Near term I think the rally continues, but after the first of the year, as the realization materializes that the "corner" turn seems to be part of a maze, equities fall.
As always, time will tell.
:)
Some light reading...
the Rally Ending/Over? Some thoughts, including a Technical-Analysis Perspective
By Doug Gillespie
Dec. 11, 2001
Dec. 10 FOMC comments
Douglas R. Gillespie Sr. oversees his own financial-market and economic consulting firm, Gillespie Research Associates, 201-447-5743 Gsrdr@aol.com
Please note: Because of space constraints the "appendix tables" referred to below are not included, but available upon request by email at Gsrdr@aol.com
INTRODUCTION
My regular research material makes frequent mention of "my technical work." Although fundamental considerations are the bedrock of all my forecasting activities, I find technical analysis an indispensable tool in the overall research process. It is something I hope to incorporate into my work in a more formal fashion and on a more regular basis next year. But I point out the obvious. There is no such thing in this business as a magic bullet. Technical considerations are a great help, a very useful tool. However, they certainly are not infallible!
The balance of this update examines matters with some common fundamental and technical links, mostly ones involving the stock market. If at times it is difficult to differentiate between technical and fundamental considerations, it's because I view and attempt to practice the respective disciplines in a highly mutually inclusive manner.
THE BACKDROP
It's no secret I've been a bear on stocks; I certainly remain one. It is my current view the equity market has entered a secular bear phase that, on balance, could last for years. But this certainly does not mean prices will be in constant decline for years. Rather, what I envision is a protracted period in which prices are in general decline, but in which there are several, perhaps even many, counter-trend rallies of significance. The mid 1960s through 1982 might represent an analogous period, although I'm not suggesting, at least not now, that the current episode will last that long.
But the excesses of the 1990s are indeed formidable. Take, for instance, the debt bubble, something my friend, Doug Noland, no stranger to Prudent Bear website readers, was so early and studious in discerning and has been equally studious and eloquent in writing about. It is highly improbable this malady will get unwound either quickly or without considerable systemic pain.
Equity-market bulls now see an economic recovery around every corner and under every stone, a recovery that includes a quick, sharp snapback in corporate profits. I doubt very much this is the configuration that is ahead of us. But even if the "official" recession does end next year, I envision an ensuing period of very sluggish growth, something in the old days we called a "growth recession." One of these would not foster a spiffy rebound in earnings, which means that overall valuation levels would remain exorbitant from a historical perspective. This is a major ingredient, probably the most major ingredient, in my current thinking as to why the stock market may well remain mired in a secular bear phase. It will take a protracted period for fundamentals to catch up with prices. In fact, the "catch-up" process will be a combination of eventual rising earnings and dividends against a backdrop of declining prices. At some point, value returns, but this will be well down the road. It will also be at considerably lower levels for some of the market's bellwether measures. That is my current scenario.
There is another possible outcome, of course. It is some kind of cataclysmic market event -- a crash -- that brings prices and fundamentals into line quickly, a 1987-type event. While I certainly do not rule something like this out, it is not the outcome I presently favor as most likely.
And there is also the consideration of whether such an event really would bring prices and fundamentals into line quickly. After all, a stock-market crash would likely result in an additional depreciation in fundamentals sufficient to maintain a gap between something resembling price and valuation parity.
THE CURRENT AND SPRING EVENTS JUXTAPOSED
Retrospectively, the spring stock rally turned out to be a prototypical counter-trend affair. I'm happy, especially for my clients, I saw it as such at the time. I feel strongly that the current advance is another of these, another of what may become many in coming years. And I also believe the current advance is about to end, may already even have done so.
(An update sent to my clients yesterday opined: "Is the second big counter-trend rally of the year about to end? It may already have done so last week!" Yesterday's sharp decline certainly increased this possibility somewhat.)
Table 1 in the appendix breaks out the autumn event through last week, as well as the one in the spring. The DJIA, S&P 500 and NASDAQ 100 are the proxies. Table 2 in the appendix details the autumn-only rally through last week, using as proxies all seven market measures tracked here regularly.
