From the Q thread
(4/2/01 issue) Barrons interview with Don Hays (described as : "A onetime ' perma-bull ' pores over a host of indicators and
turns bullish again").
APRIL 2, 2001
Barometer Readings
A onetime "perma-bull" pores over a host of indicators and
turns bullish again
An Interview With Don Hays - If you think only a rocket scientist could figure
out the centrifugal forces of this market, then this is the guy for you. A former
engineer working with the team that developed the Saturn rocket for NASA some
35 years ago, Hays long ago found that Wall Street could supply him with the
same thrill of going to the moon and coming back to earth, with a bigger, and
definitely more essential, payload attached. His skills in detecting market patterns
by using a battery of barometers, then drawing historical correlations from those
patterns, have led to an enormously successful run of correctly gauging the
market's flight path. Notably, he warned his clients early on that the movement in
the Nasdaq showed a remarkable resemblance to Japan's Nikkei index in the late
'Eighties and would likely return to its pre-Internet-madness level of 1800 before
all was said and done. Coming from a self-appointed "perma-bull" who turned
bullish in 1981 with the sage prediction that disinflation would lead to an
unprecedented period of prosperity, this was sacrilege, indeed. Still, he was right.
He was in Florida when we caught up with him by phone the other day. Listen in
to learn where Hays, who has run the Hays Advisory Group
(www.haysmarketfocus.com) since leaving First Union and its Wheat First
Securities unit in the fall of 1999, sees the market headed next.
-- Sandra Ward
Barron's: I hope the weather is better in Naples than on Wall Street.
Hays: It was a little cool yesterday, but back up to 80 today, the sun is shining
and there are no clouds on the horizon.
Q: No wonder you turned bullish.
A: Well, it's been that way for the past three months and I've only just turned
bullish.
Q: Why does the world look rosier to you? You've cited the Arms Index as one
reason. Why don't you tell us about that?
A: It has got all kinds of names. It was known as the MKDS and sometimes it's
referred to as the "Trin." It was developed by Richard Arms. I like it because it
has worked so well. To me it is like the fuel gauge on your car. It's as if you have
a dragster and you want to go from zero to 120 in four seconds, and you have a
carburetor that just sucks gas and it takes a huge amount of fuel to push the car
down the strip.It's the same way with the Arms Index. It measures the amount of
upside volume to downside volume in relation to the number of stocks. So think
of it as a measure of energy being required to push a market up or down. Anytime
it goes above 1.3, and that's the 10-day average now, it's a sign that you have got
to stop and refuel before you go down some more. But when it goes above 1.5 it's
a sign you are virtually out of gas and running on fumes and there isn't much
more energy to push it down, based on historical examples, of which there have
been 12.
Q: So we've hit bottom? Or do you need some other signal to confirm that?
A: You are not kidding we need more evidence. We got the signal one day before
the October 19 crash in 1987, but you lost your shirt -- 22% -- if you bought into
the market the day it gave a signal. In almost every one of the instances where the
Arms Index moved above 1.5, there was always some more vicious decline after
it. So there is more to go on the downside and you don't want to pull the trigger
yet. But you have got to be ready in the next couple of weeks.
Q: Can you be more specific?
A: I have no idea when it will be, but I know in the past the longest wait was 20
days from the signal. I don't think it will be 20 days. For the past 15 years, it has
always been in the four days following. That's the reason I think yesterday's
[March 22] intraday low probably will be the low. I will be dollar-cost-averaging
into the market in the next two weeks. The signal to watch for -- a rally of 1% in
the S&P on increasing volume from the previous day -- should come after the
first three days, between the fourth and the 10th day. That says the odds are high
for a move on the upside.
If I see that happening, I may jump ahead a little bit. But I always like to go back
to history and find other examples that I think are similar in background and
similar in action. I find March 24 of 1980 to be the most equivalent. In
1979-80-81 we were going into a period in which the new theme was disinflation.
