Bobby, The only place you get mo ho ho ho`s than on the clown thread is the mtv video awards.
will the real slim shady please stand up, please stand up.
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Mr. Sentiment
A market technician who tracks investor moods sees a
correction coming
An Interview With Price Headley ~ As a young man from one of
America's first families of thoroughbred racing -- his granddaddy founded
Keeneland Racetrack in Lexington, Kentucky -- Price Headley learned early
to study past patterns of performance and to consider the special
circumstances of each race before stepping up to the window to place a bet.
He's carried those lessons into his career as a market technician and founder
of BigTrends.com, a Website that provides market advice and investment
strategies. Prior to starting his own company last year, Headley served as
director of research at Schaeffer's Investment Research. This year, his picks
were up 70.1% through August 31, compared with a gain of 3.4% for the
Nasdaq Composite. And from the firm's October 1999 start, BigTrends has
delivered 126.7%, versus the Nasdaq's 56.4%. To hear why he thinks a
major correction is coming and why he uses options only selectively, read on.
-Sandra Ward
Barron's: How do you spot market trends?
Headley: I've developed a number of indicators that monitor investor
behavior for extreme readings in investor fear, which is likely going to be near
the end of severe selling pressure and present good buying opportunities or,
on the other end of the spectrum, for excessive greed, where it appears
everybody has already piled in to the market, and which likely means the bulls
have exhausted most of their purchasing power. That's where you get major
tops and a good place to sell. These investor-behavior indicators allow you to
get out a little bit ahead of the rest of the crowd because most people follow
momentum and price trends. That can make us a little bit early sometimes. But
it is tough to get out when the panic starts, as a lot of people found out in
March and April.
Q: Is your work all technical, or do you care also about fundamentals?
A: It's driven more by technical and sentiment indicators. We have had a hard
time finding indicators on the fundamental side that can be timely enough on
the broader market. We do look at some fundamentals when we make
decisions on individual stocks. But for the broader market, it's tough. We find
we're switching in and out of the market more frequently because sentiment
and investor opinion is changing much more rapidly than ever before, partly
because so many people have more access to information. Our market-timing
switches are probably averaging about a three-week holding period in 2000.
But in past years, we would stay with a view for probably double that, if not
more. As the markets swing much more rapidly, we've had to adjust much
more quickly.
Q: Why try to time the market, rather than buy and hold stocks?
A: Market timing has gotten a very bad name, because most investors do it
badly. That's what we are taking advantage of. I'm monitoring the behavior of
most investors by watching the flows into the Rydex bear and bull mutual
funds, the CBOE volatility index and the equity put/call ratio, so that I can do
the opposite of most investors at major turning points, basically unloading and
selling to those people who have piled into the market or buying when
everybody else is panicking. It's definitely a contrarian approach, but it works
very well, even in this kind of environment where the volatility is so great.
It's not that we have made that much money on the downside, but we have
preserved our capital. Even though we have been correctly worried about the
market at three major tops -- on March 10, April 7 and July 17 -- and were
telling people to get out of the market ahead of those dates, we didn't really
take advantage of it very well on the downside. I am a market timer, but I am
not a daytrader.
Q: How's that?
A: We believe it takes some time for the sentiment
stuff to unwind. Even though it's unwinding much
more quickly than it used to, it doesn't unwind in a
day. Sentiment is not going to be completely
accurate, and that's why we factor in the technicals
along with it. But the sentiment provides important
clues and allows us to look forward.
Q: What else distinguishes what you do from
day-trading?
A: One of the things we really don't like to do is to
make judgments based on intra-day activity. A lot of battles are fought during
the day, but the war is won at the close. In this environment of excessive
volatility, that's been more true than ever. We have Emulex type of situations,
crazy moves one way or the other. So it's important to wait for the close to
assess the market. Also, we focus on weekly and monthly charts, rather than
daily charts.
Q: Explain.
