world stock market, us stock market

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9/01/01 Investment House Daily
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Investment House Daily Subscribers:

SUMMARY:
- Stocks drift higher in preparation for the new game next week.
- Friday failed to change much in the market.
- Manufacturing shows a pulse as the consumer continues to weaken.
- Greenspan discovers perhaps he was wrong after causing a recession.
- Subscriber Questions
- Team Trades

Weak rally finishes a sharply lower week.

Slightly improving manufacturing numbers offset weaker consumer confidence, and stocks moved higher Friday after three sessions of increasing distribution (institutional selling of shares). It was not a powerful session by any stretch; the Dow was up over 100 points but then gave most back as sellers took advantage of the earlier move higher. The S&P 500 showed similar action.

Friday's move appears to us as mere relief after the earlier pounding. Some investors were trying to sneak in and perhaps beat the crowd on a rally this week when the market gets back to business after a summer vacation. With vacations such as that, work should seem like a pleasure. Seriously, this week will most likely mark more volume as all fund managers will be back to work, trying to make their funds look the best they can before the end of the third quarter. That will mean some tax loss selling as well in September, one of the reasons the month is so hard on stocks. So Friday was a respite, but it was just a day of rest before the real work begins.

What is coming this week?

Even though Friday finished positive, it had bearish tendencies. Most notably the intraday action saw stocks much higher early in the session only to give back the lion's share of the gains. At least the indexes were able to close positive. Volume was also lighter on the gains after heavier selling volume all week. That is typical bearish action, but even for a pre-holiday Friday in the summer, volume was surprisingly heavy. Still, the selling volume was stronger, and Friday's buyers may be in for disappointment.

Economy's direction still up in the air as consumers start to bow out.

There is still no consensus on how the economy is doing. Most economists seem to be assuming that the economy will recover on the basis of the Fed rate cuts. The problem, as with everything, is timing. Consumers have held the economy up as best they could for the past year, but the consumer is wearing thin under hundreds of thousands of layoffs and a rising weekly continuing unemployment claims number that shows they are not finding jobs contrary to what some economists have been saying. Even with the one-time tax 'rebate' that was supposed to help so much, it appears that more are saving now than they were. After years of a negative savings rate, the fact that consumer saving jumped 2.5% last month as the economy flirts with a textbook definition of recession drives home the point that the consumer is pulling back.

When consumers as a group alter their consumption patterns from what has been the norm, there is change underway. When consumers start saving in a slow economy, that is a sign the recession will be harder to beat. This is particularly true in this instance because consumers were active for so long but thus far have not pulled the rest of the economy out of its doldrums. A suddenly reticent consumer will not continue the hoped for trickle down effect from the demand side. Perhaps the improved manufacturing numbers shown in the Chicago PMI will start to help just as the consumer starts to stall. One other consideration: unlike past recessions, there is no pent up consumer demand at this point because the consumer has been spending up to this point. The consumer has to run the course of buying, pulling back, and then buying again with gusto. Right now we are at the end of phase one, and that means the business side has to get going to avoid further recession. As noted, there are some encouraging signs, but they are not showing expansion; in other words, the recession continues for now.

Economic calendar full and company road shows abound.

There is a full economic calendar this week. With the jury still out on the economy's direction, we expect to see the same type of reaction to the individual reports as we saw last week, all leading up to the employment report to be released Friday. In addition, several companies such as EMC will be holding conferences, etc. this week, and no one is really sure if there will be 'Cisco' positive news or 'SUNW' negative news. If LRCX, a semiconductor company, is any example, the news may be less than promising. After the close Friday LRCX tried to sneak in some bad news in the hope it would be forgotten with the long weekend; LRCX is laying off employees and is closing some manufacturing units. Times still are not good enough as far as companies are concerned. Just ask Hitachi. It is laying off almost 15,000 workers worldwide and is going to lose over $1 billion in the quarter.

Now there may be some fund managers come in with a notion that the economy is going to recover and start buying. That will be good for the long side of the market, but as we know, we will have to see enough buying to get the entire market going, and that means a continued rally and follow through. That is putting the cart before the horse right now. After the selling last week, the market is trying to figure out just what it is going to do.

More downside ahead?

The market has been hammered, the indexes breaking below their July lows on strong volume. It tried to bounce Friday after some further selling. After a market has made a big move in one direction and tries to turn the other way, that is always a risky time until momentum either way is established. Still, the trend is to the downside and a further test of the lows. We would have preferred seeing Friday just tank. As it stands, the relief rally puts off what we feel is the inevitable test, and Friday could have been a set up for some serious selling on Tuesday.

After three hard selling days, more than a few buyers came into the market. As noted, the Friday volume was higher than expected for a Friday and a pre-holiday Friday at that. That tells us there were some who were in the market trying to get ahead of the curve for next week. That action, while not an exact replica, fits the action that occurred back in 1987 before the Dow crashed down on Black Monday. After some very heavy selling there was more selling Friday, but buyers came back in and the indexes recovered a bit. Then the bottom fell out on Monday. Friday did not change the downtrend; it really did not do much of anything in our estimation. It merely set up more selling in a market that still is very unsure of any economic recovery and corporate earnings and is going to get a passel of economic and corporate reports this week.

