Interesting post from Aegean Capital
Since it's a slow day, I'll post the whole thing. You gotta go to the website to see the charts, though.
(FWIW, I went nuke short via BEARX and URPIX on Thurs thinking we were done. Luckily, I still have some cash to throw and the cheapest POS tech stock I can find on Monday to hedge my shorts. Any fiber or telecom under $5.00 is fair game)
AEGEAN CAPITAL GROUP INC.
STOCK MARKET REPORT
Publisher: Aegean Capital Group, Inc., Report#36, 10-26-2002, 6:30pm PST , Page 1of 14
"Double Bottom, Or, Double Top?"
Ike Iossif (President/C.I.O. of Aegean Capital Group, Inc.) talks about the current rally, the economy, and all of Aegean's proprietary market indicators.
MARKETVIEWS.TV
Interview with Ike Iossif
By Dan Bistline
Sunday
10/26/2002 6:30 PM PST
D.B. Hi Ike, how are you doing?
I.I. Fine, thank you.
D.B. The last time we talked, on 9-15-02, you had opined that "it will get worse, before it gets better!" At the time the SP was at 889, and NASDAQ was at 1270. Subsequently, they fell to 768 and 1108 respectively. On 10-4-02 in your weekly report you said that the following week -although your intermediate term model was still on a sell signal- your short term model indicated that we should expect a rally between 10% to 15%. So, you were right with regards to things getting worse before getting better, and we have gotten a rally of 16.7% in the SP, and 20% in NASDAQ, which is just a bit higher then what you were expecting, any thoughts on that?
I.I. Yes, let's examine the last 5% of the advance. As it can be seen very clearly, the gains of the past 5 trading days have not been confirmed, which means they are built on thin air. That doesn't mean the market can't push a bit higher, perhaps 925-930 in the SP, and 1347-1360 in NASDAQ. What it means is, these gains will be given up in any pullback. Moreover, because they are built on thin air, they can be given up rapidly, and much faster than people expect.
D.B. Can one interpret the fact that the indices continued to advance in spite these divergences as a sign of strength?
I.I. Given that I have designed these indicators, and I am fully aware of what they measure and how, I can tell you with absolute certainty, that NO this is not the case! Gains in the face of these divergences are NOT a sign of strength, they are a sign of trouble to come, especially if the indices move up to the targets that I just mentioned. Keep in mind, that I have designed all the forecasting models, and over 70% of the indicators that we use in our decision making process in this firm for the past 8 years. All in all,17 of them, plus I have participated in numerous research projects -over the same period- that we have conducted over the years on behalf of our institutional clients, so, I think I have pretty good understanding of the inner workings of markets. Based upon that understanding, I'll tell you again that given the under the surface action up to now -if the action changes going forward, that's a different story- the rally has been built on weakness, not on strength. The last two and a half years, we have had two similar rallies one that ended in September of 2000, and the other that ended in March of 2002. Both of then were followed by devastating declines.
D.B. Can you elaborate more on this?
I.I. Absolutely! I think our listeners/readers will understand what I am talking about by examining how our intermediate market timing models work, what they are telling us, and why. My definition of intermediate term is somewhere between 3-4 months. Our "market timing" methodology is based on assessing "risk" at any given time, and make decisions based upon a "return to risk" ratio. We rate the market based upon our own "return to risk" ratios that we have determined to be appropriate for our investment objectives. First I would like to explain the concept behind them, and then I'll get into the details. The forecasting models take current reading of our indicators, and compare them to similar reading over the past 15 years of data that we have in our database. Then, it tells us how the market acted 90-120 going forward, and from there we deduce what we should expect for the future. To make it simple to understand, I'll give a one variable example. Let's say our system was based on just one indicator (variable) the 14 say RSI. And let's say today's reading was 11. Our system would go back and examine what happened to the market 90-120 days later every time we had a reading of 11 over the past 15 years. Supposedly it finds out that over the past 15 years, we had 10 such incidents and in seven of those incidents the market was up on average 10%, 90-120 days later. In three of those incidents, the market was down on average 6%, 90-120 days later. Thus we can deduce that based upon the historical data that we have, an RSI reading of 11 implies a 70% probability of 10% gains 90-120 days later, and a 30% probability of 6% losses 90-120 days later. The overall estimated return over the next 90-120 days is:
Rest = (.70)(.10)+(.30)(-.06) =5.2%. In addition, the probability ratio between the "bullish" outcome, and the "bearish" outcome stands at 0.70% / 0.30% = 2.3. In other words, a reading of 11by the 14 day RSI implies that the market is over two times more likely to gain 10% over the next 90-120 days, than it is to lose 6% over the same period. From that point, institutions/individual can set their own parameters with regards to their required return to risk ratio. In our case, we want a better than 2:1 ratio, and an estimated return above 10%, in order to go long the market. Others can set more conservative, or, less conservative standards based upon their own preferences of risk tolerance.
