Market Indicators - Investor Sentiment

» Normxxx - So how's business?

So how's business?

Commentary, by Kevin Murtaugh | October 12, 2004

Kevin Murtaugh is publisher of the website View from Silicon Valley which provides insights from people who live and work in the world's technology heartland.

There are bunches and bunches of quantitative measures used, and abused, to gauge the health of the Silicon Valley economy. Tech stock prices, local real estate sales prices and volume, mortgage rates, local employment opportunities, latest retail prices for electronic gadgets, etc. are all readily available. There is even a monthly table showing a broad array of Santa Clara County's local statistics(*).

Similar to practices in Washington and on Wall Street, Silicon Valley bulls and bears selectively employ, or ignore, numbers to make the case for their chosen view of the local economy. Our long-standing insistence on filtering out paid "optimists" helps, but there is still room for the old adage, "Figures don't lie, but liars can figure."

A couple weeks ago, local pundits raised their cheerleading profile by reprising the "traffic is up," therefore the economy must be "better" mantra. Unfortunately, there are no real-time (or even near-time) quantitative measures of local traffic. Nobody can really prove, or dis-prove, traffic is "up." A shift in road construction, or in time-of-day of the traffic tie-ups, or even the angle of the sun hitting US101 during commute hours can be used to explain away, but not entirely dismiss, recent front-page "news" that traffic is "worse."

As supporting documentation, the cheerleaders claim our local population is back up to 2000 levels. Their logic was a low employment rate (5.5% as of August, 2004) on top of this population rebound "proves" the Silicon Valley economy is roaring back. Unfortunately, I missed hearing where he got the population figures. I also missed where he explained why apartment, commercial real estate and rental home vacancy rates are all running much higher than in 2000 while rental/lease prices are significantly lower. I suppose the "traffic" and "population" anecdotes could both be true is if all these new workers are living in, and working from, their cars...

As counter-point, CBS Marketwatch reports, "Long-term unemployment has been particularly insidious during this business cycle. In August, 20.7 percent of the 8 million workers classified as unemployed had been out of work longer than six months. The average duration of unemployment remained high at 19 weeks."

Even with 40% of the unemployed running out of benefits while still looking for work, or giving up, the NASDAQ is up nearly 50% from its October, 2002 lows. I submit, at Silicon Valley's high cost of living, unemployed people are rapidly forced to move elsewhere, hence our low headline unemployment rate.

You and I both could site dozens of examples of the same or similar data being cast in different lights, depending on your current situation and motivation. Rather than continue to pine for hard numbers, today I am going to stoop to the cheerleaders' level.

Actually, I've developed my own system. I go around asking people, "So how's business?" Overlooking my grammatical imperfection, the results are often interesting:

The house across the street from us in Palo Alto sold in about a week. My "So how's business?" question posed to the real estate agent learned they saw a drop-off in August & September but buyer's were now back in the market. OK, even though she is clearly an "optimist," it appears real estate still sells briskly in the Palo Alto area. There seems to still be some willing buyers.

With real estate sales strong, you would think moving companies are slammed. Back in late June, one major moving company told us they were "sold out" for July. More recently, they were only too happy to compete for our business. Each week that went by, we would get a lower quote. As our range of move dates narrowed, they only needed a few days' notice. Our final price when the move was completed came in another $200 below the estimate.

Speaking to the guys physically doing the move, and getting paid by the hour, the supervisor explained they had been working 72 hours a week and were still unable to keep up just a few months ago. Lately it has been a struggle just to get in 40 hours a week.

We then went shopping for a new desk at a local office supply store. In response to "So how's business?", the warehouse guy said, "really slow." He explained their back-to-school period was over but it had been slow. Even slower than 2003. (Wasn't 2003's back-to-school rush already considered "slow"?) He told me their current activity level makes work "boring."

The CableTV technician said his activity level has really slowed down. This is particularly insightful after we needed intervention by a VP of Customer Service and three visits, the last one a team of two technicians on-site for nearly two hours, to detect and repair where a previous tenant cut the cable and hidden the splitter in the crawl space. The last technicians commented that with all the re-built homes in Silicon Valley, such complex activations are not unusual. But even with such make-work projects, the cable company's technicians feel business is slow.

We also had "fun" with the local phone monopoly. (OK, it wasn't fun and they don't technically have a monopoly, but we've gone qualitative.) After 36 hours of no service, I finally got a supervisor out to the property about 5:00pm Saturday. In the course of telling me how screwed up the wiring in our house is/was, I asked him "So how's business?" He says 2004 is slower than 2003 at this time of year. He volunteered that 2003 was slower than 2002. He also commented they expected another round of layoffs to be announced soon since nobody was willing to take a buy-out being offered by the company. (Both he and the technician accompanying him have been with the company over 25 years. They were confident such seniority immunizes them from these layoffs.)

