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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.
Short-term economic outlook: As November progresses we will gradually start to see the first signs that the economy is beginning to recover. Not a large increase, but at least the trend will not be downward. Some indicators will continue to decline, even as others begin to stabilize and some even begin rising. December will be a little better. But, October was probably bad enough that Q4 will "print" as a decline in GDP. Employment will continue to fall until GDP finally breaks above the rate of productivity growth, sometime in Q1 of 2002.
Once again, on Friday Nasdaq struggled against its 100-day moving average. A new twist is that both the 50 and 100-day moving averages are on the verge of bottoming out. Traders and sidelined money alike may consider this a bullish sign if Nasdaq can hang in there a couple more days without a major sell-off.
It was interesting to see the market reaction to the rumors of success at Mazar-e Sharif. There was a rumor before 10:00 a.m. and one around 10:30 a.m. In both cases Nasdaq jumped almost straight vertical. But in both cases Nasdaq was very quickly sold back off. This strongly suggests that the morning trading was dominated by day-traders who were forced to quickly cover their short positions and then quickly put those shorts back on. Those quick up and back down actions would not have occurred if the morning weakness had been real, long-term selling. Overall, the entire day smacked of nothing more than day-trading. By day-trading I do not mean the amateurs that were popularized in the media back two or three years ago; I mean the pros on Wall Street, the in-house trading desks at the brokerage firms, at hedge funds, etc.
The Producer Price Index (PPI) for October declined significantly, even if food and energy are ignored. This was a negative report because it indicates that the economy is very weak. I wouldn't rate it too negative though, because I believe the beginning of the month was far weaker than the end of the month and November is likely to show a more moderate level of disinflation. It was a positive report from the perspective of inflation being well under control, but it also suggested deflation, which is very bad if it begins to persist. Overall, the report was about as mild as could have been expected.
The University of Michigan Consumer Sentiment Survey for November showed an improvement to 83.5 from 82.7 in October. This was a very positive report. Both the Present Conditions and Expectations components of the index improved. Consumers continue to hold up much better than economists give them credit for. Economists believe that consumer confidence is going to weaken. I wouldn't bet on it. In fact, I would, and will, bet on consumer confidence improving over the coming weeks and months.
The Economic Cycle Research Institute (ECRI) Weekly Leading Index (WLI) for the week ended November 2 improved for the second week in a row. This was a positive report. The index is almost back up to its level in the third week of September. It's still too early to suggest that the improvement is here to stay, but it's better than a further deterioration of the economy.
The CBOE Market Volatility Index (VIX), which measures the level of anxiety in the market, FELL by 3.75% on Friday to 28.76, which is in the upper end of the moderately high anxiety zone (25 to 30). This was a second day in a row of declines. VIX actually rose on the open as the market was weak. It fell below the Thursday close after the second Mazar-e Sharif rumor, but quickly rose as the market fell back. There was a fairly steady decline from 11:15 a.m. into the close, but it wasn't until 12:50 p.m. that VIX was finally below the Thursday close. VIX was fairly flat from 1:00 p.m. to 3:40 p.m., with most of the day's decline coming between 12:50 p.m. and 1:20 p.m. It was nice to see that there was not an increase in anxiety going into the weekend. It could be that people really were prepared to believe that there MIGHT really have been substantial progress at Mazar-e Sharif. In any case, VIX is at a reasonable level for all the uncertainty over the economy, the "war", and the potential for additional terrorist attacks. Oh, and the anxiety over whether the stock market rally is about to implode and all the recent gains vanish as quickly as popped bubble. The coming week will tell a lot.
The Nasdaq-100 After Hours Indicator was mixed in the Friday evening session, but did manage to close up 0.93 points. Kind of flat, no real optimism, but no significant cynicism either. A nice even keel. Which isn't bad considering that quite a number of stock market commentators are seriously questioning whether the rally really can hold up. Funny how the stock market works: if everybody expects it to go one way, it tends to go the other. Even I admit that there's a significant chance that the rally could reverse any day. History of the market tells us that the market is unlikely to do what we expect, so the market is probably more likely to rally. But it's also possible that the pros might engineer a nice little dip that gets bought like there's no tomorrow. I suspect that the big pullback that everyone's waiting for will be nothing more than a moderate-sized pothole.
The Enron (ENE) saga seems to be set for a close. Dynegy (DYN) has agreed to acquire them.
But we still have the HP (HWP) saga to agonize over. HP is delaying their analyst meeting. That's always considered bad news.
