COMMENTS WEEK OF 7/05/99-7/09/99
|It was another day of ups
and downs, a day where the opposite of the expected dominated, a day of stellar earnings
and selling on the news, a day of rallying bonds and sinking brokerage stocks, a day when
the expected failed to deliver.
It was a day
when hopes for a sustainable summer rally continued to fade into the sunset. The much
hoped for earnings season driven rally is failing to materialize. Stellar earnings by
General Electric and Yahoo! have been greeted with profit taking rather than further
buying, a scenario which is likely to continue throughout earnings season. With the
majority of market participants having already placed their bets on the side of
superlative earnings before earnings season, there is no one left to enter the market and
push prices higher when the good news is announced.
When expectations for the best of all possible worlds are
at a fever pitch, any disappointments can lead to a mass race for the exits. We have
seen this vividly played out in the case of Waste Management, Visio, and New Era
With hopes for an earnings fueled rally rapidly
dissipating, the market's movements will be left increasingly at the whim of the bond
market and each economic report in the coming weeks. Next week's CPI, PPI, and
Retail Sales data will determine the next path taken by the market. The odds that the next
path taken will be down the hill, rather than up, increased with the release of June same
store sales data, which showed that the consumer's urge to splurge is continuing to rage
on at full force. We would pay close attention to next week's retail sales figures,
and expect a surprise on the upside.
As danger continues to increase, economic data once again
takes center stage, and the rally's breadth continues to narrow, caution continues
to be the best course of action.
|Judging by the day's
headlines alone, we should have been inspired to dream of higher prices ahead: The major
averages rallied to new highs, Alcoa beat estimates by a penny, General Electric surged to
an all time high on pre-earnings euphoria. We weren't inspired.
Yesterday's headline grabbing new highs in the major averages and
bellwether GE obscured the true picture of the market: overbought and holding a stack of
party invitations with no one in sight to give them to. Everyone who wants to put money
into this rally already has, and the pool of new converts to the cause who are needed to
keep the rally going is fast drying up. True, the Dow did move a step closer to its
rightful Labor Day home at 12,000, but someone forgot to give the rest of the market
directions to the path up Rally Hill.
Losers outnumbered advancers by a 3 to 2 margin yesterday,
and we think we've seen this same story played out somewhere before. It's called A
Narrowing of Breadth. The broad based advance is no more, and that spells trouble
for the expected summer long rally. After an initial relief laced buying spree
following the Fed bias error last week, the big money has moved increasingly to the
sidelines. In its place, the traditional last ones in and last ones out are now
piling into the familiar: the same narrow strata of well known blue chips and speculative
growth issues that they always gravitate to near the end of a move.
Rather than a sign of technical strength, we see
yesterday's new high by GE as a sign of weakness. Near the end of a rally, at that
point when dry rot has begun to gnaw away at the rest of the market, the big cap blue
chips keep chugging right along the rally trail because investor's tend to gravitate to
what they know best: the bluest of blue chips. If the transports had made a new high
yesterday, then you would hear us singing songs of market staying power, but they didn't
even come close, because like many stocks, they've been left behind to breathe in the
exhaust fumes of a narrowing group of surging stocks.
Signs of underlying trouble also appeared on the earnings
front. The fate of Alcoa in the wake of its better than expected earnings report is a saga
that we are likely to increasingly see played out as this earnings season progresses. It
is a saga of a market which has already discounted the best possible outcome, and
needs the actual event to exceed the best of dreams if it is to move higher. When
everyone expects spectacular earnings and have already placed their bets before the event,
earnings must surpass the brightest of expectations in order to entice new investors to
push up prices. Alcoa's crime yesterday was it surpassed the consensus, but it
failed to impress the brightest of optimists.
The earnings season led rally that many are expecting to
carry the market to new valuation heights this month is unlikely to materialize, because
it has already occurred, and the best of all possible worlds has already been discounted.
This earnings season is more likely to bring disappointment than it is joy. Minor
upward blips will occur, but when everyone has already placed their bets on an expected
move, the ability of the move to sustain further advances is drawing to a close.
|Even the most uplifting of
events begins to lose its luster with the passage of time. In a market driven by 10
second sound bytes, the maximum shelf life of a crowd pleasing event has been reduced to 3
days, tops. Such was the predicament investors found themselves in as the last
vestiges of post FOMC bias change euphoria began to melt away and traders searched for
their next source of rally fuel.
short hunt, two new sources of inspiration soon appeared to ignite a morning rally: The
Sunday New York Times and Quotable Market Guru Ralph Acampora. A very positive story
on AOL's future prospects (prospects that include a CEO's wish to rank #1 in market cap)
in the Sunday Times ignited an Internet stock feeding frenzy that soon pulled the rest of
the market up on its coattails.