More or less finished with our move, I started catching up on the stuff that falls off the radar when you take up a second full-time job. First up was car maintenance, especially tires and alignment which are constantly pounded on these glorious California roads. I called to schedule a rotate, balance and alignment, expecting to have to pick a future date when they could get my car onto their equipment. Instead, the manager said things were so slow (at 12Noon on a Thursday) that, "I have the guys cleaning up" . I ran the car in and got this ("free") work done over lunch.

I was also due for an oil change and a local mechanic shop offered to do the job for less than half the dealer's price plus he could detail it in-house. (I will write more about why this is relevant in a future chapter.) He said business was "steady" but since it was already 3:30pm, he could accommodate me any day, any time but tomorrow.

So there you have it: Real estate is still strong. Auto maintenance is steady. Moving companies, office supplies, the cable company, the phone company and local tire store are all slow. How long this divergence can last is anybody's guess. How it will end is a little easier to imagine…

I don't claim this survey is scientific or comprehensive. The beauty of it is that everyone can do their own. Such a survey will, by definition, precisely match ones needs in the current economy. Next week and next month you can take a different survey based on what you need or are interested in at that time.

Next time you're out ask, "So how's business?"

-- posted by Normxxx

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» Normxxx - Recipe for a rough '05

Contrarian Chronicles: Recipe for a rough ride in '05

What we face in 2005 spells trouble. Our blind commitment to economic stimulus and faith in a bull market could wreck our long-term stability.

By Bill Fleckenstein | 12 December 2004

If Rip Van Winkle had nodded off at the top of the bubble in early 2000 and then awoken today, only his outsized beard would be a tip-off that more than a night had passed. He'd be witness to a display of bullishness and bravado that's every bit as arrogant, though definitely not as ubiquitous.

Those who are bullish appear fanatically so, in the face of having been wrong in their economic expectations (if one looks at job creation or retail sales) since the Bush administration’s economic stimulus stopped last spring. Therefore, they are obviously confident that the economy is about to get dramatically better.

I often wonder why folks worry about there being too many dollar bears but never worry about too many stock bulls. I guess it's a function of the mindset bred over the last 10 to 15 years -- that stocks just have to go up and nothing bad can really happen.

The bulls have been in a maniacal mood to indiscriminately buy, in one of the wildest demonstrations of "they're going up no matter what" that I have ever seen. Indeed, huge volume that features single-digit dogs and cats (of which there are too many to note) usually occurs at the end of a speculative fling.

Meanwhile, last Wednesday saw diminished ardor for Sirius Satellite Radio (SIRI, news, msgs), my poster boy for speculation, as it got smacked for over 23% on volume of about 600 million shares. Folks should look at the SIRI chart and think about the hype surrounding it to better understand the psychological significance of island reversals. About the only thing I tend to pay attention to on charts are exhaustion formations because they happen to fit with my desire to try to capture inflection points.

2005: Heading for a train wreck

What we face in 2005, in my opinion, will be a whole lot worse than what happened to the country in 1973-1974. (I wasn't in the business in 1972, and perhaps folks then were every bit as rabid as they are now. But I would find that hard to believe.) As speculation continues to build, it means that we continue to head toward a train wreck. For a picture of that potential outcome in S&P land, think of oil's swoon to the tune of some 30% in a month -- or the recent break in one of my favorites, silver, down 15% in two days.

By my reckoning, the only things that really matter are when speculation exhausts itself and when the economic problems shrugged off by the bulls take center stage once again. That's when life will start to get interesting, and groping for that inflection point is what continues to get me to the office early every day.

Debunking talk of deflation

I find it absolutely staggering that every time commodities get beaten with the ugly stick, pundits jump up and say it signals deflation -- never mind that folks have been saying this for 10 or 20 years, and every time, it has not signaled deflation.

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

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» BoltonCT - Parked last week due to interest.... rates

Bill Fleckenstein may represent the market psychology of early 2005. Barons fairly uniformly forecasts nothing good will come from 2005. Value line has not improved since their 70% equities commitment back in October.

I got out of my last US stocks and funds last week. Bob Brinker is still bullish but he will be able to say he predicted this return to a secular bear market way back before 2002. He actually did predict a rally that would last about a year or so... on more than one occasion. Unfortunately, now he has forgotten to say when to get out of the market possibly as he forgot in yr 2000.

I did not actually get a sell signal from my market cash flow indices yet but the pattern is developing and I usually am in or out two months before the direction is obvious. The vulnerability of the NASDAQ and higher beta stocks surprised me last week. The NYSE showed no weakness but its cash flow appears to have definitely peaked. The low volume makes the effect of buying and selling pressure much greater these days. The price changes can be much more rapid and volatile. That was what I saw in higher beta stocks last week.

I am now concerned about my foreign holdings and anything that is interest rate sensitive. A small change is such a large percentage change with rates this low. High debt is unrelenting as interest rates rise.

