Barometer Readings
A onetime "perma-bull" pores over a host of indicators and turns bullish again
April 2,2001
An Interview With Don Hays -
If you think only a rocket scientist could figure out the centrifugal forces of this market,
then this is the guy for you. A former engineer working with the team that developed the
Saturn rocket for NASA some 35 years ago, Hays long ago found that Wall Street could
supply him with the same thrill of going to the moon and coming back to earth, with a
bigger, and definitely more essential, payload attached. His skills in detecting market
patterns by using a battery of barometers, then drawing historical correlations from those
patterns, have led to an enormously successful run of correctly gauging the market's flight
path. Notably, he warned his clients early on that the movement in the Nasdaq showed a
remarkable resemblance to Japan's Nikkei index in the late 'Eighties and would likely
return to its pre-Internet-madness level of 1800 before all was said and done. Coming
from a self-appointed "perma-bull" who turned bullish in 1981 with the sage prediction
that disinflation would lead to an unprecedented period of prosperity, this was sacrilege,
indeed. Still, he was right. He was in Florida when we caught up with him by phone the
other day. Listen in to learn where Hays, who has run the Hays Advisory Group
(www.haysmarketfocus.com) since leaving First Union and its Wheat First Securities unit
in the fall of 1999, sees the market headed next.
-- Sandra Ward
Barron's: I hope the weather is better in Naples than on Wall Street.
Hays: It was a little cool yesterday, but back up to 80 today, the sun is shining and there
are no clouds on the horizon.
Q: No wonder you turned bullish.
A: Well, it's been that way for the past three months and I've only just turned bullish.
Q: Why does the world look rosier to you? You've cited the Arms Index as one reason.
Why don't you tell us about that?
A: It has got all kinds of names. It was known as the MKDS and sometimes it's referred
to as the "Trin." It was developed by Richard Arms. I like it because it has worked so
well. To me it is like the fuel gauge on your car. It's as if you have a dragster and you want
to go from zero to 120 in four seconds, and you have a carburetor that just sucks gas and
it takes a huge amount of fuel to push the car down the strip.It's the same way with the
Arms Index. It measures the amount of upside volume to downside volume in relation to
the number of stocks. So think of it as a measure of energy being required to push a
market up or down. Anytime it goes above 1.3, and that's the 10-day average now, it's a
sign that you have got to stop and refuel before you go down some more. But when it
goes above 1.5 it's a sign you are virtually out of gas and running on fumes and there isn't
much more energy to push it down, based on historical examples, of which there have
been 12.
Q: So we've hit bottom? Or do you need some other signal to confirm that?
A: You are not kidding we need more evidence. We got the signal one day before the
October 19 crash in 1987, but you lost your shirt -- 22% -- if you bought into the market
the day it gave a signal. In almost every one of the instances where the Arms Index moved
above 1.5, there was always some more vicious decline after it. So there is more to go on
the downside and you don't want to pull the trigger yet. But you have got to be ready in
the next couple of weeks.
Q: Can you be more specific?
A: I have no idea when it will be, but I know in the past the longest wait was 20 days from
the signal. I don't think it will be 20 days. For the past 15 years, it has always been in the
four days following. That's the reason I think yesterday's [March 22] intraday low
probably will be the low. I will be dollar-cost-averaging into the market in the next two
weeks. The signal to watch for -- a rally of 1% in the S&P on increasing volume from the
previous day -- should come after the first three days, between the fourth and the 10th
day. That says the odds are high for a move on the upside.
If I see that happening, I may jump ahead a little bit. But I always like to go back to
history and find other examples that I think are similar in background and similar in action.
I find March 24 of 1980 to be the most equivalent. In 1979-80-81 we were going into a
period in which the new theme was disinflation. It was setting the framework for the next
bull market. Every time inflation came back, the Fed fought it a little harder and there were
very definite signs in 1978, '79, and '80 that inflation had been defeated. That became
more evident in 1981. This time, the new theme will be deflation and the spread of
democracy. If this is similar, we have three or four weeks here of ebbing and flowing
before we take off.
interactive.wsj.com
"I think [March 22's] intraday low probably will be the low."
