I borrowed this from Harry Lew, thought it might add to what you are stating.
Message 16466683
Five indicators of a major market turn:
Trading the Bear
By Mark Weiss
From 1995 through most of 2000 "buy the dip" trading worked to perfection. Trading tech stocks was especially fruitful. It seemed like everyone you talked to was getting rich buying the same stocks every time the market sold off. Those of us who consider ourselves market professionals had a difficult time keeping up with our laymen friends who bought stocks like Cisco and Oracle and were up huge. We just couldn't justify Cisco at 200 times earnings or Larry Ellison surpassing Warren Buffet on the Forbes list of richest Americans. Frankly, I know many professionals that were jealous of the fabulous performance turned in by
investors with little market experience.
Fast-forward to October 2001 and we all know the tide has turned. The market has changed. Entering the first week in October, the Nasdaq is off 70% from the high set in March of 2000. Many investors bought when the market was down 20%, a number that is considered a correction an therefore a good time to buy. They bought more down 30% and still more down 50%. The players who used margin to leverage their buying have, for the most part, been wiped out. We know this from the dramatic fall in margin statistics published every month. We also know that the average investor was not the only one taking a hit. The Bass brothers, part of a billionaire family in Texas, were forced to liquidate 300 million shares of Disney to meet a margin call. That trade marked the low in Disney stock. The Disney trade is the kind of action you want to see at the end of a bear market. Forced give-ups by heavily margined players transfers quality stocks from weak hands to strong hands that won't be forced to sell the next dip.
Buying tech stocks that "seem" cheap or have fallen "too far too fast" is a strategy that is killing many of the traders who have been smart enough to stay afloat during this tough period. Bear markets are much more difficult to trade than bull markets. Stocks trade thin because fewer participants are willing to commit capital when they can't figure out the game. Many individual investors have stopped playing altogether. We can see this in the trade volume figures released by the largest discount brokers as well as Knight Trimark the largest Nasdaq market maker. Contrarians might view this as a good thing since the goal is to buy when the herd sells and sell when the herd buys, but remember the bull market where the herd was right for an extended period of time. They are the trend. Fighting that trend is very expensive.
Now the question is what market phase are we in now and more importantly where are we headed? To help answer this question I have to refer back to an article I read in the January issue of Bloomberg Personal Finance. The article is titled "The Only Indicators You'll Ever Need" by Chrisopher Graja and Elizabeth Ungar. The piece describes how five
easily accessible indicators flashed clear warning signals that the bull market was coming to an end months before the actual top. In fact the authors conclude the indictors also reveal good times to buy the market and often lead stocks by six months.
The first two indicators are Federal Reserve monetary policy and the yield curve. Early in 2000 the treasury yield curve began to invert. The short maturities, three months to two years, were starting to pay higher interest rates than ten and thirty year bonds. This inversion signals the end of an economic expansion. Growth stocks outperform value stocks as earnings become tougher to come by. The recession we are in today was clearly forecast over a year ago by the bond market. The inverted yield curve has always led to recession and recessions have always led to lower stock prices. Now that the Federal Reserve has lowered interest rates nine times this year the yield curve is once again normal. Short rates yield less than long rates and banks, which borrow short-term money and lend long term, can become very profitable which encourages more loans and economic expansion. The early stages usually favor value stocks that get crushed in a recession. A picture of the yield curve can be found in the Wall Street Journal. Information on the fed funds futures, which are usually the most accurate gage of fed policy, can be found on the web at dismal.com.
The next indicator, credit spreads, is the difference between Treasury yields and corporate bond yields. Credit spreads reflect the bond markets opinion of how easy or difficult it will be for companies to increase their profitability. When spreads widen, like they are today, the market has little confidence in corporate earnings power going forward. Banks are potentially burdened with bad loans in this environment and can become reluctant to loan. This makes borrowing difficult and more expensive which in turn slows growth. This indicator worsened since the September 11th attacks. The market has little faith companies can grow earning in the current environment. Information on credit spreads can be found at bloomberg.com.
The final two indicators have to do with valuation and sentiment. A few years ago the Federal Reserve released a report that included the use of a market valuation calculator believed to be helpful in determining the markets fair value. The calculation compares the ten year Treasury yield to the earnings yield of the S&P 500. Detailed information on this measure can be found at yardeni.com or dismal.com. The S&P is currently trading around 1070. I plugged in a -5% earnings growth figure and a 4.5% ten year Treasury
yield. This indicator suggests that the S&P is undervalued by nearly 18%. Many bearish commentators have been suggesting the market is overvalued sighting the historically high price to earnings ratio. This view
might be shortsighted in light of the historically low Treasury yield.
The last indicator is the asset allocation models used by Wall Street's top market strategists. During the first trading week after the September 11th attacks many strategists actually raised their allocation to stocks. The current average allocation to stocks is 70.2%. This is an
usually high number for a bull market. It almost seems like the strategists know they are a contrary indicator and refuse to be wrong at the bottom this time. In past bear markets strategists typically capitulate and recommend an asset allocation of less than 50% to the stock market. This needs to happen.
These five indicators rarely line up together. Last year they did and in the process correctly predicted one of the worst bear markets in history. So far the Fed lowering rates aggressively, the yield curve normalizing and stocks undervalued give us three of the five ducks lined up
for a recovery. Credit spreads are skewed somewhat by the September 11th attacks and should come back in line shortly. The final shoe to drop will be the market strategists. This group seems committed to getting it right this time. But history is not on their side. The market
will probably be stuck in a range until the strategists have had enough and go bearish. This environment favors traders who can take advantage of short-term price swings within a longer-term flat market.
Regards,
Mark Weiss
Yamner & Co., Inc.
299 Market Street, 4th Floor
Saddle Brook, New Jersey 07663
800.221.5676
yamner.com
mweiss@yamner.com |
