Still Bullish After All These Months
By Aaron L. Task
Senior Writer
09/26/2001 05:39 PM EDT
SAN FRANCISCO -- The V-shaped-recovery scenario got out of whack today as profit warnings from AES (AES:NYSE - news - commentary - research) and Micron (MU:NYSE - news - commentary - research), plus analyst estimate cuts on IBM (IBM:NYSE - news - commentary - research) and Intel (INTC:Nasdaq - news - commentary - research) weighed on stock proxies.
The Dow Jones Industrial Average fell 1.1% while the S&P 500 lost 0.6% and the Nasdaq Composite shed 2.5%. The Nasdaq 100 outperformed the Comp, dipping 1.3%, but the Philadelphia Stock Exchange Semiconductor Index fell nearly 8% as Micron lost nearly 23% of its value.
As reported earlier, few market watchers believe Monday was the beginning of an unfettered rally. Among the most optimistic, however, is Don Hays of Hays Advisory Group in Nashville, Tenn.
In a conference call yesterday, Hays, who has been bullish since March, described why he believes the recovery "may be V-shaped." But even if it's not, he'd "rather sweat out the next pullback because" indicators that have "never been wrong" are uniformly bullish.
In Hays' model, the market "stool" stands on three "legs" -- psychology, monetary and valuation -- and he claims they are uniformly positive now, a "very rare" occurrence.
Regarding psychology, Hays cited the following:
The 15-day moving average of the Chicago Board Options Exchange equity put/call ratio reached 87.7% last week, the highest level in history;
A measure comparing the three-week moving average of the equity put/call ratio to its 39-week average recently rose to over 20%, a "very rare, very accurate long-term buy signal" that occurred at other key junctures, such as the fall of 1998, the fall of 1992, and October 1987.
The 10-day moving average of the Arms Index rose to over 1.50 for the third time this year, the first time that's ever occurred.
The so-called Smart Money Index, which subtracts the first 30 minutes of trading in the Dow because it is believed to be emotionally driven and focuses on the last hour of trading, hit a new high last week, "further confirmation that the correction should be considered a major buying opportunity."
Regarding monetary indicators, he cited the steepening yield curve, and expanding money-supply growth due to actions taken by the Federal Reserve, from which he expects more rate cuts. (The Fed's next scheduled meeting is Oct. 2 and fed fund futures are pricing in about 70% odds of another 50 basis-point ease.)
Regarding valuation, the IBES valuation model became more than 17% undervalued as of Friday, Hays said, meaning "stocks are much more attractive than bonds at this juncture." (The model divides the earnings yield of the S&P 500 -- based on 12-month forward earning estimates divided by its current price -- by the current yield of the 10-year Treasury note.)
Today, bonds rallied as stocks slumped. The price of the benchmark 10-year Treasury rose 16/32 to 102 27/32, its yield falling to 4.64%.
The veteran strategist mentioned several other factors -- including the "historic oversold condition" of the New York Stock Exchange McLellan oscillator, and a belief in the long-term prospects for the U.S. economy -- in recommending long-term growth investors go to 100% stocks and 0% cash. For moderate growth accounts, he recommended 85% stocks and 15% bonds, and for conservative investors, 65% stocks and 35% bonds.
"At this point it's hard to find something from my point of view that is not telling you this is one of those classic buying opportunities," Hays said. "With the extreme nature [of the selling] , I doubt there's going to be a retest, but I'm not going to wait even though the possibility is there. Once the market gets any catalyst, it will go up fairly easily [and] there's almost no resistance for a long way up." (No, he didn't provide upside targets but forecast a "stable platform" for the market for the next six months.)
The problem with all this is Hays has been pushing the bullish view for some time, as this column's readers know all too well. A few conference call attendees asked about Hays' steadfast optimism (albeit in far milder terms than many emails I've received).
Emerging From Rough Seas
"We did not have the summer rally I expected -- a lot happened in the last three months that I did not expect," Hays said on the call.
The strategist, now running more than $100 million in assets, reiterated a belief that the lows prior to Sept. 11 would have held if not for the heinous terrorist attacks. He defended his pre-Sept. 11 bullishness by noting the market was mainly "biding time" from March 16 -- he turned bullish the next trading day -- through Sept. 10. (During that time the Dow was down 2.2%, the S&P off by 5% and the Comp lower by 10.3%.)
"It wasn't fun, but until Sept. 10 we hadn't lost money," he said, explaining his funds' year-to-date losses occurred mainly during the market's swoon in March.
Through Sept. 21, Hays' long-term growth accounts were down 21.9% for the year vs. gains of 19.2% last year and 16.9% in 1999. His moderate-growth account was down 17.6% after rising 22.8% in 2000 and 8.8% in 1999. (All the returns are audited and after fees.)
Granted, no one could have predicted the events of Sept. 11. But Hays' biggest mistake was not adjusting his outlook after it became fairly obvious the attacks would have serious negative consequences for stocks, at least for the short term.
Asked about that in a follow-up today, Hays said it was too late to get negative after the big decline the first day trading resumed, and predicted those losses will be recouped in the next three months. (Perhaps, but during the halt was the appropriate time for caution.)
Regardless of what you think of Hays, he cannot be accused of abandoning his discipline for a gut call, as James Cramer suggested is the case with Abby Cohen.
"I'm going to spend the rest of my life going with indicators that have never been wrong before," Hays said, recalling he faced similar circumstances in 1981, when a bullish call in November that year didn't come to fruition until August 1982. "I remain true to my discipline, and am willing to go down with the ship."
So the hull may have a few cracks but the good ship Hays sails on. I just wonder if it can handle another rogue wave, given the damage it has recently sustained.
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Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.
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