Investment House Weekend Update:
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- Breaking lower but will most likely bounce one more time before rolling over for the do or die time.
- Unfortunately, with the Dow’s breakdown, the Nasdaq and S&P 500 will most likely undercut the September lows by a significant margin while the Dow finally gets sold off.
- Disconnect between the financial markets and the economy: continued.
- Market approaching the critical level: it will hold or it will fall a lot further.
- Review of game plan.
The week closes out with no rally attempt.
There is an old adage that how a stock closes a session and how closes a week tell a lot about that stock and that market. After the reversal last Friday and the Monday bounce, the sellers took over and drove the indexes to new closing lows for the year on rising volume (huge on Friday). It was a particularly nasty end to a week that saw an earnest resumption of the downtrend. If Friday’s action is an indication of things to come, then there are going to be some September 2001 lows undercut.
While the Nasdaq 100 and the large cap indexes closed at the lows on very strong volume, the broader market did not get the torch. The NYSE and Nasdaq A/D lines did not match the carnage on the large cap indexes. The Russell 2000 closed positive. The S&P 600 small cap index looks even more determined to hold its 200 day MVA. As usual, the carnage is in the big cap stocks that were bloated up by the major run from the early 1990’s to the peak in early 2000. The air is still being sucked out of those stocks.
After the breach of the recent lows a test higher before more selling.
The breakdown below the June lows to close at 2002 lows had everyone in a very glum mood today. Most think the selling has to continue this coming week. With each new low this year, however, the indexes have tried to recover if only for a day or so. There were three wicked selling sessions to close the week as the indexes broke to lows for 2002. Strong selling and a break to a new low usually leads to a rebound attempt. Thus we anticipate a push lower Monday and then a rebound of some sort.
Thursday we explored if it would be a wimpy bounce or something more substantial. What we really have to be focused on at this point is the Dow as it has not sold off nearly as much as the Nasdaq or the S&P 500. It only took one session to get to the recent lows again. We could easily see the Dow sell off to the next support level from 9000 to 9100 early this week and then get oversold enough to try to bounce higher. That would put the S&P 500 and the Nasdaq at the September 2001 lows.
Maybe that would be enough to set the bottom. If the sentiment indicators spike higher it could be. We will definitely be watching for that, but we have that old ‘watched pot never boils’ feeling we had in early 2001 and early summer 2001. Everyone but everyone is talking about the bottom being near. Too many feel the bottom is close at hand as the indexes approach the September lows. Makes sense, but now everyone is looking at those levels. Everyone anticipates them to be the bottom after a test. They could be. Problem is, if we don’t get the sentiment indicators in line with the selling it most likely won’t be sufficient to hold. There could be a bounce of some magnitude, but in this market, if all of the indicators do not line up the chance of such a move being the bottom are small.
The Dow remains the problem for now.
The Dow has not suffered much of a bear market, but it sure looks as if it is going to join the party with the action late this week. As noted last week, it still has a lot of potential selling to get in line with the other indexes. With stocks such as MRK and IBM coming under accounting scrutiny, which ‘safe’ Dow stocks will be next and send the index sharply lower?
If the Dow breaks down to test its September lows, the Nasdaq and S&P 500, already sitting at those levels, would most likely get dragged below those levels. Now that move may in fact raise those sentiment levels to a point where a bottom could be set, but if the S&P 500 and Nasdaq get hammered too low below the September 2001 lows it is no longer a test but another breakdown.
Sentiment indicators did not rise today enough. The VIX actually fell. To us it appears that it will take the Dow to sell down close to the September lows to get the sentiment indicators spiking. The Dow is only 250 points from 9000; we don’t think that will produce the effect. Moreover, everyone will be focused on the Nasdaq and S&P 500 as they approach those levels, expecting that point to be the bottom. We have said it before and don’t want to be trite, but bottoms are like love and watched pots: they never perform on cue.
THE ECONOMY: The ongoing disconnect between the markets and the economy.
