Tim, we may as well save this and see how things turn out -g-
The Tea Leaves Are Quivering, and So Am I
Don Hays
I had believed that we had a chance of one more new high in the Dow Jones Industrial Average before the second phase of the bear market begins. But
based upon the way things are going, it looks like that expectation is not going to be met. The Dow Charts are definitely sick.
Maybe I'm just too much "old era," but I still can't get away from the terrible condition that is being displayed by the grand old companies of America.
With this type of action, I find it mind boggling that those talking heads are still smiling so broadly, as they bask in their perpetual bullish sunshine. There
are a lot of very troubling trends shown above. To begin with, you can see that after 17 years of a mighty bull market, that was being fed by a steady
persistent rise in trading volume, that all of a sudden in November of last year as Greenspan's gremlins were allowing money supply to explode--as the
Y2K ghosts were haunting their dreams--the volume exploded. I wonder who the buyers of that volume were, and more important the sellers. It doesn't
take a market wizard to answer that question. Margin debt went through the roof as Regis and his CNBC cohorts even started dressing alike and the
new investors were clamoring to get rich quick.
Check out all the major tops throughout history, and you will see this same volume trends for a period of 6 months or a year as the smart investors start
unloading and the dumb ones eagerly buy their shares. Who are the smart investors? Hedge funds?? Mutual Fund Managers?? Banks and Brokers?? I
don't think so. They never have been, as the pressures of the quarterly performance numbers as the last hurrah is being painted on the mural is too much to resist. The smart investors
typically are those old-time public investors who finally choke on valuations that reach astronomical levels. You can see this in statements of the legendary value investors like
Templeton, and Buffet, et. al. But it wasn't just those notable people that did the selling, it was the thousands of individuals that chose to sell back to those companies all their overpriced
stocks that they wanted to buy back at those astronomical levels.
It is easy to talk about the stupidity in hindsight, but very hard to resist joining the herd in the day-to-day action in practice, especially as the next quarter's performance statistics are
always just around the corner. But as you look at the Dow charts above, you can see that instead of reducing cash reserves, a wise investor should have been increasing cash reserves
in April 1999. They should have assumed a defensive stance then, and used those next 14 months pruning and planting around that reduced equity position. In the typical topping action
such as has been occurring, sector rotation becomes even more important as fewer and fewer sectors are participating.
You can readily see how important sector rotation is by looking at the above banking index. You can see that anyone that missed the massive rally in bank stocks from 1991 to 1997
missed tremendous gains. They were the stars. But beginning in the fall of 1997, smart investors would have been selling bank shares, and not buying these superstars of the last 6 years.
The chart above also shows the massive topping formation that will have dire messages if a break-down under the "neck-line" level occurs. I could easily put some flesh on those bones,
as to possible reasons for a possible breakdown in a bear market scenario. In that 1990 era, when Greenspan's swat teams of inspectors went through the banking system taking no
prisoners, forcing massive write-offs, and forcing the cancellation of long-held lines of credit, the banks decided with Greenspan's direction that they didn't want to be "old-time" banks
anymore. It was time to diversify. So now they are much more dependent upon the stock market, and also much more vulnerable to market swings. Is this another old trap, like the
R.E.I.T. traps of the past that caused massive problems in the banking industry? I, for one, certainly hope not, but as I try to put flesh on the skeleton that this chart seems to be building,
it makes me nervous.
As I look at the charts above, it makes me so glad that I was able 31 years ago to sit at the feet of such great market geniuses such as Edson Gould, Richard Russell, Charlie O'Hay,
Jack McCarthy, Joe Granville, and a young technician at J.C. Bradford named Ned Davis. I was not personally talking or listening to most of those geniuses, but was reading everything
that I could get my hands on to help me understand what they were trying to get through this thick skull of mine. Hopefully some of it stuck, and as my own disciplines began to take
root, my asset allocation model that analyzes current monetary, psychological, and valuation conditions has really kept me in the right place at the right time for all the 6-24 month time
frames of the last 20 years. Don't get me wrong. I have had to reach down and hold onto this model with intensity in certain times when it seemed to have been wrong for the short-run.
It almost always takes at least six months before its wisdom is obvious to the herd. Sometimes it has taken even longer, up to 11 or 12 months. But so far, in every instance, it has never
failed to keep me with the important trends, selling into the massive topping formations, and buying in the massive accumulation periods. I'm keeping my fingers crossed, but as I review
the charts above it is amazing how it has navigated me through this most historic last 30 months--that I believe has been a massive distribution phase. It turned me from the most
vociferous of bulls, into a bear. I don't enjoy being a bear, but that is the way my time-tested discipline forces me into at this time in history.
In our previous month's comments, I stated that the extreme market weakness that had been experienced during that late May time frame, in what I believe was the first of three bear
market phases, had ended. My expectations were that the market would move up in an interlude rally, as worries of more Fed interest rate increases began to subside. But the time
frame that I gave for this "interlude" rally to end was slated for the period as the month of July arrived--and 2nd quarter earnings began to be released. That "time-frame" expectation still
holds in my opinion, and is already starting to see some weak economic concerns begin to surface in corporate earnings' announcements. Unless I miss my guess, the next three months
will produce a very weak market environment that will encompass the second phase of this bear market. Typically the first phase is described as a denial phase, where the "guru's" of
the herd refuse to admit that a bear market has begun. But the second phase is termed as the "concerned" phase, when all of a sudden the economy and earnings begin to suffer from the
effects of the monetary restriction.
Needless to say, I am recommending a very defensive asset allocation posture at this time. |