If the selling starts heavy again, we will play it, but we also expect a pretty fast fall toward the prior lows and perhaps an undercut. It may take another two to three sessions of heavy selling to get there. The S&P is almost there, the Nasdaq is about 186 points away, and the Dow, well, it is over 800 points away. As noted last week, we may only see the S&P and the Nasdaq do the full testing, but selling at the triple digit levels the Dow has done allows it to make up ground fast.

So, we are not expecting a race higher next week, though we could get another attempt at a weak bounce before we get some further selling. We may miss the boat; the indexes may be ready for a relief rally from here, but we feel that will only put off some further selling to test the lows. We would prefer to see it over and done.

Some positive signs out there while others need improvement.

We still believe that we are not going to get much more downside than a test of the prior lows unless there is some very heavy duty, negative news. There are a few things to back that up.

Manufacturing looks to be improving slightly once again after taking a month hiatus in July. More on this later, but this is a real positive.

The dollar tanked Thursday but held its range. Friday it rallied up to close back up near the top of its recent consolidation range. It gained on the Euro and the Pound as it lost a bit of ground to the Yen. Expect to see continued rate cutting overseas to try and prop up the dollar, and a stronger dollar will help the market. This is one of those key areas where negative news could really hurt. It is trying to shore up, but the ECB's small rate cut may not be enough to do it just yet.

The Arms index (TRIN is the symbol for those wanting to track it) closed back-to-back over 2.0 (2.02 Wednesday and 2.28 Thursday), and that has historically presaged a rally by 1 to 7 days. It last happened 14 years ago on October 16 and 19, 1987. The Dow jumped 16% in two days. It did it again in 1982 that set off the bull run. It has delivered this signal 8 times since 1966 (when the index started to be kept), and each time there has either been a bull market start or a significant rally. Ideally we would like to see the indexes sell down even more the next few sessions and then reverse on high volume after slightly undercutting the prior lows.

But we would also need to see other factors line up. Sentiment is still out of step with a reversal that sticks. Volatility is too low and bulls are too high. That is why we want to see further hard selling toward the lows. That would help spike up these indexes and get those diehards to sell. When they all line up, the rally has a chance of being real.

We also need better patterns developing, something that a quick selloff may not do. One area of primary concern is the semiconductors and how they would hold up with a bout of heavy selling. Several of their patterns remain decent, but how they respond to heavy selling is key. Another key sector that can lead is biotech. Those patterns look better than the semiconductors, and if they hold up while the rest of the market plunges, we will be very excited when we see the turning signals.

At the same time we see some more leaders come crashing down. Home builders did so three to four weeks back, then it was regional banks the past two weeks. Friday the education sector, another leader, was taken apart when one of its leaders stated that next quarter results would be at the low end of expectations. It was a slaughter, and it shows that investors are still quick to jump off of any sector that shows any signs of weakening.

Summary: We do not believe we are there yet. There needs to be more selling to really set up the move higher, at least one that lasts and is not another one of these three to four day sprints that flames out. In any event, when a move higher starts to happen we need to be fast, taking positions with leading stocks (biotechs for one) and index plays as well. It may just be a shorter term rally, but it could be a heck of a rally regardless, and we could make some very good money before reloading for what we feel is an inevitable date with the prior lows.

THE ECONOMY

Last week was a big week and this week is a big one as well. Some better numbers, some worse numbers, and some truly incredible stories came out of last week.

The Chicago PMI rose to 42.5 after a dismal 38 reading the prior month. It was better than the 40 expected, and Chicago is considered a portent for the national number that will be released this week. New orders were up, hitting the highest level since October 2000. Very good news. A reading of 43.5, however, marks the eleventh month in a row of a contracting manufacturing sector. That means it has been contracting for almost one year; when it shows improvement but is still below 50 as it did in July, that simply means the contraction was slowing a bit. It does not mean manufacturing is turning things around.

Factory orders turned positive with a 0.1% rise (-0.5% expected; -2.9% prior, revised higher from -2.4%). That is always good news, and the stock to sale ratio fell slightly. Technology, however, remains waterlogged as orders for computers and electronics fell 4.4%. It is buried under several layers of muck.

Confidence as measured by Michigan fell hard to 91.5 from July's 92.4. The prior estimate for August had been 93.5. The culprits according to the survey: declining stock prices and layoffs.

Greenspan makes a stunning admission.

Remember back when Greenspan was trying to talk the market down and was coming up with all of those 'new' inflation gauges back in 1999? At the time we were incredulous that the Fed was viewing indicators of economic health and prosperity as new inflation measures. There was no inflation by historical standards, yet the Fed seemed to be trying to create the atmosphere that it was a real, tangible threat. To our shock, it worked.

One of those new inflation indicators was the 'wealth effect' that rising equity markets were causing. The Fed referred to it continually, but the only evidence it ever presented as to its existence was a short Fed statement that each percent rise in equities led to a percent rise in consumption. Whenever questioned by Congress on it, Greenspan would offer to meet behind closed doors with that Congressman and explain it. The Fed's statements about the stock market wealth effect were statements of fact, and those that kissed the chairman's ring (way too many smart people) accepted it as gospel.

