State of the Markets............................................
by David D. Moenning
There is nothing quite like a sudden blast higher to get the Bear off your back (at least for a couple of days, anyway). With confidence beginning to get more than a little shaky, the Dow’s gain of 170 points on Thursday was a welcome sigh of relief. It reminded us that stocks can actually do something besides go down, and that investing may involve more than looking for the Advil after the close. With some of the overbought/oversold indicators hitting readings that we haven’t seen for years, it was obvious to everyone that the market was very oversold and ready for some sort of rally attempt. The problem was that the rallies prior to Thursday had been feeble and the momentum had clearly swung to the dark side.
So it really didn’t matter what excuse the Press gave for the rally, the point was we were due for a pause in the Bear’s game of tag your portfolio. In reality, it was the combination of a little bargain hunting in tech, some decent economic news, a respite from the terror watch, and the realization that earnings will be pretty good, that sent shorts running to lock in profits. And before you could say, “short squeeze” stocks were flying higher on Thursday. Not surprisingly, the leaders of the mad dash higher were some of our dear old friends in the Tech sector.
And speaking of Tech, just when we were beginning to think that the Four Horsemen would never ever see a green number again, Microsoft, Dell, Intel, and Cisco enjoyed a surge higher. Frankly, the rise doesn’t change the trend of late for these darling duds, but it was nice to see some gains for a change this week. And maybe, just maybe, we are starting to see some basing going on here – especially in Dell and Cisco. If we could get some interest in these stocks beyond the one-day wonder rallies, the market could definitely enjoy a run here.
But before we get too excited, let’s recognize this action for what it is right now… a bounce. Just as we have counseled not to get sucked into all the talk of a new Bear Market, we must now recognize that one day does not a trend reversal make. Especially when the bounce occurs on less-than inspiring volume. Yes, the volume was “decent” but it was not the kind of thrust we need to qualify Thursday as a reversal day. This tells us that the bounce was, well… a bounce.
Does This Really Mean Anything?
In one morning’s work, the market recovered 25% of the recent decline. Friday’s attempt to “follow through” (which fizzled at the close) looked like it wanted to prove Mr. Fibonacci knew what he was talking about centuries ago, as we quickly approached the 38.2% retracement level (which, by the way, would be a convenient spot for the Bears to reenter the game). This was certainly enjoyable, but the question is – does it mean anything? The answer is, of course, yes, and no. (Did you REALLY expect a different answer?)
Let’s explore both sides of the coin here. No – the brief rally doesn’t mean a whole lot yet because the downtrend that is in place on most of the averages has not been reversed by the relief rally. While the blast higher did plunk the Midcap and Russell indices back into their previous trading ranges, the jury is still out on whether they can stay there over the next week. (But the longer they can stay above the old “floor” of the range, the better.)
However, the S&P, NASDAQ, and Dow remain in a downtrend and need some additional upside work to break out of the downward spiral of lower highs and lower lows. I don’t want to sound fussy, but a little volume when this move occurs would be nice.
On the other hand…Yes – the bounce DOES change things a bit… it means that we are now taking a shot at “putting in” a bottom. While the move higher didn’t have enough “oomph” to reverse the downtrend, it did make the statement that the Bulls aren’t afraid to try and make a stand. And there you have it; the game is on!
But – after their profitable three-week run, don’t expect the Bears to just roll over and go back into hibernation. I may be restating the obvious, but we shouldn’t be looking for the market to “V Bottom” and immediately resume its march higher. The fact is that the strong momentum we saw at the end of last year is no longer present. We should also expect a “retest” (at least on an intraday basis) of the lows at some point soon. And this will be where Ms. Market may tip her hand. The bulls will be looking / hoping for a reversal with some volume after this inevitable move lower – which would be a positive sign.
In all likelihood, we should expect the battle for the bottom to be spirited. In other words, don’t expect the recent volatility to go away quickly. (Although, if I had my druthers, I’d prefer to see a period of “quiet” trading on low volume, which would indicate the market was sold out.) We also need to remember that the decline did some damage, which means the bottoming process could take a while.
The Mini Bull’s Demise?
The same approach also goes for the end of the current Mini Bull cycle. As I’ve stated several times in the last two weeks, we don’t believe it’s time to start looking for cemetery plots for our friend "mini Bull." But the cold, hard reality is we will have to say goodbye to the cycle at some point. And thus, the really important question that we will most likely have to deal with at some point over the next year is: how will we know when the cycle is ending?
Having been in the investment business since 1980, I’ve seen a lot of cycles come and go. And one thing that I can say with absolute certainty is that the beginning and end of every one is different. The conditions that exist can be similar, but how things unfold is usually pretty unique. (I’ll spare you all the supporting data on this point… it’s also not really that interesting.)
We can tell you that the average Mini Bull lasts a little over 14 months (431 days to be exact) while the median is right at one year. We can also say that the average gain for Mini Bulls is about 62% for the Dow Jones Industrials, while the median is a bit lower at 50.6%. Given that, in our opinion, the Mini Bull began last March, (or in October of 2002) we could start guessing that this cycle “should” be ending in the next few months. However, this bull has been quite strong in terms of its momentum, and thus, we’d expect it to wind up being classified in the above average category. For those of you keeping score at home, if you mark the beginning of the Bull as the low of the Bear, then this cycle is now 17 months old and has moved the Dow up +47.4% from the bottom. While this may be statistically preferrable, we believe the Bull began in March of last year and thus has recently had a birthday to go along with a gain of +42.7% for the Dow, +44.6% for the S&P 500, and +69.4% for our buddies on the NASDAQ.
During the last Bull Market cycle, our models told us that the Bull was strong (which was correct). They told us that the Bubble Bull’s leadership was getting very narrow and risk was high in late 1999 (right again). They told us that momentum peaked long before the last Bull Market did (check). They told us to get out of tech in April of 2000 (double check, with an exclamation point). They told us to avoid “growth” during much of the Bear Market (another good move). They told us to take defensive measures during the vast majority of the grizzly’s reign (this helped us avoid a lot of pain). They told us to buy bonds (right again - but did we listen?) They told us to “Buy” in March and April of 2003 (Dead on, but scary). And the models told us to focus on small caps last year (small caps were the leaders in '03).
So What are the Models Telling Us Now?
As we’ve laid out over the past two weeks, our models say that the current decline is a correction in an ongoing (but aging) Mini Bull Market. They are telling us that the correction has taken its toll on the “environment” and that a lower risk profile is warranted going forward. The models are telling us to stay focused on Midcaps for now (but they may give Large Caps the nod on April 1st). They clearly tell us that Value is the style to use at this point in the cycle. The models tell us that Momentum has fallen off a bit, but is still pretty darn good for a corrective phase. They say that we should underweight bonds in our portfolio. The models are telling us that we should be between 70% and 80% invested right now. They say that stocks are still overvalued on an absolute basis and cheap relative to the levels of interest rates. The models tell us the economy is improving. They say that interest rates (and inflation) are headed higher, but only mildly so. They told us that investors have become quite pessimistic in a very short period of time. Finally, they have been telling us to expect a bounce… and that the bounce may eventually become a tradable move higher.
Good luck.
Regards,
Naz
AI