Last week we again saw some sharply improving economic numbers. The housing market remains hot, manufacturing continues to show solid expansion with the Philly Fed report jumping, and the leading economic indicators showing a solid jump back into positive territory. Even if you put some healthy skepticism in the government reports (and you should), the reports outside the government still show improvement. The markets, not just the stock market, went the other way once again.
Markets down while economy is supposedly rising.
We believe in markets as very good indicators of what is going to happen. They take into account all of the evidence and place their bets based on the sum of all of that evidence. What are the markets doing? Well, the stock market is plunging to undercut where it was after the attacks. Remember, at that time the economy was widely believed to be still in the tank. We saw signs of recovery already there, but that was it; signs. Now the stock market is going to undercut those lows even when the economy looks to be in much better shape than it was at that point. Better economy, worse stock prices. That is a disconnect. Maybe everyone thought the recovery that was going to come at some point in the future was better than the one they ultimately got, blah, blah, blah. That is cutting it too fine; there is a disconnect here.
Then there is the bond market where yields are falling back to levels where the economy looked its worst. When the economy is weak, bond yields usually fall because they are not pricing in any inflation. Once again yields are getting very low, so much so there is talk of yet another refinancing boom. Lower yields do not imply a strong economy where money is in demand for expansion and thus commands higher yields.
And of course there is the dollar heading lower and lower, hitting a 2-year low against the euro last week. Even the pound moved over $1.50 for the first time in a long time. Some call it a correction in an otherwise bull run in the dollar. Some say it is only one quarter of the way down to where it is going. All say if it falls too fast it is a problem. Without a doubt currency issues are very psychologically driven. If there is perceived weakness, it tends to snowball. That is the fear now. It feeds on itself. It is a very slippery precipice when currency issues are involved.
Why are the markets not buying the recovery?
We have discussed in previous issues the earnings/price connection and how the market at the current prices (S&P 500 average P/E at roughly 40, meaning you pay $40 for every $1 of future earnings; the Nasdaq 100 is 50) does not forecast a recovery strong enough to support those prices, much more drive them higher.
There is more in the soup that has been made over the past several years than just P/E’s, though a lot of it is all interrelated. For one thing the administration has embarked upon a protectionist course that flies in the face of the free market ideals the U.S. has been espousing to the EU and the rest of the world. Steel tariffs. Lumber tariffs. Farm subsidies. It is very hard to champion free markets and the U.S. as the pinnacle of global free enterprise when you resurrect the very policies you rail against. We tried this in the late 1960’s and 1970’s; the results are horrid. Short term gain of a few jobs and a few votes is a very poor tradeoff for a stagnant economy and wasteful government. It also has a very detrimental affect on the dollar.
And of course government is growing in the wake of 9-11; it seizes each upheaval or crisis situation as an opportunity to grow: Great Depression, Cold War, 1960’s civil unrest. History shows that more government leads to more squandered resources that could have fed economic expansion and thus benefited us all with jobs, lower crime, higher standard of living, i.e., all of those things the economic expansion in the 1980’s and 1990’s gave us that the government could not in the 1960’s and 1970’s. The markets react to this as foreign investors sell and all investors tend to view these policies as limiting economic growth and innovation in the U.S.
Then the corporate governance issues that have been opened up with Enron and friends. As we have said, this happens with every boom, but we always act so shocked and stunned. It has happened before and it will happen again. It is a testament to greed and also how no amount of regulation can stop the problems that arise. Again you have to ask ‘where was the SEC DURING all of this?’ Not doing a damn thing. Now that disaster has struck and it has to justify its bureaucratic behind or risk getting an INS-like retooling it is filing some suits with the justice department and launching some investigations, a lot like a watchdog sniffing around what is left of the flock after the wolves have ravaged it.
On top of that there is the Middle East ‘war,’ the war on terror, the FOMC bias change (that coincided with the market peak this year in March; the tariffs were imposed then as well), and the IRS announcing it is going ahead with random audits again after Congress had stopped the SS back in the 1990’s. We are heading back into the dark ages of our worst economic episodes, making the same foolish mistakes once again. Short term gains in votes, longer term carnage in the economy and markets.
