Pundits Still Fighting the Last War

October 21, 1999

Conviction in technology . . . set the tone, not only for Wednesday morning's predicable rally in the wake of stellar (rearview mirror) results from Microsoft (MSFT), but for the overall market in the Senior Averages, to the extent that reflects beliefs that America's "rolling love-affair" with big consumer spending, as well as a technology-driven disinflationary environment, will dominate. Of course life, and the market, somewhat reflect each other; and in this case are more a perception than a likely reality for the next few months. And IBM (IBM) said as much after today's close, via their affirming our long-held views about Q4 and Q1, as well as what likely occurs thereafter. We also have learned of a report coming that says "web-use growth is slowing", which will not help those arguing there's nothing generally wrong with the stock market or the Internet economy at this stage of the year. Many will say we'll go up eventually; after Y2k gets digested; no surprise.

However, there's no disagreement here as far as being secularly negative; because we're not. At the same time the problem remains that (our long-held forecast) leadership tech stocks haven't seriously discounted the next couple Quarter's risk, beyond minor lip service to these issues. We further suspect that they need to, because of the behavior of stocks that haven't shown results of a stellar nature just behind (like -reserved- or a couple others), which implies there remains at least modest sensitivity to results as they flow-in. If results are "peaking", or have already, as we suspect for the old cycle, then this market still has to discount what's in front of it, before it can at least comfortably (with a degree of reliability) start to bridge the gap for the ensuing next phase.

Beyond that, while in the same timeframe after this Fall, as you know, many stocks that lead the next advancing phase won't necessarily be just the same narrow-leadership that dominated the forecast false breakouts to '99 highs, and quite evidently led narrow Tuesday-Wednesday rallies.

Meanwhile, after an excellent reversal from long-to-short at the December S&P 1287 area in the Tuesday trading, we addressed what was expected to generally be an up Wednesday morning, followed by erosion as the afternoon progressed. The (900.933.GENE) hotline's S&P guidelines were fairly staunch in leaning conservatively against the wind for traders every time Dow Jones moved above the plus 150 area, and by the time all was said and done we actually managed to surrender a few hundred points of the thousands recently gained. Always frustrated when even a single day goes against (or partially against in this case, by not eroding much) our pattern calls in the S&P arena, we continue to suspect we're analytically correct about what might happen next. (Don't forget several Fed Governors are speaking-out tomorrow; as well as the Phily Fed data.)

Daily action; Technicals; Bits & Bytes and Economic News: (subscriber-reserved sections)

Internally Wednesday's action was considerably softer than met the eye; as breadth ran negative through much of the session, or was barely favorable in the case of the NASDAQ market. We're inclined to suspect that the Nasdaq 100 (NDX) lead will erode tomorrow, particularly as there is very little "positive" news to be anticipated on the immediate horizon, because most short-sellers into weakness last week have been run-in, and because the market will soon focus again not on the last Quarter, but the next, and the probabilities of nasty monetary news forthcoming sooner.

In after-hours trading, American Online (AOL) briefly halted after topping analysts consensus expectations, is now down 2 ¾ ; while IBM (IBM) is down around 10 points and almost broke the 100 level. (Forecast about how this action determines whether the decline will be "for real", must be reserved for subscribers, as it is specific). All this does is confirm what we've talked about for months regarding "IS expense lockdowns", though apparently fewer realized this situation than one would think. We were not the only analysts moving towards that view; even if clearly among the first to forewarn (as early as January) that some buying earlier this year (computer buying) was of a non-recurring "one shot" purchase, to gear up for Y2k concerns. We also thought that a slew of inventory builds ahead of Y2k would presage a period of digestion as we transit into Y2k.

If we are right in this, and even IBM seems to say we have been, then the ideas of the majority as far as responding to any impact from Y2k only "if and as" presented in the new year, might of course apply to computer glitches (like flying for instance), but not to investment decisions, or to advance ordering, which we thought (particularly for tech) has mostly been a long-done-deal. Do note how few stocks were participating in this forecast failing rally (balance must be reserved).

We also have been asked if we're being contrary just to be contrary; which absolute must come only from new readers since we tend to do that at extremes sometimes, but love following trends when there are trends to follow. So we'll comment a bit about "contrariness", and emphasize that the contrary player here is the buyer, since there's not internal evidence of any enduring low; but we are multiple months off the highs (internally or for the S&P), so of course it gets a bit tougher. On top of that, you probably had lots of players excessively comfortable getting bearish late last week, which was a pretty decent prescription for a rebound, even if but within a downward trend.

