“Say it ain't so Joe” . . . and that famous lament from the Chicago White Sox (later termed Black Sox) was all we could think of late last week. Clearly, our Black Sox reflection about the 1919 World Series' Shoeless Joe Jackson incident was driven by Sammy Sosa's corked bat episode of last week. Recall, penultimate batsman Ted Williams conducted an unscientific batting study decades ago and found that it wasn't the size, or the weight, of the bat that determined how far one could hit the ball. Rather, Ted discovered that the speed of the bat is what counts! Consequently, the lighter the bat, the faster the bat speed, which is why the much lighter corked bat was outlawed.
Recently, however, a corked bat has been at work on Wall Street, but in this case said “bat” is the excess liquidity in the economic system. Indeed, with the Fed pumping the money supply at an obscene rate (M1 growing at 25%+), a tax cut on the books, irregularly lower energy prices, a dollar dive, and some $3 trillion in money market funds, the resulting surge in liquidity has produced a “liquidity rally” in the stock market. The same can be said of the bond market, but our focus today is on stocks. Manifestly, liquidity rallies are very difficult to play because what you have is too much money chasing stocks to valuation levels that the fundamentals just don't justify. Difficult, indeed, because participants looking at the fundamentals typically get left behind, or worse yet, get “killed” because they are actually shorting stocks.
Plainly, the recent liquidity rally has lifted stocks to overbought levels, based on our breadth indicators, that are as overbought as they were in the spring of 2000. Consequently, we suggested in both our written and verbal strategy comments last week that participants should be looking for an upside blow-off with a “look” above 9000 due for the DJIA. Yet, determining the short-term trading peak of a liquidity rally is extremely difficult because it is just that, driven only by liquidity. Or, as one savvy seer opined, “On Wall Street it is either hunt or be hunted,” which implies either get on the right side of the market or be left out!
Since the “corked bat” effect has “hit” the stock market higher, and further (read: duration), than most expected, participants piled into the perceived “right side” of the market last week for fear of being left behind. And, we think that pile “in” effect hit its maximum inflection point on Friday. Indeed, the senior index (DJIA) opened sharply higher Friday morning in what looked to us like a blue heat blow-off. Now blue heat is the hottest part of the flame and if Friday morning's 172-point Dow Wow wasn't the hottest part of the flame, we would be surprised.
Still, we would not look for any big downside “let down” from here, since our notes show that markets almost n-e-v-e-r immediately collapse following an upside breadth stampede like that which we have seen over the past few weeks. Verily, what typically happens from a blue heat parabolic peak is a three- to five-session pullback and then there is another rally attempt. With that tendency in mind, and our sense that many folks have just plain missed this current rally, we think there will likely be buyers on the back-end of any three- to five-day correction. Moreover, with only 15 sessions left until quarter-end “report cards” are due for portfolio managers (PMs), the performance derby should keep the pressure on them to be fully invested.
Therefore, following the anticipated three- to five-session pause/pullback, look for on/off strength into quarter's end where the PMs will likely trust the blue chips, at the expense of their more speculative brethren, many of which have probably already seen their highs, as noted in this week's Barron’s by the astute portfolio manager Paul Wick. Come July, however, the real question should become, “Where does the excess liquidity go now?” Does it continue into stocks, bonds, and real estate? Or, is there a directional change when it becomes apparent that the hoped for robust H2:03 economic recovery continues to prove elusive as growth remains sub par and unemployment mounts?
Even more intriguing could be the realization that while everything currently appears to be working on the upside, the reality is that the U.S. dollar is buying less! Or, as one Canadian portfolio manager lamented to us over dinner last weekend, “Viewed in Canadian dollars, the S&P 500's perceived 12% year-to-date gain (in U.S. dollars) disappears!” Indeed, the question might be not which asset, but which yardstick (read: currency), since the powers that be have gouged the American saver (given the negative real returns of CDs and money market funds), and now it looks like they are going to try and gouge the foreigners (lower dollar).
The call for this week: We turned bullish at the end of February, albeit a few weeks too soon, suggesting that a rally of some import was at hand. Further, on April 16th, before we left for Europe, we opined that, “They will sneak the markets up on low volume and break the markets out above the 8522 reaction high with a confirming upside breakout by the D-J Transportation Average above 2264. That would turn the secondary trend of the stock market positive. It would also cause the pundits to declare this THE new bull market. Consequently (we said), when the pros return next week the upside breakout should panic them into stocks, lifting the market toward Ralph Bloch's 8800 target, and possibly more. (We continued), While we continue to think this is nothing more than a rally back to the top of the envisioned trading range, a breakout above 8522 would suggest at least a move to 8800 and that, ladies and gentlemen, is enough to trade.” Last week's missive suggested that an upside blow-off was in the works with a “look” above 9000 due for the Dow. We think you saw that early Friday morning. Still, the trend should be on/off strength into quarter's end! We'll see!
June 9, 2003
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