THE MARKET
The Nasdaq was down 4.2% last week as it and the S&P 500 head toward the September 2001 lows at a fast clip. The large caps are in a freefall punctuated by failed weekly attempts at bouncing. The will most likely follow Monday with some more selling and then again try to bounce. That has been their pattern. They are now reaching critical levels (S&P 500 and Nasdaq) where everyone is looking for a bottom. If they do not hold (and it can undercut them and still ‘hold’), these big cap indexes could fall a lot farther. The market is not responding to the economic news, indicating at least for now that there is a more fundamental need to drain the pool after the run up from 1995. To put it in perspective, the Nasdaq 100 is already at the 1998 lows in that bear market. The fact that the market is ready to break below those levels is indicative of a much more fundamental problem that has to be worked out of the system for the large caps.
On the other hand, the small cap indexes managed to bounce late and finish positive or just slightly lower. The small cap performance continues in spite of the large cap selling. As we have noted in past issues, small caps tend to outperform the large caps after economic slumps. We play the large caps to the downside and the small caps to the upside.
SENTIMENT INDICATORS
VIX: 31.28; -1.22. Amazingly, S&P 100 volatility fell on a day when the S&P 100 and the Dow tanked. It just is not getting to the level it needs to be for a strong bottom even with the selling Friday. That is one of the reasons we see the indexes falling further even if there is a short term bounce.
VXN: 59.30; +1.37. Getting better but hardly a spike on the selling Friday.
Put/Call Ratio (CBOE): 1.27; +0.23. Another close well over 1.0 indicating excessive speculation in option buyers and anxiety in portfolio managers buying puts to hedge further downside. When all option exchanges are added together, the put/call ratio Thursday was 1.0 and Friday was 1.18. This is even a stronger negative sentiment indicator. If the other indicators would line up behind it we could see some decent upside action.
The sentiment indicators have to ling up for an attempt at a bottom. If the selling continues and the sentiment indicators do not hit extremes, we expect more selling will be necessary for a final bottom. That could be much further down if the September lows do not hold.
Nasdaq
Stats: -23.79 points (-1.62%) to close at 1440.96
Volume: 1.963B (+14.93%). The strongest selling volume in since early May, spiking above average. No doubt something to do with option expiration shuffling, but strong selling volume nonetheless.
Up Volume: 365M (+148M)
Down Volume: 1.563B (+85M)
A/D and Hi/Lo: Decliners led 1.05 to 1. It was a large tech selloff as the broader Nasdaq was not hammered.
Previous Session: Decliners led 1.32 to 1
New Highs: 61 (+3)
New Lows: 199 (+15). Rising, but not anywhere near the 400+ level we see at bottoms. It is either getting sold out or still has a quite a bit of work. More likely the latter.
The Chart: (Click to view the chart)
Rapidly approaching the September low (1387.06), checking up before the point where it tested the September bottom (1418.15) right after making that low. It is going to test those levels this week. After that it bounces toward 1500, a prior support level and the 10 day MVA (1506.87).
There is a long term up trendline from the early 1990’s near 1400 that could act as support. After markets balloon higher and then let out the air they tend to return to the point where they started if it is a full blown collapse. That could be this up trendline though that is more wishful thinking. The Nasdaq is in that big head and shoulders pattern, and to get back to where it started from would be near 1000. That is a generous read. Much depends upon how deep the Dow tests.
Dow/NYSE
Stats: -177.98 points (-1.89%) to close at 9253.79
Volume: 1.806B (+31.38%). Volume almost eclipsed the Nasdaq volume, posting the highest volume since the market reopened in September 2001.
Up Volume: 479M (+125M)
Down Volume: 1.31B (+313M)
A/D and Hi/Lo: Decliners led 1.31 to 1. As with the Nasdaq, not broad selling, just the large caps.