Well, Friday Greenspan admitted that the Fed did not really understand how the wealth effect works, indeed, even if it existed. The reason: the stock market has tanked, U.S. citizens have lost trillions in retirement accounts, and yet the consumer has continued to do what by definition they do: consume. That led the maestro to wonder if perhaps it was home equity and not stock market gains that led consumers to spend. He even went as far as to ask for economists to submit data on the subject so the Fed could study what was supposedly fact just two years ago.

Could it be that consumers simply consume when they have jobs, when inflation is low, and when technology makes goods and services cheaper? Is that the wealth effect? Heck, that is just common sense, something we were saying at the time. Consumers consume. Until the economy tanks and they lose their jobs or are faced with the eminent threat of job loss, they continue to consume. We said that over two years ago, and it seems the Fed is just starting to grasp that.

Indeed, we pointed out three specific studies (as opposed to the Fed's self-generated, statistically barren conclusions) that concluded that at least 80% of stock market gains over the past 20 years have been put right back into the market to generate further returns. Not surprisingly, investors were using the stock market as a store of wealth and a method for achieving their own social security. Contrary to the Fed's statements, consumers were saving in the best place to put your money until the Fed chased wild aquatic fowl and tanked the market and then the economy.

The unbelievable, sad, pathetic, frustrating and tragic consequence of this is that the Fed acted on a half-baked theory that had NO empirical substantiation and wrecked the lives of millions of U.S. citizens not to mention sending the entire global economy into recession. We said it at the time: as the U.S. goes, the world goes. The results we see now speak for themselves. It was a bunch of guys behind closed doors deciding that things were too good and all good things must come to an end. So, they set about bringing those good things to an end, thinking with the supreme arrogance that 20 years of riding an economic boom they could not grasp engrains that they could control the rate of decent.

Just as their predecessors on the 1929 central bank fought non-existent inflation by tanking the stock market and the world economy, the 1999 Fed ushered in a stock market crash and global recession. Then to hear Friday from the author of the collapse himself that one of the very foundations of his plan of action was 'not fully understood' by the Fed is simply mind-boggling. Will he get the rebuke that he deserves? He has not yet, and thus far we have heard no strong outcry. We have said it before: when a couple of lawyers who do nothing more than read history and apply common sense can see what economic geniuses supposedly cannot, something is wrong. Either they are caught up in their own self importance, or there are other more sinister forces at work. Either way it is shocking and frightening, and the majority of the world's citizens are poorer because of it. Unreal.

THE MARKET

Overall market stats:

VIX: 27.85; -0.23. Falling slightly on Friday's gains, volatility has moved to the higher end of the 20 to 30 range where 20 marks complacency and 30 marks some fear. Don't be fooled, however, if this week you hear financial stations start chattering about volatility being high if the index moves over 30. As noted before, that is the MINIMUM level of possible reversal. It often takes a reading of at least over 40, and then readings of 50 and 60 are much more accurate reversal indicators.

VXN: 52.86; +0.58. A slight gain on Friday's upside action, but basically volatility was flat. As with the VIX, it is moving higher, but still well off of the 68 and higher levels that led to the prior turn off the low in April.

Put/Call ratio (CBOE): No data was available for Friday's close.

Sentiment indicators are secondary. They can show signals of what to expect when they reach extremes. They do not replace primary indicators such as price and volume, especially when the sentiment indicators are mixed as they are now.

NASDAQ:

It waited a session to rally, but even when it did it smacked the recent low on the high and pulled back from there. Volume was lower. If it was the start of a rally, it was inauspicious. Selling can start that way, but not many upside moves.

Stats: +13.75 points (+0.8%) to close at 1805.43.
Volume: 1.232 billion shares (-29%). Volume fell back below average on the gains, but it was not bad for a summer Friday ahead of a holiday. Up volume led 745 million to 468 million downside shares. All in all, hard to take much from the action other than it was substantially lower volume when the index tried to move higher.
A/D and Hi/Lo: Advancing issues led for the first time in days at 1.27 to 1 (decliners led 1.89 to 1 Thursday). New highs rose to 48 (+3) as new lows fell to 115 (-78).

The Chart: http://www.investmenthouse.com/cd/$compq.html

The Nasdaq bounced, but it hit the prior August intraday low on the session high (1817.72) and pulled back to the close. It was not much of a rally, and individual stock volumes back this up. We had a pre-holiday Friday session in all respects, and it did not do anything to change the downtrend. After such a hard selloff, however, indexes usually try to regain lost ground up to the down trendline. Right now that is near 1855. With the fund managers coming back on Tuesday, however, picking which way they will take the market is dicey. All of the sudden there are a lot more players on the field with their own agendas, and we have to see where they take it. One thing to keep in mind: we don't expect to hear a lot of good things from the upcoming warnings season. Some of these conferences next week could give us more SUNW news.

End Part 1 of 2

world stock market
us stock market