December 19, 1999
Last week, the Dow Jones Industrial Average was up 32.73 points to 11,257.43 (+0.29%), the Nasdaq Composite was up 132.82 points to a record high of 3753.06 (+3.67%), the S&P 500 was up 3.99 to 1421.03 (+0.28%) and the Russell 2000 index of small cap stocks was down 0.50 to 466.21 (-0.11%).
There is a chart that accompanies this week?s newsletter. Please view it at the following area of the StockMotions Website:
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NYSE Cumulative A/D Line Quickly Dropping
Over the past few months, I?ve spent quite a bit of time expressing the bear market drop in the NYSE breadth. During that time it was mentioned that the 25,000 to 30,000 area for the NYSE Cumulative A/D line would be a critical area of support for this indicator ? if indeed the bear market in the neglected stocks was to come to an end. For a while from late October to late November, things looked good?.a broad based rally was underway and it looked as though there was a glimmer of hope that the market was putting in its finishing stages of its overall bear market.
It was also mentioned that if the 25,000 area didn?t hold then the next area of support was 25,000 units lower or at zero! Well, over the past three weeks, this indicator has continued its collapse. As of Friday, December 17, 1999, the NYSE Cumulative A/D Line stood at 19,838 or about 61,874 units from the high set back in April of 1998. By the way, I had also mentioned that if the 25,000 area didn?t hold, then the zero level was the next area of support ? so I don?t look for a turnaround anytime soon.
Which brings us back to the overall theme of the past few weeks. That is, this is market of the ?haves? and the have-nots? ? there is no room for anything in between. The problem with all of this is that right now the ?haves? have had such a tremendous run, that it takes too much fortitude to get on board.
So what caused the overall market to give back the broadening rally of late October to mid November?
One reason, in my opinion, was the rise in interest rates. On November 16, 1999, the Federal Reserve decided to raise the federal funds rate target for a third time this year by 25 basis points to 5.5%. The Fed also chose to raise the discount rate for a second time by 25 basis points to 5%. The main reason given was the persistently tight labor market. Since then, the 30-year bond rate has risen about 35 to 40 basis points.
The Fed is concerned that the economy is expanding beyond its potential. I do not totally agree with this argument. If indeed productivity remains high and industrial capacity is in place to meet the robust demand, then inflation should continue to remain tame. For example, the Producer Price Index has risen 3.1% year over year as of November and the Consumer Price Index has risen 2.6% year over year as of November ? and all of this is in the face of a 140% increase in oil!
Now looking ahead, it is very difficult to make the argument that oil will experience another 140% rise in the next 12 months ? especially since Barron?s had a bullish piece on the subject on Page 3 this past weekend. Furthermore, the capacity to grow food isn?t being diminished in the US?. Just spend a few moments contemplating the fact that Congress approved direct payments of some $24 billion in farm aid to farmers who over produced again this year. Some call this a waste of money?.I call it a cheap way of containing food inflation by maintaining an ample amount of capacity to supply food not only to the US but also to other parts of the world.
So how much further can the Fed tighten before possibly touching off a recession?
Looking at the accompanying chart, the answer is probably in the range of 50 basis points. The chart shows the 30-year bond on a monthly basis from February 1977 to November 1999. It shows the peak in interest rates (in the early 1980?s) brought on by the external oil shocks of the 70?s?.from there a long-term downward trend emerged. I?ve drawn in a trendline from the peak in 1987 to all the subsequent lower peaks since then. Note that the trendline actually sits at about 7.00% today?.and that during the last up cycle in 1996-97, the trendline wasn?t touched (the ceiling being around 7.00%.
Of course, I would like to see this recent run up stop at the 6.40% level ? a level of some resistance. That would likely allow a resumption of some broadening in the market.
What the Fed has done is created an atmosphere of uncertainty in the equity markets. The ironic outcome of all this is that those non-speculative sectors in the market are being punished with this uncertainty and the speculative sectors of the market got even more speculative.
If a recession does happen, it will have to happen without a major prolonged market correction/crash?.because unwinding such excesses can be just as painful as the euphoric feelings being experienced right now.
OK?enough economic stuff.
I still think that the information revolution is just in its infancy. The many smart consumer devices being prepared to be launched over the next five years will vastly change the way we do our everyday stuff?.and this is a good thing. Additionally, this will continue to push the technology sector further. Over this past year, we have experienced profit explosions by a great number of high tech firms (especially coming off the depressed levels created by the Asian financial crisis)?.so the tech sector had some catching up to do. Now it has gotten a bit ahead of itself. When the Nasdaq finally corrects?.and it will?.after all +44% in eight weeks is extraordinary and precedent setting?.but when it does correct, it will surely create better buying opportunities. By the way, the Nasdaq closed above 3000 for the first time on November 3, 1999. Thirty-one market days later it sits just 6.6% away from 4000! Simply amazing, breathtaking, historical, etc. etc.
And Finally?
It wasn?t too long ago that such persistent deteriorating readings in the market internal indicators would cause many to raise the warning flags and proclaim that the end is near. However, this time around there isn?t such proclamations. Many of us have simply been humbled by the divergence in performance between the NASDAQ?s largest players and the rest of the market?recognizing that these are truly historic moments that we are currently experiencing in the US Stock Market. How history treats these moments is yet to be written?but the road there is certainly turning out to be an educational one ? and quite profitable for many!
What the Heck Does All This Mean?
Interest rates are at a critical area on a short-term basis. A break above 6.40% on the long bond should be the catalyst for a correction in the Nasdaq. Now because their exists enough uncertainty with regards to rates and the fact that we are a few weeks away from Y2K and that the bulk of this move is over with in the Nasdaq, I don?t find it a bad idea to get into cash and sit and wait.
The Major Moving Averages
For those who are interested in the moving average levels, here they are. As of the close on Friday, December 17, 1999: The Dow?s 200 day MA is at 10686.40, its 50 day MA is 10766.10. The 200-day MA is in an uptrend and the 50-day MA is in an uptrend . The Nasdaq 200day MA is 2753.80 [1000 points below the Nasdaq!!!], and its 50-day MA is 3189.80. The 200-day MA is in an up-trend, the 50-day MA also in an uptrend. 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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Copyright: 1999 StockMotions.com |