Q: All this comes to you via the Arms Index?
A: Oh, no. But it is a great indicator to tell you that there is something very significant
happening. Until this point, I thought the capitulation phase of the bear market would not
come into effect until sometime in the April-June period. About three or four weeks ago I
changed my mind. The Arms Index gave the signal, and you could just feel how everything
felt so much like March of 1980, when everybody was thinking the end of the world was
here. I realized we were going out of the interlude and into the capitulation phase, and so I
upped my cash and decreased my equity position.
Q: What charts other than the Arms do you rely on?
A: I'll give you the most pertinent ones that are sending me a message now. A valuation
gauge that is very important is one developed by I/B/E/S measuring the earnings yield of
the Standard & Poor's 500 based on 12-months forward earnings. That earnings yield is
then compared to the yield of a 10-year-note and from that you can glean whether the
market is overvalued or undervalued. At yesterday's close [March 22] it was 8.7%
undervalued.
It is the first time it has been in the undervalued category since the panic selloff in 1999
and before that in 1997-98. It had been 70% overvalued at March 10 of last year. That's
one, but psychology is my favorite indicator because, I think, psychology determines what
the Federal Reserve does.
Q: Isn't that the hardest one to get right?
A: Not if you have the right indicators. I use the equity put/call ratio, and that has the best
record of measuring real bullishness or bearishness.
Q: That gives you a read on the mood of individuals, not professionals?
A: It is more focused on the individual investor and individual stock. It excludes indexes.
The three-week average is 12% above the 39-week average. Like the Arms Index it
doesn't tell you it is going to turn around the next day. It tells you that the "wall of worry"
has been rebuilt. A fairly recent addition to my psychology composite is the Smart Money
Flow indicator. It is fantastic, and I like the philosophy behind it.
Q: Explain.
A: It confirms other signals. If the Dow makes a new high, the Smart Money Index has to
confirm the action. It called 1987 perfectly. One of my subscribers brought it to my
attention about three years ago. He had been keeping it all these years and in 1998 before
the August debacle, it started plunging and called that one perfectly. Again, in the fall of
1999 it started plunging. Every time the Dow tried to rally after the January-February high,
this kept on plunging. It has not had any higher highs until the last two months and it has
really been acting good.
Q: What exactly is the Smart Money guage?
A: You calculate it by taking the action of the Dow in two time periods, the first 30
minutes and the last hour. The first 30 minutes represents emotional buying based on good
news or Maria doing handstands. It is dumb money. So the keeper of the index, Lynn
Elgert, subtracts the dumb-money action on the Dow that occurs in the first 30 minutes
and he adds the last hour, which represents the smart money because the action in the last
half of the day tends to be based more on logic and reason. For the very first time that
index has been making higher highs. Yesterday [March 22] the real snap-back was in that
last hour. I think that is more evidence that psychology is good.
Q: So these indicators are still viable even though there's increased access to information
and news flow leading to lightning fast changes in the markets?
A: I don't think that makes a bit of difference because people are still driven emotionally
and I don't think that fear and greed have changed. No matter how quick you get
information, it still takes about the same length of time for fear or greed to build up. So I
don't see any difference in the volatility of the market. Depending on where you are in the
cycle, in the super cycle, not just the three-year cycle or four-year cycle, but if you are in
one of the 18-year super-cycle markets, or in an evolutionary stage, I think the indicators
are still very accurate.
Nearing A Bottom?
In almost every instance in which the ARMS Index moved above 1.5, a market bottom occurred not long after.
Signal Date Closing Dow Low Days Until Final Closing Low Dow at Day Low Decline of the Dow From Signal to Closing Low
May 28 '62 576.92 20 536.77 6.96%
Oct. 1 '62 571.95 16 558.05 2.43
Oct. 7 '66 749.6 1 744.32 .70
May 4 '70 714.55 16 631.15 11.67
Sept. 30 '74 607.86 4 584.55 3.83
Nov. 19 '74 614.04 12 577.89 5.89
Mar. 24 '80 765.44 3 759.97 .71
Sept. 3 '81 867.01 15 824.01 4.96
Aug. 6 '82 784.34 4 773.59 1.37
Oct. 16 '87 2246.74 1 1738.75 22.61
Nov. 30 '87 1833.55 4 1766.73 3.64
Oct. 27 '97 7161.14 0 7164.14 .00
Mar. 16 '01 9823.41 ? ? ?
