Untying the Market's Knots

May 5, 2000

A "Buyers Strike" . . . anticipated to start Tuesday ahead of the week's key Employment Report as traders shied-away from any new commitments, occurred in harmony with our annual outlook that called for April and May declines interspersed with a couple rebound efforts. And now we're increasingly preparing to being on alert for yet-another upside effort, coming precisely when the fewest numbers of analysts and traders probably expect it; within the next couple of sessions. It will not necessarily be more than a rebound, but also has potential to be quite the short-squeeze, especially if the numbers (or the reaction thereto) is handled adroitly by stock market players.

To us there is an open question as to whether such a rebound has greater probability of success in the days ahead; but that depends on technical levels that are breeched or not, the actual news or lack of impact, and maybe even commentary from the Fed-head during an address Thursday. In essence, we're looking to slightly lean against the wind of this downside romp, after not only calling for a renewed May decline, but catching the overwhelming vast majority of the forecast snapback from the April lows, and then capturing almost the entire Tuesday-Wednesday decline.

Technically . . . last week we warned, that the very inability of the market to surmount the June S&P 1470-80 area, even before a little beginning of month buying on May 1, particularly given an abysmal failure on the closing weekly basis (in fact the market tried and failed several times in a very evident fashion, which was increasingly ominous and), should have helped determine the extent of vulnerability for most traders. (Further analytical remarks reserved.)

Daily action . . . in anticipation of that, saw us move back to the short-side of the June S&P at the 1466 level during Tuesday's mid-session action; maintaining that guideline until nearly the close on Wednesday. In the process the hotline (900.933.GENE) pulled specifically 4600 points from that single effort, closed at the 1420 level, and is now flat ahead of Thursday's opening. (Balance reserved, as are the remainder of daily, technical and economic news commentary.)

The Haberdashery's In Knots

As for Thursday, we suspect early efforts to lift (if any) won't get far or last long, although after a subsequent effort to decline, we wouldn't tend to press the downside of this short-term action. In fact, whether Mr. Greenspan has something to say or not (and he may soothe things surprisingly to some), the market might really be preparing a "necktie party" for those stretching-out bearish positions into weakness after such a hard breakdown. We don't mean to impugn those targeting the downside based on fashion changes to greater color (supposed to be bearish, but ridiculous actually), but do mean to question all those trying to find a reason for the forecast decline, when things in that respect are, and have been, fairly orthodox, both fundamentally and seasonally.

Most of these areas have been thoroughly explored here in recent days and weeks, and include the core factors underlying our forecast for an April/May market decline, including these phases of alternating action. We think the market is not particularly Fed driven here, but rather that some forget to consider the Fed is responding to the higher rates abroad, and the weakness oft noted in the Euro (which have a connection), not to mention the renewed upside of late in Crude Oil. It is a little absurd to simply say the Fed gets what it wants (of course it does over time, but bearish concerns for many months preceding in the Senior Averages were tied to not fighting the Fed, as opposed to those who think they've suddenly figured something out about monetary policy), even though it's impossible to trade the market simply based on macro Fed strategies, that even they do not know the longevity of. But a changing trend in rates should instantly put anyone on alert.

Hence, when an Inverted Yield Curve forewarned of more trouble, but more so on the short-end rather than in T-Bonds, in recent months (now flattening as bonds even now simply get overdue normal corrections within an uptrend in our view), we were emboldened to believe that this year's pattern very much would unfold as per the general Letter outline; and there's no change in that. And yes, that means a better second half of the year, if we're right, and panic doesn't somehow grip the majority of investors anew, or on a lasting basis. It likely will not, as they are not the ones deleveraging with insane irrationality, after being over-leveraged, as we long ago forewarned.

Those are the vagaries and curiosities of the professionals, particularly the "hedge fund" guys; in fact an area we've been alerting you too increasingly in the weeks and months recently past. The realization was several fold; that the migration into Y2k safely would be bearish, as it impacted at minimum the disinflation quirk that had existed for a couple years, mostly as the world suffered in the wake of the Asian Contagion. Disinflation was not simply based on increased productivity; of course that helped (and will in the future) to some moderate extent. In some industries more so. At the same time the arrogance borne of success caused many managers to embrace "new era" ideas, as if the business cycle had been outlawed, which we consistently argued it surely wasn't.