D.B. I hope by now, all of our listeners/readers have understood the concept behind the model. Now let's get into the details, into the "mechanics" if you will.
I.I. Our intermediate term model is comprised of two variables, a "technical" one which carries a weight of 65% in the equation, and a "fundamental" variable which carries a 35% weight in the equation. In addition, more recent outcomes carry higher weight than more distant outcomes. Everyone, would understand that how markets acted 6 months ago based on the same data, is more relevant to how they acted 15 years ago, based on the same set of data. The "technical variable is comprised of a few "sub-variables" such as our 30 day Buy/Sell equilibrium Index, the 50 day Summation Indexes, the SI25s, the Quantifiers, the Aggregate Bullish Sentiment Indicator, and a 2-3 others that I do not wish to mention. The "fundamental" variable is comprised of the rate of change of few "sub-variables" as well, such us: ECRI's L.E.I., the "Help Wanted" index, the M.L. High- Yield Master II index, the I.S.M. Index, the Consumer Confidence index, and the federal funds futures.
Last time we talked which was on 9-15-02, we had a target -over the following 4 weeks- for the SP500 of 740 (+/-1.%) and a target of 1080(+/- 2%) for NASDAQ. The SP reached 768, and NASDAQ reached 1108, I would call that pretty darn close! Not to mention that our model has earned us a spot among the "Top 10 Timers" (as per "Timer Digest") for the last 14 consecutive months. I do not recall anyone else who has been among the Top 10, for longer period, over the past 2 1/2 years, so, we must be doing something right! However, the interesting part is that after reaching those levels, our intermediate term models indicates that the risk is still on the downside, even after the advance of the last 3 weeks. In fact (see page 2) our model is forecasting an estimated Rate of Return of -7.1% for the SP, and -7.3% for NASDAQ.
(Charts and targets updated on 10-26-02)Our intermediate forecasting model, has produced two scenarios for the next 6-8 weeks. On the bullish side we have a target of 1430, and a probability of 39.21% to materialize, and on the bearish side we have a target of 1060 and a probability of 50.51% to materialize. NOTICE that the ratio between the bearish and the bullish scenario stands at 1.3:1 (50.51% divided by 39.21%) thus producing a "sell" signal. (The red line represents the most likely price action to take place on the way to reach the target price. The ratio means that it is 1.3 times more likely -at the present time- for the index to fall to 1060 than it is to rise to 1430. It should be noted that a 1.3:1 ratio indicates a weak signal. However, notice that from current levels the projected upside target is 7.4% higher, while the projected downside target is 20.36% lower. Thus, the estimated rate of return over the next 6-8 weeks is -7.1%.
The obvious question, is why our intermediate term model has continued to give a sell signal, even though our short-term model forecasted a 10%-15% advance. The answer is simple: as I explained in the beginning, our model compares current technicals and fundamentals with previous ones and it has seen no difference what-so-ever between the current readings, and the readings we got during any of the rallies of the past two and half years, which resulted in lower prices 3-4 months down the road! So, what the intermediate model is telling us, is simply that unless the underlying technicals and fundamentals change rather quick, three months from now the market will be lower than where it is at presently.
D.B. Can we dissect that?
I.I. Of course we can. Let's take a look at a few things that everyone can understand. Bear market rallies are characterized by low volume, in fact every single one of the rallies that we had since the beginning of the bear market has shared this characteristic. The current rally -as the charts indicates- does too, in an undisputed way. Notice that not only volume has been decreasing on the way up, but also the only time it increased, was on Thursday 10-24-02, when the market fell! That's not what you see at the beginning of intermediate term rallies. We are only 10 trading days into it, and the market is running out of fuel, how is it going to continue at this rate for another 3-4 months? For example notice that the volume on the Dow was 410 million shares on 10-15-02, it has been decreasing steadily at an average rate of 18.8m per day! On Friday it hit a nine day low of 242 million. Theoretically speaking, just to drive home the point, If the rate of decrease continues at the same pace of 18.8m shares per day, in 13.4 days there will be no more volume to trade! Is that what you see at the beginning of intermediate term rallies? can one expect the market to be higher 3-4 months later under these circumstances? I do not think so, and you do not need a fancy model to figure that out.
The next charts come courtesy of my good friend Mr. Carl Swenlin, of www.decisionpoint.com. By the way, once again I want to give Carl credit for his immense contribution to technical analysis, his charts are simply second to none. The first chart is the percent of stocks that are above their 200 day moving average.
