Tom Galvin is a hardcore bull and opposite of hardcore bear Fleckenstein. Here's what he has to say about market upturn:
Week of July 18, 2001 MACRO VIEW
Thomas M. Galvin, CFA
Portfolio Strategy Technically Speaking
· Despite worse-than-expected profit news over the past six weeks, big-cap
market indices like the S&P 500 and Nasdaq have essentially moved side-
ways for three months, with little inclination to test the April 4 lows. When the
market can stabilize in the face of overtly bad news, its resilience speaks vol-
umes with a rebound a more likely next step.
· The NYSE advance/decline index has firmly broken above its 200-day moving
average, which has only happened three times in the past 15 years. Each
time, rising markets have subsequently transpired. The NYSE took a bear
market turn two years before the Nasdaq and it is now resurfacing. Try not to
allow the volatility and high valuations of the Nasdaq to cloud the recovery
under way in old-economy NYSE shares.
· Consistent with historical market rebounds following economic downturns,
small- and mid-cap shares are leading the way. Because a great many
cyclical shares are often small by nature given a limited duration of market
appeal, their recovery should be viewed as a leading indicator of a turn for
the economy.
· A review of the more than 100 industry groups that constitute the S&P 500
reflects, in general, a market rotation toward cyclical areas and away from
defensive groups. Industries with a recent healthy breakout above their 200-
day moving average include auto parts, steel, retail building supplies, retail
electronics, life insurance, and generic drugs. Groups moving out of favor in-
clude airlines, drugstores, household products, medical supplies, natural gas,
and energy exploration and production.
Investment Summary
We’ve decided to hold off this week from spouting about where the market is
headed and instead immerse ourselves with a technical analysis introspection to
determine what the market is currently telling us. Here are the conclusions. First,
despite worse-than-expected profit news over the past six weeks, big-cap market
indices like the S&P 500 and Nasdaq have essentially moved sideways for three
months, with little inclination to test the April 4 lows. This time last year, companies
were broadly exceeding earnings estimates and the indices were heading south.
The fact that we are caught in a trading range amid big earnings misses and con-cerns
building in Asia, Latin America, and Europe suggests that the bar of
expec-tations is generally low even though some stocks are getting sandbagged. When
the market can stabilize in the face of overtly bad news, its resilience speaks
volumes, with a rebound a more likely next step. Even Compaq shares rose 5%
following a forecast of feeble revenues and renewed cost-cutting. Same type of
reaction for Yahoo, Motorola, and Microsoft. Imagine if any positive news ever
occurs?
Second, the front-page charts show that the NYSE appears to be creating a new
bull market leg-up. The advance/decline index has firmly broken above its 200-day
moving average, which is a rare occurrence—only three times in the past 15
years—and rising markets have always subsequently transpired. After a two-year
drought (May 1998-April 2000), NYSE new highs continue to exceed new lows by
a healthy margin. From an economic perspective, the U.S. periodically experi-ences
focused industry or regional recessions like the oil patch, agricultural belt, or
real estate areas, but the remainder economy remains afloat and keeps chugging
along. In a similar fashion, the stock market often experiences rolling bear and bull
markets simultaneously. The NYSE took a bear market turn two years before the
Nasdaq and it is now resurfacing. Try not to allow the volatility and high valuations
of the Nasdaq to cloud the recovery under way in old-economy NYSE shares.
Third, consistent with historical market rebounds following economic downturns,
small- and mid-cap shares are leading the way. As we show in the S&P Average
Price Performance table, the average stock is faring much better than capitaliza-tion-
weighted indices. The average stock in the S&P Small Cap Index is up about
16% this year compared with only a 3% gain for the Index and 8% fall for the S&P
500. In addition, more than 60% of the constituents in the S&P SuperComposite of
1,500 companies are outperforming the Index. Tables showing the indices versus
their respective 200-day moving averages also depict a strong technical foundation
with the small- and mid-cap averages holding above the all-important 200-day
moving average. Because a great many cyclical shares are often small by nature
given a limited duration of market appeal, their recovery should be viewed as a
leading indicator of a turn for the economy.
Fourth, a review of the more than 100 industry groups that constitute the S&P 500
reflects, in general, a market rotation toward cyclical areas and away from
defen-sive groups. However, industry or stock selection rather than broad-based sector
appeal is winning the day. The Groups Breaking Out section highlights industries
with a recent healthy breakout above their 200-day moving average—namely, auto
parts, steel, retail building supplies, retail electronics, life insurance, and generic
drugs. Groups moving out of favor, in the Groups Breaking Down section, include
airlines, drugstores, household products, medical supplies, natural gas, and en-ergy
exploration and production firms. As described in our “Tri-Cycle” report of
June 11, we are hitting another three-year cyclical trough not too dissimilar to 1998
and 1995. Therefore a cyclical rotation for portfolios is the appropriate strategy.
Our real money model portfolio entitled SABERS (see June 25 report) was
inten-tionally structured to be 75% cyclical including technology and 25% growth (mostly
health care).
Fifth, the Nasdaq performance is taking a page from history and—if you’re
sit-ting!—a lead from the Korean Kospi stock market. The charts in the Nasdaq
Tak-ing Page from History and Lead from Korea section offer an eerie similarity to the
last Great Bear Market of 1973-74. The difference is primarily time, as then it took
18 months to accomplish the same price decline established lately in 12 months,
which in effect is a tribute to the Moore’s Law economy. While seemingly outland-ish
to mention, a repeat of history could see a 50% rebound in the next 8 months.
The top right graph under the Poised for a Rebound section also shows that violent
downswings very often are followed with equally violent technical upswings. In
1998 and early 2000, the Korean Kospi moved in advance of major shifts of the
Nasdaq by one to three months. The rationale would be the heavy concentration of
electronic and semiconductor firms in Korea. This year the Kospi is up over 10% in
dollar terms, which could be leading the way for the Nasdaq. Separately, we pro-vide
under the Virtual Twins section three virtual twins to tech heavyweights that
have benefited from the rotation out of tech. Sysco Corp., Suncor Energy, and
Veritas DGC have recently stopped rising and their tech counterparts appear to be
bottoming. Stay tuned to these three sets of twins to monitor a legitimate rotation
back to tech.
Last but by no means least for benchmark enthusiasts, we provide the
reconsti-tuted sector weightings for the Russell Indices. As we previewed on May 14, the
Nasdaq implosion shifted many tech shares from the Russell 1000 to 2000 and
from growth- to value-style indices while financial shares did the reverse, gaining in
growth while happily losing share in valueland. Tech has fallen to 28% of the
Rus-sell 1000 Growth Index, down from 38% previously. Also, consumer discretionary
and health care lost share of the growth index but gained on the value side. No
doubt the Russell Shuffle added unwanted additional selling activity for tech, health
care, and consumer cyclicals as well as unnatural buying of financials, but
comple-tion of the reconstitution could provide some near-term reversal of these trends. |
