On
the eve of the last FOMC meeting of the decade, a little profit taking and
a minor case of the rate jitters were to be expected. In the midst
of a euphoric momentum driven surge, another new record high was in
order....and the market delivered on both counts on Monday, with the Dow
Industrials squandering an early lead to end the day down 113.16 at
1144.27, yields on the long bond shooting up to 6.44%, and the NASDAQ
adding another 30.83 to close at yet another record high.
Although the NASDAQ Composite scaled to
new heights of excess today, the index's ability to maintain its lofty
levels is in doubt. The sprightly duo of euphoria and momentum are showing
no signs of tiring from their quest, but they will soon have to toil
without the aid of one of their prime ally's: the window dressing
portfolio manager.
End of year/quarter portfolio moves, or
window dressing, by fund managers have contributed significantly to the
NASDAQ's narrow surge. Now, while we have always regarded end of quarter
window dressing as a quaint exercise in futility (The customer's first
concern is the value of his fund holdings, and if those holdings drop 5%
in a quarter, it is unlikely that the customer will be appeased after
looking at the "hot performers" the fund manager has added days
before the quarter's close), it does serve its purpose during periods of
unbridled enthusiasm by giving an added boost to the crowd's favorite
basket of stocks.
Subtract the year-end boost provided by
fund managers, and replace it with a bout of first-of-year selling by
investors who have been waiting until after January 1st to take their
profits, and the NASDAQ Composite could be in for rough sledding in the
first half of January.
Of course, even without the withdrawal
of window dressing fund managers and the addition of capital gains tax
delaying tech stock investors, the odds are mounting against the narrow
band of tech stocks that have accounted for the lion's share of the
NASDAQ's recent gains remaining at their current lofty levels.
The silent army, the legion of the
bubble popper, is waiting in the wings, looking for the first opening to
make an unexpected attack. The leaders of this army are none other
than its current heroes euphoria and momentum, along with their pals bad
breadth and equity inflows.
The increasingly narrow breadth of the
NASDAQ's advance, with decliners leading advancers by a margin of 27-20 on
the NASDAQ last week, increases the burden that the market's current
leaders must bear. The widening gap between the haves and have nots,
and the increasingly narrow flow of money into the market, has
exponentially increased the vulnerability of the current crowd pleasers to
the unexpected.
In the event of the unexpected, there is
no where to go but straight down, NASDAQ's parabolic rise has left it
riding on a cloud far above the nearest support levels. While
technology shares continue to benefit from money flowing into them, with
the most recent data from AMG Data showing investors pumping another
$811 million into tech funds last week despite a $9.1 billion net outflow
from equity funds, this money will turn on a dime and run in the event of
a crack appearing in the euphoric technology juggernaut.
We continue to believe that we are
witnessing an end of trend blow off top. If the history of excess
holds true to form, the current euphoria and upward momentum which have
lifted the NASDAQ parabolically will become its worst enemies on the way
down as the pendulum of market sentiment follows its historical course of
overswinging to the opposite extreme.
In the event of a breakdown of the
current market leadership, there is no clear contender to step into the
leadership role and cushion the blow of a decline. Small cap stocks
are heralded by many as a contender but their recent performance, when
combined with their lack of crowd appeal and the recent large-scale
outflows from small cap funds, make them little more than a pretender.
No, rather in the event of a serious
stock market break, it will likely be this week's arch villain, the
Federal Reserve, who is forced to once again step in to soften the blow.
While we expect the FOMC to bow to
pressure and unwisely leave rates unchanged at tomorrow's meeting, thus
giving euphoria one more month in the sun, we do expect them to attempt to
put a damper on unbridled enthusiasm and complacency by shifting towards a
tightening bias.
Any negative side effects of a move to a
tighter bias are likely to be limited. The stock market will repeat
the pattern of the Summer and Fall: a momentary lapse into sorrow, an
acceptance of the inevitability of a quarter-point rate hike bump, and
then an ensuing period of upward bound complacency-- a pattern that has
allowed demand to remain on an upward slope despite the Fed's efforts to
rein it in.
At some point next year, the Fed will
have to take decisive steps to break the continued overheating of the
economy. We continue to believe it will take several more interest
rate moves by the Fed before the effects of interest rate hikes counteract
the positive push given to demand by the wealth effect.
Now, of course we could be wrong about
there being several more rate hikes waiting in the wings next year--wrong not
because this truly is a "New Era" and the rules of the game have
changed thus negating the need for higher rates, but rather wrong because
history repeats itself and there's a whole legion of people who haven't
learned from their past mistakes...as a headline on the front page of
Monday's Financial Times illustrates: "Standard & Poor's puts US
on 'credit bust' alert".