It was setting the framework for the next bull market. Every time inflation came
back, the Fed fought it a little harder and there were very definite signs in 1978,
'79, and '80 that inflation had been defeated. That became more evident in 1981.
This time, the new theme will be deflation and the spread of democracy. If this is
similar, we have three or four weeks here of ebbing and flowing before we take
off.
Q: All this comes to you via the Arms Index?
A: Oh, no. But it is a great indicator to tell you that
there is something very significant happening. Until
this point, I thought the capitulation phase of the bear
market would not come into effect until sometime in
the April-June period. About three or four weeks ago
I changed my mind. The Arms Index gave the signal,
and you could just feel how everything felt so much
like March of 1980, when everybody was thinking the
end of the world was here. I realized we were going
out of the interlude and into the capitulation phase,
and so I upped my cash and decreased my equity
position.
Q: What charts other than the Arms do you rely on?
A: I'll give you the most pertinent ones that are
sending me a message now. A valuation gauge that is
very important is one developed by I/B/E/S measuring the earnings yield of the
Standard & Poor's 500 based on 12-months forward earnings. That earnings yield
is then compared to the yield of a 10-year-note and from that you can glean
whether the market is overvalued or undervalued. At yesterday's close [March 22]
it was 8.7% undervalued.
It is the first time it has been in the undervalued category since the panic selloff in
1999 and before that in 1997-98. It had been 70% overvalued at March 10 of last
year. That's one, but psychology is my favorite indicator because, I think,
psychology determines what the Federal Reserve does.
Q: Isn't that the hardest one to get right?
A: Not if you have the right indicators. I use the equity put/call ratio, and that has
the best record of measuring real bullishness or bearishness.
Q: That gives you a read on the mood of individuals, not professionals?
A: It is more focused on the individual investor and individual stock. It excludes
indexes. The three-week average is 12% above the 39-week average. Like the
Arms Index it doesn't tell you it is going to turn around the next day. It tells you
that the "wall of worry" has been rebuilt. A fairly recent addition to my
psychology composite is the Smart Money Flow indicator. It is fantastic, and I
like the philosophy behind it.
Q: Explain.
A: It confirms other signals. If the Dow makes a new high, the Smart Money
Index has to confirm the action. It called 1987 perfectly. One of my subscribers
brought it to my attention about three years ago. He had been keeping it all these
years and in 1998 before the August debacle, it started plunging and called that
one perfectly. Again, in the fall of 1999 it started plunging. Every time the Dow
tried to rally after the January-February high, this kept on plunging. It has not had
any higher highs until the last two months and it has really been acting good.
Q: What exactly is the Smart Money guage?
A: You calculate it by taking the action of the Dow in two time periods, the first
30 minutes and the last hour. The first 30 minutes represents emotional buying
based on good news or Maria doing handstands. It is dumb money. So the keeper
of the index, Lynn Elgert, subtracts the dumb-money action on the Dow that
occurs in the first 30 minutes and he adds the last hour, which represents the
smart money because the action in the last half of the day tends to be based more
on logic and reason. For the very first time that index has been making higher
highs. Yesterday [March 22] the real snap-back was in that last hour. I think that
is more evidence that psychology is good.
Q: So these indicators are still viable even though there's increased access to
information and news flow leading to lightning fast changes in the markets?
A: I don't think that makes a bit of difference because people are still driven
emotionally and I don't think that fear and greed have changed. No matter how
quick you get information, it still takes about the same length of time for fear or
greed to build up. So I don't see any difference in the volatility of the market.
Depending on where you are in the cycle, in the super cycle, not just the
three-year cycle or four-year cycle, but if you are in one of the 18-year
super-cycle markets, or in an evolutionary stage, I think the indicators are still
very accurate.
Q: So where are we in the super cycle?
