MASTERING
THE TRADE
ORIGINAL, INTERACTIVE SEMINAR ON TRADING USING
TECHNICAL ANALYSIS 

 SEC FILINGS

The Dow gained 112.39 to 10197.70 and the S&P 500 added 17.11 to 1344.00.  Market breadth perked up on the day, with up volume outpacing down volume by a margin of 2 to 1.  The improvement in breadth brought many a pundit out of the woodwork to proclaim that a broadening of the rally was at hand.

We wouldn't start digging the grave for bad breadth just yet however.  The Russell 2000's gains lagged the big cap averages by a mile, and the index continues to run into a brick wall at the 400 level.  Figures released by AMG Data Services yesterday throw further water on the belief that the small caps will join in the rally.  Equity fund inflows over the past week totaled $3.36 billion, with 84% of the money going into large cap growth funds. Unless Economics 101 and the basic laws of supply and demand have been repealed, the figures point to a continuation of the current narrow rally and not to a broadening.

That aside, the continued strength of the old-line brokerage stocks indicates the market is unlikely to fall off a cliff just yet. Yahoo and the Internet stocks might get the press, but bellwethers they're not.  For a true leading indicator you need look no further than Merrill Lynch (NYSE: MER), which continues to power higher.  We would keep a close eye on the stock over the next few weeks.   Peaks in Merrill Lynch are usually followed in short order by tops in the overall market. Insider trading in the stock has been relatively benign of late, in stark contrast to the heavy net selling that preceded last July's price peak.  When the stock's current runup ends, take it as a warning for the rest of the market.

While stock and bond traders cheered yesterday's 50 basis point cut by the European Central Bank and 25 basis point cut by the Bank of England, we have a sneaking suspicion that the exhilaration was a wee bit premature.  Previous cuts by the BOE have done nothing to stir the stagnating U.K. economy.  The rate cut by the ECB will lift spirits, but it does nothing to address, or cure, the problems that have caused the German economy to slip into the initial stages of a deflationary spiral.   Interest rate cuts, as 1990's Japan has shown, are not magical cure-alls.   Until Germany addresses the structural problems that are hindering its exporters ability to compete effectively with companies from lower cost nations, the German economy will remain mired in a slump.  At this point we have yet to see any German political party step forward and be willing to take the politically unpopular measures that will be necessary to address the country's high cost basis.  Until a party is willing to face near certain political death at the polls by tackling Germany's high labor costs, the country is likely to remain a shackle on European growth.

The Transports, Utilities, and Russell 2000 all ended the day on the downside.  The Utilities took the hardest hit, despite a strong day for bonds, and are once again brushing against the 293 support level.

Another surge by the Internet stocks helped NASDAQ buck the trend and gain 3.09 to a record close of 2563.15.  For the third straight day, a rise in the index couldn't prevent an ugly NASDAQ advance/decline line from getting uglier, with declining issues swamping gainers by 889.

The continued deterioration of the advance/decline line continues to worry us, but as we've said before it will take an event that causes a change in the public's sentiment to signal the end of the market's current trend. A signal given by a technical indicator such as the A/D line will not be the event that causes a shift in crowd psychology. The major averages are being driven higher at this point by the lethal combination of inexperience (we include here both investor's new to the stock market and analysts who skipped the class on such "archaic" fundamental indicators as P/E ratios and P/S ratios) and a fear of "missing out on a sure thing, guaranteed money making opportunity." 

When investor's choose a mutual fund, they tend to gravitate towards those funds that have shown the best return during the past year. The disclaimer, "past performance is no guarantee of future results", more times than not, goes unnoticed or unheeded.  The same phenomenon is currently happening in the stock market, where the magnetic pull of large paper returns is proving to be an irrestible lure for incoming investor funds. The large equity flows into the big caps and the Internet stocks help to drive prices up further, and the rise in prices creates a false sense of security in the investor--a  false perception that the investor has mastered the market, that making money in the stock market is a given, that it is easy.

We have seen this same chain of events unfold many times in the past, and always with the same unfavorable end results. Investors who make money in a market or sector that has doubled or tripled in a matter of months are often unable to see that "a rising tide lifts all boats", and instead are often left with a dangerous sense of self confidence in their trading ability.  When the tide goes out, these investors or traders are unable to adapt because they have not acquired the necessary skills.

The Dow Industrials, S&P 500, and NASDAQ all finished at new closing highs.  The Dow gained 174.82 to 10,007.33, with the S&P 500 tacking on 27.40 to close above the important 1318 resistance level at 1321.12.  NASDAQ gained a misleading 66.73 to finish at a record 2560.10.

We use the word misleading to describe yesterday's NASDAQ surge because for the second straight day, the index rallied while declining issues led advancers.  The NASDAQ has now rallied 99 points in two sessions (the equivalent of almost 400 points in the Dow) and declining issues have led advancing issues by 490 over that span.

Breadth on the NYSE yesterday was also narrower than we would have liked to see on a day when the major indexes gained nearly 2%.  Advancers led decliners by a margin of just 383 issues on the Big Board, new lows outnumbered new highs 81 to 73, and volume remained weak at 697 million shares.  The percentage gains in the Transports, Utilities, and Russell 2000 were half those seen in the blue chip indexes.

The continued concentration of new public buying in a handful of big cap blue chips and speculative Internet issues, while insiders and NYSE members are selling, continues to mirror the patterns seen at prior tops.  Just as at past major market turning points, it is an extreme degree of positive sentiment by the public towards the prevailing trend that is fueling the last legs of the market's move. It will take a crack in the public's affection for stocks before the final top is in place for the blue chip averages.

Market participants return to work this week with smiles on their faces and S&P futures up strongly after Friday's employment numbers came in weaker than expected. Nonfarm payrolls grew by just 46,000 in March and average hourly earnings growth slowed to a 3.6% annual pace.  While the weak showing will temporarily remove the fear of a rate hike, it should be noted that the numbers were skewed to the downside by severe March weather.   One month does not make a trend.

With fears of a Fed tightening on the back burner (until the release of Friday's PPI numbers), the market will shift its focus to earnings. Sentiment remains at extreme levels, and any news that meets expectations will be greeted as a positive by traders. We expect the market to rally during earnings season as companies meet lowered forecasts.

The bullish sentiment of traders, and of the consumer sector (where sentiment is at an eight month high and has risen every month during the market's rally from the October lows) will likely be tested during the second quarter however.  The profits of the big cap multinationals, the stocks which have led the market's rally, will likely come under increasing pressure as the quarter progresses.   A sharp slowdown in European growth will remove the one international bright spot for many big caps.

We believe the effects of the slowdown in big cap multinational growth will be large enough to finally put a dent in the excessive bullish sentiment which has built up in recent months.  The extreme levels of bullish sentiment currently in the market have allowed the myth of, and belief in, a Goldilocks economy to obscure the reality of negative corporate profits growth.

Recent figures paint a picture of the health of corporate profit growth that is in stark contrast to the belief  held by many adherents of the "new paradigm, new era" economy.  Last week's final revision of fourth quarter GDP showed a decline of 2.2% during 1998 in corporate profits.  The profit decline was the first since 1989   The release of the latest Fortune 500 survey this morning only added to the disturbing picture.  The profits of Fortune 500 companies fell 1.8% in 1998, the first decline in 7 years. 

The market has been able to ignore shrinking profits up to this point, but a second quarter profits slowdown in the big name stocks which have led this rally, will likely make traders and investors sit up and take notice.