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MORNING COMMENTS WEEK OF 7/26/99-7/30/99

 

7/30/99

Amidst the gloom of yesterday the bright spots were few and far between, and  the few glimmers of hope that did appear were of the "sigh of relief, it could have been worse" variety.

The long bond provided the day's lone technical bright spot with its successful test of, and rebound off, the key 6.11% yield level.  The Dow's and S&P's bounces from their lows eased the pain felt by many yesterday but were not enough to prevent the two averages from finishing the day below their respective support levels of 10860 and 1343.

The day's minuses far outweighed its pluses however, and perhaps the largest negative of the day was the relative calm seen throughout the trading session.  Volume remained light, and panic was noticeably absent--both events signaling that yesterday's recovery from the lows did not mark a bottom.

The number of buyers has dwindled, but there has been no rush for the exits.  While fear has crept in and out of the market on a day by day basis depending on the direction of the day's price movement, complacency still remains at high levels.

Last week's post Humphrey-Hawkins selloff did little to instill fear in individual investors, instead the market's drop was seen as a chance to "get good stocks cheap by buying on the dip".  Investors poured $5.4 billion into equity funds in the week ending Wednesday according to the latest figures from AMG Data62% of that money flowed into growth funds, the very sector of the market that is likely to see the sharpest declines as P/E ratios

Today's economic data has done little to dispel our belief that the Fed will act sooner rather than later.  Today's personal income figures showed their largest gain in 7 months.  The pickup in personal income, combined with the drop in inventories in yesterday's GDP report, points to a pickup in growth during the third quarter.  We are likely to see third quarter GDP once again approach 3.5%-4%.

The expected pickup in third quarter GDP ,when combined with the drop in the rate of productivity growth that yesterday's GDP figures implied, and the upward pressure on wages that yesterday's ECI implied, signals higher interest rates ahead.

Today's Chicago Purchasing Manager's Report, which came in at a higher than expected 60.5, also added to the picture that is developing of an economy that shows no signs of slowing in the coming months.

The strength of today's economic data has erased yesterday afternoon's bond market rebound, with yields rising to 6.12%.  Next week the market will have 3 key economic reports to digest, with traders living precariously report to report, hoping for a glimmer of hope.  While either Monday's NAPM or Friday's Employment Report could provide that needed ray of sunlight, the deceleration that we  expect in Thursday's Productivity numbers will increase the likelihood of a Fed hike.

7/29/99

The second episode of Greenspan on the Hill proved to be a carbon copy of the last time around, with little in the way of new news offered to move the markets.

The stock market's response was muted with only NASDAQ, led by an increasingly narrow group of stocks, able to mount a significant rally.  The overall market's internal technicals continued to send out warning bells yesterday, with a severe case of bad breadth, a loss of momentum, an advance/decline line within striking distance of its lows, and a developing leadership void raising doubts as to whether the market's two day recovery would amount to anything more than a dead cat bounce.

Also adding to the negative technical picture yesterday were continued weakness in the Dow Utilities and the Dow Industrials second straight failure to close above its former support level, now resistance, at 10985.

The question of whether the stock market's 2 day recovery was merely a dead cat bounce began to be answered in overseas trading last night, and the answer that emerged was a resounding yes.

A higher than expected 3.0% jump in Japan's June Industrial Production figures sent Japanese stocks higher and caused the dollar to sink to a 5 month low against the yen.  The assault against the dollar continued in Europe, with a jump in French business confidence and an upward revision in U.K. first quarter GDP pushing the greenback and the S&P futures lower.

 This morning's eagerly awaited U.S. economic data put the final nail in the coffin of the market's 2 day recovery.  While GDP rose at a less than expected 2.3% (estimates were for 3.5%), the Employment Cost Index surprised on the upside, jumping 1.1%, its largest gain in 8 years.

Today's data increased the odds that a rate hike will occur sooner rather than later.  The tightness in the labor markets is now exerting an upward push on wages, and with that rise the prospects of an acceleration of inflation in the broader economy.

