Bernie Schaeffer's August Option Advisor Commentary: Bottom? Probably Not
8/2/2002 10:02:51 AM
schaeffersresearch.com
The following is a reprint of Bernie Schaeffer's market commentary from the August edition of the Option Advisor, published on July 25. For more information or to subscribe to the Option Advisor, click here. schaeffersresearch.com
"Nobody ever had to restate a chart." Ian McAvity, veteran technical analyst, as quoted by Thom Calandra of CBS.MarketWatch.com, July 3, 2002
"In the 1990s, the stock market was touted as a great leading indicator of the economy. Now that equities are floundering, there's a lot of earnest discussion about why it's not following the perceived strong economic data. I think the only ‘disconnect' between the stock market and the economy is in the media. Could it be that the stock market's recent swoon is telling us what's coming for the economy?" Aaron Task, TheStreet.com, July 25, 2002
"Time to Stock Up. Forget the gloom - equities haven't been this attractive since the mid-1990s" Barron's, July 22, 2002 story headline
A bit of background before I discuss the above quotes. You're probably aware that the basis for my market timing and stock picking calls is what we at Schaeffer's Investment Research call Expectational Analysis®. Simply put, our EA approach encompasses the intersection of technical, fundamental, and, most importantly, sentiment analysis. Bull markets are defined by bullish technicals, improving fundamentals, and skeptical sentiment. Bear markets are defined by bearish technicals, deteriorating fundamentals, and hopeful sentiment. And both the bull market of the 1990s and the current bear market followed this script to near perfection.
If you've read any of my market commentaries this year, you know how bearishly I've been viewing the market's technicals, and there's been no improvement on that front. The purpose of the Ian McAvity quote was to underline just how foggy and downright useless fundamental analysis can become during periods of corporate malfeasance and just how objective is the basic foundation of technical analysis.
Aaron Task is a reporter who distinguishes himself by asking the right questions instead of accepting the conventional wisdom, which in this case is that the "bad" market is somehow "disconnecting" from the "good" fundamentals. Aaron's approach is the classic "Humphrey Neill contrarian" way to view the fundamentals - you examine the potential upsides and downsides to the fundamental environment and try to determine whether investors are giving undue emphasis to one side or the other. And in classic bear market "hopeful" fashion, the market is now considered to be "wrong" or "disconnected" in its assessment of the economy.
And finally, the Barron's quote, which relates to the very important subject of sentiment. Bear markets decline on a "slope of hope," and over the past six to eight weeks there has been a mad rush on the part of Wall Street analysts and strategists and the financial media to call the final market bottom. I also find it significant that stocks, which the Barron's headline describes as being at their most attractive since the mid-1990s, are currently at levels relative to GDP that significantly exceed those reached at the 1929 and 1987 market tops.
So we're back to a contrarian analysis of the fundamentals, and in this case it's clear that the bullish comparison to 1990s valuations is being emphasized at the expense of the bearish comparison to 1929 and 1987. But I know what's on your mind. "Fine," you say, "so this was a classic bear market. But we've paid the price big time and we took a huge plunge over the past couple of weeks. Was this the final bottom?"
Perhaps. But probably not.
In my July 8 SchaeffersResearch.com commentary, I noted that "the 160-month moving average of the S&P 500 Index (SPX - 977.60) is currently at about 775, just shy of the 776.56 mark, which defines half of the index's all-time high. Thus, the 775-780 area seems like a logical target for the next leg down." With Wednesday's low coming in at 775.68 and with the index now having bounced by about eight percent from this low, this looks like it was a decent call. And on the sentiment front it should be noted that on this leg down we matched the peak in negative sentiment from September 2001 as measured by the 21-day moving average of the CBOE equity put/call ratio and by the CBOE Volatility Index (VIX).
So why do I hesitate to call this the bottom? For four major reasons.
1. As I just discussed, current market valuations are in the stratosphere relative to what we normally see at major market bottoms. And this fact is being ignored by the vast majority.
2. The "conventional wisdom" minimizes the possibility of a major additional decline in the dollar. But a sharp and rapid dollar plunge could crater the U.S. stock market even further while at the same time putting pressure on the Fed to hike rates.
3. The conventional wisdom ignores the crushing debt burden on consumers and corporations in the wake of the stock market bubble as well as the possibility of a housing market bubble.
4. The individual investor has not come close to the capitulation stage. Yes, there are some mutual fund outflows, but they are a small fraction of what they could be in a serious panic. And in a June 28-30 USA Today/Gallup poll, 63 percent said their personal financial situation is not likely to (or has no chance to) get worse over the next 12 months. And 62 percent expected the stock market to be much higher, somewhat higher, or about the same a year from now.
This complacency does not preclude a major rally from here, just as a major rally off the September 2001 bottom was not precluded despite the widespread complacency that existed at that time. But the "all clear signal" for jumping back full bore into this market has not sounded, and the possibility of major additional damage before the ultimate bottom is far from remote.
Based on Bernie's market outlook as set forth above, he recommended that his Option Advisor subscribers allocate a higher percentage of their account to specific option plays on Dell Computer and IBM. For more information on how you can take advantage of Bernie's exclusive insight and option recommendations, click here.
- Bernie Schaeffer
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