August 29, 1999 - Weekly Newsletter Report
August 29, 1999
Last week, the Dow Jones Industrial Average was down 10.44 points to 11,090.17 (-0.09%), the Nasdaq Composite was up 110.57 points to 2758.90 (+4.18%), the S&P 500 was up 11.66 to 1348.27 (+0.87%) and the Russell 2000 index of small cap stocks was down 1.93 to 432.45 (-0.44%).
For the year, the Dow is up +20.79%, the Nasdaq up +25.82%, the S&P up +9.68% and the Russell 2000 up 2.49%. The StockMotions Newsletter Tracking Portfolio is up 37.16% for the year. To automatically receive portfolio updates before they happen, you may sign up at:
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Fed Raises Rates, the Market Lowers Them
From last week?s newsletter:
"It is pretty obvious that the rate hike is guaranteed. The market, however, seems to be signaling that lower rates are just around the corner again?.a strong close below 6.00% would be quite bullish for the bond market ? with or without a rate hike by the Fed."
Through Thursday, most market participants were quite convinced that the Fed was finished with its rate hikes for the year. The market was in pretty good spirits going into another slow late summer Friday session. Then came word that Alan Greenspan said a few words regarding the dangers of having a stock market that is overvalued (he even mentioned the word "bubble"). As would be expected, the stock market wasn?t too crazy about such words of warning from Mr. Greenspan and thus proceeded to "sell-off" on Friday?.actually to be fair, Thursday wasn?t a great day for the Dow either.
Part of Alan Greenspan?s comments were aimed at the dirty accounting that some companies (especially high tech ones) are using to mask labor costs (expenses). He is concerned that companies that issue stock options as a form of compensation are actually overstating earnings because the stock option grants do not show up as an expense in the income statement?.and if companies are overstating earnings then the excessive P/E multiples on their shares are even more irrationally exuberant - couldn?t help using the phrase.
Well that was the message on the surface of Friday?s financial media coverage ? the following is my take on all of this.
First off ? I still think that rates are in an overall long term down trend. The correction over the past ten months (in rates), is more than likely over. Secondly, let?s take a look at how fairly or unfairly valued the current market really is.
The current estimate on the Dow?s 1999 earnings is $487.59. That puts the Dow at a P/E of about 22.74 for this year?s earnings?.certainly not out of the norm given the past few years?.and certainly maintainable given a low interest rate environment. FY2000 estimates are at $560.49 or a forward P/E of 19.79. In other words, analysts expect the Dow?s earnings to grow by 14.95% in 2000. Now if we add to that a benign interest rate environment, and let?s assume that the Dow can sustain a P/E of 23 in 2000, then the Dow should reach 12,891.27 in 2000. That?s a 16.24% gain from where the Dow closed on Friday. Of course a P/E of 24 or even 25 would bring the Dow closer to 14,000 next year ? but I think that is a far stretch. Once the market starts to focus on third and fourth quarter earnings, I see the potential for the Dow to make a run at 12,000 ? this market has a tendency to get prices closer to the good news rather than the bad ? and right now, it isn?t reflecting enough of the good news.
Now what does this have to do with AG?s speech? It is entirely possible that he is trying to stall the market in order for the earnings to catch up ? knowing that the earnings are really there.?and maybe it isn?t such a bad thing to do. After all, the past few months have certainly washed out a large amount of speculative frenzy from the market?.and it seems that we have a healthier market because of it, for instance, how many brokers allow Internet stocks to be bought on 50% margin - not very many.
The whole argument of stock options masking employment costs to me is a weak one at best. Stock option granting is reflected in a company?s stock price through the use of reporting dilutive earnings per share. The company actually transfers its salary expenses to the shareholders in the form of a lower stock price?.
Again, the key to all this is a benign interest rate environment. Just for kicks, let?s say we get a 20% correction from this week?s highs. That would put the Dow at 9060.83 or at a 99 P/E of 18.58 and a 2000 P/E of 16.17. At the low last October, the Dow reach a 99 P/E of about 15.17?and that was in the face of the threat of collapsing economies and financial institution failures. Many of those recessionary economies are recovering and hopefully there isn?t another LTCM debacle around the corner ? and if there is, shame on the Fed for allowing it to happen.
Am I forgetting about inflation?
Not really. This week there was news that average housing prices actually fell a bit in the past month ? higher mortgage rates are to blame. Over the weekend, Saudi Arabia, Venezuela and Mexico announced that the oil production cuts of last Spring will stay in place through next Spring and what I found was even more important was that they would like to keep oil within a range of $16 to $20 per Barrel for Brent North Sea Crude?.which means that we have probably seen the majority of oil?s inflationary forces ? that is, its price should remain stable without much further increase. (read more about this in the following link) [http://express.isyndicate.com/reuters/ReutersOnlineBusiness/08_29_1999.robtz0302-story-bcbusinessoilmeeting.html]
And lets not forget us ? the consumer. Outside of the recent real estate boom, we are still demanding the absolute lowest prices for just about anything that we buy?this has got to be the most non-inflationary force in the US economy - just look at the CPI.
Let?s Make It Official
I still think that the Dow will reach 12,000 this year (with some backing and filling thereafter) and 13,200 next year ? with the possibility of even 14,000, that?s a 2000 P/E of 25. On the low end ? we always have the 50 and 200 day MA as a guide whenever the market gets a bit ahead of itself ? that?s what the MA?s section is all about.
The Internal Indicators
The dismal volume on Friday allowed the market to selloff more than it probably would have during a regular trading session. But with the selloff came what could be regarded as a gift. The NYSE Arms Index closed above 1.50 on Friday. To be exact, it closed at 1.65?.which leads me to believe that a rebound is just around the corner?and given that we are at the end of the month and that we are going into a holiday weekend?these are some of the main ingredients for a pretty positive week (the >1.50 Arms Index closing is icing on the cake)?.the SM Portfolio will likely hop on some Dow calls on Monday ? but remember this a speculative bet at best. Should the market go against us ? we take the losses and prepare for next time.
One internal indicator that is still quite concerning is the NYSE Cumulative A/D line. Hopefully this indicator is in the final stages of its bear market by testing levels not seen in years. If this is the case and it does finally turn into a sustained uptrend, it would bode quite well for a broadened market advance?.this bears watching.
What the heck does all this mean?
For the time being, interest rates remain the main catalyst for any sustainable market move.
The Major Moving Averages
For those who are interested in the moving average levels, here they are. As of the close on Friday, August 27, 1999: The Dow?s 200 day MA is at 10092.70, its 50 day MA is 10950.40. The 200-day MA is in an uptrend and the 50-day MA is in an uptrend. The Nasdaq 200day MA is 2421.50, and its 50-day MA is 2673.10. The 200-day MA is in an up-trend, the 50 day MA is also rising. If any reader would like to see the charts that indicated the relative movement of the 50 day MAs on the Dow and the Nasdaq, please click on
stockmotions.com for the Dow and
stockmotions.com for the Nasdaq.
Paulo
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