A: You get a much cleaner read of overall trends in the market. For instance,
last year, when Qualcomm broke down below a 50-day moving average, that
provided a lot of people with an exit signal, and it created a lot of panic. But if
you were looking at a weekly chart with a 10-week moving average -- the
equivalent of a 50-day -- you would have waited until the end of the week
and you wouldn't have gotten shaken out of Qualcomm because, by the end
of that week, it had reversed and closed well back above the 10-week
average. Extending the time frame blocks out the noise from your investment
decisions. If you're getting conflicting signals, the chart with the longer duration
will ultimately win. Certainly, we are short-term investors -- our time frame is
a couple of months-but we are trying to get a sense of the bigger trends. We
use options so we want to minimize the time the option is at risk but still try to
capture the most out of a directional move. The main issue with my short-term
approach is that it comes with a taxable consequence, which is a concern for
high-net-worth individuals. So far, the returns we have generated more than
offset even the highest tax rates.
Q: Tell us about the indicators.
A: The three key ones I focus on are the flows into the Rydex Nova and
OTC funds, bullish funds, relative to the bearish Rydex Ursa fund. That's my
most bearishly positioned indicator right now. The other two are the VIX, the
CBOE volatility index, and the equity put/call ratio. I mainly follow the CBOE
equity put/call ratio because you can find the data every day at the end of the
day at their Website (www.cboe.com).
It is very easy to track, and they have several years of data, although I have a
lot more years of data in my data base. But like the Rydex data, it hasn't been
as widely followed. Rydex is a group that allows active switching between
bullish and bearish funds. The bullish Nova fund tracks the S&P 500 and
contains a leverage factor of 1.5 times the S&P 500. The bullish Rydex OTC
fund tracks the Nasdaq one-to-one. I track the assets in those key funds each
day and compare those total bullish assets to the assets in the bearish Rydex
Ursa fund, which is actually tracking the S&P 500 inversely.
At September 1, the ratio of Nova and OTC assets over Ursa assets was at a
ratio of 17.08. That was an all-time high. Even though the market is not at an
all-time high, we are seeing this incredible bullishness from people who think
there's clear sailing ahead. For perspective, the prior high was a ratio of
15.96, reached in late March when the Nasdaq was above 4500, right before
the early-April plunge and the eventual decline in mid-April to about 3200.
Another high reading of 15.68 was logged on July 14, when the Nasdaq
Composite was at 4246. The next session, the Nasdaq began a descent to
just 3521. Clearly, when fund investors get this bullish, it signals short-term
market tops with the potential for sharp short-term declines. I have never
recalled being this bearish in the 11 years I've been doing this. There is just
too much optimism. It would be rational to have record optimism if the market
were making new highs. But the S&P is testing its highs and the Nasdaq is
well below its highs. And the Nasdaq is where most of these assets are
concentrated in the Rydex funds -- about $3.5 billion are in the OTC fund,
whereas Nova has about $650 million. About $250 million is in the Ursa fund.
Q: So it's a case of wishful thinking rather than true optimism?
A: Exactly. That's a major concern to me, especially so because we are now
in one of the seasonally weakest periods, September and October. What
you're going to see out of all this is a short-term decline by the end of October
that will likely undercut the prior lows of just around 3400. It reminds me of
the 1997 period, where much the same thing happened. There was a top in
July and a correction that lasted into August. There was a bounce back in
September. Then the market rolled over and really tanked in October with a
500-point drop in the Dow when 500 points meant a lot more. That's a
concern, too. You are going to have to see a lower low, something that really
shakes people to the core, to shake out this optimism.
Q: What about the other indicators? Do they confirm the Rydex
reading?
A: The next one would be the CBOE volatility index, the VIX, which I find is
an important measure of investor fear or greed in the options market. It has
also given a sell signal recently. The VIX is a measure of the expected
volatility of the stock market going forward based on the pricing of S&P 100,
or OEX, options. If the VIX is at 20% it implies that investors expect the
market will move plus or minus 20% over the next year about two-thirds of
the time -- or about one standard deviation. If you look back over the past
several years, a VIX reading of under 20%, particularly near 18%, suggests
problems for stocks over the near term. The most recent reading was a low at
18.06 on August 28. In the past two years, there have been two readings
under 18, and both signaled a market top and the beginning of a very nasty
few months for the Nasdaq and the S&P.
