Archived Comments``Markets can remain irrational longer than you can remain solvent."
--John Maynard Keynes

Detailed Comments Last Updated on Sat May 10 06:05:19 2003

Pre-opening comments for Monday, May 12th:
Stock & Bond Markets

Job Losses Continue

``Keep your fingers crossed,'' indeed. We certainly haven't seen much positive in the latest employment statistics. Yes, they are a lagging indicator, but you don't normally see jobs falling off at better than 100,000 per month in a recovery. John Challenger, keeper of much more accurate statistics than the government on jobs and the unemployment rate, says the real unemployment rate is 12.3%, not the paltry 6% the government says it is. That sounds more like it, since many job seekers lose their benefits and, though still as unemployed as before, and willing to work if they can find anything, drop silently and conveniently off the bean counters' spreadsheets.

At the current rate of layoffs, this consumer-driven economy (business leaders are hunkered down in cost-cutting survival mode only) may soon run out of gas. Just a glance at the headlines off a Google News search reveals these goodies:

  • Rise in layoffs dashes recovery hopes
  • Public Sector Layoffs on Rise
  • Layoffs at US firms grew 71 pct in April-report
  • I Want Your Job, Lady!
  • Too Worried to Take a Vacation

And, hunkered down executives know it, too. They are not only not buying shares in their companies, they are selling shares at the highest rate since last November, as this page at Thomson Financial Network graphically shows. The ratio of sells to buys in May so far is 12.07. It was 11.7 in November 2002 — the month preceding the December 2 top in the stock market. This is not bullish by any means.

The highest — and most bearish — sell/buy ratio occurs in the large-cap sector (23.23). This confirms the technical picture of a weak large-cap market. Mid- and small-cap sectors are more reasonable at 5.06 and 4.75, but they're still on the bearish side. One way for investors to use such data is to take a balanced approach by selling short large-cap ETFs or stock index futures and buying mid-cap and small-cap ETFs or stock index futures. Although all sectors may go down (very likely), the big, bloated large-cap stocks are more likely to go down much more. And, if the market stages a rally, they are likely to go up much less. In either situation, a profit can be realized. In other words, only a sudden change of character where the large-cap stocks suddenly started outperforming would lead to a loss on the position. This is what they mean when they call it ``stacking the odds in your favor'' — or, heads you win, tails you win — the coin falls through a crack, you lose.

For everyone who misses the late, great stock Bubble of three years ago, it's b-a-a-a-c-k! Last week had all of the froth of 2000. Intel reported they might have some problems ahead — the stock surged higher. Let's see: Intel, the former high-flyer, is now stuck in a commodity market (computer chips) where the revenue is falling at 5% per year (that's called deflation or, in FedSpeak, falling inflation), so they bid up the stock price in anticipation of . . . . a miracle? If this isn't a reflated Bubble, it certainly is a reasonable facsimile thereof. Maybe the Fed has panicked and is buying shares to shore up the economy. Don't laugh, the Japanese are doing it — they passed the $1 billion mark in March in shares purchased. But, it hasn't prevented the Nikkei from continuing down through the sub-basement.

This week we have more options fun-and-games. After eliminating call time premium last week, it appears option short sellers are bent on eliminating put time premium this week. We expect little more than a narrow trading range into expiration Friday.

Looking back in history. It was exactly a year ago, option writers staged a big rally, got everybody bullish, and expired all those May 2002 calls and puts worthless. The week thereafter, the raft went over the crest of the waterfall and didn't stop falling until July. Will history repeat? Possibly, but definitely count on it rhyming!

Sentiment, at least amongst OEX and QQQ options players, has yet to really get that frothy. These intraday zigs and zags seem to be keeping players edgy. But, intermediate term sentiment is about as frothily bullish as it can get with the Investor's Intelligence number hitting 56% last week. The bearish percentage was only 24%. With such a preponderance of bulls on the deck of this ship, capsizing is a definite possibility. Don't those brand-new, baby bulls realize the market cannot go up if everyone is on board? By the way, one year ago, just before the market went into a three-month waterfall decline, there were about the same number of bulls and more bears than there are right now.

A background bearish factor is the US Dollar, which is plunging. Some folks at Morgan Stanley say fair value for the buck is 80 on the US Dollar Index (the index closed at about 95 last week, well off its high of 121 made 10 months ago). However, typically securities markets move like a pendulum with fair value being the lowest point in the swing, but also the highest velocity point as well. In other words, If we release a pendulum at 121 and it swings down to 80, it should keep on going to about 40 before it finally reverses course. There aren't many foreign investors who would be willing to see the buck that low and to continue to hold their US investments we wager. There's always hedging to eliminate the risk of the dollar going that low, of course. And, perhaps that's why foreigners have yet to really start selling in quantity in the US. But, it is a big risk factor that most bulls have been blithely ignoring recently.