Also, the strengthening of the dollar will hit my foreign investments two ways. First because the dollar is now weak the foreign income that will be reported for this period will be down because Americans are buying less. Secondly, when the worsening income reports roll in... it will be about the same time that the dollar has begun to strengthen so the dollar value of foreign investments will be less. This may be a time to get out of everything.

I have switched to margin accounts so that I can now go short when an opportunity arises.

These market concerns are all due to the belief the administration will do what the pundits have been saying it should have done for over a year. These concerns presume the administration will now address the fiscal and trade deficits. We would be having inflation too if we counted commodities, food, energy, housing and everything else but automobiles and computers. It is amazing how removing all the essential items of life makes inflation look minor. Fixing all these problems will hobble interest sensitive equities and any high debt-ridden corporations and individuals.

-- posted by BoltonCT

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» Normxxx - CAUTION!

MARKET INTELLIGENCE REPORT: Sentiment Gauges Suggest Caution

by Dr Joe Duarte | December 13, 2004

[Normxxx Here:  Kirk: Bulls!?! You have trouble finding Bulls? You haven't been looking very hard! ]

Market sentiment continues to suggest that this is a very vulnerable market to disappointments and external events.

Newsletter writers, as measured by Investor’s Intelligence have reached levels of bullishness usually associated with market declines. Our MASI indicator has again given a sell signal.

The CBOE Put/Call checked in at 0.63 on 12-10, a neutral reading. This indicator is now neutral and will require several readings above 1.0 to make it bullish again. The indicator read 1.07 on 10-14 for the second consecutive day, after the 1.01 reading on 10-8 and the 1.00 on 10-12. This is still a good string of bullish readings. But the market is ignoring the wall of worry. Recent bullish readings have been 1.10 on 9-22, 1.05 on 9-8 and 1.03 on 9-3. This has been a good run of pessimism as the market has stopped falling, as it followed a fairly good reading of 0.92 on 9-2, and a bullish reading of 1.05 on 9-1. Other good readings preceded the recent bottom, such as the 1.03 on 8-10, and the bullish 1.38 on 8-6 which finally eclipsed the readings of 1.12 on 7-16, and 1.17 on 7-12. We like to see investors turn bearish when the market starts falling, and we also like to see them remain cautious as markets rally. A consistent string of low readings can be a sign of excessive optimism and often signals a top in the markets. Readings below 0.5 are of concern, but not as serious as readings below 0.4. Readings above 1.0 are bullish. The numbers cited here are meant to be evaluated on a closing basis.

The CBOE P/C ratio for indexes on 12-10 was 1.34, hardly a reversal of the 1.0 it delivered on 12-10, which quickly knocked the indicator down from 1.80, on the previous day. This is of some concern, as it shows a rapid deterioration in the wall of worry. The reading on 11-19 was 2.53, a bullish reading, which followed several weak readings, 1.08 on 11-8 and 1.02 on 11-17. Recent bullish readings were increasingly distant than the 1.95 on 10-5, and the 1.83, on 10-4. The 9-29 reading of 2.32 was very bullish, and launched a nice end of month rally. The ratio was 1.81 on 9-27, and correctly predicted a bounce. The 9-20 reading was 2.42, as high a reading as we‘ve see of late. Recent bullish readings have 1.97 on 9-15, 2.24 on 9-10, and the 9-8 reading of 2.29. The reading of 9-1 was 2.20, a bullish reading, exceeding the 7-16 reading of 1.92, and the 7-12 reading which was 1.96. Readings below 0.9 suggest too much bullish sentiment, just as readings above 2 are usually required to mark major bottoms.

The VIX and VXN had readings of 12.76 and 19.57 on 12-10. Both have again turned lower. When these indexes begin to rise, it is a sign of concern as rising volatility indexes suggest that an acceleration of the prevalent trend is on its way. In this case the implication is that the down trend is going to assert itself. This series correctly predicted that a trend change was on its way. If the volatility indexes begin to rise, it usually means that the market trend is about to change, usually to the down side. A fall near or below 20 on VIX and 30-40 on VXN is considered negative, a fact that is usually confirmed when the volatility indexes begin to rise. Readings above 40 and 50, respectively, are often signs that a bottom may be close to developing.

Newsletter writers reached new weekly highs on bullishness on 12-10. For the week ending 12-10-04, the 13 week moving average of the ratio of Bulls/ Bulls + Bears from Investor’s Intelligence’s weekly sentiment figures crossed above 70%. Major rallies have traditionally been launched usually when this indicator falls below 40%.

[Normxxx Here:  Myself, with these low VIX and VXN readings, I believe the market isn't going anywhere in the near term! ]

The futures traders polled by Market Vane dropped to a 62% level of bullishness from last week’s 69% reading. This survey delivered a sell signal on 2-20, with a reading of 70% bulls on stocks, which preceded a significant market decline.