Duration, Magnitude and Breadth
Using the DJIA as the yardstick, the spring advance lasted about 8.5 weeks, with the fall episode about 10.7 weeks old as of last week's high (Wednesday, 12/5 for the Dow). Trough to peak (closing-price basis), the DJIA was up 20.8% from 3/22 through 5/21. During the current rally, the Dow rose 22.8% from 9/21 through 12/5. Therefore, adjusting for the longer duration of the current episode, the Dow's spring gain was actually somewhat stronger in relative terms.
In the spring, the respective gains for the S&P 500 and the NASDAQ 100 were 19.0% and 49.7%, versus 21.1% and 52.7% during the fall event so far. But the spring rally in the S&P and the NASDAQ lasted only about 6.7 weeks. So if you do a rough proration, you again find that the spring advance was stronger than the current one. I believe the common perception is that the current episode is clearly the stronger of the two. To date and in relative terms, it is not.
From 3/22 through 5/21, there were 11,988 more NYSE advancing issues than declining ones, which works out to a weekly average of about +1,410. From 9/21 through 12/5, NYSE advancing issues exceeded declining ones by 15,067, for a weekly average of about +1,408. It doesn't get much closer than that, does it? (See Table 3 in appendix.)
I will not go through the numbers here, but the pattern in NYSE 52-week highs and lows during the respective periods is not dissimilar.
"X" Factor #1
There are two "X" factors I'll mention, and let me dispense with the simpler of the two first. It involves any additional acts of terrorism. At present, the stock market, based on my technical work, is highly short-term overbought. In this condition, anything vaguely hinting of an act of domestic terrorism would send the market into a tailspin. The American Airlines Flight 587 tragedy several weeks ago bears ample witness to this potential phenomenon.
"X" Factor #2
The second "X" factor involves Greenspan and Wall Street's incessant effort to use interest-rate cuts to keep stocks afloat. Rate cuts have truly functioned as the opium of the investing masses this year. While the Street and its friends at CNBC, Bloomberg and the other outlets in the regular propaganda loop can still froth up the public with the rate-cut hype, its potency appears to be on the wane.
The lower section of Table 3 details the interest-rate events taking place during the spring and fall rally periods. The Fed's "surprise" rate cut on 4/18 rekindled the spring episode, as that upswing was beginning to lose momentum. Just as the attempted rate manipulation announced on Halloween kept the fall rally alive. Although the 10/31 announcement came from the Treasury, I view the incident as a Greenspan-inspired maneuver, intended as much to goose stock prices as to bring interest rates down.
After an initial decline of significant magnitude, with the close on 11/7 marking the nadir, rates have since blown up. From the 11/7 close through last Friday, the yield on the 30-year Treasury bond (5.375s of 2/15/31) was up 81 basis points, up 95 basis points from the intra-day low of 4.66% on 11/7. Over the same period, the yield on the 10-year T-Note (5.00s of 8/15/11) rose 98 basis points, up 110 basis points from 11/7's intra-day low yield.
As another example of the horrors that have befallen the debt market, look at what has happened to the two issues the Treasury auctioned only about a month ago in its November refunding operation. At first blush, this looked like it would be an innocuous enough affair -- two issues, a five-year note and the reopening of a 10-year note sold in August. It totaled a mere $23 billion to refund $21.6 billion in maturing securities and to raise $1.4 billion in new cash. As of last Friday, the losses on these two issues exceeded a whopping $1.14 billion!
(See Table 4, Table 5 and Table 6 in the appendix. Table 6 illustrates a range of potential total returns on the present on-the-run 30-year and 10-year Treasury issues. It may be of special interest to people not familiar with how yield changes affect the principal value of fixed-rate debt obligations.)
Stock Valuations Versus Interest Rates
Many if not most capital-market pricing models place heavy emphasis on the 10-year T-Note yield as a guide to what price-earnings multiples are reasonable for stocks, although it does not turn out to be a parallel relationship. In other words, if the T-Note is yielding 5%, it does not summarily lead to stocks being worth 20 times earnings (the reciprocal of the note yield, to wit: 1/.05 = 20).
A few weeks ago, stock bulls were rejoicing over the sharp decline in the 10-year T-Note's yield, suggesting this was justification for an expansion in price-earnings multiples, despite that earnings are still in general decline. But the recent spike in yields has quickly quieted this outburst of joy.
