Bernie Schaeffer: My 2003 Market Forecast – A Mid-Year Update
schaeffersresearch.com
There is no sadder sight than a young pessimist, except an old optimist.
--Mark Twain (1835 - 1910)
<<...But there is one more factor that dooms these forecasts to consistent failure. As I stated in my January 3, 2003 market forecast: "It is impossible to forecast the future direction of the economy and corporate profits. The best one can do is to develop a number of potential scenarios, assign some probabilities to them, and move on … My purpose is primarily to illustrate the folly of "single point forecasts," but also to illustrate that such forecasts tend to be best case … because most "wild card" events that can seriously affect such forecasts tend to have a negative impact."
And now, on to excerpts from the Journal's most recent survey (all italics are mine).
"Massive fiscal stimulus, in the form of tax cuts, and improving business profits should lead to a long-awaited economic rebound in the second half of the year, according to 54 economists surveyed by The Wall Street Journal.
"A forecast for an improving economy isn't new and needs to be read with caution; the same group of economists has been predicting better times for nearly three years, only to find the path marked by disappointments. Warning signs continue, as the Federal Reserve raises concerns about possible deflation, and the job market remains stagnant. Nevertheless, economists argue that the expected improvement, which is being hinted at by a rising stock market, will be real this time"
Schaeffer comment: The bullish bias is quite evident. Note also how the rising stock market is now cited as a reason to expect economic improvement, whereas a weak stock market was not considered a concern vis-à-vis the economy in their prior forecasts. This logical inconsistency is the direct result of the bias.
"Forty-nine of the economists surveyed said they expected the Dow industrials to finish above 9000 points this year. Many are putting their money where their mouths are; 35 said they had increased their own stock holdings in the past year, up from 14 who said they were increasing holdings when surveyed in January."
Schaeffer comment: A major contrarian "red flag", reinforced by the fact that the vast majority of the economists were skeptical about the market in January ahead of a major rally.
"Several economists say they should be excused for being too optimistic about the outlook in recent years because growth has been derailed by a series of unpredictable shocks -- including the Sept. 11, 2001, terrorist attacks, the war with Iraq and the accounting scandals that rattled the corporate sector."
Schaeffer comment: Each individual shock was unpredictable, but what is almost certain is the fact that there will be shocks. To forecast based on a future environment that is shock-free is not only to be bullishly biased, but is also to veer toward intellectual dishonesty. You make your forecast based on no shocks, and then should shocks occur you disclaim responsibility for your forecast because "no one could have predicted them".
"Yet these unexpected developments don't explain all of the missed calls on growth. Last year at this time, for example, after the magnitude of the accounting scandals had already become clear, the consensus was still predicting a return to growth rates of about 3.5%. Instead, the economy grew at a 1.4% annual rate in the fourth quarter of 2002, and repeated that performance in the first quarter of this year."
Schaeffer comment: The Journal's diplomatic way of saying "bullish bias".
"What is so alluring about the 3.5% growth number that both the Fed and mainstream economists keep coming back to in their forecasts? Since 1930, that is exactly what growth has averaged. Economists call it the long-run growth trend and they believe that through the ups and downs of economic cycles that is what economic growth will revert to. It is also the number that is considered the minimum needed to keep unemployment from continuing to rise. The surprise this time around has been that it is taking so long for economic growth to get back to its long-term trend. But many economists believe it is inevitable."
Schaeffer comment: So there you have it. Why are these economists predicting 3.5-percent growth? Is it based on sophisticated, computer crunched economic wizardry adjusted for all the uncertainties of the post-millennium world? Hardly. In fact, the answer is a child-like "because." You calculate the long-term average growth rate, conclude that a reversion back to this growth rate is "inevitable", and decide that this reversion will take place over the next year. Could this forecast have been the product of an undergraduate attending an Economics 101 course? Perhaps, but his prof would likely have graded it a "D".
By no means is it impossible that the economy will grow as robustly as 3.5 percent over the coming year. Just understand that this consensus forecast is so biased and so methodologically flawed and so grounded in simplistic nonsense that it is merely a factoid with no value as a tool. Yet this is unfortunately reflective of what you as an investor see, read and hear every business day.
Let's now review the major bullet points (underlined below) contained in the "conclusion" section of my January 3, 2003 forecast, along with my current expectations.
"I expect 2003 to be another bear market year" - Through July 3, the Dow Jones Industrial Average (DJIA) has year-to-date gained 8.7 percent and the S&P 500 Index (SPX) is up by 12.0 percent. These were decent gains, but not nearly enough to move either into bull-market territory. It is widely cited that we are in a "bull market" because we've rallied by more than 20 percent off the lows, but this is nonsense as 20-percent-plus rallies in bear markets are a dime a dozen.
What does a bear market look like? See the charts below of the DJIA and the SPX with their 80-month moving averages, which I've long viewed as demarcation lines between long-term bull and bear markets.
For some historical perspective, neither the DJIA nor the SPX came close to breaking below their 80-month moving averages during the "crash" of 1987. But the DJIA is now working on its 13th consecutive monthly close below this trendline, while the S&P 500 is working on month #15.
The SPX is about 10 percent below its 80-month moving average. Zooming in for a closer view of the DJIA below, there is nothing nice about the fact that the rally off the March 2003 bottom stalled at the 80-month moving average, as did the rally off the October 2002 bottom.
Unless and until the DJIA and the SPX close for two consecutive months above their respective 80-month moving averages, the bear market remains in effect according to this analyst's technical view.
Regarding the fundamentals, for reasons amply discussed in my introductory remarks the market is clearly discounting a best-case economic recovery scenario. And at current valuations the market is all the more vulnerable if this scenario does not come to pass.