Today's GDP figures, while at first glance benign, will also add to the pressures on the Fed to act at its next meeting.  Falling inventories knocked 1% off GDP last quarter, and the fall in inventories sets the stage for growth to pick up once again as inventories are replenished.  The closely watched GDP deflator rose at a higher than expected rate of 1.6%, again pointing to signs of a pickup in inflationary pressures.  The manufacturing sector also showed signs of an acceleration in its recovery, with spending on durable equipment rising by 15.3%, compared to 9.5% in the first quarter, while at the same time the pace of growth in productivity slowed.

With earnings season winding down, and inflationary pressures rearing their head, the market's ability to rally has been pulled out from under it.  At this point, the stock and bond market's only remaining hope is a reversal in the dollar's recent slide, an event which we view as unlikely.

The recent record trade deficit figures pointed to a dollar that is 5%-7% overvalued.  The pickup in overseas growth will continue to exert downward pressure on the dollar, and concerns about the U.S. stock market will only add to the dollars woes.  We expect to see a pickup in the pace of the repatriation of foreign money, a scenario which bodes ill for the U.S. stock and bond markets, and increases the risk that the sharp declines in equity prices seen last August will be repeated this year.

For today, we would watch the support levels of 10860 on the Dow and 1343 on the S&P 500. If the Dow closes below support today, a swift retest of the 10440 level is likely, with a breach of that level leading to a testing of the 200 day moving average at 9800.  The key figure to watch on the long bond today is 6.11%, with a move above that level leading to a rise in rates to 6.20%.

7/28/99

Another week, same prepared speech as last week, different audience, same message.  The market once again awaits the words of Alan Greenspan, and once again the result is likely to be disappointment.

While yesterday's dip in consumer confidence from a 30-year high, and today's weak durable goods orders have once again rekindled hope among many traders, a hope that springs from a vision of an economy that slows from its own volition without the need for Fed intervention, Greenspan is unlikely to  once again refuel the stock market's dwindling supply of euphoria.

The question and answer session of Greenspan's Humphrey-Hawkins testimony  today will hold the key to the market's next move, and we expect Greenspan's answers to maintain the evenly balanced, but hawkish in tone stance that was exhibited last week.

Little has changed since last week. The week's major news thus far has provided little ammunition for either the dovish or the hawkish:  a lower than expected durable goods report and a fall in consumer confidence have been counterbalanced by a sharp jump in existing home sales and the dollar's slide against the euro and yen.

The key for the bond market today will be Greenspan's thoughts on the dollar's slump.  If Greenspan views the greenback's recent weakness as only a temporary blip on a still upwardly pointing path, the bond and stock markets will rally.  If Greenspan instead voices the opposite opinion, focusing on a recovery in overseas markets and a record trade deficit, a steep fall will be in order.

We do not believe Greenspan will give either the bond and stock markets, or the dollar  a second chance to rally, he likely learned his lesson after announcing a change to a neutral bias last month.

The day begins with uncertainty the ruling emotion, a state of affairs in which it will likely end.  Consumer confidence will have to dip further, the trade deficit will have to narrow, and tight conditions in the labor market will have to ease before Greenspan once again gives the stock market a reason to rally.  

7/27/99

Rate hike jitters, uncertainty, and a lack of participants dominated yesterday's trading, with the Internet stocks and big cap techs continuing to suffer the heaviest damage.

The Dow successfully held support on a closing basis for a second straight trading session, closing 2 points above support, while the S&P 500 also finished the down day 2 points above the 1345 support level.

Today, aided by the combination of stronger overseas markets and a rebound in the beleaguered dollar, the S&P 500 futures are up 10 points shortly before the open and the market will rally from the opening bell.  We expect pre-Greenspan part II jitters to once again step to the forefront late this afternoon, limiting the day's gains.