The rally was given added fuel after Acampora upped his
targets for the Dow to 12,000-12,300 by Labor Day and 12,500-13,000. When a Quotable
Market Guru speaks the buy orders pour in, and yesterday was no exception. Talk of
Dow 13,000 soon ignited talk of a different sort: talk of the Fed's reaction if the Dow
hit Acampora's targets.
With Fed fear once again in the picture, the institutional
money on an extended holiday, the bond market sinking, and only .Com enthusiasm holding
the market aloft, the urge to take profits soon overcame the urge to splurge, and what had
been a rally soon turned into a down day.
While the major averages finished the day on the downside,
sentiment continued its upward march. The CBOE Equity Put/Call ratio joined its
cousin VIX in the danger zone, ending the day at an alarmingly bullish .297.
With the equity put/call ratio and VIX flashing the
traditional warning signs of an onrushing top, the market enters earnings season with the
odds now stacked against it. The market has already factored in superlative second quarter
earnings, and in many cases has already discounted a beating of estimates. The mere
meeting of analysts' estimates will likely not be enough to propel the market higher.
We would pay close attention to trader's reaction to
Alcoa's earnings today and Yahoo's earnings after the close. The prices of both
stocks already factor in a beating of estimates. The market's reaction in the event
lofty "whisper numbers" are not met will be the key to the ability of the
current euphoria driven rally to continue. If the market is unable to keep its balance in
the event earnings expectations are met but not exceeded, then the current
"irrational exuberance" driven rally will soon turn into a savage correction.
|It was a typical summer
holiday weekend in our little town on the Hudson: concrete baking as temperatures soared
to over 100 degrees, the annual Macy's Fourth of July fireworks show over the East creek,
and perhaps most importantly for observers of the present day stock market, the 82rd
annual Nathan's Famous Hot Dog Eating Contest down at the Atlantic pond.
For those of you who are unfamiliar with our town's hot dog eating
contest, it is an annual rite where contestants gather at the Coney Island boardwalk to
gorge themselves on hot dogs: the winner this year eating 20 1/4 of the morsels in 12
minutes. The participants' desire for hot dogs knows no bounds, the ability to acquire
(eat) them is limited only by the ticking of the clock. The winner takes home a mustard
colored belt, and all of the participants return home with a severe case of indigestion
following their gastronomic feeding spree.
A desire to acquire, a feeding frenzy, a ticking of the
clock, and an inevitable case of indigestion--a description of the chain of events in this
past weekend's wiener bingeing contest, and a description that is equally applicable to
the present situation developing in major global stock markets.
After a brief one month respite, the desire to acquire, in
this case equities, once again knows no bounds. The stock market is once again seen,
by individual and professional investors alike, as "the only game in town".
The road ahead seems clear to all, with a global recovery and a benevolent Fed
helping to create one United Nations of Goldilocks, an environment in which the path to
eternal higher stock prices and prosperity has been unfettered from potential stumbling
The return of the days of wine and roses has brought with
it an unquenchable feeding frenzy for equities. "To not partake in the market
is to lose out on a chance for riches" is once again the mantra sung from rooftop to
The feeding frenzy has set in motion the ticking of the
clock. The widespread urge to splurge on equities is fast creating a dangerous sense
of complacency. In the wake of the Fed's severe error in judgement last week, the risk of
a serious market setback is now seen as slim to nil by many people who are rushing to put
hard earned money into the surging stock market. The inexperienced new breed of
"traders", who view the market's risk-to-reward ratio as 100% reward to 0% risk,
are once again leveraging their bets with margin without hedging for the inevitable risk
that is inherent in all trading situations. Extreme levels of bullish sentiment, and
the parallel decline in bearish sentiment are creating a situation in which the risks of a
trend ending emotional letdown are being multiplied with each uptick in prices. Each
surge to new highs in confidence, and the corresponding upward pressure applied to stock
prices, helps to create a situation in which today's benevolent Fed will be forced to
become tomorrow's Fed Bull Wrecking Crew.
The ticking of the clock has created an environment in
which the arrival of the inevitable case of indigestion is being hastened as each
new upsurge in sentiment increases the risks. The Volatility Index ended last week in the
danger zone at 18.85, a level last seen just before last summer's market decline.
The complacency surrounding the upcoming earnings season,
which kicks off with the release of earnings from General Electric and Yahoo this week, is
also increasing the dangers that today's smiles will turn to tomorrow's tears.
One potential monkey wrench in the sunny outlook for
corporate earnings which could make its presence felt is the strength of the U.S.
dollar. We expect the dollar's strength, and the corresponding record low in the Euro, and
3 year low in the pound, to impact the earnings of multinationals with heavy European
exposure going forward.
We would also keep a wary eye on the price of oil, which
has surged to over $20 a barrel.
The skies are bright today, there is little in the way of
economic reports this week to sully the outlook, but the risks that last week's feeding
frenzy will lead to a severe case of indigestion are rising.