Q: Do the indicators you watch have to be lined up in order for you to
get a clear signal?
A: My model tends to look for where the majority of the evidence is coming
from. I look at a lot of different indicators, but these three are the core of it. If
two of the three indicators are giving very negative signals, as the Rydex and
the VIX are, but the other key one, the put/call ratio, is neutral, that's enough
evidence to be pretty negative on the market. If two are neutral and one is
bearish, we would tend to wait for the majority of evidence to line up on one
side or the other.
Q: What are some other gauges that are
useful to you?
A: We look at a lot of different indicators, but
one that is a pretty useful tool is the moving average convergence divergence,
or MACD, developed by Gerald Appel. Even though it has become more
popular the last few years, we still find that it works pretty well. It tracks two
different exponential moving averages, basically trend lines, and picks up
changes in momentum a little faster than other momentum indicators. All the
indicators we look at tend to have some kind of a leading-edge component.
We tend not to like coincident or lagging indicators. A lot of people will talk
about the advance/decline line, but I'm not a fan of using the advance/decline
line as a tool because it's a lagging indicator of what's happening in the
market.
Q: Any others?
A: One proprietary measure I have developed, my favorite indicator, consists
of acceleration bands, which allow me to spot stocks that are exhibiting
unusual trends. It's two bands created around a 20-day moving average.
When a stock breaks out of the top band, it suggests it will keep on
accelerating at a faster and faster rate. I also have a re-entry signal that gives
me a chance to get back in. One of the biggest mistakes investors make is
getting out of a good stock because they think it's overpriced but then they
don't have another plan to get back in. Even if they are correct and the stock
retreats, they don't typically think about getting back in and they usually miss
out on a great buying opportunity. The focus has been on the technology
leaders the past two years because that's where the action has been. If we get
a change in the market in which other groups begin to go through acceleration
phases, then we would naturally move toward those areas.
One stock that was great for me was S1 Corp. We had a couple of different
acceleration periods that we really took advantage of in the spring of 1999
and the beginning of 2000. When the acceleration ended, we were out. We
exited at a price of about 110. Now the stock is trading at 18. We like its
prospects for the long term, but we are waiting for the next acceleration phase
before we buy in again. What we really care about is how a stock is doing
relative to our other opportunities.
Q: Are these charts and indicators always relevant to what's going on in
the market?
A: I try to make things more relevant to the recent activity. One of the things
I'll do is plot 21-day Bollinger Bands around a put/call reading or a Rydex
reading with two standard deviations on either side which implies that 95% of
the price action should occur within those Bollinger Bands. If there's a break
above or below the bands, it would send a signal that's been adjusted for
higher volatility and greater extremes.
Q: Why do you use options, and is now a good time to be buying
options?
A: Options are a leverage vehicle, and leverage is really a double-edged
sword. I use options when we are in a nicely trending environment, where the
market is steady or rising predictably. In an environment that's choppy and
very trading-range oriented, like now, buying options won't be a great
strategy because you very easily may wind up going nowhere on your
underlying stock and losing time on your option. And time is everything when
you value options. If you try to use options all the time, it will chew you up,
financially and psychologically.
Q: What about holding a stock and buying a put? What about selling
options?
A: Our focus is on buying options, not selling them. I will sell options
occasionally for tax purposes, when I have grown concerned about a stock
but must hold it until the next year. If you are writing covered calls, where you
own the stock and are selling out-of-the-money calls against it, the problem is
you tend to get a very small piece of the upside if the stock roars ahead. It
defeats the purpose of trying to find the best stocks and riding them through
the good times. Buying puts on a stock is a viable alternative for people who
have a low-cost basis and don't want to incur a taxable consequence or
believe in the stock long term and want to ride out any downturns. But I find
that strategy tends to limit overall returns over time. I don't want to get stuck
in a situation where I'm paying too much for put protection on a stock that's
flattening out.
