I was going to post this note to you yesterday morning but I had to get back to work and hence the post never materialized. Anyhow, here is something to make your day (I am sure you read it already)
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September 1, 1999
The bear market continues! Well now that I have your attention, I guess you want to rave about the Dow Jones Industrial Average still trading right in the shadow of the new all-time record high that it made last week. Maybe you want to reference it is still up over 17% for this year. The "talking heads" continue to live in that distorted world, but we continue to state that the overall market has been in a bear market since April 1998. Yes, that is right, 1998. We are indebted to a study done by Merrill Lynch's Richard McCabe that was based upon studies completed last Monday as the Dow Jones Industrial Average was making dynamic, widely heralded new record highs. That study found that only 27% of all NYSE common stocks and 23% of NASDAQ common stocks have been able to exceed their individual 1997-98 highs anytime in 1999. It goes on to reference that 57% of the NYSE stocks and 73% of NASDAQ stocks were still 20% or more below those prior bull market highs. It found 41% and 63%, respectively, 30% or more below those highs.
Please read those statistics over again. It will help you to keep your head on straight as the media gives so much praise to the perpetual bulls of today that relish in their own "success" in the wake of the Dow's very distorted message. We would guess that their portfolios (and their guts) don't come close to matching their big smiles for the camera.
To put this environment in perspective, we are indebted to our asset allocation model that turned very defensive last year as the April-July 1998 enthusiasm was filling the headlines. Then on September 5, 1998, as the panic decline of August jolted Greenspan into executing another one of his panic "flip-flops" and flooding the system with liquidity, our asset allocation model pushed us back to a fully-invested bullish posture. It was based upon that September 1998 bullish shift in our asset allocation model that we projected in November of last year that the first 8 months of 1999 would look very similar to 1998. The similarity with that period proved to be astounding, as exact correlations with the peak and valley days often occurred.
Our asset allocation model remained in that super-bullish posture until mid-February, 1999, when it began to ease into a defensive stance that over the following 6 weeks became very defensive. A look at any broad market perspective will quickly verify that this model has been virtually perfect as a tool to help formulate an offensive and defensive game plan to ride the market waves of the last three years. It is not just a perpetual bull, or perpetual bear.
In the meantime, using our short-term oscillators during this very volatile period, the short-term waves have also been fairly predictable. They helped us to locate the April peak, the slight pull back into mid-June, the new high in July and the weakness since then. So now we are at another fulcrum point. We think the juice that Greenspan fed to this bull market last fall is starting to show the negative effects of trying to abort the natural effects of supply and demand. It is like taking the easy way out in raising children. When they cry loud, give them what they want. If they really throw a tantrum, pour on the goodies, no matter how much it brings on future health and behavior problems. There is no such thing as tough love.
Last fall the excesses that had built up in the 16-year bull market certainly came home to roost. These excesses began to really show their "spoiled" nature as long ago as 1996, when the small cap stocks began to drastically underperform and the dumb old "large-cap" dominated S&P 500 began to outperform everything in sight. In mid-1997 the Asian Pacific crisis threw the stock markets of the world into a temper tantrum. Don't cry investors, Big Daddy will feed you a lot of sweet tasting money, and indeed Alan Greenspan poured it on. Sure enough, the cries quieted down as the temporary fit turned into giddy giggles. Of course the other infants of the world learned something. Investors and hedge funds even accelerated the massive globetrotting aggressive shift in their derivative-based trading strategies. As we have discussed before, the amount of derivatives floating around the globe has grown asymptotically, leaving massive oscillations in stock, bond, commodity and currency markets in their wake. Their leverage was being funded by the super-banks of the world.
But the spoiled children are growing up. Their screaming fits are not nearly as easy to explain now that they are even more spoiled by the "easy way out" lack of discipline in the past. All of a sudden warts are growing out all over, and every body part seems to have a nasty rusty ring protruding from it. The image I'm trying to paint is hideous. These kids are UGLY, and now may be beyond saving.
Maybe you think I'm overstating the case. But just look at the headlines of the last couple of days. Bank of China's bad loans have tripled. Revolts and corruption still running wild in Indonesia. Korean prosecutors have arrested the Chairman of Hyundai Securities for fraud. Japan's weak economic bounce-back seeing the construction contracts plunging, housing starts drop, employment down 920,000 and wages dropping by 1.3%. Japan's retail sales down 2.5% in July and auto output down for 4th month in a row. In the face of this, their international competitiveness is declining as the yen moves to 109 yen/dollar.
A normal supply and demand cycle has natural periods of "excessive optimism" and then a curing "excessive pessimism." In the "excessive optimism" period, greed builds and corruption explodes. But in the pain of the following "excessive pessimism," the people rise up and markets weed out the corruption. In our opinion, the excessive flood of money fed to quiet the temper-tantrums of the greedy spoiled economies of the world during the last few years, temporarily circumvented the natural "curing" phase of the natural supply and demand trends. But now it may take more than a stick of gooey candy to quiet the new tantrums that appear to be brewing. Now Big Daddy Greenspan may have no other choice except to exert the long-delayed "tough love." Too much money chasing too few goods. That, according to any monetarist is the definition of inflation. The disturbances of the world, causing sharp currency weakness and plunging import prices, certainly did its part to keep inflation statistics artificially subdued during the last two years. Don't get me wrong, I don't think that hyperinflation is about to return. There is simply too much idle capacity in the world, and the Internet technology is doing its part to keep it subdued.
But for now, the artificial subduing of inflation for the last two years is now seeing the other side of the hill as the excess money fed to investors has worked its way through the system. Yesterday, the bad news was released by the National Association of Purchasing Managers, when their prices paid index jumped to 59.8 from 54.7. This was the highest reading since June 1995. Commodity prices have also seen sharp escalation in recent weeks. And I don't care what any of the statistics are showing, as someone who is building a new home now, there is no doubt that wages are moving up in the housing industry, finding any capable worker is almost impossible. This pinch is something that is already resulting in lower productivity and higher inflation. No one is a winner in this, the builder, the stressed-out sub-contractors, and the new homeowner. It is not just in the construction industry. You can't find any business that is hanging out signs craving for new employees.
As we have been citing, Big Daddy is once again showing his "flip-flopping" personality. Gorge/Starve/Gorge/Starve, anything to keep the tantrums quieted. For the last 12 years of Greenspan's tenure, we can show many different examples of how Fed starving led to gorging and then back again. But finally the international excesses forced two sprees of gorging in the last two years, with no good opportunity to starve the little "fat babies." As a result the fat babies are even fatter, and less able to help themselves. As of February of this year, the Federal Reserve has once again tried to take some of that money out of the system. Now it is time to see what type of withdrawal pains occur. The cries are starting. Can he stand the screams? Only time will tell, but so far, the "obese adolescents" have still been kept on their diet. Money supply is still headed down. The next three months will show the resolve of Big Daddy. But unless some miraculous cure if found for curing "spoiled" economies and markets, we believe the next two months will be very chaotic, and take away those perpetual grins off those who think the bull market is still alive.
Unless we see money supply moving up dramatically, and interest rates move down dramatically, we see little chance that this fat, ugly baby can run any races anytime soon. It is having a very hard time even climbing out of its bed.
As shown in Mr. McCabe's study referenced above, 73% of the stocks on the NYSE and 77% of the stocks on the NASDAQ already are feeling the bed-sores from being on their back for the last 12 months. This is the majority of stocks, and they would argue forcefully against those giddy bullish giggles.
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