Were you to apply a one-to-one relationship, Friday's 5.17% close on the T-Note would equate to a P-E multiple of 19.34. Apply this to the DJIA's latest reported 12-month earnings of $358.18 and you get a value of 6,927 -- versus Friday's Dow close of 10,049. Bringing the numbers in line would have required either a 161 basis-point decline in the T-Note yield, to 3.56%, or a 3,122-point, 31.1% decline in the Dow, or some combination of yield decline and Dow price decline. (See Table 7 in the appendix.)
I've kept plots on this relationship on an end-of-week basis for a long time. In turn, I have found that when you get into the general area in which we are, something gives -- usually the price on the Dow industrials!
Dow-10,000
There was much hoopla from the bulls last week when the industrials made it back to an above-10,000 close. I did not hear much from these folks in the other direction yesterday, though, when it was back to a 9,000 handle.
At any rate, from the perspective of the secular bear market I think we have entered, the important Dow numbers right now are 11,723 and 11,338. The former, of course, was the last record close, set on 1/14/00. The latter was the closing peak in this year's spring rally, recorded on 5/21. Therefore, there's a lot of headroom between last week's closing high -- 10,114 -- and the May figure, so there surely is no near-term risk of making a higher high.
Sentiment
I remember very well that back during the equity market's spring bacchanal, CNBC, etc. had a parade of guest analysts/strategists justifying the event using the old "climbing the wall of worry" shtick. As it would turn out, that wall was not dissimilar to the one used by Humpty Dumpty.
Never say die, though, and the wall of worry rhetoric has been much in evidence again during the current episode. But what worry? (Or perhaps it is the Alfred E. Newman adaptation, as in, "What, me worry?").
Table 8 in the appendix examines the behavior of the CBOE Volatility Index as well as Mike Burke's Investors Intelligence numbers during both the autumn and spring rallies. As the figures reveal, neither series was rendering wildly bearish readings as the respective rallies progressed, but they surely were not skewing very much toward the bullish side of the ledger, either. In fact, you can make a pretty decent case the results were/are not nearly as bullish as they should have been or should be, thereby resulting in a de facto bearish result.
Short-Term Rates of Change
Over time, I have found short-term rates of change to be a very useful indicator of overbought/oversold levels. I employ two-week compound rates in my work, and Table 9 in the appendix breaks these out for the DJIA, the S&P 500 and the NASDAQ 100. The periods shown again cover the autumn and spring rallies.
As was the case in the spring, there have been some excessive levels reached during the current episode, but the phenomenon most troubling at the moment is the length of time in which the numbers have remained positive. Although the Dow had a small lapse into negative territory during the week ended 11/30, the general results have been on the plus side for 10 consecutive weeks. Based on the historical experience of this series, I would find this troubling, were I a bull.
Miscellaneous
At present, my technical work on the US dollar is more or less neutral. My work on gold remains long-term positive. Improvement in the bullion picture has been agonizingly slow, but there has been improvement. And Table 10 in the appendix shows an interesting phenomenon that most investors probably are unaware of. I've based the cumulative return numbers in this table to 12/31/99 = 100.00. From 12/31/99 through 12/7/01, physical gold (Comex, spot month) has fallen 5.2%. But -- the DJIA is down 12.6%! This does exclude the Dow's dividend return, but over the period, this was paltry, not amounting to anything near enough to close the 7.4% gap versus gold.
______________________________________________________
FOMC Meeting (Dec. 10, 2001)
"No man can serve two masters: for either
he will hate the one, and love the other;
or else he will hold to one, and despise
the other. Ye cannot serve God and mammon."
-- St. Matthew 6:24
_________________________
It's my view the FOMC will cut the federal funds and discount rates a quarter-point each tomorrow, to 1.75% and 1.25%, respectively. In addition, I believe the committee will publish a post-meeting statement suggesting economic weakness remains a threat, thereby leaving in place the possibility of additional rate reductions. But there just might be a surprise or two in the wording of this statement.
I've never been a big fan of either the accuracy or even the honesty of government economic data. This said, I do think the recent GDP data from the Commerce Department, and Friday's employment report from the Labor Department, have it about right in portraying the current state of the US economy. If nothing else, these reports provide cover for the Fed to cut rates again, which I think it will do at tomorrow's meeting of the Federal Open Market Committee. Shortly after the FOMC's November gathering, here was my take on the December get-together.
