Today's comment from Don Hays. Investment risk?
wheatfirst.com
August 30, 1999
Welcome to the last two trading days of August 1999. The broad
market has shown some definite weakness leading up to this period,
but it is very obvious that during the last 6-7 trading days it has finally
broken loose from the pattern of last year. On August 31, 1998 the
Dow Jones Industrial average dropped 500 points, and scared the
daylights out of Alan Greenspan and his cohorts. They opened the
money spigots like they have never been opened before. I doubt that
the world really knows the potential damage that they were trying to
abort, but it must have been mind-boggling to have produced that
type of response. Now, only one year later, with the Dow Jones
Industrial average blasting out to another new all-time record high last
Monday, has the problem been miraculously cured?
We don't think so. It is not making the headlines, but the cracks in
the economy are showing through. For instance, in the first six
months of this year, the number of corporate bond defaults has
already exceeded the number of defaults for all of 1998, according to
S&P. Even more nerve-wracking, the dollar amount of those defaults
for the first six months is almost twice the amount for all of 1998.
And at the same time that the analysts are espousing the dynamic
earnings expectations for the next two quarters, the Commerce
Department released data for corporate profits that account for
inventory draw-downs and depreciation on a replacement cost basis,
and accounts for depreciation on an economic rather than an
accelerated basis dropped by 1.1% in the second quarter.
This is a big difference in the numbers being used to calculate the
already "out-of-sight" price earnings ratio. Which also brings up Mr.
Greenspan's mention on Friday morning of the distorting influence of
the mimicry that today's accountants are using to exclude stock
options to inflate wages, but not including them in the profit/loss
current expenses. Some economists estimate that in the last four
years, corporate earnings have been inflated by somewhere between
$250 and $500 million by using this option gimmickry to reduce wage
expenses. As is so often the case, we are finding once again that
earnings are more often than not, a figment of the accountant's
imagination. Some estimate that there is as much as $1 trillion of
these options overhanging the market. That disturbing overhang
probably had a lot to do with Mr. Greenspan's mention of them on
Friday.
Even though the current market is at the very least buffering the
EXTREME weakness produced in last year's waning days of August,
the weakness is still hanging around threatening to feed on itself.
Even as the Dow moved to the new all-time record high, the
advance/decline line was right on the verge of breaking down to a new
low. Another classic case of camouflage as those few dollars are still
chasing fewer and fewer stocks. The majority of stocks are still
suffering badly. Less than 45% of all stocks have been able to even
move above their 50-day moving average on the new high by the Dow
last week.
As we prepare to put a cap on August 1999, we believe the next few
days are going to be extremely telling. Last week we noted 5 of our
benchmark stocks that we are watching for clues in these next few
days. This morning we would reiterate that watch list. For instance,
in the basic industry stocks that the herd turned so bullish on in April
1999 when they experienced a long-delayed "bounce," I am watching
International Paper as a proxy. The stock had moved up to 55 on that
"bounce," but during the period when those few technology stocks
grabbed the headlines with dramatic new highs, International Paper's
stock could not follow along. It now is treading water close to the 50
break down level. A move above 55 would be very bullish for the
group, but a more likely, in my opinion, break down under 50 would
be a sign that the bullish enthusiasm for cyclical stocks has hit an
air pocket.
The next stock is Citigroup, my proxy for the large international
banks. Citigroup's stock had resisted the extreme weakness seen in
many of the bank stocks. In fact, last week as the Dow was making
its new record high, Citigroup's stock tipped slightly above 51, trying
to follow the Dow into that rarefied air. But so far, it's valiant effort was
not enough to break out, and instead hit a second lower high and has
dropped along with the market in the three ensuing days. But at 47, it
is still a lot closer to the high than to 41, its recent low in early
August. The next few days are going to be very interesting, and if the
stock does succumb to weakness, as we suspect, it will be a very
bad sign for the financial stocks as they lose their last strong warrior.
It also conceivably could be an indication that international financial
conditions may be losing some of their newfound optimism.
While we are on financial stocks, let me once again mention Merrill
Lynch. We have mentioned this stock on numerous occasions as a
possible ominous sign for the industry and the bull market. But just
as it broke under a significant resistance level of 66-67,
merger/buy-out rumors came along and moved the stock right back
up to the 80-81 zone. When this happened, it really started my
technical analysis tentacles quivering, because it sets up an eerie
pattern that looks dangerously like an emerging head-and-shoulders
top. Before you head for the bomb shelter, however, the progression
from this point is very important. It is true that trying to forecast these
emerging patterns before the actual break down can be very
dangerous for your financial health. But it certainly is worth watching.
