Speaking of Larger Cycles..., you may have missed this piece. The end is more interesting then the front half.
Call for another Supercycle bear market period:
"Election problems on top of corporate earnings problems, continue to postpone the year end rally."
by Bob Bronson
02 December 2000 05:46 UTC
csf.colorado.edu
--------------------------------------------------------------------------------
There is a feedback loop between the stock market and the Presidential election
according to history and cause-and-effect logic. Our forecasting model
considered the stock market trend to be a leading indicator for Presidential
election voters before November 7, with a bearish effect correlating with the
increasing prospects of Bush defeating the incumbent (party) Gore, especially
since the peak in his popularity following the Democratic convention. Following
the Florida voters still-as-yet unascertained collective decision on election
day, both the lead and trend effect logically reversed with the stock market
then bearishly reacting to increasing prospects of Wall Street and investor
class favored Bush losing his electoral vote lead. The combined impact of these
two pre- and post- election day lead and trend effects has contributed to the
continuously bearish trend for the stock market since its March 24 high, more
than eight months ago.
We believe that the bearish election trend will continue since some 90% of
institutional investors believe Bush will be president *and* the Gore team will
undoubtedly not accept that until all legal avenues of recourse are exhausted,
as long as Bush's lead is diminishing, tiny and/or questionable. Furthermore,
and contrary to consensus expectations, we continue to fully expect the bearish
trend will continue beyond Florida's nomination of its electors on December 12,
just a week from next Tuesday, and probably just beyond the national elector
voting day, six days later on December 18, before the traditional year end stock
market rally kicks in. In addition to the media's coverage past 24 days
coverage of various court decisions/appeals on Florida's disputed votes, we
continue to expect at least several more weeks of several electoral challenges
and outcomes from the Florida legislature, the Electoral College (i.e., perhaps
alternate elector slates for Florida, faithless elector nullification,
postponement of deadlines, etc.), and/or finally the US Congress (can a
non-senator VP break a tie vote in the senate for himself as a Presidential
candidate?).
There is a tendency for institutional research analysts and portfolio managers
to underestimate the negative effect of the Presidential election quagmire for
two reasons. First, they tend overly rely on analytical pricing models which
don't even factor in such political effects. Our forecasting model includes
many political factors which have historical and logical effects on capital
markets. Second, the capital markets are complex adaptive systems, and as such,
are subject to catastrophe physics, where sand pile avalanching is instructive.
It only takes one final piled-on grain of sand to start an avalanche when the
sand pile has reached its repose angle. And so it is with the extremely
overvalued and overbought stock market, where bearish election factors can take
on exaggerated significance as an additional catalyst in a bear market.
As much as we believe the stock market trend continues to be bearish, by at
first leading, and now tracking the Presidential election quagmire, corporate
earnings reports continue to be the most market moving factor. And there is a
major problem here, too, which supported our previously posted expectations that
not only would this be a down year for stock markets around the world, in spite
of the US Presidential election, and that the three summer month's rallies not
make new all-time highs, but also that the October lows would not hold, with
lower lows occurring before year end. In fact, already November was the worst
performing month this year, as well as the worst monthly percentage decline ever
for the NASDAQ.
As of November 28, S&P reports that their tally of S&P 500 companies third
quarter operating earnings per share, shows only 9.3% growth, on a one-quarter
(1Q) year-over-year (YoY) basis. This should not be confused with the four
quarter (cumulative) rate which *was* 15.0%, or the aggregate dollar (ignoring
per share effects) growth rate, on a 1Q YoY basis, which *was* 16.5% - its four
quarter rate *was* 20.4%. The one quarter growth rate, on a per share basis, is
the most relevant metric, and it is about 50% lower than was expected because of
the impact of lower revenue from the economic slowdown, as well as from profit
margin pressures caused by higher costs of employment, financing and energy. As
we've pointed out before, higher employment costs include higher cash
compensation to offset imploded stock options that are no longer acceptable as
salary substitutes.
We note that our tally of the *median* (to avoid skewness covered up by the
mean, or simple average) of now over 6,800 companies reports of per share "net
income" (usually less ebullient that "operating earnings", but more constrained
by GAAP as the SEC requires to be reported), *was* less than 8% YoY, whether on
a one-quarter or a four-quarter (cumulative) basis. Now that fourth quarter
pre-announcement December is upon us, bottom-up analysts are scrambling to get
their fourth quarter, and full calendar year, forecasts right which will result
in diminished growth rate projections for 2001 and thereafter that will be
almost 50% lower than were expected at the spring market highs, and just as
recently as at the late summer rally highs.
This sharp downward revision in actual growth rate(s) is the primary driver of
much lower future earnings growth rate expectations, which in turn, negatively
impacts P/E/G ratios, and hence, market and sector P/E ratios . All three of
these earnings valuation components are currently being simultaneously cut,
creating a sharply negative revaluation effect on the stock market. This
negative-compounding valuation effect from downwardly-revised corporate earnings
growth rate expectations is the most important (of several) factors that
typically create fourth quarter stock market lows - and not always in October,
especially considering the Presidential election quagmire, as I have explained
in previous posts about the history of six months good-bad seasons and fourth
quarter lows. In the current environment, 50% lower earnings growth rate
expectations from 20%/year during the past few years to below 10%/year over the
next several years, plus a corresponding decline in P/E/G ratios from as high as
2 to as low as 1, causes P/E collapses of 50% to 75%, which translates to price
declines of almost as much for the overall stock market and the high tech
sector.