Previous Session: Decliners led 1.22 to 1
New Highs: 91 (+5)
New Lows: 145 (+44)
The Chart: (Click to view the chart)
Broke below the recent intraday low at 9260.99 on huge volume, partially attributable to triple witching. A serious round of selling of almost 500 points the past three sessions should continue a bit lower this week on that downward momentum and then try to rebound. 9100 to 9000 is where the index consolidated in October 2001 after the first move off of the September low. That could be the bouncing point. On the upside, the March down trendline is at 9430, and that is followed by 9500 and the 10 day MVA (9537.77) as the key resistance points.
That is for the short run bounce after some significant selling. The September low is still much further at 8062.34. Even with a fall to 9000 that is another 1000 points. That gets it closer to the 7500 level marking the 1998 bear market. If it were to erase the gains since the ‘excess’ started, however, it has a lot further. There is a long term up trendline at roughly 5900. The start of the run in 1995 is at 4000. But that is not even the real start of the big run in the Dow. You have to go all the way back to 1982 when the Dow broke above 1000 to get back to the real beginning of the run up to March 2000. That is how far the Dow would have to fall if it too retraces the gains that started at the point where it is said the ‘bubble’ began. If that happens we will all be doing something a lot different than we are now.
S&P 500:
Sold hard on that strong NYSE volume, but did not come close to breaking the intraday low at 981.63 hit the prior Friday. 944.75 is the September 2001 intraday low. Unlike the Nasdaq, there is no near long term up trendline to potentially rescue the index. If there was we would feel a whole lot better about a bottom being set on a test of that level along with the Nasdaq doing the same. As it is there is the October 1998 low at 923.32 that is the next potential support after a breach of the September low. 923 on down to 900 is the point to hold if it is going to do hold. Where is the S&P’s long term up trendline? Near 700. Where is the point where the start of the big run would be found? Around 500; that is also the point where the 5 year head and shoulders pattern would reach its full consummation.
Before that happens (if it even does) we expect a rebound after the selling. The September 2000/May 2001 down trendline is at 1002 and the March 2002 down trendline at 1013. That is backed by the 10 day MVA at 1018.21. Those are the resistance points on any rebound.
Stats: -17.15 points (-1.7%) to close at 989.14
NYSE Volume: 1.806B (+31.38%)
The Chart: (Click to view the chart)
REVISITING THE GAME PLAN
A few things to take from the discussion of the major indexes. First, there is nothing that says the large cap indexes have to go back to the beginning before starting up again. There are too few times in history bubbles have occurred and the variables too great to draw air tight conclusions. The theory of returning to the beginning did not happen after the market took off post WWII; that marked a fundamental change in the U.S. economy as the new age industrial economy exploded. The Dow did not fall back to that level after the big run up through the 1960’s ended in the early 1970’s.
The point: predictions of a fall to the 1995 or 1982 levels are so remote, would take so long, and involve so many variables that they are for the most part worthless. While the ‘new economy’, as all economies, is not immune from downturns, the dramatic gains in technology in the 1980’s and 1990’s provided another fundamental change in the U.S. economy. The U.S. became a technological and service leader as opposed to an industrial leader. These fundamental changes set new watermarks that do not get stripped back to the bone with each economic turnover or upheaval.
The market is CURRENTLY telling us that large caps are not going up. It has shown selling to this point, and it is giving no indication that the selling has stopped or is about to stop (sentiment indicators are not there even if prices are near the September lows). On the other hand, it is showing us that smaller issues are moving higher and continue to do so with periodic downturns as they ride the waves created by the large cap indexes. This is typical small cap action after an economic downturn is ending where the large caps rode high on that prior economic rise.
Play the large caps down, the small caps up.
That is how we map out our game plan. We look at what the market is giving and we take it. That means we can play the large caps and their indexes to the downside with short positions. We prefer to buy put options to selling stocks short because or risk is defined and limited going into the play. We buy them when they turn down from down trendlines or resistance points such as the 10 or 18 day MVA. We buy them when they test breakdowns and then roll over. Don’t chase them to the downside, but let them set up for us just as they were doing last week. Many are extended to the downside now after last week’s selling; we let them set up and make the play again. Last week we started a few downside plays again that just made us some excellent money two weeks back.
