MARKET OBSERVATIONS

Take A Deep Breath

MARKET OBSERVATIONS - 4/18

And Now Exhale...Feeling Better?  We're living through a remarkable period (not that the last few years have not been similarly remarkable).  Until proven otherwise, we have to believe the direction of this market is down.  Having said that, nothing ever happens on Wall Street in a completely linear fashion.  If this is a bear market we have entered, rallies are to be expected and can be quite sharp and quite short.  Let's not waste any time.  Let's get right to a few tables and let the numbers do the talking.  Monday's "rally", especially in the NASDAQ, can be considered nowhere near a victory for the bulls.  Characteristically sloppy breadth.  Today was clearly good deal better for breadth, but to be expected as those who missed "another buying dip" hustle aboard.  The so far two day snap back has been virtually textbook in that it featured extravagant moves by an incredibly narrow group of doyens of this bull market.  (One more inhale and exhale before you look at the following):

   Without these powerhouses of the NDX 100, the NASDAQ, the S&P, and partially the DOW, Monday would have been simply no fun at all.  Likewise for today as all extended their little run.

Is The Glass Semi Full or Semi Empty?...Give up?  The answer is who cares, just as long as it's semi, baby.  (Forget inhaling and exhaling, try to keep from hyperventilating over the following):

These moves would have been acceptable for one year's performance, let alone one day.  Some of these powered ahead strongly today.  The seeming move from selling panic to buying panic just doesn't seem logical, does it?

The Fingerprints Of A Secular Top?...No matter how wild this market action seems, once again, this type of activity is not without precedent.  As you know, market periods exhibiting characteristic similarity are ones found in historical extreme circumstances.  A week or so ago, we trotted out our "return engagement" chart for the price volatility surrounding the '29 final top period.  There were a few days in the current market two weeks ago that were dead ringers for a few days of activity directly preceding the "final bell" in 1929.  Well if you thought that similarity was eerie, what till you see what happens next:

Interestingly  enough, the performance noted in the cells highlighted in red were duplicated almost to the tenth of a basis point on two concurrent days about two weeks ago.  More interesting is the significant and quick two day plunge on October 28 and 19th of 1929 and the rebound the following days.  The 10/28-31 action looks almost exactly like the NDX 100 over the last four to five days for the period ended today.  What intrigues us most is not "counting days", but rather watching similar rhythms.  The performance rhyming is nothing if not completely similar.  The patterns and rhythms were those characterizing a market that was entering a period of secular change.  Drastic and emotional perceptual change.  The opening pitch in a process of confidence destruction.  Play Ball!  

In one sense, the table above is an emotional Richter scale.  Although it reflects changing financial values in an overall index, it more reflects the shifting emotional sands of significant human perceptual change.  To say that today's market is a "new era" may just be a bit presumptuous.  We're directly repeating the actions of prior period market participants.  Unfortunately for many of today's new age bulls, 70 years simply isn't enough time to effect significant change in the kaleidoscopic structure of the DNA responsible for human emotion.  Just ask poor Celera or HGSI, they'll tell you.  Physical human evolution is sadly not on 'Net time quite yet.    

A Few Simple Questions Deserve A Few Simple Answers...In what may very well be the unfolding of the end of the mania, we want to try to keep the analysis simple.  Q&A time.

1.    Has the game changed?  YES            

2.    Are the favorites still priced too high?  YES (CSCO, ORCL and SUNW p/e's still near or above 100x's.)

4.     Will the public panic?   At the moment, the answer is NO.  We still believe that ultimately the answer will turn to a strong YES.  As you know, there was virtually no true fear exhibited last week.  $8.4 billion came into mutual funds for the week ended 4/12.  Bullish sentiment numbers actually increased last week as reported by Barrons.  For now, the dangerous casino mind set stands.  We have not yet broken the "who wants to be a millionaire?" mentality.

5.     Is there more at risk than stock prices?  YES   Consumer spending (GDP) and real estate prices should be highly correlated with future stock market action.

6.     Are all the contrarian signs there for a meltdown in the broader tech groups?  YES   History shows that there has NEVER been an instance where a financial mania or asset bubble has ended in any way other than badly.  There are no soft landings for asset bubbles.

7.     Is the stock market rational?   From a long term perspective, the answer is YES.   Short term movements are anything but rational.   The market is an exercise in crowd behavior.  Today, it is simply an online study in human nature.

8.     Does the public understand that stock market investments can involve substantial risk?   It's beginning to happen, but hope is a powerful human emotion to negate.  Optimism, to us, seems as basic as the will to live.  So far, the mania portion of this bull market has been characterized by quick and substantial market recoveries.  The crowd learns by watching actions of others in the crowd.

