| Read Jack's "diary" of life in Washington, DC after the terrorist attack. Click here. |
My tech stock "safe" signal is still stuck at 0.0 since none of the major tech companies is yet publicly claiming that they have evidence (other than "hope" or "hints") that their business has started to accelerate out of the tech downturn. My "safe" signal requires at least 20% or 1 out of 5 of the top 25 tech companies to signal acceleration. Expect at least two quarters to elapse from the time of the first indications of an upturn and the return of solid growth. The theory is that the stock market should begin a sustainable rally six months in advance of the return of strong growth. Despite recent events, I continue to peg Q2 (May or June) of 2002 as the timeframe for the return of relatively strong growth for the bulk of the tech sector.
Current short-term economic outlook: Recent events will cause a sharp drop in economic activity, but those effects may be short-lived as pent-up demand needs to be satisfied. The economy will be completely up in the air until mid-October. November and December may show the beginnings of recovery, but only to the extent that the "response" to terrorism does not continue to drag down the economy. To get the "pulse" of the economy, focus on employment, income, and advertising spending. The government issues unemployment numbers every Thursday. But, don't waste time with these numbers until after mid-October (end of this week) when the new wave of layoffs peaks.
Friday's Nasdaq action was probably mostly just "squaring" of positions by short-term traders in advance of the weekend: shorts buying and longs selling. The fact that Nasdaq was up suggests that there had been more shorting than buying going during the week.
The Consumer Price Index (CPI) report for September showed that the Fed does not need to worry about inflation for now. Energy prices had spiked up, but have already reversed. The only really disturbing part of the report is that health care costs continue to climb faster than overall inflation. Still, I'd rate this a neutral report since it neither helps nor hurts the economic outlook.
The Economic Cycle Research Institute (ECRI) Weekly Leading Index (WLI) for the week ended October 12, rose to 115.5 from a revised 114.9 the previous week. This is an improvement, but too small to be worth celebrating. Still, it was a positive report. The WLI six-month growth average is still declining, but given all that has happened, I would not let all that ancient history discount current progress. This report was a surprise, even for me. I am anxiously awaiting this Friday's report as it will be the first that covers only the period after October 15, my hypothesized "turning point".
The U.S. Trade Balance for August improved more than expected. Actually, it's still a trade deficit, so we say that the trade deficit shrank. Exports grew unexpectedly and imports shrank. This was a positive report.
The bottom line is that the economic news on Friday was not too bad.
The CBOE Market Volatility Index (VIX), which measures the level of anxiety in the market, FELL 4.07% on Friday to 35.84, which is still up in the very high anxiety zone. VIX fell a little on the open but quickly rose up into the 37.75 range and stayed there until just before 1:30 p.m. when it began to fall sharply and steadily right into the close. This is a nice improvement, but the high level still suggests that people are very concerned that "something" COULD happen and result in a sharp fall in the market. Basically, VIX reflects the degree to which people are buying "portfolio insurance".
The Nasdaq-100 After Hours Indicator fell 1.54 points in the Friday evening session. That would suggest that people didn't view Friday's gain as very "durable". Basically, there was no sign of optimism.
Fed Funds Futures suggest a 100% chance of a quarter-point cut in interest rates at the November 6 FOMC meeting. The chance of a half-point cut is 25% (up from 20%). The chance of a quarter-point cut at the December 11 FOMC meeting is 60% (up from 50%). The likely scenario is a quarter-point cut at both meetings.
The New York Stock Exchange Member Firms report on Customers' Margin Debt for September showed a decline of 10.2% from August (from $161.13 billion to $144.67 billion). Margin debt is now at its lowest level since December of 1998 ($140.98 billion). Cash in margin accounts rose 11% (from $103.99 billion to $115.45 billion), the highest EVER. That's a lot of cash sloshing around, waiting for "a sign".
The launch of Microsoft (MSFT) Windows XP is on Thursday, October 25, so traders could use it as an excuse to move the stock up even though the short-term impact of the release is nil. Actually, it's not nil, but negative since the launch is very expensive.