"... Now clearly in place is the probability of the next rate reduction, and that it will come at the FOMC's meeting on 12/11. After all, this meeting falls in the midst of a Christmas selling season the strength of which has most analysts quite concerned."
After Friday's horrific employment data, the federal funds futures market fell neatly into line with a quarter-point cut in administered rates tomorrow. If this is the outcome, it will be the Fed's 11th of the year, and will have brought the target rate on federal funds down 475 basis points, from 6.50% to 1.75%, and the discount rate down the same amount, from 6.00% to 1.25%. (Table 1 below breaks out Friday's closing levels in fed funds futures. Table 2 recaps the Federal Reserve's 10 rate cuts through the November policy meeting.)
The statement the FOMC will release after tomorrow's meeting is a tricky affair. While it is probable the committee will continue to highlight the continuing threat of economic weakness, thus suggesting the possibility of further rate cuts, there may also be some attempt at suggesting future reductions are not a fait accompli. This would represent an attempt at serving two masters, always a treacherous undertaking.
On the one hand, such wording would be another positive gesture to the stock market, since Greenspan remains obsessed with keeping it afloat. Although 10 rate reductions to date have done little to nothing to rekindle the economy, rate cuts still retain their role as the opium of the investing masses, although probably not as strong a role as was the case earlier in the year.
On the other hand, an attempt at suggesting further rate cuts is not as strong a likelihood as was once the case would represent at least a hoped-for fig leaf for the bond market. Surely part of the recent run-up in bond yields has been the result of concern the Fed's aggressive rate cutting, and the immense liquidity creation necessary to peg the federal funds rate at the level to which the Fed has reduced it, is sowing the seeds of future inflation.
So if there is any excitement to come out of tomorrow's FOMC get-together, it will likely be the result of how the committee chooses to word its post-meeting communique.
TABLE 1.
Contract
Month 1/5
Close 5/4
Close 7/6
Close 9/7
Close 11/2
Close 11/30
Close 12/7
Close
January 5.91% Expired
February 5.46% Expired
March 5.31% Expired
April 5.06% Expired
May 4.98% 4.27% Expired
June 4.90% 4.04% Expired
July 3.85% 3.75% Expired
August 3.82% 3.70% Expired
September 3.81% 3.63% 3.47% Expired
October 3.82% 3.58% 3.22% Expired
November 3.58% 3.12% 2.18% Expired
December 3.67% 3.09% 1.99% 1.85% 1.82%
Jan. '02 3.74% 3.08% 1.92% 1.78% 1.74%
Feb. '02 3.05% 1.84% 1.73% 1.69%
March '02 3.04% 1.84% 1.78% 1.74%
April '02 3.12% 1.85% 1.80% 1.78%
May '02 1.90% 1.90% 1.92%
June '02 2.01% 1.99% 1.92%
NOTE: Scheduled meetings of the FOMC during the balance of 2001: 12/11.
TABLE 2.
2001 SCHEDULED MEETINGS OF THE FEDERAL OPEN
MARKET COMMITTEE AND POLICY ACTIONS TAKEN
Meeting Date Interim Action Taken
Fed Funds Rate Discount Rate
(2001 Opening Levels) 6.50% 6.00%
1/3 (No meeting) -50 bp to 6.00% -25 bp to 5.75%
1/4 (No meeting) -25 bp to 5.50%
1/30-31(Reg. meeting) -50 bp to 5.50% -50 bp to 5.00%
3/30 (Reg. meeting) -50 bp to 5.00% -50 bp to 4.50%
4/18 (No meeting) -50 bp to 4.50% -50 bp to 4.00%
5/15 (Reg. meeting) -50 bp to 4.50% -50 bp to 3.50%
6/26-27 (Reg. meeting) -25 bp to 3.75% -25 bp to 3.25%
8/21 (Reg. meeting) -25 bp to 3.50% -25 bp to 3.00%
9/17 (No meeting) -50 bp to 3.00% -50 bp to 2.50%
10/02 (Reg. meeting) -50 bp to 2.50% -50 bp to 2.00%
11/06 (Reg. meeting) -50 bp to 2.00% -50 bp to 1.50%
12/11 (Scheduled meeting) |