What that set-up was excess consensus expectations by the earnings estimators, a blind-sided view of Y2k's start, where few concurred with our view (since last Summer) that IT professionals were not going to order much new software or computer equipment until they navigated what the majority thought would be more treacherous waters going into the new year (which would have, as a matter of fact, been more bullish from our viewpoint, because then disinflation would have lasted longer, as the majority of the world would have experienced even greater tech problems). That it did not occur meant that many American companies spent more than necessary (though they won't generally admit that) on Y2k preparations, while other countries deferred doing much (notably Italy, where the attitude was, according to the commerce minister late last year, "if it's bad we won't fly in planes for awhile, and then we'll fix it; if Y2k is not bad, then no big problem, and by doing little we'll save an awfully lot of money too" . . . presumably vs. the U.S. … anyway a paraphrase, but very close to what the office said, and while funny at the time, very apropos).

Of course the point here is not that Italy had it right (though they did, and so did we, by virtue of viewing the interpretation of a successful migration essentially meaning the opposite of majority thinking), but that Q1 earnings were impacted not only by such costs, but by the eating-through of inventory builds that we knew would have to be worked-through before new supplies or goods got ordered in many industries that were affected. If we avoid a recession, we're getting towards that time. Of course that's the second part of the ideal pattern call, (balance reserved).

Fundamentally . . . we have no argument about the poor stature of e-tailing and retailing; both in fact are areas we've warned of for as far back as a year ago. Our representative short-sale (after earlier efforts were closed) remained WetSeal (WTSLA), which dropped by about two-thirds in the timeframe until it was recently closed around current prices; now of course now comes the results forecast by the year-long price decline (which should surprise nobody, in this or others). That in itself begs the question about those downgrading retail now, especially as that group's shares have already been decimated, and it would seem nothing much is anticipated by turning bearish on retail now. Or is that the case? (Speculation about Goldman's thinking is reserved.)

And therein lies the contradiction in terms by the general worries about the Fed. The Fed must (we would hope) recognize the risks, and also understand that being proactive is fine, but killing the economy is not really a goal (quite the opposite). If the Fed recognizes that higher Oil means more than their policies (they wouldn't be effete enough not to recognize that, would they?), or that anything that stabilizes the Euro might temper the tendency to maintain Dollar-denominated assets by foreign holders, or that Fed policy will not deter the problems of the hedge fund guys.

Our view has been that the hedgers were primarily purged before they protested publicly; and as we suspect the losses were in the currency arena, we think we understood the Dollar's strength. Probably they were short the Dollar (bad move) and long the Swiss Franc (for instance, and also a bad move), and got caught in a classic squeeze in both directions. Hence Dollar strength that we've discussed in the presence of the weak Euro, while managers parked more money here in the U.S. Take that Dollar strength away and theoretically you risk something other than simply a market decline, but retain it and you have a climate that might not require more rate hikes by the Fed (beyond the coming perceived one), because then the troubles abroad and firm Dollar would combine to allow a Fed that can say they're "impressed" by the disciplined domestic price levels.

Now of course today's Beige Book didn't give much solace to that idea, given the wage pressure reports in every Fed District noted. However, whether housing or big-ticket spending, things are slowing fairly rapidly in real world anecdotal reports, which the Fed presumably is aware of. They need to be; otherwise they'll be hiking increasingly into a slowing economy, prompting stagflation risks which we've argued all along are out there, under certain sets of developing circumstances.

Now, price levels did not increase in that same report, but the market chose to ignore that detail. It's not out of the question that if the stock market's going to hold key former lows (rest reserved, including parameters both for the DJIA and June S&P in Thursday's market and for next week).

Again, we're nearing an oversold hourly basis condition, but are fairly neutral on a daily basis; so we can't be overly optimistic, especially in front of Friday's numbers. However, with the mood so somber out there, it is absolutely on our minds to lean against the wind just a wee bit, looking for a coming rebound at minimum, and if more develops, so much the better. Friday could be set-up almost for a very classic bear squeeze, if we do another decline Thursday (with basic abstinence ahead of Friday's numbers), then get numbers the market worries about Friday, turning around (thereafter). It may not work, but we'd be surprised if stocks didn't try something like this idea.

