Excellent market comments from Wheat First Union:
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Don Hays' Market Update -- March 5, 1999
We are writing this before the "headline" statistics showing employment come out, but it looks very much as if the market wants to rally here. The stock markets look eerily like they did in mid-June, 1998. In both instances the markets on the New York Stock Exchange and on the NASDAQ had reached extreme oversold levels, with the 21-day cumulative advance/decline line (our 21-day oscillator) dropping under -8000. Only 30% of all stocks were trading above their 50-day moving average. Then and now, the volume had dropped to much lower levels than in previous weeks. In both instances bond yields had moved up, with worries of a Federal Reserve restrictive action. Japan's stock market had been threatening to break down under its major resistance level, but the eager beavers started to see signs that they had cured their problems (for the 32nd time.) In May-June 1998, the Nikkei Dow had a little bounce off of that dangerous 14,800 level--seemingly confirming their belief. And for frosting on the cake, in both cases our Valuation model, which uses the comparative earnings yield of the S & P 500 based upon 12-month forward earnings versus the yield of the 10-year Treasury note, moved to an all-time high level of being 26% overvalued. You have to agree that this similarity is very eerie.
Now we will have to wait to see if the similarity continues. In that 1998 example, the oversold market had one last "blue-chip" rally, moving the large-cap indices to new highs. The bond market started a rally, which encouraged the late-to-the-party traders who were trying to find excuses to justify their over-valued investments. We now see that this "bear-market" that started in April 1998 for the broad market, looks as if it wants to show an echo of that June-July 1998 scenario. The Dow Industrials really would like to go out of this 1982-99 bull market with blazing guns. Could it generate one more surprise to lay the trap for the gullible? Our fantasy world has been itching for the last year to write that report comparing the first penetration of 10,000 to the first penetration of 1,000 that occurred back in 1968. So far the Dow has only teased us, but who knows. We'll have to wait and see. Our asset allocation model is telling us that the possible short-term gains are not even close to worth the risk, so purchases at this point should be made only by two categories of investors. First, those "value" investors who find that rare undiscovered stock selling at abnormal historic values. (We believe almost all of these kind of rare gems will be in the small cap universe.) The other category of possible purchasers here could be by very nimble "short-term" traders, and those purchases should be concentrated in retail, financial, or oil stocks that seem to be finding support here.
If this extreme oversold stock market is able to rally here, we believe it will prove to be, as it was in July 1998, the prelude to a period of extreme weakness. We also believe that like that prior example the current period will prove to be the high level of bond yields. Like the stock market, the bond market is extremely oversold.
But unlike the stock market, bonds are undervalued, and investor sentiment has turned pessimistic (which is very bullish, of course.) We would envision that whether or not the stock market rallies here, that bonds will rally in the weeks ahead. Today's employment news could put some extreme volatility in bonds, but the action today should give some hint of forthcoming action.
With the unemployment insurance claims at a 10-year low, it would be amazing if the employment numbers do not show big increases in employment. But the key figure that the bond market will be watching will be wage increases, and with a still nervous employment universe, that number will be very interesting. Either way, our asset allocation model continues to say that over the next 6+ months bonds are more attractive than stocks, on a historical valuation basis by a ratio of 70 to 30. Despite the hints of a market rally, keep nervous about any unexpected news that breaks the back of the tentative rally. We have given you many "fail-safe" levels on different indices, and if that should occur at any time, all bets of a short-term rally are off. We don't expect that imminently, but stay close to home.
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