Our Big Trend Model fell to 47.5 from last week’s 62.5% on 12-10-04. We don’t like it when this indicator loses a lot of points in a hurry, as it often points to a loss of momentum in the market. Readings near or below 40% often precede market bounces, but may initially be signs of caution when markets have had a rally. Readings above 80% are usually bearish. The Big Trend Model is composed of technical and monetary indicators and updates automatically on a weekly basis.

Our MASI indicator has given another sell signal, its fourth sell signal in six weeks. We don‘t like to see MASI start to deliver clusters of sell signals. The indicator gave an accurate sell signal on 10-8. MAGI is still on a buy signal, after it correctly gave a sell signal on 7-2, its first after gave a buy signal on 4-9. When these two indicators agree, the market usually follows in the direction of the signals. MAGI is based on the weekly data provided by Investor’s Intelligence’s poll of newsletter writers, a group that has been bullish for several years, and stayed bullish and wrong, throughout the bear market. When both indicators agree, there is a high degree of correlation with a significant market move. When these indicators disagree, it is often a sign that the market is about to go nowhere but that volatility is on the verge of increasing. MASI buy signals when MAGI is bearish are rarely worth acting on. MAGI is an intermediate term indicator with an excellent predictive record. The best market bottoms occur when both of these indicators are both on buy signals, a telling sign of intense fear on the part of investors. MASI and MAGI are sentiment indicators that are updated on a weekly basis.

The NYSE insiders were buyers of stock on 11-26, but only mildly reversing the selling from the prior three weeks. This set of indicators is still overall bullish. We would become very concerned to see increasing levels of short selling by the specialists, which is still not evident . We will be watching this indicator carefully over the next few weeks, for that development. This indicator is very positive when short selling by the specialists is low as the same time that they are net buyers of stock. This is a set of very smart investors, and when they turn positive or negative, it is just a matter of time before the market follows. Spec data is released to the public with a two week lag, so is not useful as a market timing tool, but is excellent background and confirmatory information.

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

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» BoltonCT - Re: Parked last week due to interest.... rates

In response to Re: Parked last week due to interest.... rates posted by Kirk:

We seem to be between the proverbial rock and a hard place.

Yes I have looked at the alternatives. The one I think most probable though is:
"These market concerns are all due to the belief the administration will do what the pundits have been saying it should have done for over a year.

These concerns presume the administration will now address the fiscal and trade deficits." Since the president is still talking about tax cuts, that leaves it up to the Federal Reserve to hike interest rates until foreign investors are convinced we are acting responsibly.

The pundits think that if we do not address this deficit problem soon we will face an economic disaster. If we hover near full employment we will move from Keynesian to the classical economic relationship and head toward a Jimmy Carter type stag-inflation. Worse yet they worry about a world economic crisis caused by a possible run from the dollar.

The third alternative is one you suggest where interest rates are stable and relatively low. That could imply a tax increase like father Bush had... only steeper. Would we have another USA 1990 or would it be a Japan 1990? It also implies the world will be patient and will wait for America to do the right thing. Somehow I don't think the president will raise taxes but who knows.

There is a possible fourth alternative that is what I thought was happening for the past year. Interest rates can and should stay low if we are in the Keynesian region and the world acts accordingly.

All the scenarios involve risk and uncertainty. What the market does will depend on what investors think will happen… not on reality.

Currently I perceive a heightened sensitivity and the potential for rapid corrections. I saw it in the stocks I held as well. They would creep up 15% and then get beaten back down in a day or two. Finally I tuned in and took profits before they were beaten down but I did not like being forced into almost becoming a trader. Another problem I noticed was that the information on the stocks was often weeks out of date and the financials were for the most part eroding as the year progressed. I doubt that I had picked just stocks with exceptional financials that were regressing toward the mean. Independent of the fundamental economic hurdles we face, we need better corporate earnings. We don't have that now either.

To me the economic situation most resembles the 1970's when we still thought we could have guns and butter, energy prices were out of control, and the dollar was taking a beating. We were caught in a wide trading range with little gains for buy and hold investors. Market psychology can turn on a dime and I sense (with MCFI) we are near the local high for this round. We need fundamental technological innovation to recharge our economies. We need nuclear energy, conservation, hybrid motors, and the other things we know we should have planned to build years ago.

Think of it as a larger longer term market channel superimposed over the channels your stocks normally move in. Potential reward turns completely to risk at the top of the channel where I perceive we are today.

-- posted by BoltonCT

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» allancoleman - Re: Re: Parked last week due to interest.... rates

In response to Re: Parked last week due to interest.... rates posted by BoltonCT:

well CT , how does it feel to be ' parked ' on the sideline and miss a day like today . ? ? i set a new year to date high today .

i agree with kirk that it's nice to see a few bears to give credit to our rally . i think there's alittle more to be made this year and maybe until mid january .

keep us in touch with how things are ' off the field ' and ' on the bench ' . .