To the upside we still have a lot of choices despite the overall indexes. Split plays are still good even in this market. Why? Because they keep us in the leaders. Whether anticipating an announcement, playing a pre-split, or playing a post-split, we are looking at leaders in this market. As we continue to see, they move into the split and they tend to even rally after the split because they are performing. Stock funds have to put their money to work somewhere. They are putting it into stocks that split because the ones splitting are the leaders that are economically sensitive and are continuing to post good earnings and sales in the improving economy. These provide both short term and longer term plays.
We then look to put small and mid-cap stocks into our longer term holding accounts such as IRA’s, education accounts and the like. When these stocks start to outperform after a long period of underperformance the run can last 4 to 6 years. At most they are 2 years into the move. Yes we can still make long term picks by looking at the right stocks in the right sectors. Leaders can be small caps. Small caps can breakout, double, split, and do anything the larger caps can do. Right now they can do at least one thing better: hold a gain. Not all will do it because even in a full blown bull market not all stocks breakout or hold breakouts.
So we continue to invest in the breakouts and weed those out that do not perform and add to those that are performing. Thus we focus our efforts on the winners. That flies in the face of all of the weak-kneed advice you hear these days on diversification, but diversification is the surest way to insure sub-par returns. The ‘advice’ you hear on the financial channels all depends upon the time you listen. The bears that missed out on massive, massive gains because they felt a fall was coming are saying I told you so. The Jack Bogles are out there saying you have to diversify. What you have to do is sell stocks that break down when they break down. If you get 20 bad stocks you might as well have just one bad stock if you are going to ride it to the ground.
How to ‘diversify’ in the market.
Here is how you diversify in this market and any other market when you are looking at longer term investments. Don’t put all of your money into one stock. Choose a handful that you really like based on the patterns, sales and earnings. We look at those every day and put them on the reports. Buy equal amounts of those stocks (dollar amounts). The ones that don’t perform you cut quickly. The ones that do perform you let run. Then when they give you the next buy point (a test of the breakout, a test of the short term moving averages, a test of the 50 day MVA after a good run, a break over the next resistance level), you add to the position with the money you have from any stocks that you cut because they did not perform. You are averaging UP into a WINNER as opposed to averaging DOWN in a LOSER.
In our interviews of investors that we have conducted over the years (and when we were trying to figure out a way to make money as opposed to what we heard from brokers), almost invariably the best and most successful averaged UP into stood stocks. Winners tend to win. Leaders tend to lead. Losers tend to keep on losing until there is a fundamental shift. Small and mid-caps were laggards behind the S& P 500 in the 1990’s, particularly starting in 1995 and beyond (any bells ringing? That is when the large cap indexes really exploded higher.). They started taking over in 2001 as the large caps peaked and rolled over. Fundamental shift. Small and mid-caps are now leading and will continue to do so until the excess is taken out of the market and the current ‘nifty 50’ are put to pasture.
THIS WEEK
A heavy economic news week. Good news has not had a lasting impact on the market trend, at least no lasting upward trend. We see momentary blips higher and then a resumption of selling. Those blips higher usually occur when the market was already prepared to bounce higher after some selling, and the better economic news was a reason to buy or, more precisely, a reason to cover shorts.
The FOMC meets Tuesday and Wednesday, and that should be one of the bigger non-events of the week, but it will be talked about. Do not be surprised that if the market is able to bounce up early in the week after this selling round dissipates Monday or Tuesday that a ‘no bias change’ by the Fed sets off the next round of selling. The market topped this year on the day the Fed changed its bias from down to neutral. It was a bogus decision and the market knew it. If the Fed still keeps this charade going it just solidifies the market’s lack of confidence in any of the government’s numbers as the market perceives the government is ignoring reality at best or spicing the numbers at worst. That announcement could set off the next round of selling after a brief attempt to come up for air.
