Just another opinion--Technical--"don't shoot the messenger"
--me
A Conversation With Phil Roth--(Smartmoney Article)
By Scott Patterson
October 2, 2003
PERHAPS IT'S THE spookiness of All Hallows Eve. Maybe it's the colder weather. Or maybe investors are just too distracted by the World Series to buy shares. Whatever the reason, October just isn't kind to the stock market.
This isn't mere superstition. The market crash1 of 1929 that kicked off the Great Depression was in October. Black Monday, when the Dow Jones Industrial Average disgorged 508 points, happened on Oct. 19, 1987. The Asian currency crisis that sent U.S. investors scurrying for cover? October 1997.
So as we venture into October on the heels of a significant market rally, should we brace ourselves for yet another pummeling? Technically speaking, yes, says Phil Roth, chief technical market analyst at the brokerage firm Miller Tabak. "My game plan every year is to expect two corrections and two lows of consequence," says Roth. "One is between mid-March and mid-June, and one is between mid-September and mid-November."
And that, says the analyst, may be a good thing for investors fishing for deals. "The seasonal probabilities are very strong for a fall low," he says, "and that's usually the best buying opportunity of the year, too."
SmartMoney.com asked Roth where he thinks the market is heading after a red-hot summer, and what bargains investors can look to harvest in the chilly trading days of October.
SmartMoney.com: What exactly is technical analysis?
Phil Roth: The difference between technical analysis and fundamental analysis is that fundamental analysts are concerned with companies and the economy. Technicians are concerned with stocks and the market. They're quite different, because no matter what you think of the fundamental position, the stock market is a discounting mechanism, and you have to be in a position to anticipate changes in investors' attitudes toward stocks, and that means often anticipating changes in the fundamentals. Technicians are also concerned with believing that there is a trend and believing that trends are forecastable.
SM: What indicators do you look at?
PR: I follow four kinds of indicators. The first is trend and momentum. These are the indicators that deal with the direction something is moving and the force behind the move — price, breadth, volume and relative strength are trend and momentum indicators. But these kinds of indicators don't necessarily tell you where you are in the trend. To do that, I look at sentiment and supply/demand indicators. I want to know who's bullish and who's bearish. Because the most important technical precept to me is that investors make bottoms and traders make tops. Investors are motivated by price and value and tend to get active when prices are declining and low. Traders are motivated by the trend and tend to get motivated when prices are rising and high.
Finally, I do intermarket analyses, trying to understand the relationship between bonds and stocks and currencies and commodities. And the basic thesis here is that changes in the supply/demand picture for any of the alternatives to equities are going to affect the supply/demand picture for equities. In other words, all other things being equal, if the bond market goes up in price, it means it should be relatively less attractive compared with stocks.
SM: So what are the indicators telling you about the recent market rally, which seems to have trailed off in the past few weeks?
PR: To understand this rally, you have to look at the longer-term picture. The most important thing that's happened in the past 10 years has been the tech bubble and its collapse. Those kinds of bubbles are unusual events. Bubbles bursting are usually followed by many years of out-of-favor action in whatever was in the bubble.
And people get misled by the action. The Nasdaq is up 70% from the lows of last year. Naively, you can look at that and say, tech is back. But technology stocks, using the Nasdaq index, only recouped one-fifth of the entire decline. So there's been a temporary rebound, but odds favor an extensive correction coming out of this again. Normally out of a bubble you get short-term bull and bear markets. It's a zigzag type of environment. So this is a cyclical bull market in the context of a flat secular trend. If I'm right, and it's a cyclical bull and it lasts one to two years, that means it should carry into 2004. Right now, that's my game plan. We'll have more of a correction in the fourth quarter and come on again in the first half of 2004, when maybe we'll get another top.
SM: What kind of stocks will do well in that type of environment?
PR: I'd focus on economy-sensitive stocks, because the only case for an up market is the case that investors have confidence in the economy. This isn't about valuations. Valuations are high. We've had a big move up in the bond market. From here, you can't expect any help from interest rates. I think the bond market looks quite extended. So rates should go up, and the only kinds of stocks that can do well in a rising rate environment will be those that are showing a cyclical earnings rise. That means groups like industrials, basic materials, energy and perhaps some tech as well.
SM: Why do you like energy stocks?
PR: In general, the stocks that look best to me in the sense of a good profit-to-risk profile are the stocks that didn't do to well in the second half of the 1990s. I think a conservative investor could buy an integrated-oil company like Exxon Mobil (XOM2) or a smaller integrated oil company like Murphy Oil (MUR3). If you're a little more aggressive, you might be interested in an exploration and production type stock like EOG Resources (EOG4) or Apache (APA5). You'd also want to play the oil service and drilling stocks like Rowan Cos. (RDC6) and Ensco (ESV7). But all kinds of energy stocks look attractive. If all the world economies are going to go from soft to strength, obviously that's good for oil.
SM: How about financials?
PR: Financial stocks are not all the same, in my opinion. Some financial stocks are sensitive to interest rates, and some are more sensitive to economic conditions. I see a huge difference in financials. I like regional banks a lot, but I think money-center banks are poor. The financial-services stocks are up in big areas of resistance, and I don't like them. I also like a fair number of insurance stocks.
SM: A lot of people like gold now.
PR: Gold has been a crummy investment for years, and now it's a lot better. I think the psychological background for gold now is quite good. Nearly all the major central banks are concerned with stimulating their economies, and therefore we're going to have inflation. A little bit of inflation is a good thing. So all currencies are going down relative to gold, and that's an important factor. That means hard assets are going to do relatively better than they did in the 1990s. I think gold can break out through $400 and go to $500 sometime in the next five years.
SM: October is a bearish month historically. Can we expect a repeat of that trend this year?
PR: My game plan every year is to expect two corrections and two lows of consequence - one is between mid-March and mid-June, and one is between mid-September and mid-November. Every year I expect to find a low of consequence in those two windows. It doesn't happen every year, but I always look for it. This year, the low came very early in the middle of March. And now we're in a seasonally weak period. It's possible that we could make another low in October. The seasonal probabilities are very strong for a fall low, and that's usually the best buying opportunity of the year, too.
SM: You've noted that the latest Consensus Inc. survey of stock index futures traders is 67% bullish. What conclusions do you draw from that?
PR: Most sentiment indicators of traders show a fair amount of optimism. The Investors Intelligence survey of market-letter writers has shown about three-to-one bulls to bears for weeks. The American Association of Individual Investors poll of investment-club participants has shown similar numbers. So the polls show great optimism, and that's a bearish signal. On the other hand, transactional type sentiment indicators like put/call ratios never showed that kind of optimism. Put/call ratios have either been average or in fact high. Put/call ratios on the QQQ (QQQ8) and on the Diamonds (DIA9) are fairly high. So people might be talking wildly optimistic, but they've still been hedging a bit. So I haven't seen the clear psychological conditions for a top. I think enough of the indicators are bearish that we should look for the market to go down, but it's not as one-sided as you might think.
SM: You've also noted high trading volumes in penny stocks. Is that an indication of a speculative market that's primed for a correction?
PR: Clearly the speculation in the market has taken a very different form in 2003 than in 1999 and 2000. Speculation at the top of last cycle was in big stocks. This time, for whatever reason, investors have gravitated toward the bulletin-board stocks. And I think that is quite bearish. That is a sign of a top.
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