Breadth — the plurality of gaining stocks over losing stocks, generally considered to be bullish if it's strong — may be a hook to fool the bulls into buying just before the market tanks. With the weakness in the blue chips and the strength in the small- and mid-cap sectors, a spreading strategy can be used to play the divergence (as we mentioned above). But, a long term indicator of breadth suggests it is a false hope for a new bull market: the McClellan Summation Index, which computes a cumulative advance-decline line, is near record highs here. The last time it was here? 1997, just before the market took a three-month swan dive into the deep part of the pool.

Anyone who is bullish here is just not paying attention. Or, they're paying attention to the Wall Street flacks who desperately want to sell them stock. Realize that no Congressional Witch Hunt is going to put a stop to investor greed, which inevitably is the emotion which results in huge losses.

Of course, we recognize that the Bradley Calendar says the market should be up for the next month. That's entirely possible, but we will continue to emphasize risk control via balanced positions (otherwise known as spreads) which make money whether the market is going up, down or sideways. We are working on refining a trading system which is oriented toward holding positions longer than a day in spreads — in other words, being able to get into a trend and stay with it, but also with the ability to take profits when they are called for. Not taking profits is like growing a garden where the land is tilled, seeds carefully planted and nurtured to maturity, fruit develops, but rots on the vine. This system will be quick to gather in the harvest in a profitable position, as well as to reverse course when the market says we need to. It will be designed to always be in the market, so there will be minor losses to contend with — that's the price you have to be willing to pay to limit risk. As soon as the system is ready for prime time, we'll be sure to let you know all about it.

Bonds soared last week as the market digested the implications of the Federal Reserve's statement following their regular meeting at which they decided to leave rates unchanged. The admission that deflation (``declining inflation'') was a problem that is worrying Fed officials confirmed the bond market's hopes that the economy was in worse shape that many of the Bushy Administration flacks said it was. Although short term rates don't have far to fall, the 10-Year bond rate is still above 3%, so there's room to get rates lower, which will help recharge the mortgage refinancing engine to inject funds into consumers' hands. After all, that's one of the few sources of motive power for this economy and we can't let that fire die out.

Euro Currency:

After breaking out a couple of weeks ago, the Euro paused only briefly and is accelerating higher. This mirrors the crash in the US Dollar we alluded to above. Note that a crashing US Dollar in 1987 precipitated the Stock Market Crash on October 19, 1987.

U.S. Dollar Index:

Will the US Dollar's crash precipitate another crash? All we can say is, most of the elements appear to be in place for just such an event. Foreign investors in US assets must be hedging their currency risk by selling the US Dollar Index short — otherwise, it seems highly unlikely that the plunging dollar would not have already precipitated a decline in US stocks. Of course, such hedging activity, which consists of selling the US Dollar Index contract short, puts downward pressure on the currency, leading to a self-fulfilling prophecy if enough market participants engage in it. That seems to be the current reason for the accelerated decline underway now. No bottom in clear sight, but we suspect there could be support at 91.38, the October 1998 low, then 80.05, the April 1995 low.

Canadian Dollar:

Like the Euro, after the Canadian Dollar broke above resistance, it has not looked back.

S&P Toronto Stock Exchange

Like US stocks, the Canadian stock market is in serious trouble here — and it shows it with bearish divergence not confirming new relative highs on this rally.

Australian Dollar:

The worldwide rush out of the US Dollar has caused the Aussie Dollar to accelerate higher, which is a mixed blessing. It imports deflation into Australia, making foreign goods cheaper, relatively, but also makes Aussie goods more expensive for export. For US investors in the Australian stock market, it means the stock market chart corrected for the strength and weakness of the currencies between the two countries looks really, really bullish. The chart is of EWA, the ETF for Australian stocks traded on the American Stock Exchange.

Australian All Ordinaries:

Well, that's the bullish side of things in Australia for this week, because the chart of the All-Ords in local currency is pretty bearish here. The market hit that downsloping resistance line in the daily chart and has simply rolled over and died. This canary in the mineshaft is warning stock market investors the air is getting pretty bad in this mine.
Australia Business News
Yahoo! Australia Business News

London Financial-Times 100:

Despite that little flurry midweek, the FTSE put in a pretty convincing performance of making a top.

CRB Index:

A plunging US Dollar helped levitate commodity prices last week. Corn prices zoomed over the red downtrend resistance line. At least a 50% retracement of the recent six-month bear trend should be achievable on this rally (for the July 2003 contract, that targets the 262 1/8 price level; the contract closed Friday at 252). With the Dollar in a virtual freefall, it may be time for commodities to retake center stage as the strongest bull markets in the US. However, Copper may be a big exception, since it depends upon a growing economy and that doesn't seem to be in the cards near term. A Time Ratio High due Tuesday would be the next timeframe to look for a trend change.