Contrariness . . . as a function of trading is certainly not always an appropriate strategy, and it definitely is oversimplification in the way some pundits or observers are presenting it. An old wag once said that in a bull market the bulls are right; while in a bear market the bears are right. That too, is oversimplification, but comes closer to the mark than the idea that just because technician worries persist, that somehow means the stock market must advance. That only works briefly at best; probably merely capable of temporarily sustaining the kind of reflex rebound we just had.

The future of the stock market is a combination of monetary, psychological, fundamental, and for the most minor longer-term aspect, technical considerations. On a short-term basis, no doubt the technical analysis aspect takes on greater significance. The psychological aspects will not; not if the underlying fundamentals are as bullish as some perceive them, and definitely not if the top is well behind this stock market (it is). And certainly the T-Bond market, which makes arguments about all the bull vs. bear categorization of this market somewhat mentally challenging, as there is not an argument, since the stock market is long-fractured as discussed last night, with bonds having of course been descending since last year, well ahead of the Senior Averages in equities.

Yes, we identified the area around 130 in T-Bond futures as the top in bonds (low in rates) last year; even suggesting it as a great time to be buying or refinancing a home (last best chance in that entire phase; and nailed it). Now is not a great time to be buying a fabulous home or a boat, unless you're selling yours at an astronomical price, and buying another from some hedge guy who likely got a margin call and is underwater in more ways than not (no offense, but kudo's to the few who probably also got it right in the past 6-9 months, which tested everyone's mettle). One of the interesting hooks this year, would be if bonds found an early low, but stocks (here we refer to the Senior Averages, not the already-throttled run-of-the-mine stocks) didn't hold well. That would cause lots of new-era analysts and managers to ponder how bonds could perform at all well, without stocks extending a move. Doubt the knowledge of anyone you hear so pondering in the weeks or months ahead. Classic interaction would have bonds topping-out months ahead of the large-cap stock Indexes, and it follows that they would bottom earlier as well. Specifically, that is how you may anticipate less risk in bonds than in stocks in the months ahead. Part of that will of course reflect a shifting of assets from equity to debt sectors, defensively as more realize that the days of consumer-driven or foreign-funds-buoyed equity prices are increasingly behind.

Of course as the "mass psychology" increasingly grasps that concept, we'll be looking more and more to buy stocks; not because we'resuperbulls (some will probably say that just for the heck of it), but because the idea is to scale-out (as we did) into strength early this year, and start to of course scale-in, particularly as no one wants stocks, or as tax pressures ebb, or a little of both. I suspect we'll touch on a few more possibilities in the next Letter; but again there's no rush to this.

Pundits fighting last war

By the way; while pundits pontificate on contrary thinking, remember we're nowhere near a high; they are fighting the last war the bears won back in August and September, and long before that in small-caps. We absolutely agree multinational big-caps and tech-laden Nasdaq 100 (NDX) is where risks more currently are, and have said so. We are not interested in buying strength in this area; that's solely the no-brainer decision-maker purvey (who buy after good earnings results), or those who follow into-strength upgrading, which works only in a momentum market, which this is not, and hasn't been for quite some period of time. Liquidity-driven moves are dying on the vine; despite what may seem arguably a few hours of extension against that idea in today's market.

Meanwhile; the Dow Transports are near 52-week lows, as Dow Utilities are essentially near there also. A near 190 point DJ rally NYbreadth predominantly negative; not exactly a bullish factor overall. So, in the presence of such matters, though not resolved, the idea that "everyone" is bearish, so the market should go up, is not a correct interpretation of "contrariness". Ponder what might be considered as truly contrary here, in an environment with bears slowly "giving up the ghost" (because of the rebound), while the bulls are "newly complacent". What single market pattern is not being considered or heard much about at this point? O.k., you say explosion higher and that would be right. But the fundamentals don't support that, nor the multiple levels. Thus the antithesis might at least be considered, though the Street will do everything they can to prevent or forestall it from happening. The antithesis would of course be a short-term collapse, or worse.

(reserved) Either way will suffice overall, as we work through a projected down-up-down pattern as a preliminary outlook for Thursday. For now, S&P 1302 is resistance; while cash S&P topped right at the 18-day moving average (by our calculations; yours may be slightly at variance, as this is not an exact science, but an art) around 1290. Note the cash closed on the high; futures didn't. While happy for those who shorted the S&P with respect to their chances for morning gains, we'd be surprised if "the boys" didn't try to bring 'em back at least one more time. Fail that, and stock markets could readily be in trouble, anytime now, and within the parameters discussed Tuesday.