The Hall Of Blame?...An interesting phenomenon over the weekend was the blame game.  After all, doesn't somebody have to pay for a $2 trillion loss of paper wealth?  The bulletin boards and chat forums were full of venting against the "nearest target".  The Injustice department and poor Microsoft.  A conspiracy between Clinton and Greenspan to slow the economy down.  The topper of them all was that Abby caused this.  Although we cannot verify authenticity, we saw an open letter alleged written by CMGI CEO David Wetherell posted on RagingBull.com.  The writer listed the reasons why he believed the "correction" occurred.  We do give him credit for directly targeting margin debt, but numero uno on his list of reasons was Abby's 5% reduction in equities in her recommended asset allocation model.  Believe us, we had to try hard to stop laughing.  If an Abby asset allocation shift from 70% equities to 65% equities was the root cause of a 40% decline in the NASDAQ, well then God forbid she ever drops the recommendation to 50% equities.  If that happened, would the NASDAQ drop 100%?  Thinking that "Abby caused this" gives us incredible confidence that ignorance continues to reign on Wall Street.  Clearly we have not seen the bottom yet given the complete lack of rational thought.

The Spin Cycle...After a week like last week, it's simply time to put another quarter in the machine.  A newly "reformed" Abby, "Kamikaze" Tom Galvin, Art Hogan, Joey B., you know the characters.  We're particularly intrigued by Mr. Galvin.  In our eyes, Tom just made a "career bet" by upping his equity allocation from 80% to 90%.  Oh well, we guess if he loved them at 5,200 on the NAZ, he simply had no other choice at 3,300.  In addition to these esteemed "gurus", we also have a large cadre of sell side analysts rushing to upgrade their ratings on stocks prior to the consensus expectations for great earnings (especially from the technology crowd).  It's just a shame that poor Mark Edelstone upgraded Intel to a super-duper buy right before a little "portfolio management" in terms of Intel producing the number this evening (and the sagging stock in after hours antics).  

What Happens Next?...As usual, our first comment is that we have absolutely no idea over the next few days or weeks.  For any disheartened bears believing that rationality was fleetingly starting to seep into the cracks around Wall Street and has now vanished, remember that a two day rally does not a market make.  Severe technical damage has been done to the market over the prior weeks.  The charts of the indices and plenty of the favored darlings do not scream "on to new highs".  Far from it.  Having the NASDAQ descend significantly four straight days in a row is pushing historical boundaries.  Nothing on Wall Street ever happens in a linear fashion.  (Is there an echo in here?)  In our minds, the volatility we have experienced on the upside in the last two days is just as dangerous as what the total market experienced last week.  We are simply stunned that the market of today could be so closely repeating almost the exact experience of the 1929 top.  Seriously.  We never thought we would see something like this actually unfold.

As we have said too many times already, the long term future of this stock market is in the hands of the public.  Many "players" have been burned with margin debt.  A very key question is "Has the process of deleveraging begun?".  Our current answer to this is YES. Remember, just like confidence destruction in a bear market, deleveraging is a process.  Over the past few years, leverage is what this stock market has been all about.  Margin debt as well as all other forms of consumer and corporate leverage have been the fuel.  The true process of deleveraging certainly takes more than two weeks to unfold.  The levered portion of the equity market is clearly the tech sector.  The Internet's and the Biotech's have done a good job of highlighting that leverage risk, but the recent report on margin debt still shows a move to a new all time high.  We expect periods of sector illiquidity ahead.  When illiquidity rears its ugly head, one has to sell what is liquid to deleverage - namely big cap issues.  Parabolic stock moves are regressing to the mean amidst a period of extraordinary leverage.  This will effect the entire market.  The downside of leverage cannot be an isolated event.  The deleveraging process extracts order by drawing on whatever liquidity is available at the time.  That ultimately means big cap DOW, S&P and NASDAQ issues will become "food" for the deleveraging process to remain semi-orderly in the aggregate (and we're just not sure it can remain orderly). Sound a little convoluted?  (We hope not.)  Leverage is the pin in the grenade.  Once the pin is removed...well, you know the rest.  Fire in the hole?

Indispensable...Tim's chart work is simply indispensable in a period such as this.  The perspectives brought to bear by the pictures are invaluable.  Time for the updates:

The similarities in these graphs just speaks volumes.  The evolution and conclusion of a mania.   The 1929 experience dramatically typifies that even secular bear markets are a process, not events to be concluded in a week or two.  

Watch Tim's channel work closely.  Any serious violations spell big trouble for the bull.  This chart of the SPX dramatically shows that rallies in a (potential at this point) bear market are steep and fast.  Clearly there is no time to think.  Only time to react.  

Can two days of upside action heal the NDX 100?  Take a look at the following chart and you'll know the preceding question was rhetorical: 

Patience and pacing are mandatory for "staying alive" and potentially prospering in a secular bear market.  Remain flexible in your outlook at all times.  Ignore this little tidbit at your own peril.  Once again, sorry to beat you over the head, but nothing on Wall Street ever happens in a linear fashion.

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