Last night we touched a bit on Gold stocks (XAU), where a squeeze was in effect considerably of greater visibility than in the metal itself, as June Gold had barely started to move. Europeans of course are more comfortable playing precious metals than are Americans; but there's more to it. The strength in the Dollar keeps Gold down in our currency terms, whereas it bounced more in many foreign currency terms, as those came under pressure. That's a product of investors very little faith in the Euro, renewed high Oil prices (though June Oil halted at noted resistance), may combine to ignite inflation on the Continent higher than in the U.S. If so, as previously noted, the greater short-term risk may be abroad, although some initial falling of equities would be the norm into midmonth here, as anticipated anyway, and as generally seen. Also, increased short-term upside moves in Gold, which wouldn't be reflected greatly in Dollar terms, at least not unless the Greenback eventually edged lower, though it would have to be before Gold fell anew, are likely. It is probable that today's action was a consolidation after the tentative move of the XAU to the breakout area, which is not affirmed. For our part, while Gold's oversold or due for some bounce following shares, we're not going to be more optimistic than as outlined before, which requires a move above 285 or so to get Americans attention in what would be another (but due) rebound. If the Euro subsequently stabilizes and firms, then the action in metals will be just another flurry. (It is irrelevant whether the European Union itself survives, which we suspect handily will yet occur, irrespective of outlined Euro currency action, bedeviled by conflicting member financial policies.)

As for the heart of the U.S. market, the NASDAQ pressures were noteworthy, with higher volume on Wednesday, which is what we want to see to potentially complete the daily action. Of course this is tougher given the area we're coming down from (orthodox "A-B-C" rebound territory), that leaves open the possibility of a failing rally and then another trumping. That's precisely why bulls would have preferred the market to make higher highs above key resistance before resuming the downside; but that's not what the market's advance messages were via the multiple rally failures.

As noted Tuesday, buyers basically evaporated, allowing the Nasdaq 100 (NDX) to close off in excess of slightly over 200 points, while the NASDAQ Composite lost over 172 points. Tuesday, not Wednesday, was the really hard-hit session, with most key stocks coming back late today in moves that cannot be called more than "squaring", but which are of interest and noteworthy. The NDX today lost only 65, while the NASDAQ just 78; both signs of potential downside exhaustion, if only on a daily basis. Yes there may be some more margin calls, yes there may be news that the markets don't like Friday, but yes, the higher volume (even given the testing nature) showing that shareholders want out smacks of the type of desperation that normally occurs before lows. If not, and the market wants to implode anew, we'll be flexible in our efforts (mostly S&P, but surely can be correlated to our thoughts on the NDX or surrogates) and try our best to catch such new waves to the downside. However, for now, we're thinking this one exhausts shortly, and rallies. It is probably not going to be sustainable (tough time of year, even our own forecast is'nt calling for that yet), but we do not intend to "press" the downside after such a very profitable steep decline.

In summary . . . to us, there was never any doubt that this week's initial upside efforts would be limited, with nervousness seen in front of the Friday Employment Report, generally anticipated to feature not only a large increase in non-farm payrolls, but also a noteworthy increase in average hourly wages. The "oracles" warning of doom and gloom beyond this month's forecast pressure, are back indeed. And we are cognizant of how complicated it could be getting from here to there (the downside to the upside later this year), by virtue of the currency complications and an angst filled Fed, that has to balance international concerns with domestic, (while that's not really their primary mandate, it hasn't stopped such considerations before, nor should it, given how key the Dollar is as the Reserve Currency), and we assume they know what happens if the Euro holds.

The McClellan Oscillator had gotten a bit overbought (it was over +90 on Monday); eased to +59 Tuesday, and is around -19, just shy of the neutral zone at the moment, generally targeted. We would expect it to move back above the neutral area over the next few days and then we'll see. In any event, we nailed the decline, closed our hotline's (900.933.GENE) June S&P short-sale off the 1466 level at 1420, for a 4600 theoretical gain (very doable for those inclined, with the normal caveat that decisions are the individual's, as we do our best with the guidelines as a resource, trading for none but ourselves these days; emphasizing patterns). Now flat overnight, as we ponder a minor turn (almost semi-climactic by the way) that could be the precursor to one more robust upside thrust, especially with so many new bears recently on the short-side of this. Again; we're not daily oversold, so we're not talking about anything with finality, but suspicious of all the newfound negativism that's permeated so many sectors well after such very hard hits.

As of 7:15 p.m. S&P premium's extremely firm at 1090 (contrasted with last night's 121, nearly a panic); with Globex futures hovering right around 1426, up about 350 from the regular Chicago close of 1422.50, which was off 2800 for the day. Last night we were short overnight, suspecting rallies will not be sustainable, which they certainly were not in the morning. Tonight, with a great theoretical gain, we're not about to press the downside with the masses; quite the opposite soon is feasible, if things fall into place just right, though rally sustainability is again a serious concern.

The periodic symbol for gold is AU which come from the Latin for gold aurum.

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