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To
OTC Journal Members:
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Fear and Confusion
Ruled the Market This Past Week |
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I believe the market always gets
in right in the long term, but often emotionally over reacts in the short
term. Irrational fear and confusion ruled the markets this past week.
The anticipation of some moderate
interest rate hikes has the market scared out of its wits. The yield curve
is the steepest in memory, which is simply insane. If you draw a line from
short term interest rates, through medium term rates, out to long term,
you have the yield curve. The steeper the line, the greater the difference
in interest rates as you go farther out.
The spread between the overnight
FED funds rate and the 10 year note has averaged 1.36% since 1953. Presently,
the overnight FED fund rate stands at 1%, and the 10 year note is yielding
4.75%. The spread is 3.75%, 175% higher than average. The FED funds rate
is controlled by the FED, the 10 Year yield is set by market prices, meaning
traders have decimated bond values this past week. The market has now priced
in a full one point interest rate hike by the FED before the end of August,
which isn't going to happen.
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Both
Sides of the Argument |
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Here's the negatives on the market:
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Rising Interest Rates: There
is no question that historically, in a higher interest rate environment,
earnings are worth less as it translates to stock prices. This is because
investable money flows from stocks to the safe haven of bonds as interest
rates bcome more attractive. The last two unemployment reports have been
much stronger than expected, which fuels fears the FED will have to raise
interest rates to cool off the overheated economy. Wasn't it just sixty
days ago that the Bears and the Democrats were decrying the jobless
recovery? The "good news is bad news" theme continued this past
week.
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Rising Oil Prices: Oil prices
have skyrocketed recently, fueled by turmoil in the Middle East. The tensions
from the Iraq War have been exacerbated by the POW mistreatment scandal
which sent the media into a frenzy this past week and Secretary of Defense
Rumsfeld to Capitol Hill to explain himself. Oil bounced off $40 per barrel
for the first time in history. In my view, this is the only legitimate
fear the market can lay claim to, as this is a major drag on the world
wide economy.
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Uncertainty of a Presidential Election
Year: The Presidential Election race is neck and neck. The market hates
the uncertainty with a passion.
Here's the positives on the market:
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Increasing Employment Statistics:
The economy created 288,000 jobs in April and an upwardly revised 337,000
jobs in March. While we are far behind the 1.5 million jobs the Bush Administration
predicted the economy would create by now, this long awaited recent surge
ends the jobless recovery, which has been the lynch pin of
the bearish argument.
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Corporate Earnings: As I reported
early this week, the current 52wk forward estimate for operating earnings
on the S&P 500 stands at $66.20, by far the highest level in history.
Balance sheets are also stronger than ever, and many large American Companies
are simply loaded with cash. In short, companies are delivering outstanding
results.
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Healthy Economy: The economy
appears to be extremely healthy, and consumers are spending. Consumer spending
represents 70% of GDP.
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Some
Historical Perspective |
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This past week I reviewed some historical
data which bears a remarkable similarity to today's environment. Here's
a chart of the S&P 500, correlating '91 and '92 to '03 and '04.
In May of 1991 the nation was preparing
for a tight Presidential Race between an incumbent Republican named Bush
and an upstart democrat who came out of nowhere. Oil prices were sky high,
fueled by war with Iraq and turmoil in the Middle East (remember the oil
fields burning in Kuwait?). The economy had been mired in a recession,
and was just starting to show signs of recovering. Sound familiar? Today's
headlines are deja vu all over again.
The market put in a strong showing
in the 4th quarter of '91, but went into an extended grinding phase until
late September of '92. Once the outcome of the election was known, the
market took off and didn't look back until the bubble burst eight years
later in March of '00.
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The
Market: A Picture of Confusion |
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You are looking at the picture of
a NASDAQ Composite that can't decide which way it wants to go. The market
is grinding in a range, forming a triangle of support and resistance. As
you can see from the red lines, the recent highs are getting lower, against
the lows getting higher. As the market grinds closer towards the apex of
the triangle, it will eventually break out in one direction or the other.
It is storing energy up for a prolific move which could go either way and
take months to resolve. It took nine months to resolve in '91/'92.
I suspect the market will continue
grinding just as it did in '91. The uncertainty of the Presidential election
outcome will weigh heavily on money managers. As far as the market is concerned,
it won't matter much who wins. It just needs to be decided. After all,
we had a bull market under Republican Reagan, a bear market under the first
Bush Republican, and a raging bull market under Democrat Clinton.
For the foreseeable future, up days
will be fueled by news of rising GDP, outstanding corporate performance,
and limited geopolitical conflict. On down days, the headlines will include
terrorist attacks, escalating fighting in Iraq, skyrocketing oil prices,
and Presidential campaign politics.
Over the past several weeks I have
seen some values erode quite abruptly, but rarely has there been any volume
associated with the pullbacks. This suggests more of a buyers' strike than
a sell off, and also suggests a few days without negative headlines could
bring buyers back and send values back up quite easily.
For those who participate on the
long side, we don't want to see a series of lower lows. If you trade with
a short term outlook, you might want to consider selling everything if
the NASDAQ Comp breaches 1900 with conviction for more than a day or two.
If you are a long term investor who is betting on growth to eventually
lead to higher stock prices, don't worry about it. Pullbacks will provide
outstanding opportunities to accumulate at bargain basement levels.
Charts Provided Courtesy
Of TradePortal.com |