A: I think we are going to go back to the
Presidential-election cycle during this turn. We
haven't seen it in many years. It will come back into effect for the first time since
probably Greenspan has been there. He is such a manipulator. He has done a lot to
keep it from working. For many, many decades, the first year of the
Presidential-election year was always the weakest year. A new President came in
and decided to get the tough stuff out of the way before he had to run again four
years later. The second year is not as weak as the first year but it's still a so-so
year. But the third and fourth years, when they are trying to get everything just
right to run again, typically those are the very best two years of the
Presidential-election cycle for the market. So we are going to have a rally, but we
are going to have to pull back again sometime before we begin the new
super-cycle bull market based on deflation and democracy.
Q: You called the bull market of 1982, but you turned bearish in 1997. Why?
A: I was known as a perma-bull, but starting in the fall of 1997 I started believing
the super bull-market of 1981 to 1997-98 was about to end. We saw extreme
weakness in the market and we were pretty exact in our timing. Most stocks,
70% of all stocks peaked out in April 1998. The real decline started in August, and
got to where almost no stocks were poking their heads up. That was the first
bear-market phase of the typical stock, the whole universe of stocks. The market
rallied right after that. But psychology, monetary policy and valuation, all the stuff
we look at, turned very positive in September of 1998, which really surprised me.
I expected a normal bear market the way we used to have them and I thought it
would last 15-18 months. I thought it would cure the excesses of the world. But
Greenspan decided to rescue the world. So he flooded the system with money and
he bailed it out. But he also blew the bubble up a little bit higher.
In 1999, the broad market once again turned weak in the August-September
period of time and turned weaker by the time we got to March of last year. We
only had 10% of all stocks above the 100-day moving average. In my opinion, that
was the second bear-market phase of the total universe of stocks. But we had this
pumped-up stage of New Era technology totally masking it, and it was helping
people's portfolios because everybody benefited from these stocks going up. So it
helped everybody to feel better and helped them to believe that we were in a bull
market. Then the bubble burst. The Nasdaq had a price/earnings ratio of 153 and
was going through the roof at 5100. Part of the reason for that is a marketing
trend started by Merrill Lynch brokers some seven, eight, nine years ago in which
they persuaded people to stay fully invested. If they sell something they don't hold
cash, they just put it right back in. This is called strategic allocation.
Well, when Big Daddy Merrill did it, you know every other brokerage firm in the
world trotted right along behind it. At the same time, Jeffrey Vinik took over from
Peter Lynch at Fidelity Magellan. When Vinik came in, he thought the market was
vulnerable and he raised cash, bought bonds and got his head handed to him. Now
Fidelity began telling its managers to stay fully invested. Every mutual fund trotted
right along behind them. So we have a system now when you sell something you
have to buy something else immediately. As investors started phasing out of the
technology stocks, they started pumping up the rest of the market. The Nasdaq
had its first phase of its bear market from March 10 until April 15 of last year.
Then there was an interlude rally. The second phase of the Nasdaq bear market
started about August or September of last year, and that ended the first week of
this year. This is the third phase, the capitulation phase. In capitulation, you don't
sell one stock and buy another, you go to cash. That's why the stocks in the
broad market are going down with the technology stocks.
Q: Sounds like you think Greenspan caused the bubble and the bust?
A: If you look at Greenspan's record in the past, he has never, ever, ever called
the economy right and never called inflation right. Why should somebody like that
have his hands on the puppet strings? He is also very aggressive. People give him
credit for busting inflation. Well, that's a joke. Inflation came down in Paul
Volcker's first term. Came way down, almost to where it was not too much
higher than it is now. Up until 1996-97, he used to say that the economy could
never grow above 1% without causing inflation. He used to say that
unemployment could never fall under 6% without causing inflation. It was a
coincidence with his marriage, but he all of a sudden turned from a Scrooge to a
Santa Claus, and during the 1997 Asia crisis he did not let the natural forces run
their course. Now he has gone overboard on money supply.