And then there's the Amazon (AMZN) saga. I like the company, but I'm still not quite ready to buy the stock. The big anxiety is how the Christmas season will shape up. Obviously many people are in a mood to believe that Christmas will be a very gloomy affair this year. I'm not so sure about that. In any case, Amazon's fortunes will rise and fall with the economy. But another risk is that as soon as the economy does take off, Amazon's stock probably will already have risen in anticipation. Hmmmm... maybe Amazon's stock price is actually a good surrogate for overall sentiment about the economy. Maybe I should buy a little Amazon as a side bet on the economy and the Christmas shopping season.
And don't forget the Argentina debt restructuring saga. That place is still a financial mess, but it's no surprise and nobody on Wall Street can start raising a flag and saying "Oh, look! What a surprise, Argentina is crumbling!". The bottom line is that they have to devalue their currency and current debtholders have to take a haircut. That gets classified as a "default", but as long as debt payments continue to be made, no meltdown or "contagion" need spread to other areas. Still, somebody on Wall Street might use all this as an excuse to sell off stocks, ala 1998.
Fed Funds Futures suggest an 80% chance of a quarter-point cut in interest rates at the December FOMC meeting and NO cuts after that. Economists are warming to the concept of a slight recovery in Q1 and stronger growth in Q2 of 2002.
Only three more days til the November 15 launch of the hot new Microsoft (MSFT) Xbox game console The box goes on sale at 12:01 a.m. at the brand new Toys "R" Us store in New York's Times Square. The line officially starts at 3:00 p.m. Wednesday, November 14. I may wander by to check out the line.
It's Monday, so it's once again time for me to make my latest weekly dollar-cost averaging (DCA) purchase. I'm still focused on LEAP options for the S&P 500 Tech Sector "Spiders" (XLK). If the recent rally gains really are poised to collapse as some commentators are suggesting, buying now would seem like the height of folly. But most of the point and benefit of dollar-cost averaging is to side-step all the anxiety about market timing.
My view is that the October/November rally is still intact and has a 2 in 3 chance of continuing without a major pullback (>10% or >180 points) and a 1 in 3 chance of a major pullback. Yes, there are lots of issues, concerns, and anxieties, and some of them are even real. But the truth of the market has always been that a bull market climbs a wall of worry. The economy is poised to begin recovery sometime over the next few months. Any sell-off based on "market technicals" such as stocks being "overbought" or "overvalued" will likely result in massive dip-buying by sidelined money. If you're anxious about profits, take SOME. Sell to the sleeping point. Leave some money on the table, but take off just enough money so you won't feel completely cheated IF the much-ballyhooed correction really does happen. Oh, and don't expect to catch the bottom of the dip, because it will probably happen so fast and the pros will buy it so quickly that you won't have time to recognize that it happened until its gone. As the bottom of the dip is happening, commentators will be warning you how the market is on the verge of an even bigger decline. You could place some Good Til Cancel (GTC or GT90) orders that will execute if stocks fall below a limit price. But trying to guess the depth of the dip is a real gamble: 5%, 10%, 15%, 20%, 25%, take your pick and take your chances. Even if the dip was 25%, snagging your stock at 10% or 15% below current prices is better than buying at current prices. But if the Mother Of All Corrections does not materialize, the market could rally 15% above current prices and leave you behind in the dust. Your choice. That's the "fun" of market timing and why dollar-cost averaging is so boring and so effective.
The pros (including hedge funds) had several great opportunities to dump their positions last week. Besides, they KNEW that Nasdaq was going to run into that 100-day moving average. So, I would presume that the pros are already out if they had any intent of getting out. There still is an excellent chance that the pros could still short the market on even the slightest hint of weakness. The resulting downdraft could instill enough fear into other investors to get them to dump their stocks very quickly, further accelerating the downdraft in a vicious downwards spiral. And whenever that vortex hits bottom (i.e., when selling peters out), the pros will step back in and start the next up-leg of the rally. That's ONE possible scenario, possibly the worst-case scenario (besides additional terrorist attacks and a dramatic weakening of the economy). But there is also a really good chance that such a scenario simply won't happen. The economy is much further along in the process of wringing out excess than it was in May and June, so it's more likely that more people are really ready to believe that a strong recovery in likely over the coming year.
Since the start of the Nasdaq rally on September 21, there have been several times where the rally petered out or declined before continuing its rise. That's no guarantee that the rise won't continue this time, but does argue for the case that a slowing of the rally and some profit-taking do not indicate that the rally is over. The rally is ultimately in the hands not of the people who are in the market, but in the hands of sidelined money who will decide whether and when to buy any dips.
The best case scenario for the market is to trade in a relatively narrow range for a little while, what they call "consolidation". This establishes what they call a "base". This process gives plenty of opportunity to weed out the frothy momentum traders and establish stock ownership by people who have longer-term aspirations. Then, on that base, a much larger rally can be built. And the base then acts as a level of "support" if the market should correct after the next rally phase.
