Email to Fleck
Reader Font of Wisdom, Plume of Illumination : Speaking of email, I now would like to share some thoughts about the current rally from a reader who retired from the money-management business after a career of 40 years. It's a bit long, but his insights are terrific. Pay particular attention to his analysis of what market bottoms tend to look like. It's quite a bit from what we've recently seen.
He writes: "I have no idea how far the current little rally might carry. The paid-to-play idiots are facing that all-important year-end calendar ax that might end their careers. Therefore, they are trying to patch up the holes in their portfolios by buying some 'speed.' That's the only logic behind chasing junk like INTC and AMAT -- classic late-cycle stuff that 'worked' during the bubble. But , I don't think they have a lot of firepower left, and the great unwashed is paralyzed, and either can't or won't play like they used to."
"In any case, I see no evidence that anything more than a typical bear-market trading bottom has been put in. I would expect the final low to take place only after everyone has stopped trying to identify it. There is far too much complacency, and there is still too much 'bull-market-business-as-usual' mentality in the market. It takes a long time for the herd to accept major change. It took the herd about 20 years to figure out the bull market that started in 1975. By the time they figured it out, it was essentially over.
"The same was true of the gold market. It took the Bank of England almost 20 years to figure out the bear market in gold. When they hit the $257 tick, I said to myself, 'That's gotta be it: The slowest of the slow learners has finally acted .' The fools had spent 500 years trying to accumulate gold. Where the hell were they back in 1980, when it was clearly ridiculous? Why finally sell some after the decline had become universally recognized?
"Many typical historical technical patterns at major lows are evident on Swenlin's excellent Decision Point Web site. We had much of the same info when I was running money, and we had a fair amount of 'stuff' he does not have. For example, virtually every major low in the market has seen the 30-day ratio of advancing stocks to declining stocks at or below about .50. This indicator, calculated on a ratio basis, allowed for direct comparisons, regardless of whether the market was trading 1,000 issues per day (1920s), 700 issues per day (1930s), 300 issues per day (early 1940s), 2,000 issues per day (1970s), over 3,000 issues per day (1990s). It will take any number of issues, such as combining all markets (NYSE, Amex, and Nasdaq), to produce the same sort of extreme readings at the major lows.
"In effect, when that indicator says that on average, over the past 30 trading days, declining issues have exceeded advancing issues by at least a 2-to-1 margin (a ratio reading of .50 or lower), then you can be pretty sure a decent bottom is forming. There were several of these readings during the 1929-1932 cycle, and I wouldn't be surprised to see a similar phenomenon before the current market cycle finally bottoms out.
"Another little-noticed indicator with an excellent track record is the 'New-Lows-as-a-Percentage-of-All-Issues-Traded' index. We calculated this number going back daily to 1928. The really big bottoms have seen between about 50% and 75% of the entire market hit a new low on the same day. The greatest extreme happened at the 1937 low, when 89% of the entire market made a new low on one day in October. If I saw anything like that percentage, I'd be thinking 'bottom.' However, we're a long way from that kind of number, and I doubt we could get it on the NYSE (too many interest-sensitive, nonequity-type proxies there.)
"However, it could happen in the Nasdaq, where the really hot air still hangs out. John Mendelssohn used some of this type of logic when he computed his Diaper Index back in the 1970s and 1980s. In effect, he identified major bottoms by measuring how frantic the players were to get out. When they crapped their pants, the bottom was in. He claimed the index was proprietary in much the same way Russell claims a proprietary hook in his PTI. In the case of the Diaper Index, it was a compilation of the rate of change in breadth, up and down volume, total volume, and some rudimentary put/call data. I suspect similar logic can be applied to today's market.
"The new breed watches the VIX, but the VIX history is too short for me to put much faith in, other than for quick trades. Who knows where it might go if 'it' really hits the fan? However, with the market totally in the hands of so-called professionals, if all those idiots suddenly read the same mail and tried to bail out, then October 1987 would pale by comparison. The NY Fed would be the only buyer around (and you can bet they will be there if such an event happens!)
"Another interesting thing is the material from Investors Intelligence . Most people have only a few years of data to compare, and there was a lot of hoopla and hype attached to the recent blip where bears briefly exceeded bulls. Big deal. This was not any sign of a real bottom. We studied all the Investors Intelligence data going back to 1963 and found that prior to major bottoms (1966, 1969-70, 1973-74, 1982, etc.) the bears outnumbered bulls by as much as two to one or more for many weeks and even months . So far, after almost three years of bear market, the Investors Intelligence data have consistently shown far more bulls than bears virtually every week!
"If I saw bullish sentiment running 10% to 25% for weeks on end, with bearishsentiment running 50% to 65% over the same time frame, I might start thinking 'bottom.' But given the extreme nature of the 1995-2000 bubble, I would probably not be surprised to see something along the order of 10% bullish and 70% bearish, with the market continuing to fall. That would be entirely within the historical parameters. There have been such extremes in the past, and those were during simple bear markets that broke from normal, historical valuation peaks. Given the fact that current market valuation still exceeds any prior valuation peaks over the past century, it seems foolish to expect an easy, pain-free release from the trap this market has been caught in.
"Finally, I really don't want to even think about valuations as a guide to measuring the bottom. However, in 1932, the major indices yielded 10% and sold for 50% of stated book value. And, the accounting was quite conservative by today's standards (We had access to Moody's Industrial Manuals 1920-1970). Virtually all the post-Depression bottoms have seen the big averages trade below or very near stated book value, with dividend yields between 5% and 8%. As recently as 1974 and 1982, the lows were reached at book value and about a 6% dividend yield.
"We put 10% of each client's portfolio into Polaroid in late 1974, at an average cost of $14 per share (down from $149). The company was debt-free, had a net $15.50 cash per share in the bank, was staring at about $2.00 EPS, and still had a proprietary position in the photography market. We got a triple within six months. Boeing was so cheap that its entire market capitalization amounted to the selling price of three 747s. In 1932, Goodyear Tire and Rubber traded down to $5 per share. The company had a net free cash in the bank of $20 per share.
"But, as everyone 'knew' in those days, stocks like PRD Polaroid , BA Boeing , GT Goodyear , and dozens of similar examples were 'terrible' investments. After all, look how far they had fallen! When that sort of logic once again prevails, I suspect the risk will have been squeezed out. But before it happens, the slowest of the slow learners will have to become bearish." |
