This weeks commentary from John Murphy:
Update for Nov 2, 1997
MARKETS DON'T ALWAYS CRASH Throughout the past week, the media fed us a steady diet of comparisons to 1987. Was this another crash or wasn't it? Percentage declines weren't as great as 1987.1997 is different from 1987 because of low inflation and low interest rates.1987 didn't hurt the economy.therefore, this slide carries no economic implications.stocks aren't good leading indicators anymore.remember 1987. Everybody knows the market always rallies to new highs after sharp selloffs -- it did in 1987. Fortunately, we have charts that go back further than 1987. And we can state with some confidence that market tops don't usually occur with crashes. Most major tops take place over time and are much more gradual affairs. Our guess is that is what will happen this time. No crash. Just a long period of rises and falls. Except that each rise will fail to exceed the previous high and each trough may be lower than the one before.
1966 AND 1974 TOPS AS MODELS We thought it would be interesting to see what happened at the last two major tops prior to 1987 - that is, 1966 and 1974. Both tops began in January. Prices fell throughout most of 1966, recovered during 1967 and 1968 (although not to a new high) and fell again throughout 1969 into 1970. During those four years, the Dow lost 30% of its total value. Prices recovered into the start of 1974 (again no new high). Prices began falling at the start of 1974 and lost 45% over the next two years. That's a loss of almost 50% over a period of 8 years. Prices then traded sideways until 1982 (another 8 years) before beginning the major bull market that has lasted 15 years. It's interesting to note that 1998 will market the sixteenth year of this bull market - the exact number of years the market spend losing money from 1966 to 1982. Some cyclical work suggests there may be some meaning in that.
RULE OF ALTERNATION This is one of the principles of market behavior that is derived from the Elliott Wave Theory. It states that markets don't so the same thing two times in a row. In other words, if the first correction in the uptrend is a steep selloff, the next one will be a sideways consolidation. If one market top resembles a crash, the next one will be a more gradual affair. What this suggests is that if we are looking to the past to make market comparisons, 1966 or 1974 may be much better models than 1987. While we're on the subject of market crashes, 1987 isn't even the best model for that - 1929 is. Not that we're looking for a 1929 crash. But, as we pointed out last week, the current economic environment of a strong economy and low inflation is remarkably similar to the situation in the late 1920s. Apparently,
all of the economists that the TV media has been interviewing don't have charts going back that far either.
IS IT OVER OR JUST BEGINNING? We honestly don't know the answer to that question. All we can do is consider the probabilities and percentages. If you've been reading our weekend updates since August when the Dow hit 8000, you know that we've become increasingly cautious on the stock market. We've advocated increasing one's allocation to bonds and cash. In addition, we've suggested rotation to more defensive stock groups such as energy, real estate, and utilities. The market downturn during October (which we warned about) did nothing to bolster our confidence. The good news is the bulk of this decline is probably over. All major stock averages survived tests of their 200 day moving averages. In addition, the market is in a deeply oversold condition. Even with allowances for a retest of last week's lows and even marginal new lows, the short term downside risk has been greatly diminished for now.
WHAT NOW? We think the market will spend the next few weeks trying to find a bottom. Tuesday's massive upside reversal on record volume may have been a selling climax. A lot of people will be tempted to treat the current decline as a major buying opportunity. That strategy has worked for the last 15 years and we can't guarantee that it won't work again. We just think the odds are against it. The more likely scenario would be a rally attempt in the form of a Santa Claus rally. That should carry us into January of 1998. We don't think any major moves will take place for the balance of the year -- just backing and filling, possibly with an upside bias.
WHAT TO DO? Our view is that one should not commit major new funds to this stock market. If you want to hold on to what you have, fine. If you want to recommit a little bit here, fine again. Just don't throw a lot of new money at this old bull market. If you do put some money to work, put it toward the more defensive groups we've been talking about. A more prudent strategy would be to quietly utilize any decent bounces during November and December to prune some money out of stocks toward Treasury bonds and/or money funds.
FOLLOW STRENGTH.AVOID WEAKNESS The idea is to emphasize groups that held up best and avoid those that fell the most. Last week large stocks did better than smaller stocks. The top performing stock groups were real estate and utilities. The worst were precious metals and technology. U.S. stocks did better than foreign stocks. The worst global sector was Latin America - the best was Europe. Fixed income markets had a good week. The best performing bond funds were intermediate (5 - 10 years). Utilizing relative strength, the best places may be -- intermediate bonds, real estate, utilities, and large U.S. stocks. Avoid precious metals, technology, and foreign stocks especially Latin America. While small stocks should do better than large multinationals in a weaker global economy, they usually fall harder in a market downturn.
CONSUMERS OVER CYCLICALS Consumer staples have done better than the general market during October while cyclical stocks did much worse. Given new deflationary concerns arising from the Asian breakdown, economically sensitive stock groups like industrial metals (copper and aluminum), paper & forest products, and machinery have gotten roughed up. By contrast, consumer staples like beverages, food, drugs, tobacco, and personal products have attracted more money. Normally when bonds are outperforming stocks (which has been the case recently), the defensive consumer stocks usually do better than the economically-sensitive cyclicals.
RETAILERS GAIN This group also turned a good relative performance this week. Top gainers were the Gap (GPS) and Dayton Hudson (DH). The Gap is testing its summer high. Both stocks are above 50 day averages. Nordstrom (NOBE) and Wal Mart (WMT) are trying to climb above theirs at 52 and 36 « respectively. K Mart (KM) has managed to bounce off its 200 day average. Part of retailing strength may come from the idea that they benefit from Asian deflation.
WINNERS AND LOSERS In keeping with our plan to seek out the strongest and weakest parts of the market, we took a look at several individual shares. Among the more actively traded stocks that closed under their 200 day averages were Coke (KO), Merck (MRK), Philip Morris (MO), Intel (INTC), 3Com (COMS), Sun Microsystems (SUNW), and Echo Bay Mines (ECO). Some cyclical stocks that did the same were Alcoa (AA), Phelps Dodge (PD), and International Paper (IP). Two stocks that closed above 50 day averages were Cisco Systems (CSCO) and Pepsi (PEP).
STOCKS TESTING AVERAGES: Compaq (CPQ) is bouncing off its 100 day average near 60. Dell Computer (DELL), however, closed beneath its line at 82. Stocks that have bounced off their 200 day averages are General Electric (GE), IBM, and Oracle (ORCL). Microsoft (MSFT) has fallen 20 points (-13%) since July and ended the week at 130. MSFT may be headed for a challenge of its 200 day average near 120. The strongest stocks are those that have crossed over their 50 day average -- including Cisco, Pepsi, Gap and Dayton Hudson; and those that may be close to doing so -- such as Nordstrom and Wal Mart. Those stocks bouncing off longer term moving averages include Compaq, General Electric, IBM, Oracle, and K Mart.
DON'T LOOK FOR AN UMBRELLA DURING A STORM One thing we noticed this past week were the number of inquires asking what do to during Monday's panic. We simply pointed out (not unsympathetically) that we had been advising what to do for the past month. The time to do it was then, not this week. We also noted a number of messages asking if we favored buying the dip or selling rallies, if we favored the sidelines, or whether to sell everything and buy T-bills. It's hard to give simplistic answers like that. What might be good for a short term trader or a mutual fund switcher, might not be good for a longer term investor. That's why we spell out our views over the weekend, and suggest a variety of alternatives to choose from that best suit your circumstances. The best time to act is when the market is quiet, not when it is in turmoil. If the weatherman tells you it's going to rain, don't wait for the downpour to shop for an umbrella. |