So Monday we anticipate some more downside action that will hopefully hit some more of our downside targets. Even with the ‘good’ news from QCOM Friday, it still hit our downside target after saner heads took over with the ‘how can QCOM be increasing its sales when everyone else in the sector is foundering. The Dow will test 9100 to some extent, the Nasdaq and S&P 500 will creep closer to the September lows.
Then we get a bounce up after the tremendous selling. The market is way oversold and could stage a stronger bounce. However, it tried that last week, moving past the 10 day MVA to the 18 day MVA, and it failed. We anticipate thus a test lower and then a bounce toward the nearer term resistance at the 10 day MVA or near down trendlines. Then comes the real test of the lows. Unless we see something significant change, we see the Nasdaq and S&P 500 undercutting them as the Dow knifes lower to ‘catch up’ to their losses. The Dow has been the poorer performer and it could make up some lost ground. It will be key that the large caps and the Nasdaq do not undercut their lows by more than say 5% while the Dow falls. Otherwise it is no longer a test of the September lows but another downleg that sends them much lower. That is the risk right now for the upside in the large caps.
We will also watch the small caps closely. They hit the 200 day MVA and bounced, at least the S&P 600. We would like to see that index make a bounce with the rest of the market and continue to hold that line or start to improve. It will have a chore of it if the overall market continues to tank, but its relative performance has still been excellent.
Support and Resistance
Nasdaq: Closed at 1440.96
- Resistance: Closed just below the first March down trendline (1445). 1500, a level of price closes. That is followed by the 10 day MVA (1506.87) and the 18 day MVA (1539.42). Then the May low is at 1560.20. The second March down trendline at 1585.
- Support: 1420 is where the Nasdaq tapped intraday four sessions after reversing off of the September 2001 low. After that is the September low at 1387.06. 1357.09 is the October 1998 bear market low.
S&P 500: Closed at 989.14
- Resistance: 1000 could mark some minor resistance from prior price points. The September 2000/May 2001 down trendline is at 1002. The March down trendline at 1014. The 10 day MVA (1018.21). The 18 day MVA (1030.49). The second March down trendline at 1048. The May low at 1048.96. 1060 offers minor resistance from previous prices. Then the February lows at 1074.
- Support: The bottom channel of the March down trendline at 985. The recent intraday low is at 981.63. The September low is 944.75. 923.32 is the October 1998 bear market low.
Dow: Closed at 9253.79
- Resistance: The March down trendline at 9427. 9500 is next. The 10 day MVA (9537.77) and the 18 day MVA (9643.59). 9750 is next and then the April and May lows at 9800 to 9811. The 200 day MVA (9834.50). The September 2000/February 2001 down trendline is at roughly 9920 and the 50 day MVA at 9871.40. Then 10,100, followed by 10,250 to 10,300.
- Support: 9100 is some support from the October 2001 consolidation after the move off of the September low. 9000 is the November low off of the first rally from the September low. There is a rest stop at 8500. The September low is 8062.
Economic Calendar
6-25-02
- Consumer confidence, June (10:00): 109.6 expected versus 109.8 prior.
- Existing home sales, May (10:00): 5.63M expected versus 5.79 prior.
- FOMC meeting day 1
6-26-02
- Durable goods orders, May (8:30): +0.5% expected versus +0.8% prior.
- New home sales, May (10:00): 915K expected versus 915K prior.
- FOMC announcement (2:15): Expect no change in rates or bias.
6-27-02
- Initial jobless claims (8:30): 385K expected versus 393K prior.
- GDP (final), Q1 (8:30): 5.6% expected versus 5.6% prior.
- Chain deflator (8:30): 1.0% expected versus 1.0% prior.
- Help wanted index, May (10:00): 47 expected versus 47 prior.
6-28-02
- Personal income, May (8:30): 0.3% expected versus 0.3% prior.
- Personal spending, May (8:30): 0.0% expected versus 0.5% prior.
- Michigan sentiment, revised , June (8:45): 90.8 expected versus 90.8 prior.
- Chicago PMI, June (10:00): 58.5 expected verus 60.8 prior.
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