Ghosts of Markets Past
Morning Market SnapShot for Friday, July 30, 1999
In April 1987 I began work in the stock brokerage business. People in the business had never made as much money as they did then in all the years they had been corporate financiers, salesmen and traders. It was party time each evening for those lucky men and women who were the Masters of the Universe. IPOs were all the rage. As the year wore on, interest rates rose, the Dollar fell and the trade deficit made a larger record each month. Summer came and the market made new highs, but of course, the guru of the day had set targets ever higher so there was no need to worry. As fall approached, many stocks were down from their highs and a sense of unease began to replace complacency. Commissions fell, as clients grew frustrated by the market's lack of progress. Hope was the operating word.
One Friday morning, I was sitting at my desk, very hung over after yet another night of partying. It was October 16, 1987. Suddenly there was silence at the office as people realized something was very wrong. The September bounce had been feeble, but the market seemed OK. Now, it was not right – and in a big way. The party had ended.
During the trading day, I analyze the market from the open to the close. I look at the S&P and Treasury bond futures along with a host of stocks. When one is always in the market, watching is every wiggle and squiggle, there is a tendency to be overly concerned about its health. I live and breathe with the market each day and have done so since buying my first mutual fund as a teenager in the early-1980s. I have been a keen observer of humans at work, of crowds in particular, for a very long time, since the sugar shortages of the 1970s that sent all of the neighborhood Moms to the local grocery store to stockpile it by the 20-pound bags. I watched people line up outside of banks before the open to buy bullion during the height of the gold mania. I watched people buy real estate like it was going out of style. And now with the passing of the Internet frenzy, with most of the stocks at half price, we have to ask ourselves some hard questions. If the market continues merrily on it's way from here, that would be great, but the question now is this – are we prepared for turbulence or worse?
Justin Mamis is one of my favorite technical analysts. He embodies the technician one hundred percent. He is the technician's technician, one who thinks independently and tells it like he sees it. Reading charts is an art, notwithstanding all the television advertisements by charting software companies that promise to deliver profits to anybody that buys one. Just like any other profession, trading and analysis is a learned skill. It requires some talent and intelligence but demands understanding, imagination, humility and hard work. Success in the market is finding the balance between risk and reward. The money is made using one's ability to correctly read the action in the battle between buyers and sellers. One must take action in a timely manner and have an exit strategy at all times.
On August 30, 1993, Mr. Mamis wrote a special report named The Philosophy of Tops – Unamended for 1993, which was a two-page preface before a reprint of his July 31, 1987 special report, The Philosophy of Tops.
He wrote, “All sorts of arguments are being thrown at us, like the proverbial tomatoes hurled at politicians and comedians. “But how can you say this is like…?” whatever it is we are saying it is like. The arguments consist chiefly of fundamentals – that interest rates were rising then, or that the public wasn't pouring trillions in over the transoms the way it is now, or that there was a credit crunch or credit controls or too much credit in those days…We forget the litany, even though we've heard it many times over. But we are not saying that now is the same as, or even the equivalent of, any one particular top, especially 1972-73's.
The top may be similar but of course conditions are different. Conditions are always different – because economic and social and political factors have nearly infinite possibilities and permutations. The market, our charts, our indicators, have a much narrower scope. After all, how many different head and shoulders tops can there be? Once you've seen one you can grasp what all the others look like. As a result, what we see, as technicians, is not reasons, causes, motivations, but human nature at work...thus all tops have vast fundamental differences, and a small but telling number of “technical” similarities…”
In the July 31, 1987 special report Mr. Mamis continues:
“Tops are not made in a day. Unlike bottoms, which often can abruptly materialize on a climactic panic, with many stocks making their lows at the same time (although still requiring ample subsequent base-building), tops form over a much longer period of time. Also unlike bottoms, which form in anticipation of discernable, albeit unbelieved, change, tops seem to come out of nowhere, indeed, out of glowing good-news climate. Nevertheless, there are several repeatedly appearing essential ingredients to tops, the chief of which is, of course, how to fool the most number of people into confidently holding (and even buying) stocks as the bull market ends. The way this is done…is often by magic: Tops don't look like tops.”
“The notion that there will be some perfect top formation – Dow up, nothing else confirming – so that the sell bell will ring for thee alone, is nostalgia for the past.
This blurring of a precise signal has been compounded by a change in the definition of “market timing.” Because of the seemingly easy one-decision profit potential of options and futures, such timing has come to mean “at the precise moment”…Old-fashioned timing is now better described as “anticipatory patience”…
While it may be important for someone who wants to spend the grocery money on one perfect purchase of put options, others (particularly those involved with portfolios of individual stocks) must realize that tops form along the way lacking precise “timing”. That is, there is no one top, and it may well be that “the market” (in particular, the DJIA) is the last “stock” to top out. It is precisely because of that lack of precision that important tops consistently reveal three groundwork “anticipatory” ingredients. Breadth begins to deteriorate ahead of the peak in the Dow Industrials…The Utility average starts down ahead, sometimes months ahead, of the other averages…Third, volume reaches its peak somewhere along the bull's path, and, by the end, has diminished noticeably…
If you look at every top we've lived through, they each have certain ingredients – internal market deterioration; rationalization and lulling; using up buying power even though you used to know better; and waiting and waiting for the bell to go off, which proves in hindsight to be rather more of a little tinkle that you thought you heard but weren't sure enough to act upon. The one eternal aspect of every market top is that it occurs before we're ready for it.”
By now, you can guess that the subject of today's essay is a look at what is happening to the market. When we anticipated that Microsoft would fail on the first attempt at the test of top on the weekly chart at a big obvious round number like $100, we knew the potential for trouble, for if the undisputed leader of market capitalization cannot breakout, what else can?
It seems like a long time ago but it was mid-June, just as the “neckline” from the Three Little Indians top on the Dow Utilities was being tested, that we pointed out a top in that index. Now, after a bounce to the 20-day exponential moving average (EMA) overhead, it has broken again. Interest rates are on the rise.
We must now watch what the market does as it approaches the 20-week EMA. If support is not found there on a test, it will be a signal of a larger correction looming…or worse.
One of the most important aspects of market internals is the number of new NYSE 52-week highs and lows. This figure has been very useful for short-term tops and bottoms when we plot the 10-period moving average of high/low net differential (10MAHLND). We can also use divergences as warnings along the way. In the chart above, we can see that the high on the 10MAHLND peaked in mid-1997 and it has diverged with the market ever since. So far, market action of the past several weeks suggests strongly of a false breakout. Big deal, right?
The 1998 debacle was preceded by a false breakout after a consolidation and the break of the 20-week EMA. The 10MAHLND had been diverging for about a year leading up to the sell off.
A failed test of top and the subsequent break of the 20-week EMA preceded the 1987 Crash. The 10MAHLND had been diverging for about two years.
The 1973 top, at the end of the spectacular Go-Go Era, ended with a false breakout and the subsequent break of the 20-week EMA. The 10MAHLND had been diverging for almost two years.
The bottom line is this. As traders and investors, we must be constantly vigilant, keeping our risks balanced with the rewards. We must hope for the best, be prepared for the worst and deal with whatever the market hands us.
Those interested in Justin Mamis's books may wish to order the only title in print, When to Sell for the '90s: Inside Strategies for Stock-Market Profits
amazon.com His best book, The Nature of Risk is now out of print.
Charts specific to these comments have been posted to intelligentspeculator.com |