-- posted by allancoleman

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» BoltonCT - Re: Re: Parked last week due to interest.... rates

All the stocks I sold are now lower than when I sold them. That includes Kinross Gold Corp which peaked 10% higher than when I sold it with a 39% gain. I cherry picked out in January and cherry picked back in during July-August 2 months before most people said we were in a bull market.

Likewise, while my MCFI may not give a sell signal for another 2 months I cherry picked out because the NASDAQ was beginning to show money exiting the market and not coming back in. When money exits it is far more risky because it can become a panic.

It takes a while for the effects of cash flow changes to be felt because the velocity of money can compensate for the change. For instance as a market tops the frenzied activity causes the velocity of money to increase so that more money may be changing hands while profits are being taken completely out of the market. Likewise at the market bottom the influx of cash may be offset by the declining velocity by which money exchanges hands.

That is also true of the economy as a whole. We know money is being pumped into our economy and Japan's economy but the slowdown drops the velocity of the money and we don't see the magnitude of stimulus we would have liked.

About 25% of the cash that went into the NASDAQ market since July has now exited with little effect so far.

This week the NYSE began to show an exit of cash. It had been stalled for a month. The N255 inflow of cash now appears to be stalling.

A MCFI sell signal for the US market could come within the next two days to two months depending on the circumstances.

I recently bought one stock that appears near its bottom and sold two short that appear overpriced.

I am now 20% in foreign equities, 1% long US and 4% short US equities. The rest is parked at lower risk... no bonds either.

You folks can phantasize any financial scenario you want, and postpone any decisions until it is too late. But the scenario I think still comes closest to our reality is the market we had in the 1970s. We were also being beaten up with Japanese imports the way the Chinese are doing it today. We can add that to the currency, war, deficits, and energy crisis similarities.

I would not be surprised if the market drops quickly by 20% and they regains it all back in 2005. That kind of rapid shock happened at least twice in the 70's.

-- posted by BoltonCT

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» Normxxx - BERNARDO: Please Note!

Market Action as Information
http://www.hussman.net/wmc/wmc050118.htm

By John P. Hussman, Ph.D. | January 18, 2005
All rights reserved and actively enforced.

One of the central notions of the efficient markets hypothesis is that prices reflect all available information about future fundamentals, whether held publicly or privately, so outperforming the market is impossible. I take the EMH seriously, though as you might expect, not literally. Aside from the fact that the EMH makes implausible assumptions about the rationality of market participants (which can be disabused by watching a few interviews with Wall Street analysts), the EMH has several far less recognized implications, including that trading volume is exactly zero and that all traders agree. Even a slight relaxation of assumptions such as perfect rationality and purely speculative trading motives results in a market that looks much more like what we observe – one in which traders disagree, trading volume is non-zero, and where prices fluctuate in a potentially wide but stable neighborhood around fair valuation.

If you accept that broader view of market efficiency as a “stable neighborhood,” it follows that the market doesn't simply trade at “fair value” at all times. Rather, it trades in a neighborhood around it, the width of that neighborhood being determined by the extent to which the basic assumptions of the EMH are violated (which was patently true at the 2000 peak, even to a blind monkey). “Stable” in this context means that there is a tendency, however weak, to converge toward efficiency, even though new events constantly whack the market toward or away from that efficient point. So while there may be very little tendency to “revert to the mean” in the short run (which is why valuation is not a reliable tool for predicting market direction), valuations remain a very good indication of long-term investment returns. In that kind of market, there are still profit opportunities available, but only by making trades that consistently provide the market with scarce, useful services (such as information, liquidity, and risk-bearing). Unfortunately, actually providing those services can be very uncomfortable from time to time.

In general, comfort is an expensive thing to purchase in the financial markets. Still, investors do it all the time. They seek comfort by liquidating stocks – even deeply undervalued ones – after the market has experienced a long period of weakness. They seek comfort by chasing stocks – even wildly overvalued ones – after the market has experienced a long period of strength. It is very uncomfortable to actually provide other investors the comfort they seek, by standing there bidding for stock in frightening, undervalued markets, and by selling into exuberant, overvalued markets. But it's that very willingness – to trade in a way that provides scarce, useful resources to others – that is the foundation of long-term gains.

Market action as information

Price movements have at least two components. One is tied to fundamental values, and the other is tied to investors' willingness to accept market risk at any given time. The problem is that we don't get to directly observe which one is making stock prices move.

For instance, a decline in price may by a signal that future fundamentals are likely to be poor, and the fundamental value of the stock has declined. On the other hand, it might be that the stock price has declined even though the outlook for future fundamentals hasn't changed, in which case the stock is now a better value. How can you tell which is happening?