If the stock convincingly breaks above that 80-81 right shoulder
resistance, without some definite merger/buy-out news, it would
remove much of this technical analysis threat. But if the days ahead
show that the rally to 80-81 last week was its last hurrah, and if it
eventually breaks below the 60 level, I believe that would be an
ominous signal that even the most strident bull would have to throw in
the towel that the 1982-1998/99 bull market had been stopped in its
tracks. I believe that would once again allow the press to give Mr.
Greenspan another halo for talking about tulip bulbs and Russian
collapses in last Friday's message.
Watching the action of Merrill Lynch could also give some help in
putting a time frame on our expectations. Since
"head-and-shoulders" patterns have a mysterious habit of being very
symmetrical around the peak of the head formation, it would give
some indication as to when the breakdown might occur. So far the
right shoulder has exactly emulated the left shoulder. The current
time frame from the peak of the head to last Friday's try at
penetrating the right shoulder, has taken 4 ½ months--exactly the
same as the time taken from the head to the left shoulder. So you
can see why this is more evidence that the next few days could be
extremely forthtelling. If the chart continues this "exact" correlation,
the stock would show very sharp weakness in the next couple of
days off of that 80-81 shoulder. BUT, once again, on the other side, if
it rallies from here, then that would not only add credence to the
merger/buy-out rumors, but could be sending a message about the
market as well.
We are not going to dwell on them too much, but the last two stocks
to watch in our small basket of key "benchmark" stocks are Dayton
Hudson and AMR Corp. A breakdown below 57 by Dayton Hudson's
stock would be a very bad sign for the US consumer that has been
the lifesaver of so many struggling world economies in the last two
years. AMR has been trying to rally for the last couple of weeks, but
having a very difficult time making a meaningful breakout. If the rally
attempts should break down, however, it would seem to deflate the
recent rally attempts for the economy, and would be sending some
chilling messages about the future economic progress.
That's enough of this chart-talk. We consider charts excellent tools,
but only a tool. From a fundamental standpoint, as we see so many
of those charts walking the threshold at major fulcrum points, we also
see the dollar/yen relationship sinking dangerously close to the 108
level. If it breaks under this level that was reached during the first
couple of weeks of this year, it would once again be pointing out that
money flow is definitely not seeking out US investments. With the
huge current account deficit, the possession of 1/3 of US bonds in
the hands of foreign hands produce sweaty palms on any further run
on the dollar. That weakness would also put a real damper on
Japan's price competitiveness, and we are not sure how much
competitiveness the fragile Japanese economy can stand.
In many ways the Fed is caught between the rock and a hard place.
They have now raised interest rates twice, and Greenspan is now
trying to jawbone the stock market down. The next meeting is early
October, and that is closing in on the last three months of Y2K
preparation. Many believe that the Federal Reserve has to make sure
that there is sufficient liquidity around during those last months to
cushion any disturbances that might mysteriously arise, but who is
to say. We suspect that Greenspan would like to cool this market,
and the economy off some NOW, to try to give a little room for
expansion if the situation should require it at that time. He also finds
that the hiring plans being forecast by the Manpower survey is very
robust, the unemployment insurance claims are at a 26-year low, and
the monthly unemployment news comes out this coming Friday. But
on the other side of the equation, there was some indication last
week that commodity prices are easing a little here.
In the bond market, there are at least as many disturbances as in the
stock market. For instance, the spread between AAA corporate
bonds and the 10-year Treasury note is now 85 basis points. The
normal is about 50 basis points, and this spread is now very similar
to the spread last fall that led to the Long-term Capital Management's
problems. The mortgage market is even more distorted, with the
spread between the 30-year fixed rate mortgages and the 10-year
Treasury note up to 210 basis points. The normal is about 140 basis
points. We also find that for the first time in history, in the 12-months
ended on May 31, 1999, foreigners were net sellers of US Treasuries
by an amount of $2.75 billion. With the growing surplus projections
that amount can easily be digested, but an economic and stock
market slowdown would negatively affect those projections the same
way they have positively affected them for the last four years of Mr.
Clinton's Press conferences.
As we enter September, we can give you a positive and a negative.
Over the years, September has been the weakest month of the year,
but in recent years September has strayed from that "weak" path.
The weak action in the last days of August for recent years, has
been followed by digestive action in September that has not been so
bad. Of course, we'll have to wait and see what this year brings, but
unless interest rates rally strongly, we believe this September will be
a time of growing worry about Mr. Greenspan's early October FOMC
meeting. That would be tough for the most overvalued S&P 500 in the
history of US stock markets. |
