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Will Poker-Face Market Raise or Fold?

http://biz.yahoo.com/rb/021130/column_stocks_week_2.html

Saturday November 30, 4:22 pm ET
By Pierre Belec


NEW YORK (Reuters) - The excitement is building and the suspense is so thick, you can cut it with a knife now that the stock market has had its longest-running streak of gains without flinching in more than three years .

What happens now? Will this poker face market raise or fold?

The smart money says the script hasn't changed so much as to justify a raging bull market. The Street's moonshot climb from last month's lows may be built on shifting sand, they say.

The risk is that people are being fooled into thinking that things are in better shape than they appear.

Big fund managers are dominating the market with their bullish bias, trying to get around the bearish fundamentals.

"Most fund managers are petrified at the prospect of missing any rally," says John Hussman, professor of economics at the University of Michigan and publisher of Hussman Econometrics, a research firm.

"With the market still sporting deep losses for the year, these managers are looking for any reason to buy stocks, which largely explains their eagerness to take highly volatile data, like the weekly unemployment claims that fell to their lowest level since July, as a sign the economy is turning," he says.

The Dow Jones industrial average is on track to post its eighth consecutive week of gains since crashing to a five year low in October, when investors thought that stocks were worthless.

"There is a reason the market traded to such depressed levels in October," says Rick Macdonald at Standard & Poor's. "There does not appear to be a quick fix to problems such as depressed corporate profit margins, audit worries, lackluster economic growth, threat from terrorism and action in Iraq."

OTHER PEOPLE'S MONEY

The cold reality is the folks at the fund houses are playing with other people's money. Fund managers have a vested interest in keeping their jobs after a spectacularly ugly year.

Of the 100 largest stock mutual funds tracked by Pensions & Investments magazine, only two had positive returns for the 12 months ended on Sept. 30. The third quarter of 2002 was worse for the fund managers than the dreadful third quarter of 2001 as the Standard & Poor's 500 index plunged 7.2 percent. In fact, it was the biggest money-losing quarter since the crash of 1987.

It's entirely possible that the stock market's latest rally "is little more than self-feeding, short-covering panic by the pessimists that will soon fizzle out," says James Dines, publisher of the Dines Letter.

BRRR! COVER YOUR SHORTS

Just as autumn's chill arrived, the number of short-selling positions on the Nasdaq market sank in October to the lowest level since February after increasing for three straight months.

Dines senses that this supposed "new bull market" is overbought and may be setting itself up for a nasty correction, possibly by December.

History is full of examples that the market has topped out when most investors are bullish.

What's troubling is that stocks have been rising even in the face of some less-than-optimistic news on corporate earnings and the economy.

Few economists are convinced the economy has turned a corner. And it's hard to imagine that a struggling economy will generate more profits for Corporate America.

What's happened is the unexpectedly big interest-rate cut of a half-percentage point by the Federal Reserve in November -- a panic reaction to head off a possible double-dip recession -- has masked the real problems facing the economy.

For that reason, investors should feel nervous about the market's prospects.

Industrial production sank for the third straight month in October. While consumer confidence edged up in November, it still hovers at a nine-year low and in recession territory.

The economy grew in the third quarter by a brisk 4 percent, but a lot of the gain was generated by the continued strength of car sales -- thanks to Detroit's zero-percent financing and other teaser deals.

Several signs are now suggesting the economy hit a soft patch in the fourth quarter, with car sales hitting a wall as the third quarter drew to a close.

BRAKE FOR BAD NEWS

There's more bad news. The National Association for Business Economics, which includes some of the nation's most influential economists, has cut its estimate of fourth-quarter economic growth to the stall speed of 1.4 percent and lowered its first-quarter 2003 growth forecast to 2.5 percent.

Before the Thanksgiving holiday, sentiment picked up on Wall Street on news that consumer spending rose and weekly jobless claims fell. But the positive signals were tempered by the fact that seasonal factors played a role in consumer spending and the jobs data. Retail stores hire more people and personal spending increases in the run-up to the Christmas holiday.

So why are investors so enthused about throwing more money into a market that's on course to post its third losing year in a row?

The best explanation is that investors' emotionalism has typically been high at this time of the year. They look back at a lousy year, shake off their pessimism, then become more optimistic as the new year approaches.

BRING ON THE VIDEOTAPE

For example, the Dow late last year zoomed up by nearly 22 percent from its September low, the Nasdaq shot up nearly 40 percent and Standard & Poor's 500 rose 19 percent. But the bullish exuberance proved to be irrational as the market plunged in early 2002.

The Nasdaq is again leading the rest of the market this year, soaring more than 30 percent in the past eight weeks.

Louise Yamada, managing director and head of technical research at Salomon Smith Barney, says investors will have to keep their eyes peeled for signs of what sort of animal might emerge on the Street: a bull or a bear.

The Dow's current gain of more than 20 percent from its Oct. 9 low qualifies for a bear market rally. Ditto for the S&P 500 -- also up over 20 percent from its Oct. 9 low.

"The average bear market rally for the Dow since 1896 is an advance of 19.4 percent, which has been followed by new reaction lows," Yamada says. "Since 1929, the average bear market rally for the Standard & Poor's 500 is 17.4 percent and for the Nasdaq since 1973, the average rally has been 29.0 percent."

Time for the bulls to take a sanity check?

For the week, the blue-chip Dow Jones industrial average gained 1 percent to finish at 8,896, based on the latest figures. The tech-heavy Nasdaq composite index added 0.7 percent to end at 1,479, while the broad Standard & Poor's 500 index rose 0.6 percent to close at 936.