While the markets will likely close above support again today, we would not take it as a sign that a bottom was put in place yesterday.  The necessary conditions for a bottom were noticeably lacking yesterday: namely the lack of a panic driven surge in volume as traders rush for the exits.

Short term sentiment has been damaged, but the damage thus far has been of the garden variety mild concern type rather than of the  rampant paranoia stock-o-phobic sort typically needed to signal a bottom.

Long term sentiment remains firmly bullish, with individual investors remaining upbeat about the market's prospects.  Money continues to flow into mutual funds, and the percentage of bearish investors remains low, 22% in the latest A.A.I.I. poll.  Complacency has been dented, but still remains the overriding emotion.

The fear currently evident among many institutional investors will have to spread to the retail investor before the necessary conditions for a sustained rebound are in place, and that will take time.

The Internet sector, which will likely rebound in today's trading on the strength of eBay's smaller than expected decline in earnings (earnings fell from 5 cents to 4 cents, analysts were looking for 3 cents), has also not yet made a bottom.  Sentiment in the sector has turned negative, but panic has not yet set in.  The Internet IPO market remains strong, a condition which will have to reverse before a buying opportunity is once again at hand in the sector.

Expect a morning rally today (the Dow is up 65 and NASDAQ up 52 in the first ten minutes of trading), but don't grow complacent as a result of today's rally. After a one day respite, uncertainty will once again return to dominate as Greenspan's Humphrey-Hawkins testimony and Thursday's spate of economic releases take center stage.  

In any down trend, countertrend rallies are common occurrences, fooling many, but the downdraft remains intact until  panic fully gains the upper hand, and panic is still a distant speck on the horizon at this point of the market's correction.   

7/26/99

Summertime:  a time of days at the beach, a time of steam rising from the sweltering concrete of the city's streets, and a time when the markets begin their annual four month swoon, a time when the year's easy money has already been made.

Historically, a strategy of being fully invested from late October to late June-early July, and then moving to a 100% cash position during the July-October period would have paid off handsomely in more years than not.   This year is shaping up to be yet another year when heeding the time tested strategy would be wise.

To a contrarian, the warning signs that trouble was brewing in the markets and this year's top was fast nearing have been coming hard and fast the past 3 months: plans to invest social security funds in the stock market, the extreme euphoria among Internet stock investors leading up to April's peak in the sector, Goldman Sachs May IPO, the extreme euphoria exhibited by investors following the Fed's misinterpreted change in bias.

Perhaps the greatest warning bell of all sounded on Friday however, and the signal to head for the air raid shelters was sounded by none other than Dick Grasso, head of the NYSE, in an interview with CBS MarketWatch. The headline of the story?- "NYSE Aiming at November IPO".

When the public rushes to jump on the latest stock market fad, whether it be early 90's biotech stocks or late 90's Internet stocks, we merely take it as a warning that the end of the fad is approaching and hedge our bets accordingly to minimize the downside risk.  When the insiders begin to sell however, it  often signals that the last possible exit has been reached, and the time to sell is at hand.  When the insiders seeking to cash in their chips are members of NASDAQ and the NYSE it is more than a warning.

As this week begins, remember that although an intermediate term sell signal has not yet been given by any of the 3 major averages, the warning signs of trouble ahead are in plain view.

To loosely quote an idea echoed by Warren Buffett, "A seller sells when the optimal price can be obtained, when the time is right".

While we regard this as a time to lighten up exposure to U.S. equity markets  and to raise cash, it is not yet the time to foolhardily "short the entire market".  Technical confirmation of the beginning of an intermediate term down trend is needed first.

While the final technical confirmation to go short has not yet been given for the U.S. market, it has been sounded for several overseas markets, with Italy and Hong Kong leading the list.

Several other European markets are also on the verge of giving signals to move to a position biased to the short side: Germany, where a break below 4980 is needed; Spain: a break below 9500; and the U.K.: where 5995 is the downside trigger. 

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Last modified: April 02, 2001

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