As always, context matters. Stock prices can never be analyzed properly without additional information to place their movements in context. For instance, if the price of a particular stock is plunging, but the overall market is also plunging, and all the other stocks in that industry are plunging, then we take the decline as a signal about what they share in common: overall economic conditions may be deteriorating, or investors may be broadly concerned about risk (those two possibilities could be further distinguished with additional information about the economy, valuations, credit spreads, and so forth). On the other hand, if the price of a particular stock is plunging, but the overall market and other stocks in the industry are holding up well, we take the decline as a negative signal about that specific company's prospects, or at least investor attitudes toward that specific company, and immediately look for information related to products, management and other factors idiosyncratic to that particular stock.

With the broad market, it is equally important to examine not only valuations but also market action. On the valuation front, knowing that the price/peak earnings multiple of the S&P 500 is 20.5 is already enough to anticipate that long-term returns (over the coming 7-10 years or more) are likely to be unsatisfactory. It is important to recognize that P/E multiples aren't just arbitrary objects, but are instead complex little mathematical beasts that have a long-term rate of return built into them, just as bond prices have a long-term yield to maturity built into them (for more on this, see Natural Consequences). This knowledge of valuations is a major advantage to investors who take the information seriously, because it provides an enormous amount of context in which to interpret shorter-term market action. As Charles Dow wrote a century ago, in one of the single most important observations in stock market history, “To know values is to comprehend the meaning of movements in the market.”

Now, we already know that long-term returns have not historically been penalized by avoiding market risk at high valuations. Still, there's a lot of “tracking risk” to that valuation-only approach, and it turns out that investors would have historically done better by considering the risk preferences of investors as well, which I do by analyzing market action.

Though the recent selloff in the major indices is certainly what one might have expected from an overvalued, overbullish, overbought market, it does not follow that stock prices are inherently poised to fall apart. Again, valuation has everything to do with long-term returns, but precious little to do with short-term ones. As long as investors have a robust willingness to accept risk, there can be very little pressure on the market to decline toward more historically normal valuations. So in addition to valuations, we have to consider the quality of market action. The greatest plunges in market history have always emerged from overvalued markets in which investors have recently become skittish toward risk, as evidenced by market action.

So far, strongly negative evidence from market action hasn't emerged. That's not to say we can rule out a further decline, or an abrupt shift in risk aversion ahead, but for now, our investment discipline prevents us from taking a fully hedged position against market fluctuations.

Frankly, I've been impressed by two things in recent weeks. One is the failure of credit spreads to widen (the difference between risky corporate bond yields and default-free Treasury yields), and the other is the failure of new 52-week lows on individual stocks to expand above the number of new highs. Richard Russell notes that the Dow Transportation Average has already broken its December low, so a like breakdown from the Dow Industrials (below 10,440.58 on a closing basis) would be a negative from the standpoint of Dow Theory. So far, however, even that sort of event is not in place.

Now, I certainly believe that credit spreads are overly narrow, and that this will end badly, and I am equally convinced that recent bullish extremes will ultimately give way to considerable pain for investors. Valuations are already extreme enough to warrant holding a very defensive put option position against our stock holdings. But that doesn't mean that a fully hedged investment position (a full offsetting short sale in the major indices against our stock holdings) is warranted – yet.

The bottom line is simple. So far, the recent market decline tells us that an overvalued, overbought, overbullish market has corrected. This is not enough information content, because the market has failed to produce the sort of wide internal divergences that have historically been the hallmark of extreme market risk. Again, we can't rule out further market weakness, and defending our stock holdings with put option coverage is essential, but we still don't have enough evidence to warrant a fully hedged position.

I expect that we will derive an enormous amount of information as we observe how the market responds to the current, oversold condition of stocks. Given that the bulk of our put option coverage is roughly at-the-money, I would expect the Strategic Growth Fund to participate modestly in any early weakness from here, but that the put coverage will substantially mute the impact of any sustained decline.

It will be very important to see whether new divergences develop on any market advance that might occur. In any event, the behavior of market internals in the weeks ahead will matter far, far more than the behavior of the major indices. For now, we're well defended against any serious market weakness that might emerge, but particularly with the market now reasonably oversold, the continued modestly favorable Market Climate demands at least some benefit of the doubt.

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

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» doc008 - Re: Re: BERNARDO: Please Note!

In response to Re: BERNARDO: Please Note! posted by Kirk:

Just to be fair to Hussman, it must be noted that the data in your HSGFX chart include such items as capital gains distributions. That is why your chart shows HSGFX actually down in calendar 2004, while Hussman's website claims a gain of 5.16% for that same period.

-- posted by doc008

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» Normxxx - A Late 40-week Cycle?

A Late 40-week Cycle?

1/22/05: From A Usually Reliable Source. . .