Technically, the October/November rally could still be a bear market rally. It really takes about three months to establish a new, overall market trend. The classic definition of a bull market is a period of months in which both intermediate highs and intermediate lows are increasing. In other words, if you draw a three month trendline, the trend is clearly up. We're not even at the two-month mark. People won't generally acknowledge this as a new bull market until we have some decisive confirmation of a solid stabilization of the economy.
And what about tech stocks being overvalued right now? First, tech stocks are ALWAYS overvalued. Occasionally you may find individual tech stocks that are undervalued, but that's the exception, not the rule. Second, the famed P/E ratio is a very poor measure of a business, in part because is blends the short-term balance sheet performance with a company's operational performance. The long-term health of both operations and the balance sheet are what really matter. It's rare when you see an analysis which really focuses on long-term health. Sure, a company has to survive the short-term to get to the long-term, but you have to give priority to one of them. It's unfortunate that so many people would like to see a single number to measure and compare all aspects of all companies. That's crazy since not all investors, even conservative investors, have the same evaluation criteria. So many people who should know better are asking for the impossible and then acting as if they've been cheated when the impossible can't be delivered. If coming up with a single standard was so easy, FASB (the Financial Accounting Standards Board), would have done it by now. A better measure of companies would be a subjective evaluation of management, their underlying business, and their plans for the future. Ultimately, that's what the stock market does. And that's why traditional valuation metrics are almost always out of sync with stock prices. Of course, investors are always changing there perceptions of businesses as new information becomes available, and the result is the rollercoaster ride called the stock market. It's rare to find a major business that does not have setbacks on occasion. Even Warren Buffett, the Oracle of Omaha, the epitome of conservative investing, just announced a big loss for his company, Berkshire Hathaway (BRK.A) due to exposure to World Trade Center insurance claims. By the way, his stock is "overvalued" as well, primarily due to the premium investors place on his management and investment abilities. Does that mean that people (including me) should sell their Berkshire stock? Nope. There are a lot of "premiums" that get added to book value that indicate the "value" that investors place on the various aspects of a company's business, including the "value" of management talent, market share, stability, growth prospects, intellectual property, etc. Accountants and other "analysts" that talk about assets being "overvalued" refuse to recognize the value of those premiums. Granted, those premiums can fluctuate wildly and vanish overnight, but the value of real property (land, buildings, machinery, inventory, investments) can fluctuate more than the accountants and analysts acknowledge.
If the accountants and analysts are right about one thing, it's the need for full disclosure using consistent standards. As much potential as Amazon has, their insistence on playing games with the accounting rules is still hurting credibility. But they are not unique. As much as I focus on long-term potential, misleading short-term reporting hurts more than it helps. Still, all the focus on a single metric, the P/E ratio, is a colossal waste and misguided effort. Maybe you might be able to distill the accounting down to a handful of numbers. Even then, the debates would continue raging. You might as well try to propose a set of criteria and objective standards to determine who makes the best pizza. Good luck. But if you forced me to accept exactly one metric, it would be the annualized percentage change in book value per share, using an eight-quarter moving average. I think even Warren Buffett would accept it. But NOBODY is proposing it. And even this metric has problems because sudden changes in performance may not be representative and opportunities to enhance future performance are not represented. A single, objective metric is truly an unobtainable holy grail.
The "war" seems to finally be making some measurable progress. It's too soon to tell for sure and setbacks are very possible, so it's best to wait a few days for some of the dust to settle before declaring the progress definitive. The Taliban retreat could be the beginning of the end, or it may be just a strategic move to be followed by an even more intense stalemate. Too soon to tell for sure. There will be lots of twists and turns in this campaign. And surprises than we can't even imagine. Some very negative, and some very positive. The knee-jerk reactionaries in the market will exploit every shred of rumored bad news to try to push for a sell-off. It's best to stay calm and let the gradual accumulation of hard facts be your guide in all weighty matters.
As usual, all bets are off in the market if another major terrorist attack occurs, or even if a rumor of one occurs. I think, finally, the market is able to cope with reports of trace amounts of anthrax that will be popping up for quite some time as a result of cross-contamination of mail and mail-handling equipment. "Trace amount" means "medically insignificant" which means nobody dies. The terrorists may be under enough pressure that they would prefer to hide until the pressure lets up. There were some superficially scary statements in the media concerning nukes, but when you read the full stories, you realize that the threat is purely hypothetical and no different than what some people knew of even before September 11. The big uncertainty is the role of Iraq in supporting terrorism. The Bush administration is still divided on Iraq, but that is subject to change at any time. The hope may be that Iraq will become a model of circumspect behavior as they see what we're doing in Afghanistan and assume that we're implying that we'd be willing to do the same to Iraq.
Jack Krupansky
Updated: November 12, 2001 08:49:59 AM -0500
Copyright © 2001 John W. Krupansky d/b/a Base Technology