Fast, Furious Rallies May Be A Mirage
By Pierre Belec
Saturday May 18, 9:31 am Eastern Time
NEW YORK (Reuters) - Get ready for a summer market that will be bubbling over with relief rallies or just plain one-day wonders that will eventually fall flat. The reason: The stock market has become vulnerable to outsized reactions to economic news and corporate events.
It's proof that the desert isn't the only place where you can see a summer mirage.
"The savage beating most stocks suffered recently has made investors desperate for any good news," says James Dines, publisher of The Dines Letter, a financial publication.
Investors reckoned the world had turned this week and the bulls were running again after technology stocks -- the worst performers over the last 18 months -- surged on upbeat results, sparking three-digit gains in the Dow Jones industrial average and lifting the Nasdaq composite by its biggest gain in more than a year. Less than a month ago, the technology-heavy Nasdaq was hugging six-month lows.
Smart money people are skeptical about the sudden enthusiasm over the improved earnings outlook of the battered tech sector. One reason: Technology stocks are headed into what has historically been a weak period from June to July.
Wall Street has a knack for creating inspirational rallies when the mood of investors is at a low ebb. This may be another one of those "dead cat" bounces for the volatile Nasdaq.
Even the Dow, the dean of stock market indexes, hasn't been immune to false rallies. Seven times since early 2000, the Dow has zoomed 300 points, but five of those triple-decker gains did not hold for more than two weeks, Merrill Lynch says.
The Dow this week revisited the 10,000 level for the 17th time since it first broke that magic number in March 1999. But the last 16 attempts have failed to hold.
"What's happening," says Dines, "is that shallow thinkers assume all is well and the bull market must be about to resume, in view of the so-called 'economic recovery'."
Dines says there's no consistency in the market because investors have still not adjusted their expectations after the bubble burst two years ago and sent the Nasdaq into a hair-raising crash of more than 60 percent from its March 2000 high. Yet there's still a desire to own every stock, no matter how absurd the companies' earnings forecasts.
ROUND UP THE USUAL SUSPECTS
The market's unprecedented volatility is a symptom of the confusion among investors, who are latching on to every bit of good news.
The usual suspects behind these one-day stock spikes have been short-term traders, such as short sellers and "quick buck" punters, instead of long-term investors.
Investors are scared. Conservative money has sought the relative safety of the Dow, the home of the nation's time-tested companies.
Gold has also become an investment alternative, something that hasn't been seen in more than a decade.
Dines, based in Belvedere, California, says the crash of the New Economy and the implosion of "must own" stocks like Oracle (NasdaqNM:ORCL - News), WorldCom (NasdaqNM:WCOM - News) and Enron (Other OTC:ENRNQ.PK - News), have created a "shipwrecked" mentality.
"Investors are fleeing to supposedly safe stocks such as Philip Morris and other Dow blue-chips," Dines says.
People are betting that when the economy bounces back, Old Economy companies, such as commodity and consumer-based stocks, will be the first to ride the wave.
This explains why the Dow has outperformed the rest of the market this year. The blue-chip index is ahead 3 percent, while the Standard & Poor's 500 is off 4 percent and the Nasdaq has crumbled 11 percent.
GOLD'S ANXIETY CRISIS
Hard money people have jumped into gold because the precious metal has a very good track record of forecasting the returns on the stock market. In April, for instance, gold mutual funds were the best performers of all types of funds, gaining 6.4 percent while U.S. stock funds lost 3.9 percent.
Gold's surge to a two-year high of more than $310 an ounce may not be awesome. But what's significant is the rally has been fueled by one of the biggest buying binges ever, comparable with the frenzy in 1996, as speculators/investors bet on continued dollar weakness and inflationary pressures from soaring oil prices. There's talk that gold could reach $500 an ounce before the rally flames out.
While gold may be viewed by New Economy investors as a "barbarous relic" with no modern role to play, it remains the main safe-haven asset in times of uncertainty. Gold provides a safety net, an insurance policy against financial risks. It also has an uncanny ability to distinguish between the relative and absolute strength of currencies.
SLIPPING DOLLAR RATTLES INVESTORS
"Confirming that there is a massive flight out of the stock market is the strength of the euro against the dollar," Dines says. "This confirms our suspicion that we're are all now watching the very earliest phases of an historic flight to quality, driven by mass fear."
Dines, a long-time gold bug, says the rise in gold will probably approximate the drop in the stock market. According to Dines' Law, the road of stock market excess always leads to gold -- the building block of the palace of wisdom.
The current slide in the dollar has negative implications for U.S. stocks because the deeper the dollar drops, the more foreigners will have an appetite for gold, which is dollar-denominated. In other words, a cheaper dollar makes gold more affordable.
The lack of offshore demand for U.S. equities may keep the stock market in the dog house for some time. Foreign investors are already pulling out of the Street because of concern about being paid back with cheaper dollars when they exit the American market.
The interest-rate story is also hounding investors. After slashing interest rates to a 40-year low last year and keeping them unchanged so far in 2002, the Federal Reserve is expected to start raising rates later this year.
Investors are playing the hunch that it's only a matter of time before the Fed raises rates and sucks money out of the economy to slow growth in an effort to head off inflation.
It may be too soon for the Fed to start moving on rates because the outlook for a recovery is still unclear. Fed Chairman Alan Greenspan won't act until higher rates can be justified when the economy accelerates and there is no global crisis to delay monetary tightening.
While negative sentiment has been tempered, economists are not popping the champagne corks because the odds are the recovery will be slow and there's still the risk the economy may dip back into recession.
BEWARE OF BEARS
For investors, it comes down to considering how the economy will claw its way back to good health and how corporate earnings will look six months to a year from now. The danger, though, is jumping back into the market with too much exuberance and getting it wrong.
The earnings of the Standard & Poor's 500 companies, which have been down for the last five quarters, will inch up by only 1 percent in the second quarter versus a year ago, according to Thomson Financial/First Call, a tracking firm in Boston. For the third quarter, the crystal ball readers forecast an eye-popping gain of 21 percent and an even more spectacular 34 percent gain in the fourth quarter. Stay tuned for downward revisions. It has been the pattern since last year.
There's a glimmer of hope, though.
"It is the nature of bear market rallies to be very convincing," says Jeff Walker, publisher of the Walker Market Letter. "When the bulls do finally get things turned around, the rally will be very violent and quite impressive."
But for now, Walker says stocks will be solidly in a bear market, waiting for the "all clear" signal to sound.
For the week, the Nasdaq composite index (NasdaqSC:^IXIC - News) climbed 140.54 points, or 8.8 percent, to close at 1,741.39, based on the latest available figures. This marked the Nasdaq's biggest weekly gain in more than a year. The Dow Jones industrial average (CBOT:^DJI - News) jumped 413.16 points, or 4.2 percent, to finish Friday at 10,353.08. The Standard & Poor's 500 index (CBOE:^SPX - News) added 51.60 points, or 4.9 percent, to end the week at 1,106.59. For the Dow and the S&P 500, these were the best weekly gains since September.
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(The Stocks View column runs weekly. The opinions expressed in this column are strictly those of Mr. Pierre Belec, who is a free-lance writer.) |