As we can see very clearly, despite the robust rally of the past few days, the percentage of stocks that are above their 200 day moving average is back to where it was at the last three major lows! In other words -so far- the emphasis on "so far" this rally has been the narrowest we have had since the beginning of the bear market. One can argue that given that we had three major rallies every time the percentage of stocks below their 200 day moving avg. got that low, we may again be at the same point, and the rally instead of petering out, it may accelerate. That I agree, it could happen. However my analysis is not based on speculating what may happen, it is based on the facts of what is happening right now, and right now nothing is happening, the majority of stocks is not moving. Is that what you see at the beginning of intermediate term rallies? I do not think so!.
Next we got three other terrific charts from Carl illustrating the Participation Index (click here for a complete description) Basically, the PI measures short-term price trends and tracks the number of stocks pushing the upper or lower edge of the short-term trend envelope. Notice that as the major indices have mover higher, lesser and lesser number of stocks have been participating in the move.
So, not only the current rally lacks volume, not only it lacks broad participation by the overall market, it even lacks participation by the stocks in the indices that have been leading the rally!. Is that what one would expect at the beginning of intermediate term rallies? Definitely not! My point here is that the technicals -so far- are not supportive of an intermediate term rally. Unless they improve 90-120 days days down the road the market will be much lower than where it is at now, that is why our intermediate term model has remained on a sell signal. I do not know whether the background will change for the better, or, worse. What I do know, is that this is not a background supportive of sustainable bull moves, and if it does not change quick the rally will collapse.
Now let's take a look at the fundamentals. Every rally we have had the past two and a half years has taken place during earning seasons under the premise that "things are so bad, they have to get better!" I took issue in the April 2001 newsletter with Mr. Jonathan Joseph -the semiconductor analyst at Smith Barney- who at the time upgraded the chip stocks, because according to his rationale "things were so bad, they had to get better!" For somebody who draws a seven figure salary you would expect more sense and analytical integrity, but of course these are qualities that Wall Street can't be bothered with, or, nurture in its corrupted environment. By the way Mr. Joseph's number one recommendation at the time was -guess what? KLAC! Because of course "things were so bad, they had to get better!"
Unfortunately, the fundamentals anyway you look at them are deteriorating at an alarming rate. First off all, in the technology sector and more so in the semiconductor sector , overcapacity has actually increased over the past year due to the fact that the "tech geniuses" (especially the know-it-all folks at Intel) stubbornly added capacity in 2000, in 2001, and yes again in 2002, foolishly attempting to spend their way out of the tech downturn. At the end of downturns, overcapacity ceases to exist, at the moment it is just as bad, and in some tech sectors even worse, than it was at the beginning of 2000! Is that a recipe for a recovery? I do not think so!
NASDAQ has outperformed the rest of the indexes in this recent rally, however according to a study done by John Mauldin (www.2000wave.com) "...15 largest companies on the NASDAQ, which represented at that time about 37% of the NASDAQ market value. For the group of 15 firms, total 2001 pro forma earnings added up to $25 billion. Real earnings were about half, or $13 billion. But total option expenses for the 15 firms were $12.5 billion. That means pro forma income was cut in half, and real, Honest-to-Pete profits were a mere $423 million, give or take a few million. Earnings Before Interest and Hype These 15 firms had a total market cap of roughly $750 billion (the total value of their stock). That means the combined P/E ratio based upon 2001 earnings which deduct option expenses, and using their
stock price today, is a little north of 1,789! If you take away Microsoft, the combined earnings of the remaining 14 is a NEGATIVE $3.5 billion. That means 14 of the largest NASDAQ firms could not combine to make a profit, if you deduct the expense of their options. Seven of these firms had negative earnings once options were deducted."
Moreover, we are now entering the period after the bubble burst when consumer spending should indeed begin to decline! Both in the 1930s, and in Japan recently, consumer spending did not begin to deteriorate until 2 to 2 1/2 year after the stock market bubble has erupted. We are beginning to see this in the deteriorating retail sales, in the durable orders, and in the reluctance of corporations to hire new workers due to lack of final demand.
Thus, our model sees even weaker underlying fundamentals, than the ones the previous bear market rallies were built upon, and thus it deduces that in the next 90-120 days, stock prices will be lower than where they are now.
When we look at the current technicals and fundamentals, we conclude that U.S. equities have neither investment, nor, speculative merit in the intermediate term. If the technicals were to improve,signaling a rally similar to the one coming off the September 2001 lows, then equities will develop speculative merit, and in that case our model would give an intermediate term buy signal, but that's not the case as of now.
Now let's move on to part B, so we talk about what it would take "technically" for the market to develop speculative merit.
AI
