Bernie Schaeffer, a longtime bull, has shifted his market stance to neutral:
Bernie Schaeffer: Long-Term Posture Switch from Bullish to Neutral
12/1/2000 4:47:31 PM
Long-standing followers of my market commentaries know that I established a long-term bullish market posture on
the day after the October 1987 crash after having turned bearish on the day of the market top in August 1987. And
my long-term bullishness has been unwavering ever since that fateful day in October 1987. Even when I've been
most concerned about the market during the ensuing 13-year period, I've advised long-term investors not to disturb
their positions.
At the time I reestablished my bullish stance in October 1987, the Dow was about 1800, the S&P 500 Index
(SPX) was about 250, and the Nasdaq Composite (COMP) was about 325. I mention this because I feel it is
important to put into perspective the service that has been done for investors over the years by long-term bulls like
myself compared to the damage that can be attributed to the many advisors who've been bearish through most or
all of this period. Yes, these bears were negative at the market top this year, but they've also kept legions of
investors from profiting from one of the greatest bull markets in history.
I'm now switching my long-term posture from "bullish" to "neutral." As you likely know, I use a 20-month moving
average to define the line of demarcation between bull and bear markets. If a stock or index is trading above this
trendline, it is in long-term bullish mode. If the stock or index is trading below this trendline, it is in long-term
bearish mode. Since I utilize a monthly graph to gauge this, I evaluate this variable on a monthly closing basis.
On Thursday, November 30, the SPX experienced its first monthly close below its 20-unit monthly moving average
since 1994 (see the chart below). Thus, this broader-market barometer is now in bearish mode, which is a major
driving force in my switch to "neutral" today. I have a number of reasons for switching to "neutral" instead of
"bearish" which I'll discuss a bit later.
Chart courtesy of ILX Systems
The monthly close by the SPX below this longer-term moving average was not the sole driving factor for my
posture change. Sentiment and fundamental factors were also heavily considered in this decision. Investor sentiment
has been extremely complacent throughout this market pullback which has tempered my bullishness in recent
months. In fact, I've been outright negative on the COMP and the tech sector for the past couple of months, given
that the COMP had already closed below its 20-month moving average in October when it finished the month at
3370 (see my recent Market Commentary).
Allow me to address my view of the current sentiment backdrop. In a nutshell, this pullback is unlike other
pullbacks we have seen in this great bull market. In other words, prior declines in the market were greeted with
extreme fear, which meant that there was a huge amount of cash built up to sustain a rally when the market finally
found longer-term technical support. This pullback, however, has been greeted with complacency, suggesting that
there is still the potential for more selling, as stubborn investors who grew accustomed to "buying the pullbacks"
eventually capitulate.
There is no evidence of such capitulation as of this writing. For example, Investors Intelligence reports that 55
percent of advisors are bullish, while only 29 percent are bearish. As the market declines, this bullish percentage
has actually increased. During past corrective phases, pullbacks to longer-term support have been greeted by these
advisors with a great deal of fear. For example, the bearish percentage actually exceeded the bullish percentage
during the Asian crisis of 1998.
In addition, Wall Street's high-profile market strategists have become even more bullish as the market has
weakened. In fact, their average recommended allocation to stocks is now close to 66 percent, its highest level in a
decade. The recommended allocation to stocks suggests that this is the most aggressive optimism in response to a
decline in many years. Money that remains committed to the market as a result of these high recommended
allocations creates an atmosphere of increased vulnerability, as further declines in the market could result in
capitulation by these strategists and heavy selling by their followers.
I'm also seeing a disparity with respect to the actions of mutual fund switchers in response to the declines in the
stock market. For example, I closely watch cash flows into and out of the Rydex funds. Among the Rydex family
are funds designed to leverage bull market moves and also funds designed to profit from bear markets. The Rydex
OTC fund is designed to leverage bullish moves in the tech sector, while the Artkos fund's goal is to profit from
slides in the technology sector. Unlike past market declines, recent cash flows into the bullishly oriented OTC fund
have been much heavier than cash flows into the bearish Artkos fund.
Finally, while option speculators have shown some fear, I question whether this fear has become sufficiently
climactic. For example, the 21-day moving average of the CBOE put/call equity volume ratio peaked at 0.64 in
October. While this is relatively high, when one considers the duration and magnitude of the market's slide, it pales
in comparison to the 0.68 reading in the fall of 1998. Furthermore, portfolio insurance is cheap, as indicated by the
CBOE Market Volatility Index (VIX) which measures how expensive or cheap index options are on the S&P 100
Index (OEX). At past market bottoms, fearful investors and speculators bid up option premiums as they saw the
need for portfolio insurance at any cost. The VIX peaked at 55.48 at the October 1997 bottom, 60.63 at the
October 1998 bottom, and 35.48 in October 1999. With the VIX now trading in the low 30s even as the market
continues making new lows, I must attribute this to a measurably lower level of fear now than at the aforementioned
market bottoms.
The fundamental picture is also not particularly pretty. A number of high-profile companies have reported earnings
significantly below expectations in the technology sector and still others are warning of future profit shortfalls. Yet
the price/earnings ratio of technology stocks is in the neighborhood of 40, still rich and about double the projected
20-percent growth rate in earnings for this sector in 2001. Also discouraging is the fact that the Federal Reserve
continues to maintain a rate-tightening bias, despite: 1) a stock market that peaked last March, 2) an inverted yield
curve, 3) strong signs of distress in the corporate bond market, and 4) plunging emerging market currencies. These
leading indicators suggest a recession may be on the horizon, which would defeat Greenspan's "soft landing" hopes.
But Fed action to lower rates may not come until a good deal more damage has been done to equities.
So why am I adopting a "neutral" posture and not a "bearish" one?
The foremost reason relates to the technical picture. Note from the chart above that while the SPX did close below
its 20-month moving average in November and this moving average has now flattened out, it has not yet turned
lower. As I've previously stated, a confirmed bear market is one in which the 20-month moving average has rolled
over and turned lower. Should the market fail to rally this month from current levels, it is likely that the 20-month
will begin to roll over, thus confirming a bear market. But should the SPX once again rally sharply from support at
1300, it is conceivable that by the end of December we will close back above the 20-month moving average and
the rollover will not occur.
It is also conceivable that we will begin to see the kind of fear and capitulation that is needed for a credible market
bottom to occur. I believe the odds of this occurring are worse than even, but the possibility remains particularly
given that our equity put/call ratio indicator is already at historically high levels.
Be sure to keep in regular touch with our publications and with SchaeffersResearch.com, as significant changes in
the factors discussed above could trigger a move back to our former bullish posture or a move into the bearish
camp.
- Bernie Schaeffer |
