful investing), risks inviting a defeat. And he or she doesn't have unlimited new borrowing capacity, as do governments. That is why putting part of one's "fleet" into dry-dock from time-to-time is not unpatriotic. In fact it's the most devout thing to do for one's self, preparing the foundation for a next advance of the overall American market.

In Summary. . . the rebound has not moved (at least as yet) above anything significant at least; though as noted it probably will try to do so before the next meaningful declining effort. However, this could be something measured in minutes or hours; not days (though open-minded on this). Therefore; risks of this being just a downward consolidation (upward pause-to-refresh within a downtrending market overall) is a very real contingency going forward over the next several days for broad-based markets; allowing for another (hoorah!) rally if they get the numbers they want.

The market's still generally in limbo with rallies not only unimpressive, but barely ahead of neutral ahead of the Friday Employment data. TheMcClellan Oscillator postings were -65 for a couple consecutive sessions, then it deteriorated to -75 on Wednesday, and on Thursday it is at -49. A light volume rally coming off a short-term vicious purge as seen in recent weeks, isn't exactly the stuff magnificent rallies are made of. And today's wasn't. That doesn't argue well for a dramatic acceleration just yet; though we are expecting a little more upside before the market comes into new trouble, inline with the parameters outlined in the "technical" section tonight. However, the real "hook" for this market may be when (or "if") the knee-jerk market response to even a Fed not hiking rates turns out to be transitory, or just merely a "relief-event" preparatory to new negative price behavior. In the interim we're holding our macro June S&P 1380 short, and continuing to trade intraday scalping moves mostly successfully, as was again the case on Thursday on the hotline. The most bearish pattern for Friday would be a rally on favorable news that is sold into. (That didn't happen, which is exactly why the 900.933.GENE hotline is flat, at the moment of this release to participating sites; while we look for the next hourly turn against the noted backdrop.)

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