Bernie Schaeffer: Fear? What Fear?
By Bernie Schaeffer
9/24/2001 9:23 AM ET
What does sentiment look like at a real market bottom? Please indulge me as I quote extensively from the always astute
Jim Grant in the September 14, 2001 issue of his Grant's Interest Rate Observer (bold text is my emphasis):
For this lesson in the cycles of investment prejudice, we revisit the fateful issue of Business Week magazine dated
August 13, 1979. The cover proclaimed the Death of Equities.
It was a very long and portentous essay that began with a news report. The Employee Retirement Income Security Act of
1974 (ERISA) had just been liberalized. For the first time, it allowed the investment of pension money in real estate,
diamonds, gold and other hard assets. For context, recall that inflation had been virulent for more than a decade and that
Paul A.Volcker, the new Fed chairman, was about to begin to engineer the last stage of the post-1946 bear bond market.
(At the end of July 1979, the flagship Vanguard S&P 500 fund had all of $63 million under management. Now, it has
$77.6 billion.)
Within two years, long-dated Treasury yields would be approaching 15 percent. Could anything be more obvious
than the conclusion that stocks were for losers?
Actually, according to BW, they were for the elderly, who lacked the acuity and dexterity to shift into inflation hedges.
Since 1970, seven million investors had defected from the stock market, the magazine said. Was there no hope
then? For argument's sake, BW allowed that macroeconomic conditions might become more hospitable to financial
assets. But even then, investors would not return to the stock market without some gigantic equity-propaganda campaign
of the kind the Big Board had successfully sponsored in the 1950s. For better or worse, then," the magazine sadly
concluded, "the U.S. economy probably has to regard the death of equities as a near-permanent condition
-reversible some day, but not soon." The point was nailed down with a quote from the dean of the business school at
a Texas university, the identity of whom and which are charitably omitted. Pronounced this worthy: "We have entered a
new financial age. The old rules no longer apply."
In none of this palaver were price or value mentioned, except to state that they made no difference. Thus: "For
investors...low stock prices have remained a disincentive to buy." Some of the reasons advanced to abandon
hope for the stock market have a familiar ring. For example, Americans saved too little. They were overregulated and
overtaxed. Undoubtedly, they were overtaxed -all Americans at all times being overtaxed. What Business Week
neglected to mention, however, were the tax cuts effected in the 1978 Revenue Act, which older readers will fondly
remember as a prelude to the great bull market of the 1980s. Past performance was held up as another bearish
pretext, much as today it is wheeled out as a bullish one. Stocks wouldn't go up because they hadn't. Robert S.
Salomon of Salomon Brothers furnished the annual average performance data: Since 1968, the CPI had climbed by 6.5
percent, single-family houses by 9.6 percent, diamonds by 11.8 percent, gold by 19.4 percent -and stocks by 3.1 percent.
So clear was the handwriting on the wall that everyone could read it. In the galloping, overvalued market of the late
1960s, private pension funds had allocated 120 percent of their new cash in equities (selling bonds to make room).
"Today," BW said, "the amount of new pension money flowing into equities is a minuscule 13 percent, as the
funds have built up their cash portions or stuffed their portfolios with short-term securities paying high rates." In
other words, then as now, investors warmed to a rising overvalued market. They spurned a falling cheap one. Not that the
editors of Business Week deemed the information germane, but, at the time of publication, the S&P 500 Index (SPX
- 977.55 ) bore a price-to-earnings ratio of about seven, ratios of equity holdings to household net worth were
among the lowest of the post-1945 era, and the ratio of stock-market capitalization to GDP was below 40 percent.
Actually, a bull market was already under way, the S&P having bottomed in 1974. It returned 37 percent in 1975, 23.9
percent in 1976, minus 7.2 percent in 1977 and plus 6.7 percent in 1978. It was on its way to returning 18.4 percent in
1979 and 32.4 percent in 1980. When, in 1981, the bond market hit bottom, the S&P gave up just 4.9 percent. The rest
is history, but a history of immediate relevance at this investment juncture.
"Today," the BW essay wound up, "the old attitude of buying solid stocks as a cornerstone of one's life savings
and retirement has simply disappeared. Says a young U.S. executive: "Have you been to an American stockholders'
meeting lately? They're all old fogies. The stock market is just not where the action's at." A proposition: Where the
"action" isn't, is often where the prospective returns are. The outcome depends on valuation, a subject of identical
apparent irrelevance both at epochal bottoms and towering tops.
By way of contrast, what does sentiment look like now, as the clamor for a "market bottom" grows louder than ever?