At the end of December 2004, everyone seemed ready to believe in the phenomenon of years ending in “5” always being up years, and investors were front-running that trade. January’s mission was to convince the public that the sky is indeed falling, that all hope really is lost, and to plan for a terrible bear market. Most of that work has been done, which means that now the market can get on with the mission of putting in an up year. A few more days’ mopping up operations are needed before the next uptrend can get underway. We do look for an up move to take the major indices to higher highs sometime ahead of the next 9-month cycle low due in June. It may take until another short term bottom due Feb. 7-9 before the up move can really get started. T-Bonds are moving up in spite of rising inflation, and in spite of commercial traders being net short. That condition cannot last, and bonds are in for a rough year, especially lower grade corporates. Gold should bounce to an April top, but it is just a bounce and not a new uptrend.

The term “right translation” is graphics analysis jargon, and is not meant to refer to works as a Republican interpreter. What it refers to is the idea that price tops for a given cycle in the stock market do not usually arrive on schedule, and the timing of their actual arrival provides us with information about the future progression of a graphics pattern.

The 40- week cycle is also known as the 9-month cycle, and the 20-week cycle is a half period harmonic of the 40-week cycle. The 40-week bottoms tend to be the more significant ones, and they also tend to be more punctual. The July 2002 bottom in the SP500 is a rare example of the market bottoming off schedule by a few weeks, but the next 40-week bottom in March 2003 was back on schedule. The 20-week bottoms tend not to be as deep, and they also tend to arrive earlier or later than the ideal schedule.

The actual 20-week bottoms arrive in reasonable proximity to their projected dates, but not as precisely as the 40-week bottoms. The current correction that is underway following the December high in the market is just the current iteration of a 20-week cycle bottom. When we see the high price for an entire 40-week cycle arriving very early in the cycle, that portends bearish things for the market in the months ahead. This is known as “left translation”, and we saw several examples of left translation all the way down from the 2000 high to the 2002-2003 bottoms. Beginning in 2003, we saw the market switch to right translation with the high for the cycle arriving very late in the cycle, and this implies very bullish things for the future. One side effect of right translation is that each 20-week cycle high is also usually late in arriving. The Dec. 30, 2004 top in the SP500 was later than the 20-week cycle’s ideal top date of Nov. 23, and so that implies that we are likely to continue seeing the 40-week cycle show right translation.

That should mean that on the next cyclic up leg out of this 20-week cycle low, we should see the major averages exceed their December 2004 highs. Whether they make all-time highs is a separate question, and not relevant to this discussion. It should be enough for the moment to have an expectation of a move above December’s highs. The next 9-month cycle bottom is due in early June 2005, and so sometime between now and then we should look for a top of the next up move. If that top is indeed higher than the Dec. 2004 top (1213 in the SP500, for example), then that will promise us continued good things for stock prices on the other side of the June 2005 40-week cycle low.

Bulls can take some encouragement from the fairly gentle way that this 20- week cycle bottom has been apparently put in. The major price indices have not really declined all that much. If the market can avoid getting hurt too much during a period when it is supposed to be weak, that is a good sign.

We have not even seen a day when the NYSE has had more 52-week new lows (NL) than new highs (NH) since Oct. 20. With the completion of this month’s 20-week cycle bottom not yet even evident in the price charts, this indicator is already starting to head upward. Having new highs start to make a comeback ahead of prices is something we have seen before at other price bottoms, so this is not all that unusual. It is an encouraging sign for the market going forward.

Bottom Line: Stocks are bottoming now on schedule for the 20-week cycle, and after a bit more thrashing around we should see a rally to another big top sometime before the big 40-week cycle low in June.

As part of a long term bear cycle for gold prices, investors have lost interest and will have to gain some interest back again in order for the next down wave to be able to proceed. We look for a rally of a couple of months’ duration, just strong enough to lure the suckers back in again, but not robust enough to bring about a new high.

We seldom mention them, but Rydex has several sector mutual funds in addition to its leveraged bullish and bearish stock market index funds. The Rydex Energy Fund invests largely in the major oil companies, with its top 5 holdings in Exxon Mobil, BP Amoco, Conoco Phillips, Chevron Texaco, and Total Fina. It is very well correlated to oil prices. The falloff in crude oil hurt that sector, and caused the investors in this fund to lose interest and pull their money out. As a result, the total assets fell by more than half from the October high, even though the Net Asset Value (NAV) has remained fairly stable. This dropoff in fund assets is therefore a statement by these investors that they are no longer interested at all in oil stocks, and any card-carrying contrarian will tell you what that means. Low readings on total assets are usually associated with tradable bottoms in both this fund and in crude oil generally. Based on what gold has said, and what these investors are saying, we expect to see a rally again in oil prices and in the stocks which track oil prices up into a March top before the next decline of significance.

Bottom Line: Oil prices should pop over the next few weeks, and should also mount a bigger uptrend toward year end.

