MORNING MARKET COMMENTS
by
Don Hays
January 17, 2000
Oh how excited I am to be traveling to New York tomorrow morning it suffers
through a real chill by Nashville standards. Since I will be catching the
6:45 A.M. plane, I am sending this out tonight. Hopefully, I will be back
to Nashville Wednesday night before those flurries hit Wall Street, and be
back live on Thursday morning from the sunny south. Unless some particular
reason comes to our attention before next Thursday morning, these e-mail
messages will come to you via a word attached file from now on. This will
help us to upgrade the appearance, adding charts of interesting
trends/studies to the content. If any of you know why we should not do
this, please let me know.
Now, let's analyze where this crazy market is. Maybe analyze is not quite
the right word, since the bubble has made all historical studies almost look
tame and useless. But we suspect that looks are deceiving and that the
market has not changed its stripes, just that it is the end of a mighty bull
market that began in 1982, and has reached its full cycle, from intense
pessimism in 1982 to a mirror image intense optimism during this
1998-to-current range. We say range because I believe history will
definitely show that for the vast majority of stocks the peak of the mighty
bull market was in that April-July, 1998 period. But it is not as simple as
that, because a small contingent of stocks continued onward and upward as
the glorious Internet economy became fully obvious to the world. And that
small contingent turned out to be the market for the momentum players.
The old traditional methods that we have developed over the last 30 years
certainly worked in that first top, as the results began to darken in the
March/April 1998 period. Our valuation gauge moved to extremely overvalued,
and the monetary component also started to weaken. Finally in the
excitement of the April-July peak, the psychology leg weakened as well,
setting up the conditions that fostered that August 1998 debacle. But then
the Greenspan money fountain was turned on full blast, rescuing the
speculator just as they were approaching the cardinal punishment pain levels
that are always needed to cleanse the system of excesses. It burned but it
didn't really blister them enough to leave any permanent scars. Our asset
allocation model once again worked like a charm. We didn't want to turn
bullish so soon, but in that one-month decline the valuation composite moved
back to "fairly-valued" territory, the psychology moved to very bullish
levels, and here came Greenspan's money causing dramatically lower interest
rates. So bullish we became, recommending a shift back to fully invested at
that September 5, 1998 juncture.
Finance, and refinance became the theme, as money supply soared to one of
the highest "real" rates in history. The economy soared, and the US
consumer bailed out the world. Even now statistics are showing that the
Japanese and Chinese recovery is almost totally a result of their exports
with good old Uncle Sam carrying the purse strings. In many ways 1999 was a
repeat of 1998, and in that same March/April period of last year the
large-cap market had once again become extremely overvalued. Then the Fed
started trying to drain a little of that high octane booze that they had
poured onto the investment scene back out of the punch bowl. The market
certainly started showing the strains in the same July/October period of
last year. Not only stocks, but the dollar started to weaken as the effects
of the huge trade deficit started to come home to roost. The quality spread
on bonds once again started to move back to the same extremes of the crisis
of the 1998 period. October 15, 1999 was the fulcrum point this time, as
the put/call ratio once again measured extreme fear. But psychology was
pretty much by itself in that panic of last year. It did become obvious in
the weeks ahead that the Federal Reserve once again over-reacted to the fear
attack. Their endeavor to rein in money supply in those previous months was
quickly forgotten as money supply and credit creation exploded during the
next three months. Strangely enough, however interest rates did not decline
this time with the new money hitting the banking system. Instead of it
feeding the bond market, it fed margin debt as speculative stocks exploded
such as never before in history.
Maybe the Fed cared a little, but not a lot it seems, as they took the
gradual route in raising interest rates, and totally dismissed the
possibility of raising margin requirements. This is not a new trend for
them. In 1994, the trend was almost identical in the way they handled their
move to a restrictive bias. The bond vigilantes did their work for them,
with long bond yields moving up dramatically before the Fed really got
serious. This year, same song, second verse, with bond yields moving from
that 4.7% yield of October 1998, to 6.69% last Friday. The Fed has raised
interest rates three times to today's level, but they keep assuring the
public that they are almost through. If you notice, however, the tone of
the Fed's jawboning seems to be turning a little darker in the last few
days. We now see the producer price index rising faster than the consumer
price index for the first time since the 1988-90 period. Before that, it
was in the 1980-82 period. Both periods led to much tighter monetary policy
in the months ahead, and to bear markets.
Even though the stock market cheered last week's report of the PPI and CPI,
when you look closely you see that the pipe-line pressures are increasing.
The intermediate PPI has now increased for 10 months in a row, and the crude
component is up 8 months in a row. With the producer price rising faster
than the consumer price, it causes extreme pressure on corporate profit
margins. What they are paying for goods is going up faster than what they
are getting for goods. If you remember, Mr. Greenspan's words in 1990
disavowed that a recession was happening until the recession was almost
over. So I'm not sure how much attention I should be paying to those
wonderful insights he gave us last week. What did he say, by the way?