Source: Hays Advisory Group
Table:Nearing A Bottom?
Table:
Nearing A Bottom?
Q: So where are we in the super cycle?
A: I think we are going to go back to the Presidential-election cycle during this turn. We
haven't seen it in many years. It will come back into effect for the first time since probably
Greenspan has been there. He is such a manipulator. He has done a lot to keep it from
working. For many, many decades, the first year of the Presidential-election year was
always the weakest year. A new President came in and decided to get the tough stuff out
of the way before he had to run again four years later. The second year is not as weak as
the first year but it's still a so-so year. But the third and fourth years, when they are trying
to get everything just right to run again, typically those are the very best two years of the
Presidential-election cycle for the market. So we are going to have a rally, but we are
going to have to pull back again sometime before we begin the new super-cycle bull
market based on deflation and democracy.
Q: You called the bull market of 1982, but you turned bearish in 1997. Why?
A: I was known as a perma-bull, but starting in the fall of 1997 I started believing the
super bull-market of 1981 to 1997-98 was about to end. We saw extreme weakness in
the market and we were pretty exact in our timing. Most stocks, 70% of all stocks
peaked out in April 1998. The real decline started in August, and got to where almost no
stocks were poking their heads up. That was the first bear-market phase of the typical
stock, the whole universe of stocks. The market rallied right after that. But psychology,
monetary policy and valuation, all the stuff we look at, turned very positive in September
of 1998, which really surprised me. I expected a normal bear market the way we used to
have them and I thought it would last 15-18 months. I thought it would cure the excesses
of the world. But Greenspan decided to rescue the world. So he flooded the system with
money and he bailed it out. But he also blew the bubble up a little bit higher.
In 1999, the broad market once again turned weak in the August-September period of
time and turned weaker by the time we got to March of last year. We only had 10% of all
stocks above the 100-day moving average. In my opinion, that was the second
bear-market phase of the total universe of stocks. But we had this pumped-up stage of
New Era technology totally masking it, and it was helping people's portfolios because
everybody benefited from these stocks going up. So it helped everybody to feel better
and helped them to believe that we were in a bull market. Then the bubble burst. The
Nasdaq had a price/earnings ratio of 153 and was going through the roof at 5100. Part of
the reason for that is a marketing trend started by Merrill Lynch brokers some seven,
eight, nine years ago in which they persuaded people to stay fully invested. If they sell
something they don't hold cash, they just put it right back in. This is called strategic
allocation.
Well, when Big Daddy Merrill did it, you know every other brokerage firm in the world
trotted right along behind it. At the same time, Jeffrey Vinik took over from Peter Lynch at
Fidelity Magellan. When Vinik came in, he thought the market was vulnerable and he
raised cash, bought bonds and got his head handed to him. Now Fidelity began telling its
managers to stay fully invested. Every mutual fund trotted right along behind them. So we
have a system now when you sell something you have to buy something else immediately.
As investors started phasing out of the technology stocks, they started pumping up the rest
of the market. The Nasdaq had its first phase of its bear market from March 10 until April
15 of last year. Then there was an interlude rally. The second phase of the Nasdaq bear
market started about August or September of last year, and that ended the first week of
this year. This is the third phase, the capitulation phase. In capitulation, you don't sell one
stock and buy another, you go to cash. That's why the stocks in the broad market are
going down with the technology stocks.
Q: Sounds like you think Greenspan caused the bubble and the bust?
A: If you look at Greenspan's record in the past, he has never, ever, ever called the
economy right and never called inflation right. Why should somebody like that have his
hands on the puppet strings? He is also very aggressive. People give him credit for busting
inflation. Well, that's a joke. Inflation came down in Paul Volcker's first term. Came way
down, almost to where it was not too much higher than it is now. Up until 1996-97, he
used to say that the economy could never grow above 1% without causing inflation. He
used to say that unemployment could never fall under 6% without causing inflation. It was
a coincidence with his marriage, but he all of a sudden turned from a Scrooge to a Santa
Claus, and during the 1997 Asia crisis he did not let the natural forces run their course.