The attached graph shows our latest update of these earnings growth rate
figures. Hopefully this chart will disabuse those who think there has been an
"explosive growth in earnings" as was mentioned in a recent "Puke Point" post on
the side list further arguing that the top of the stock market's EWT fifth wave
has yet to occur. During the almost six years (23 quarters) since the mania
began from the late 1994 lows, corporate earnings have grown at less than a 11%
annualized rate (on both a point-to-point and velocity-trend basis) and they are
again dropping below that average rate. And we expect them to decline much
further as projected on our chart.
There has been nothing "explosive" about corporate earnings, especially
considering that their growth rate is several percentage points overstated due
to financial engineering and accounting manipulations - which are both
unsustainable and completely reversible - from the disproportionately higher
weighted large high-tech growth companies in the popular market indices. For
another perspective, see Paul Kasriel's point that "...profit growth in recent
years has been anything but extraordinary"
ntrs.com Of
course, I'm referring to Cisco, who we agree with Jas is likely to become the
bad boy poster child of the big-cap high-techs, along with Microsoft and Intel.
As we pointed out at the time, those three big-cap, high-techs accounted for all
of the 2000 versus 1999 all-time new-high gain in the S&P 500, Wilshire 5000 and
Russell 3000 indices, which of course, is now history.
The caveat further offered in that "Puke Point" post of a lower-high fifth wave
is a non-starter to us since our Growth Cycle contemplates an ABC fifth is
always the most probable major topping pattern, rather than an 12345 where at
least these inequalities hold: 2<1<3>5>4>2. I agree with the rebuttal
discussion of the March 24 third wave all-time high, and especially the point
about wave, or cycle-trend, #4 being too deep for #5 to be able to make new
highs next year. I also hasten to point out that this was predictable, and our
expectation, since three subdivision ABC patterns typically mark major market
tops. For example, the last Supercycle bull market period peak in the S&P 500
was its 1/11/73 then all-time high which was also at the end of an ABC fifth
pattern (from the 5/26/70 low). I challenge any EWT aficionado to explain that
top as a five subdivision 12345 where these inequalities hold: 2<1<3>5>4>2.
As of November month end, both the equally-weighted and capitalization-weighted
indices of currently more than 7,000 publicly-traded US common stocks, which
peaked on 4/21/98 and 3/24/00, respectively, are down slightly more that 20%
from their highs - see our updated chart also attached. This is the
conventional minimum magnitude qualification for calling a decline a bear
market, rather than merely a correction, especially since the decline has
already lasted two months more than the high-to-low six months minimum duration
usually required for fully qualifying as a bear market.
This is only the second time both indices have been simultaneously down 20%
since the 1990 lows - the last time being the summer of 1998 - following our
10/7/97 peak call for another Supercycle bear market period. More
interestingly, considering the breadth of indices as well as the magnitude and
durations of their declines, this is now the most severe bear market since the
last Supercycle bear market period from the 1965-8 highs to the 1982 lows. And
unlike the several minor bear markets during the 1982 to 1997(9) Supercycle bull
market period which terminated at this point, we fully expect the current bear
market has much further to go. Our minimum downside expectations will be met
when, for example, Cisco breaks significantly below $46, and when the NASDAQ,
already down 50%, breaks significantly below the 2500 "puke point", as well as
when the more than one dozen high-tech short sale prospects that I've posted on
LWs since early 1999 reach their minimum downside objectives.
Barring an "early" Gore capitulation, and notwithstanding short term rallies
which we continue to believe are additional shorting opportunities, like the
current rally from yesterday's low, we believe there is much more loss to come
during only the next few weeks before yearend as a severe selling climax
develops with both public and professional capitulation, which heretofore has
been virtually non-existent. Only insiders have been steadfastly bearish during
this bear market decline to date, and that certainly is not bullish. Individual
investors have remained complacent having not yet finished their year end tax
loss selling or their margin account forced liquidations. Investment newsletter
bulls are as bullish as they were at the market highs which is another
incredibly bearish contrarian sentiment indicator. If Gore capitulates very
soon, then investors won't likely capitulate before yearend, and we would expect
only a weak year end rally will result, for which we will not close out our
client's long standing short positions, nor will we even likely hedge them.
As long as traders continue to try to catch a falling knife by repeatedly
calling the bottom before such a selling panic occurs, which has now become
almost a daily event now, up from weekly previously, the more they will be
whipsawed and have to capitulate and reverse their position, thus contributing
to the selling panic necessary for a significant bottom. Although there has
already been some $3.6 trillion lost in US publicly trade equity capitalization,
we continue to expect at least a $4-5 trillion loss in the current bear market,
creating enough negative wealth effect for a US-led global recession, in the
first of several recessions and second of many bear markets in this 12- to
20-year Supercycle bear market period.
So far, a MCHVIE (renamed a mass-correlation, hyper-volatility, illiquidity
event) is only evident between the NYSE, NASDAQ (including international
equivalents) and high yield or junk bonds (e.g., refer to a chart of HIF), but
eventually derivative rollover illiquidity will cause other bond market sectors,
certain commodities and the US dollar to join in with even more massive bear
market ending selling climaxes.
Bob Bronson
Bronson Capital Markets Research |