Despite last Friday's fireworks, the market is still in that January 2000
trading range, by and large. The NYSE composite is fighting hard to try to
move through the 650 right shoulder level, and even with a 31% equity
put/call ratio on Friday it didn't make it. Of course, Intel really took
off, propelled by better than expected investment results. That's right, I
said investment results. The analysis of the results showed that the bulk
of the "better than expected" earnings was due to realized equity gains. It
is amazing to know that Intel's stocks blew out to new highs, but the
revenues from its old mainstay--micro processors, was actually down for the
quarter. So another piece of Internet vapor cash helping a stock to soar.
Speaking of Internet vapor cash, do you suppose that Steve Case recognized
that his AOL vapor cash might not always have the buying power it has now?
I'm not sure that I'm ready to give Steve Case sainthood status as of yet,
but certainly he his proven to be a visionary so far. The same type of
amazing vision can certainly be awarded Charles Schwab, and he too was
willing to trade his high-flying P/E for a much less ballyhooed US Trust's
assets. We'll have to keep an eye on the CBOE Internet Index, INX, but if
the top that occurred in early December proves to be the top, it might be
wise to use all the vapor cash you can before it loses its buying power.
I speak with confidence of our asset allocation model that predicts future
stock market performance by analyzing the three characteristics, valuation,
psychology, and monetary conditions. It has always worked before. But at
the beginning of this great bull market, it took a lot of faith as those
conditions began to brighten almost a year before the August 1982 bottom to
stay the course. Is the top a mirror image of that bottom? It has been a
long-standing process, and even though only 28% of the stocks are still
playing this bull-market theme, last week saw the American Association of
Individual Investor's bullish sentiment move to a record high 71%. As
noted, our work started turning back cautious in March/April of 1999, and
the NASDAQ composite has made mockery of that. But the market has followed
this tried and true discipline as perfectly as always. But portfolios are
still very close to, or moving into new all-time record highs, in general,
unless they are unlucky enough not to have even 1 out of 3 positions in the
technology "hot" category.
As I noted last week, in portfolios that I manage I have enjoyed the
performance of Amgen, Cisco, Human Genome Sciences, Nortel Networks,
Tellabs, and Texas Instruments. That is even more than a 1 out of 3 ratio,
but when I look at the remaining stocks-which is over half of the portfolio,
I see performances ranging from miserable to mundane since our asset
allocation model turned cautious in March and April of last year. And I
plan to watch the next few weeks with extreme nervousness now that other
negative factors seem to be gaining ground. The Smart Money Index that I
mentioned last week has the potential of producing extremely negative
results if the signals that it has given in the last ten years are an
indication. If you remember the explanation from last week, this cumulative
index operates on the premise that the first 30 minutes of market trades are
often a product of emotional buying based upon the morning's hype. So it
subtracts the Dow's performance for the first 30 minutes and adds the
performance of the last one hour. The premise being, of course that this
buying comes from a pure investment perspective-smart money. In the last
ten years, all non-confirmations between this index and the Dow have proved
to be forerunners of very weak markets. As Wally Hert tells me, the lead
time varies over the years from the first non-confirmation to the actual
bust, but the one leading up to the August 1998 period occurred 81 days
prior to the actual July 1998 top. This year the first non-confirmation
occurred on October 27, 1999. If my quick appraisal is correct, so far we
have used up 76 days. If this signal is going to keep up its timely record,
the weakness should start to become apparent in the next few weeks I would
think.
We also believe that the new "tougher" talk by some new voting members of
the FOMC will start to soak in to bankers and investors very soon. When you
look at the growth of money supply in the last ten years, you find that all
periods of excessive growth of MZM, money supply with zero maturity, above
10% has led to booms, and then busts as that growth gets back into the 7%
range. We are about at that range now, so unless the Fed continues to prime
the pump as they did in the last 13 weeks of the last Millennium, the
reducing MZM does not bode well for the stock market bubble getting bigger.
Maybe Godilocks Greenspan has found a way to let the air out of a bubble
easy, but all the bubbles I've seen deflated do it with a bang. The biggest
effect would be felt by the sectors that were the biggest beneficiaries of
the money binge in recent months. So that is why I'm watching those stocks
that I mentioned above so closely. If they quit carrying the load of my
portfolios, the overall portfolio performance will quickly feel the results.
In my long-term growth asset allocation, I have 55% stocks, 20% cash, and
25% bonds, and that is highly defensive for that strategic allocation
category. But like all tough markets, you never seem to have enough cash
when stocks are going down.
That's enough for tonight. I've got to see if I can find my Tennessee
Titans stocking cap before in the morning's flight. You'll (that's
pronounced y'all--the plural is all of y'all) do know who the Tennessee
Titans are don't you? See you Thursday morning if the deicer's are working.
he Hays Advisory Group does not guarantee the accuracy or completeness of
this report, nor does the Hays Advisory Group assume any liability for any
loss that may result from reliance by any person upon any such information
or opinions. Such information and opinions are subject to change without
notice and are for general information only. Hays Advisory Group, P.O. Box
50436, Nashville, TN 37205.
(2000 Hays Advisory Group, LLC. All rights reserved. The information
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