Now he has gone overboard on money supply.
People always love easing. So since 1997 he has been applauded for being one of the
saviors of the world. But he threw all this money into the system, and it allowed margin
debt to go through the roof at the worse possible time, and it blew the bubble up to levels
that require much more pain to get rid of.
interactive.wsj.com
Q: You've mentioned you see deflation on the horizon.
A: I think what we are in is a very unique time that is somewhat equivalent to 1880. We
had the five waves of technology, they've been in a gestation phase since the 1970s when
the PCs came along and Ma Bell was broken up. Technology didn't really come out from
under the covers until 1994-95. We have already seen huge increases in productivity. This
is the beginning of where the technology revolution is permeated into the entire United
States and much of the world. We had one of the strongest economic recoveries and the
longest economic boom in history. We've had retail sales going through the roof. We had
debt moving up and unemployment coming down.
At the same exact time, the CRB Index has not even come close to making new highs.
Gold has been plunging and wages have had a small blip up but nothing like what you
would expect. Even the bears on inflation who believe inflation will go up are projecting
maybe 4% or 4.5%, not 10%, 20%, 30% we had back in 1982. On gold, the bears will
insist it is being manipulated. But you can't dismiss the price of lumber. All these things
have really plunged in the past two years.
Q: You see this continuing, but how does it continue to be a positive for the economy?
A: It will be very damaging to many companies if they can't keep up with productivity. It is
going to hurt large companies especially because they cannot change as much. I think the
day of a big-cap stock has come to an end for a long period of time. Innovation comes
from smaller companies that can produce productivity-enhancing products. I'm not talking
about just technology companies, I'm talking about building a road or anything else
cheaper or faster. Our infrastructure has been so ignored for the past 20 years, we are
going to spend the next 20 years trying to get our infrastructure, our power plants, for
instance, back up to scale. It has to be done by productivity-enhancing kind of products.
In the Industrial Revolution of the 1800s, the companies that did well were not the
companies that produced tangible products. It was the railroads and those types of things
that really had a huge jump in productivity. Deflation is not going to be a panacea for all
stocks. Exactly the opposite. But it will be the driving force behind productivity gains and
better labor relations, better everything. With the Internet and with personal computers,
nobody can keep a secret from anybody. Everything is totally wide open, and there is
perfect pricing power. The companies and countries that will benefit are the ones that have
less bureaucracy or more bottom-up management. There will be more democracy in
corporations as well as in countries. Nobody can tell for sure what is happening in China,
because there is so much secrecy, but by the same token you are seeing very vivid signs
they are gradually improving worker relations and gradually opening up.
interactive.wsj.com
Q: Which stocks should people focus on, then?
A: You want to avoid commodity companies, mining outfits and forest products and
industries where they have no pricing power and have a tough time raising their
productivity. Consumer stocks will be tough, too. Stock selection will be more important
than it has been in 30 years. Technology will still be a big, big place to go. Medical stocks
will be a big area because of demographics. You will have to be particular but financials
will be okay. Energy, has a two-year window, maybe longer, but at least two years where
you are going to see a lot of emphasis on replacing drilling and production equipment
that's been avoided for the last 25 years.
Q: What about bonds here?
A: We will not go into a deep recession, and by October I'm expecting a recession to be
acknowledged by everybody. If it's acknowledged in October, Greenspan will admit it in
November. I expect real interest rates to be at 2%-3% in the next six to nine months.
Bonds are still a great place.
Q: By October, we'll be seeing better times?
A: Right. This rough spot we're in right now will be like 1980 in that we have some
backing and filling for two or three more weeks. But, by the middle of April or
somewhere in there you will see something on the proposed tax cut; it may even be
passed by that time.
At the same time, first-quarter earnings will be out and that will relieve the market and
allow a rally. I also expect the Federal Reserve to cut interest rates again in that time
frame. That would set us up for the straight-up action we had in 1980. I expect the rally to
be a 6-12-month-type of affair, not a two-to five-year type of thing.
Q: Thanks, Don. |