Q: You talk about opportunity costs, but what about the costs of all this
short-term trading?
A: Commission costs on stocks and options are way down. The bid/ask
spread on stocks is way down as well. The issue in the options markets is
that, while stocks have gone to a sixteenth and now to decimalization, you still
have options on a lot of stocks trading at a quarter or even a half. That's one
thing holding the options industry back. Groups like the International
Securities Exchange, which will offer electronically traded options on the
biggest options contracts on the biggest stocks, have the potential to tighten
those spreads over time. If it does, you could see that business explode
because if I thought a stock was going to have a short-term move, I would
rather buy an in-the-money option, which would give you three or four times
the leverage of the underlying stock. But right now, the wide spreads eat into
my return.
Q: How is your portfolio positioned right now?
A: We have zero long positions and three short positions, and we just
recommended buying October puts on the Nasdaq 100 Trust, or QQQs.
Q: What stocks are you short?
A: We have a short on Compaq Computer They are starting to make the
headlines as a turnaround story, and its CEO was featured in a rock-and-roll
pose on the cover of a major business publication. Magazine cover stories
tend to be great contrarian indicators about 80% of the time. Generally, the
stocks featured decline over the next 12 months. In the last week, Compaq
ran up to the top of an 80-day acceleration band to 35 a share, a major
resistance point, and then backed off, breaking below the moving averages. It
tells us the stock has topped out and is headed lower, probably back to the
mid-20s. It's around 32 now.
[For a different view of Compaq, see the Technology Forum -- Ed.]
Q: How about another?
A: DoubleClick. The stock popped recently up to 45 a share and then started
to reverse. We think the stock is probably headed back to test the old lows
around 30 a share. Technical considerations combined with the focus on
privacy issues related to the Web cause problems for DoubleClick. It's now
trading at about 36.
Q: And the third?
A: Go2Net. It bottomed out just under 40 a share and rallied back last
Tuesday to 80 before reversing and falling back to 73.50. It is weak
technically. The 200-day moving average is a key trend line for Go2Net. It
pierced below the 200-day average last October, then there was a massive
reversal before the stock broke down below the 200-day average in April. It
rallied back and is now backing off again. We see Go2Net at 60 if not lower
over the next six weeks or so.
Q: And the QQQs?
A: Obviously, we're making a broader bet on the Nasdaq. The 100 level has
been important for the shares. The high in mid-June was right at 100 on the
QQQ. We had a high just above it at 101 on July 17, right before it went to
85. We just had a high of 103.50 on the Friday before Labor Day and then a
hard reversal early last week. We think the QQQs are likely to test the 89-90
area. We would expect a steady downtrend to develop here as it will a while
before people really get worried again. The 200-day moving average on the
index is just below 95, and that will act as a bit of support before it falls
further.
Q: Where are your charts suggesting investors may want to put their
money once we get the correction you predict?
A: The technical picture for some companies in the B2B arena is strong.
Ariba would be a buy at 140 and i2 would be a buy in the 130-135 area. We
like technology staffing specialist Hall Kinion & Associates at these levels but
would wait until sufficient pessimism enters the market before buying. Another
specialty play is Digene, which is developing a cervical-cancer screening test.
It's setting up nicely for a longer-term breakout after retesting its 200-day
moving average in late May.
Q: One of the darlings of the market has been a competitor in that field,
Cytec.
A: That one is actually starting to break down a bit right here. It has broken
its 200-day moving average three days in a row. It's not as attractive from a
technical perspective as Digene.
Q: Any others?
A: I've been getting a buy signal on the Japanese conglomerate, Kyocera. Its
200-day moving average is at 160 and that would be a great place to buy it.
It has been breaking out of the average and settling back and holding up
nicely. And there are still quite a few attractive biotech charts out there. Ones
that have been shaping up quite bullishly on my list are Millennium, Amgen
and Regeneron.
Q: Thanks very much, Price.
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