Grand Finale?

No one who understands markets, or is a professional with years of experience, should ever find themselves selling (or advising to sell) into extreme weakness after a breakdown. Rather, easing out of stocks (even into strength while everyone's still so-in-love with the euphoria that sellers are able to essentially vanish into the night almost unnoticed by anyone or without breaking markets) was the approach earlier in '99. This was our argument last April into strong markets, then again for the Averages into early-mid July, leading to nailing a "macro" 1428 highin then-front-month S&P contracts. This means that once the big leadership capitulates, one has to expect either a devastation, or an environment which "rains on the parade", interestingly of (balance reserved).

At this point, we view the mini-washout and reflex rebound this week, as a preview of the coming possible main event, whether it's the "grand finale" or not. Therefore, clear and present danger persists, per yesterday's warning of an up market Wednesday, and is emphasized at this time. If all goes well, we'll get the "climax" (climaxes are good, not bad) and ensuing automatic rally. We are not willing to commit new funds to the market in size now, because we may be too optimistic.

Investors in general are still overweight this market. That doesn't mean the market has to "crash" about (reserved) from now but it does mean there's risk. Tuesday's DB noted there was a "clear and present danger" of an up-and-then-down reversal over the next several days, that will be a most dangerous spot for this particular market on a short-term basis. In advance; we went on full alert for real short-term risk to actually increase if we got upward price behavior Wednesday. No change is seen as required, or appropriate, in this continuing saga towards any "grand finale".

(reserved). Therefore we suspect the Senior Averages should now ideally resume a continuation pattern to our larger bearish goals, as implied by internals both Tuesday and Wednesday, which were "bearish rallies" as we've termed them, fraught with peril and due to fail. They've already failed, we think, but there will be a mid-session fight tomorrow (Thursday).

It was -and is- our view that a non-Prozac market would have better institutional control. In this case, an absence of buyers means you get unsustainable bouncebacks which fail miserably, in a way that would not be dissimilar to the quick rallies after the first plunge that preceded an "event" in 1987. If we get such an "event" this year, that's great, because of our forecast. But we're not in the least bit interested in ego gratification, or getting excited about the downside after a smash. It should again be noted that when the market's shredded (parts are already), we'll put part of that well-determined 75% cash to work in earnest; but at this point there's no rush to catch numerous "falling safes", as the overall downtrend continues as outlined in recent days and weeks, with the structural mark-up rally (by specialists and market-makers) actually helping ease a daily oversold and setting the stage for the next purge. We argued the other day that this rally would enhance a downside risk within days; so there's no reason to change that interpretation at an inflection spot.

In Summary: will U.S. investors step-up to the plate yet again and buy stocks? They may try to; said we over the last weekend; but there's was a special rub noted this year. Profits are (or have) peaked for many of the largest leadership sectors, in harmony with our forecast; we emphasized.

Last night noted that's especially so for multinationals not directly involved in, or benefiting from, commodity-price-sensitive earnings expectations. Last year's Fed rescue occurred while ramp-ups for the Y2k transitions (in computer and technology sectors) were still in full swing; and that is no longer so. This forecast technology aberration: is a slower 2nd half, based on problems that mostly have less to do with earthquakes (convenient scapegoat for analysts who missed all this ), and very much to do with IS manager (Information Systems) "expense lockdowns" or delays of the combination which everyone awaits in the PC arena. This is precisely what we've talked about since early in the year, emphasized in July, and in the wake of a chance encounter with certain computer executives a couple months ago. We couldn't have put it better than IBM did today, and are almost stunned that everyone's initial reaction seems to be some surprise.

At Wednesday's posting, the McClellan Oscillator reading is -43, which is up considerably from Monday's -139 and Tuesday's -90 posting. We doubted the market would make it back to neutral areas before new selling strikes; potentially with some fervor; and that appears to be the case of course. There's little to do for investors outside of S&P trading, except study what they're going to be interested in later this year, as far as investing, and a caveat to keep some powder dry in that regard, to at least see if the stock market can implode in a fairly dramatic manner in the days coming up; after today as noted last night. As of 7:30 p.m. the S&P premium on Globex is -593, a huge discount-to-cash with Dec. S&P at 1283.50, down around 900 from the regular close. It's a rough approximation, but down-up-down-bounce-hard down, would be the ideal continuation.

In the Aztec language the name for gold is teocuitlatl which means "excrement of the gods."

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