People always love easing. So since 1997 he has been applauded for being one of
the saviors of the world. But he threw all this money into the system, and it
allowed margin debt to go through the roof at the worse possible time, and it blew
the bubble up to levels that require much more pain to get rid of.
Q: You've mentioned you see deflation on the horizon.
A: I think what we are in is a very unique time that is somewhat equivalent to
1880. We had the five waves of technology, they've been in a gestation phase
since the 1970s when the PCs came along and Ma Bell was broken up.
Technology didn't really come out from under the covers until 1994-95. We have
already seen huge increases in productivity. This is the beginning of where the
technology revolution is permeated into the entire United States and much of the
world. We had one of the strongest economic recoveries and the longest
economic boom in history. We've had retail sales going through the roof. We had
debt moving up and unemployment coming down.
At the same exact time, the CRB Index has not even come close to making new
highs. Gold has been plunging and wages have had a small blip up but nothing like
what you would expect. Even the bears on inflation who believe inflation will go
up are projecting maybe 4% or 4.5%, not 10%, 20%, 30% we had back in 1982.
On gold, the bears will insist it is being manipulated. But you can't dismiss the
price of lumber. All these things have really plunged in the past two years.
Q: You see this continuing, but how does it continue to be a positive for the
economy?
A: It will be very damaging to many companies if they can't keep up with
productivity. It is going to hurt large companies especially because they cannot
change as much. I think the day of a big-cap stock has come to an end for a long
period of time. Innovation comes from smaller companies that can produce
productivity-enhancing products. I'm not talking about just technology companies,
I'm talking about building a road or anything else cheaper or faster. Our
infrastructure has been so ignored for the past 20 years, we are going to spend the
next 20 years trying to get our infrastructure, our power plants, for instance, back
up to scale. It has to be done by productivity-enhancing kind of products.
In the Industrial Revolution of the 1800s, the companies that did well were not the
companies that produced tangible products. It was the railroads and those types of
things that really had a huge jump in productivity. Deflation is not going to be a
panacea for all stocks. Exactly the opposite. But it will be the driving force behind
productivity gains and better labor relations, better everything. With the Internet
and with personal computers, nobody can keep a secret from anybody.
Everything is totally wide open, and there is perfect pricing power. The companies
and countries that will benefit are the ones that have less bureaucracy or more
bottom-up management. There will be more democracy in corporations as well as
in countries. Nobody can tell for sure what is happening in China, because there is
so much secrecy, but by the same token you are seeing very vivid signs they are
gradually improving worker relations and gradually opening up.
Q: Which stocks should people focus on, then?
A: You want to avoid commodity companies, mining
outfits and forest products and industries where they have
no pricing power and have a tough time raising their
productivity. Consumer stocks will be tough, too. Stock
selection will be more important than it has been in 30
years. Technology will still be a big, big place to go.
Medical stocks will be a big area because of demographics.
You will have to be particular but financials will be okay.
Energy, has a two-year window, maybe longer, but at least
two years where you are going to see a lot of emphasis on
replacing drilling and production equipment that's been
avoided for the last 25 years.
Q: What about bonds here?
A: We will not go into a deep recession, and by October
I'm expecting a recession to be acknowledged by
everybody. If it's acknowledged in October, Greenspan will
admit it in November. I expect real interest rates to be at
2%-3% in the next six to nine months. Bonds are still a great place.
Q: By October, we'll be seeing better times?
A: Right. This rough spot we're in right now will be like 1980 in that we have
some backing and filling for two or three more weeks. But, by the middle of April
or somewhere in there you will see something on the proposed tax cut; it may
even be passed by that time.
At the same time, first-quarter earnings will be out and that will relieve the market
and allow a rally. I also expect the Federal Reserve to cut interest rates again in
that time frame. That would set us up for the straight-up action we had in 1980. I
expect the rally to be a 6-12-month-type of affair, not a two-to five-year type of
thing.
Q: Thanks, Don.
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