Bonds Still Not Giving Clear Picture
If one were to look only at the price of long term T-Bonds, one might conclude that prices are about to break upward out of a long trading range, and so therefore we should all be as bullish as all get out on bond prices.

But if one looks elsewhere, the picture changes. If we look at the data on commercial T-Bond futures traders’ net positions as reported in the Commitment of Traders (COT) Report (see www.cftc.org), we see that these “smart money” traders usually end up being right in the long run. But they have been net short by a huge degree for the last several months, and bond prices have not responded with a decline. We expect their patience to eventually be rewarded. Prices meanwhile are trapped between a rising bottoms line and a curved rounding top line, each of which has been penetrated briefly during extreme circumstances. Prices cannot remain between them forever, and our expectation is that eventually a down move is going to have to unfold to prove the commercials right. A downward price move may be more apparent in the 10-year T-Notes than in the 30-year T-Bonds.

If we look at the yield spread between the 10- and 30-year bonds, we see it is at its lowest level since early 1992. That means that 30-year T-Bonds have been moving up in price to close the yield gap. When that happens, it is usually a sign of a top in T-Bond yields. But this time it is occurring as T-Bond yields have been falling, which makes this a bit of a head scratcher. The explanation probably lies in the fact that there is a very small supply of 30-year T-Bonds, and certain institutional portfolio managers are mandated by their investment policy committees to be invested in long term T-Bonds. That puts a greater than normal price premium on the few long term T-Bonds which are out there. If the U.S. Treasury ever decides to issue more 30-year bonds, which is not likely with 30-year yields at 4.6% versus 1-year yields at 2.9%, then some relative order may be restored to the T-Bond market. For now, the illiquidity of the 30-year market is skewing the picture for yields and bond prices.

It is our belief that the participants in the T-Bond market are blind to the dangers of inflation that are looming. They are passing it all off as being related to crude oil, which it is partly, but it is not as dismissible as they think. The leading indication for the CPI that is given by gold prices offset forward by 14 months shows that we still have a long way for inflation to go before it is done going up. Indeed, since gold prices topped out in early December 2004, we have to wait until early February 2006 before inflation rates should top out.

We will also have to wait even longer than that before people stop worrying about the “horrors of runaway inflation”, which is going to be the new catch phrase for 2005. Such inflationary pressure is bad for T-Bonds, and so it likely means that the commercial traders are correct in their bearishness.

Bottom Line: Bonds keep going up against all reason, but reason will one day prevail, and catch the complacent unaware. Watch for rising yields.

Some More Market Themes For 2005
Even though years ending in 5 are supposed to be up years, based on a string of successes dating back to the 1870s, not all investment opportunities are created equal. We are projecting a year in which small cap stocks will have a much more difficult time than they have had for the last few years in terms of outperformance over their big cap brethren.

The yield curve foretells the future for small cap outperformance. Usually the real yield curve shows a portrayal of all of the different maturities’ yields, and so we are taking just a portion of the yield curve by comparing the yield on 10-year T-Bonds versus 3-month T-Bills. We set this yield spread indicator forward by 15 months to get the leading indication for the ratio of index values for the Russell 2000 and Russell 1000. The generally rising spread between long and short term Treasuries over the last few years has correctly forecasted the outperformance by small cap stocks.

For 2005 and beyond, however, the yield spread indicator says that large caps are more likely to outperform. The Fed started raising short term rates in 2004, and long term rates have held fairly steady, thereby shrinking the spread. If things go according to the normal relationship, then this drop in the yield spread should start to be especially felt later this year and into 2006 in terms of small cap underperformance. Keep in mind that we are talking here about relative performance, which can be different from absolute performance.

But looking at relative performance can often give insights about actual performance. It frequently gives valuable early warnings about directional movements in the Russell 2000 itself. The relative strength line often breaks its own trendlines ahead of the corresponding line on the Russell 2000, and it recently gave warning of a price turn when it failed to confirm the Dec. 2004 top. One other theme that we believe we will see in 2005 will be an expansion of “credit quality spreads”. Corporate bond yields of all varieties have fallen much more than the higher quality bonds, and the spread between “junk” bonds and high grade corporates is at a multi-year low. We think that this is going to change, with investors increasingly looking for discounted prices on lower grade paper in exchange for accepting the higher risk.

The relationship between the Effective Fed Funds rate and the spread between T-Bond and Aaa corporate bond yields have an usually a good correlation, with spreads rising whenever the Federal Reserve strangles the liquidity supply. So far, there has not been any reaction to the Fed Funds Rate increases implemented by the Federal Reserve. That cannot go on forever, and we suspect that there will be some sort of major corporate bond default (or the scare of one) that jolts this spread back to life again. If our analysis of the transportation sector is correct, then a major company from that sector, perhaps an airline, will be the agent of that jolt.

[Normxxx Here:  Or, perhaps, GM or Ford debt re-rated to junk? ]

The content of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

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