There are two key questions that all investors must decide for themselves. First, do stock prices currently discount enough of the uncertainty of the "war". And, how much worse will business get before it starts to rebound.
This week will probably be a classic apples versus oranges tug-of-war. The bears will focus on the "bad apples": lousy Q3 reports, lousy Q4 outlooks, anthrax "jitters", escalation of the "war", etc. (Is any of that REALLY new news?) The bulls will focus on the "sunny oranges": where the business outlook will be in six months. I don't think there is any doubt that business will be on the rebound in six months. The question is what level will business be rebounding from. Some will suggest that the rebound is already underway. Others will suggest that the rebound won't start until Q2. As usual, the truth is probably in the middle, say January or February.
The market reaction to the news about ground operations in Afghanistan could be mixed. The cynics will continue to view any news of conflict or escalation as a negative, but others will view it as positive progress. The news from "the front" will ebb and flow over coming months, so gradually the market will adapt its own "style" for reacting to each increment of news. And investors will adapt hedges to cope with those market reactions.
I view the high level of VIX as suggesting that many investors are placing a bet that "something" will happen to cause the market to drop precipitously. Eventually, all this "stuff" will sort itself out, but for the next few months there will be plenty of events, false alarms, false dawns, and scares to keep market participants on their toes. This is a great environment for long-term, buy-and-hold investors: there will be plenty of "dips" that can be bought. Any current panic or hysteria will not last for an extended period of time.
The potential for additional terrorist attacks is very real and their impact simply unknown. They could be biological or chemical in nature. Or they could be simply the taking and harming hostages anywhere in the country or wherever in the world American tourists can be found. Whether the anthrax "scare" was in fact the second wave is unclear. In any case, another wave of attacks is very possible at any time. Their magnitude could be less or more than previous attacks. Some of the potential attacks will be detected and thwarted and others may happen despite our best efforts. Some may be as feeble as the recent anthrax attempts, but others could be more effective. The potential for terrorist attacks was well known, but mostly ignored, long before September 11. The most important thing for any of us to do is to just keep on living our lives as normally as possible. That's the only thing that can prevent any terrorist attack from succeeding at its primary goal of instilling terror. If the "war" seems to be going too slowly, we just have to be more patient. The market doesn't know how to be patient, just how to go up and down frantically. But in the end, patience will be rewarded many times over.
I went out to the Pentagon City mall on Saturday afternoon and it seemed rather busy. The restaurants I dined at Friday and Saturday night were fairly busy. My Sunday dinner restaurant was as packed as I've ever seen it. So, as far as I can tell, "the economy" is coping with the terrorist threat fairly well.
Since it's Monday again, I'll be making my weekly dollar-cost averaging (DCA) purchase of S&P 500 Tech Sector "Spider" (XLK) LEAP call options. I think I'm going to move out to the 2004 LEAPS rather than the 2003 LEAPS since the volatility premium is relatively small. As the market trades in a narrower range, the volatility premium gets smaller and smaller (i.e., cheaper). But when the market does begin rallying stronger (say, in six months), this same premium will balloon and give a nice return. The longer LEAPS also decline less when the market declines since they have a lot of time for the market to bounce back.
Most of my assets are still in long-term treasuries, so obviously I haven't been ready to "bet the farm" that we're definitely past the turning point. I do think we're close enough that it's worth putting at least SOME money on the table. Close enough, in terms of whether a deeper market bottom is likely. As a result, I am still very committed to incrementally increasing my market exposure, using dollar-cost averaging. But I'm still waiting for that "magic" day when it becomes "clear" that I should shift my treasuries to stock.
This afternoon I'm going to attend a panel discussion at the American Enterprise Institute here in Washington entitled "What if Congress were Obliterated?". Two congressmen will be on the panel. It should be very interesting.
Jack Krupansky
Updated: October 21, 2001 11:18:46 PM -0400
Copyright © 2001 John W. Krupansky d/b/a Base Technology