The final area of market vulnerability relates to investor sentiment, which on many levels is at or near bullish extremes. Right now the positive impact of a huge surge in liquidity is overpowering the fundamentals and is fostering a temporary environment in which bullish sentiment is creating further liquidity rather than sopping up the last investment dollar. And as Yogi Berra is supposed to have said: "It ain't over till it's over." But vigilance is the order of the day for investors.
One final note on sentiment. I don't feel I'm being immodest in my belief that I'm responsible for a major chunk of the marked increase in the focus on sentiment indicators in the financial media in recent years. I recall not too many years ago that if I mentioned the CBOE Market Volatility Index (VIX) on financial TV, I would be greeted by quizzical expressions. Fast-forwarding to today, I must say that in my decades of following media commentary on the market there has been no period that's been as loaded with sentiment-based comments. These comments are almost entirely focused on the bearish implications of the "low" VIX and the "excessive bullish sentiment" reflected in the Investors Intelligence poll. As is the case with all indicators that attract undue media attention, it is highly likely that the market will continue to defy the so-called bearish sentiment indicators until they significantly recede from the media radar screen.
"I expect the bulk of the damage to have occurred by mid-year, with a potential DJIA low in the 5800-6000 area" - About a week after my forecast was posted, the DJIA began a steady decline that took it down to a March low of 7416. Was I too pessimistic? Yes for the short-term, perhaps not for the long-term.
"I see Nasdaq and the techs as being the least vulnerable to a first-half slide and the Nasdaq potentially posting a gain of up to 50 percent for 2003. I am most bullish on the small- and mid-cap techs - the "single-digit midgets." - The Nasdaq has steadily outperformed the DJIA in 2003 per the chart below, to the tune of 14.6 percent through July 3.
From a technical/sentiment standpoint, there are three major reasons to believe this Nasdaq outperformance will continue or perhaps accelerate in the second half.
From a long-term perspective (first chart below), the rally by Nasdaq vs. the DJIA has thus far been minor. If the Nasdaq were to correct 50 percent of the decline from its peak relative strength in early-2000 to its trough in 2002, that would represent an additional 67 percent in positive relative performance.
The Nasdaq can rally by an additional 32 percent before bumping up against its 80-month moving average (second chart below).
Despite the Nasdaq's powerful performance since October 2002, sentiment is very skeptical. Put open interest on the Nasdaq-100 Trust exchange trade fund (QQQ) has been consistently running at twice that the level of call open interest. And this skepticism even extends to technology fund managers, per the excerpt below from Barron's Online.
If you've been a constant reader of my commentaries, you well know that I consider bearish sentiment in the context of strong price action to be the most powerful indication that the strength will persist. Nasdaq 2000 is by no means out of the realm of possibility before this move is complete.
Finally, it's been the small and mid-cap techs that have led the way and that should continue to lead the way. As is clear from the chart below, the biggest cap tech name of all - Microsoft - has gone exactly nowhere this year.
"I see the biggest cap names in the Dow and the S&P as being most vulnerable to major declines. Many of these stocks have attracted "safe haven" money due to their large capitalizations and liquidity and the illusion of safety. But I see these names as being "first out" of institutional portfolios on the next market leg down." - So far, these names have simply languished, per the charts below. But I continue to see them as most vulnerable (I still don't rule out DJIA 6000 before this bear market is over), which makes the big cap names all the more dangerous because of all the money that has flocked to them seeking "safety."
"Overall, 2003 is likely to be a very tough year for heretofore "safe" or "quality" assets - mega-cap stocks, the dollar, and bonds. I suggest "thinking speculatively" - not with all your capital but with a portion of your funds - by investing in low-priced tech stocks and gold stocks" - A funny thing happened to the bond market on its way to "Greenspan Heaven" - it's taken a detour through a minefield. The yield on the ten-year note (TYX below) has popped from a recent low of 3.20 percent on "Greenspan Wednesday" to its current reading of 3.65 percent. As I stated recently in Schaeffer on Charts, I believe that interest rates have likely bottomed and thus the bond market's levitation is at or near an end.
As for the dollar, see the chart below of the U.S. Dollar Index (DX/Y) with its 80- and 160-month moving averages for a very effective presentation of the ongoing bearish story.
"I continue to believe that all investors should have at least 10 percent of their portfolios in precious metals stocks." - The metals stocks are pretty much flat so far this year, and I view this as an excellent buying opportunity unless you're 100 percent confident that there will be no deflationary implosion or no dollar collapse or no stock market crash or no surge in inflation or no major geopolitical disasters. Wall Street exudes such confidence, but if they get it wrong their watchwords will again be "Don't blame us - no one could have foreseen this disaster!"
To summarize, I believe the risk in this market is concentrated in the blue chips and the opportunity remains in the small and mid-cap techs. I also believe that for liquidity-based reasons related to the desperation of Greenspan's Fed, the market's most likely course over the next several months is to the upside. To reiterate my conclusion from this market commentary: "Once again I advise you to keep a healthy cash reserve, avoid the so-called "safe" blue chips, emphasize technology and the high debt sectors such as airlines and autos, and devote a portion of your assets to gold stocks."
Finally, as I suggested in the June 2003 Option Advisor: "If you are a sophisticated investor who thoroughly understands the risks, consider buying some put options on the largest-cap blue-chip names. Make sure you buy enough time (at least out to January 2004). And you may want to consider selling lower-delta puts from closer expiration months against your long puts as a way to pay for the time decay." At this point I'd be looking out further than January 2004 to the January 2005 expiration.
This is a market that is capable of grinding higher for much longer than the bears expect. But it is also a market that is capable of plunging much further and faster than the bulls can conceive. The investment mix I suggest above is designed to lead you safely across this very treacherous territory by taking advantage of the potential opportunities and avoiding (or profiting from) the potential risks...>> |