09/23/01 Reuters Wire: "U.S. economy set to prove its resiliency... Activist macroeconomic policymakers will force the
V-shaped recovery... Greenspan, widely revered for his economic leadership in good times and bad, was equally upbeat."
09/22/01 Dow Jones Newswire: "AG Edwards Strategist Sees V-Shaped Recovery for Markets."
09/21/01 Dow Wire: "The sentiment among most financial planners is that investors who are diversified and don't
need the money for at least another five years should sit tight... As long as it's long-term money, I would absolutely be a
buyer' (said a financial planner)."
09/22/01 Dow Wire: "Scudder Investments Sees Fast Economic Recovery."
09/22/01 Dow Wire: "Will Margin Calls Beget More Calls- Or Market Bottom? ...In general there was a lot of
capitulation yesterday. That's generally a good sign. Generally when people panic in a capitulation, it's usually the
bottom."
09/21/01 Wall Street Journal: (A chief investment officer) "said the large volumes had some of the hallmarks of
'capitulation' selling, which can mark the end of a downturn."
09/24/01 Barron's: (Quoting a well-known economist whose last name rhymes with "Bardini") "Now there's a
greater chance of a steeper, V-shaped recovery for the economy and profits. We'll go down harder, but we'll bounce back
faster."
09/22/01 Financial Times: "There is plenty of value to be found by investors with long-term horizons."
09/20/01 Dow Wire: "With the S&P 500 below 1,000 and at a three-year low, how do you respond? If you're First
Union Securities, you up the equity weighting in your model portfolio to 72 percent from 70 percent."
09/19/01 Dow Wire: "High Net-Worth Investors Remain Calm in Wake of Turmoil... (per a money manager) we've
gotten some new business... We've absolutely put that business into equities."
09/20/01 Dow Wire: "The key question about the stock markets right now is (per an analyst) is the United States
going out of business, and I say it's not."
09/20/01 Money Magazine (online): "And however hard it may be, try to imagine what things will be like a couple of
years from now, once 90 percent of the current anxiety has passed. Seems to me we're going to see stock prices a lot
higher by then, particularly for the technology issues that have been so badly battered over the past year."
09/17/01 Time Magazine (online): "So maybe it's time to relearn an old lesson: Buy the dip. It hasn't worked lately.
But now that it's no longer popular, it just might be smart."
Does this look anything like the gloom and doom of 1979, as exemplified by Jim Grant's discussion of the "Death of
Equities" article? Or is the "slope of hope" on which bear markets descend more alive than ever?
But it just got worse for those desperately seeking a bottom. Much worse.
Forget about the "death of equities." Forget about bears on magazine covers. Barron's has just chosen in its September
22, 2001 issue to depict a bull on its cover. A fierce, snorting bull with an American flag in its grip.
The cover blurb reads as follows:
Forget the fact that the above sounds like a script for a cold calling broker or financial planner. My biggest concern by far is
that the events of the past 12 days have served to increase rather than decrease the complacency on Wall Street. And
there is no better illustration of this than the appearance, now of all times, of a wildly bullish magazine cover.
But isn't the market extremely oversold and due for a bounce? Yes and yes. Per Paul Montgomery's September 24, 2001
Capital Market Update:
"Confirming the bullish potential are some historically oversold indicators. For example, Lowry is now 55; VIX hit 57 Friday;
TIR is in single digits; the McClellan Index has set three all-time records; we are 15 percent and 18 percent, respectively,
below the 50-day and 200-day moving averages; CBOE put/call volume hit a record 1.21; Trendline"s Oscillator is at -17
(we grade this tool 100 percent bullish at -10); the five-day RSI is 2.72, one of the six lowest readings since the 1800s;
and stocks (Value Line and Russell 2000) have closed lower 10 consecutive days."
But there's a huge difference between the strong potential for an oversold rally and a true market bottom. Note below that
there are a number of areas of potential resistance on the S&P 500 Index not too far above Friday's close of 965.80.
1000 (huge round number significance)
1018 (the 50-percent correction of the decline from the September 10 close to the September 21 bottom)
10-day moving average (currently at about 1060 but declining rapidly)
1081 (the March 2001 low)
My expectation is that any bounce in the S&P will fail at one of these levels and at 1081 at the outside.
What's the downside potential for the S&P? 775-800. At 776.56, the SPX would be trading at half its all-time high of
1553.11. The Nasdaq Composite (COMP - 1423.1) was halved earlier this year and is now approaching an additional
50-percent decline that would place it at 25 percent of its all-time high. Given what I see as the current excesses in
complacency, it is not unreasonable to expect the S&P to undergo such a "2-for-1 bear market split" before we can speak
of a real market bottom.
- Bernie Schaeffer |
