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Summary
Based on what I assess as a serious, continuing technical deterioration, I have decided to raise my near-term outlook for the stock market to the status of "red alert." My risk/reward assessment of the market from current levels is there is much more of the former than of the latter. Therefore, if you are holding substandard cash reserves to weather the continuation of the secular bear market when it reasserts itself, this appears to be an excellent time to do something about it!
Introduction
While you surely don't hear much about them on CNBC and other similar venues, there are fundamental reasons coalescing that should elevate concerns about the equity market.
Declining real growth, accelerating inflation, rising interest rates and peaking corporate profits are all on the list. Although the focus of this missive is on technical factors, I'll opine that what is evolving on the technical front may merely reflect the market's traditional role of "looking ahead."
Past writings have expressed the view that the bad things I thought would happen to stocks last year but didn't merely represented a postponement, not a cancellation, of events. And, on balance, most of the good things that did happen to stocks last year took place in the two months between the Presidential election and year-end. They took place in a rally that possessed the same characteristics of the proverbial three-dollar bill.
A plethora of hedge-fund managers needed that rally badly to try to get well performance wise. And at the time, overall control of the chessboard remained in the hands of the folks who can "make" rallies. Thus, the market's bad technical state in October was transformed into a much better one through the end of the year, with a Bush "relief rally" serving as the excuse.
Maybe control of what ostensibly is a "free" market remains in these folks' hands. If so, January's breakdown was nothing more than an aberration. After all, February has seen better times. On the other hand, when you examine how stocks behaved last week during one of those 12 "magical" (euphemism for "highly manipulative") times a year known as an "expiration," perhaps control over the chessboard is passing elsewhere?
I believe it probably is, and I believe this strongly enough to up my near-term outlook to a metaphorical red alert. Moreover, this shift on stocks has much to do with last week's behavior of interest rates -- ironically, triggered by the comments of none other than Maestro Greenspan.
Interest Rates
This missive's emphasis is mostly on stocks. However, interest rates may quickly be returning to a position of exerting a much greater impact -- a negative one -- on stock prices, so a few comments are in order.
* In its never-ending quest to paint the most favorable backdrop possible for the stock market, the CNBC crowd recently began championing the idea the Federal Open Market Committee might not raise the Federal Funds Rate another quarter point at its next meeting, scheduled for 3/22. In his congressional testimony last week, Alan Greenspan lent absolutely no support at all to this idea.
* Moreover, the fed funds futures market, which had shown no conviction in supporting the CNBC effort on behalf of stocks, showed even less conviction coming out of last week.
---------------------------------------------
FEDERAL FUNDS FUTURES
---------------------------------------------
02/18 02/11 Scheduled
Contract Close Close Change FOMC Meetings
---------------------------------------------
Feb. '05 2.50% 2.50% 0bp Feb. 1-2*
Mar. '05 2.60% 2.60% 0bp Mar. 22
Apr. '05 2.77% 2.77% 0bp No Meeting
May '05 3.02% 2.98% 4bp May 3
June '05 3.04% 3.01% 3bp June 29-30
July '05 3.26% 3.17% 9bp No Meeting
Aug. '05 3.36% 3.25% 11bp Aug. 9
Sep. '05 3.43% 3.33% 10bp Sep. 20
---------------------------------------------
*FOMC raised its fed funds target rate
from 2.25 to 2.50% at February meeting.
---------------------------------------------
* Recent open-market low yields on 5-, 10-, and 30-year Treasuries were set on 2/9, at respective levels of 3.57%, 3.98% and 4.47%. These issues finished last week materially higher, at 3.86%, 4.27% and 4.65%, respectively. In addition, not only did 10- and 30-year yields rise last week, they rose more than yields at the front end of the Treasury curve. This reversed, at least for a week, the strong on-balance flattening in the curve in evidence over the last several months.
Treasury Yield Differentials
----------------------------------
30 Years 30 Years V. 30 Years V.
Week Ended V. 90 Days Two Years 10 Years
-----------------------------------------------
02/18/05 +206bp +122bp +38bp
02/11/05 +193bp +115bp +39bp
01/21/05 +230bp +150bp +50bp
12/17/04 +264bp +183bp +63bp
11/19/04 +275bp +196bp +68bp
10/22/04 +292bp +224bp +77bp
-----------------------------------------------
* Several weeks back, I opined:
(1) That a 2.25% rate on fed funds was probably around the cusp of beginning to cause hedge funds some problems with their Treasury carry trades,
(2) that a 2.50% funds rate would probably begin to cause problems, and
(3) that a 2.75% funds rate would likely really do the trick.
I have not changed my mind about these general levels, perhaps explaining the heightened activity on Tout TV regarding how quickly the Fed gets us to 2.75%.
* I simply cannot imagine that unwinding the Treasury carry trade will be an entirely smooth, bloodless process. With a few bad breaks, there could be significant bloodletting. And it is not unrealistic to assume that some of that blood will belong to the stock market!
The Stock Market
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NOTE: It's been a while since I've done a "by-the-numbers" piece. Thus, the appendix at the end of the text contains the statistical tables attendant to such missives.
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* It was my view that stock bulls needed a decent push from last week's options expiration to help keep February's rally alive and well. There was nothing especially bad about the expiration, but there certainly was not much gusto, either.
* It may border on hyperbole to say that two stocks saved last week's expiration from a far worse fate for the bulls. It is not an overstatement to say that Pfizer and Merck surely helped the situation significantly.
* Thanks to an FDA advisory panel's recommendation on the drugs Vioxx, Celebrex and Bextra, Pfizer and Merck tacked on a total of 5.5 points during Friday's trading (PFE = 1.74 points, MRK = 3.76 points). This helped mask an expiration that was lackluster at best, even with the MRK and PFE contributions included.
* PFE and MRK are both components of the Dow Jones Industrial Average. Their combined 5.5-point gain was worth about 40.6 Dow points. In turn, this was equal to 131% of the DJIA's 30.96-point rise on Friday. Both stocks also have a meaningful representation in the S&P 500, so they certainly aided, likely accounting for most if not all of, the S&P's meager 0.84-point Friday gain.
* Looking at last week in broader terms, it represented the second consecutive expiration of generally weak stock performance.
Feb. Expir. Jan. Expir.
------------------------
For Week For Week
Measure Ended 02/18 Ended 01/21 Avg.
-----------------------------------------
NASDAQ 100 -1.0% -3.7% -2.4%
DJIA -0.1% -1.6% -0.9%
Russell 2000 -0.7% -1.0% -0.9%
S&P 500 -0.2% -1.4% -0.8%
-----------------------------------------
* January was a lousy month for the stock market. So far and on a net basis, the market has had a much better time of it during February. But to keep the better times rolling along, to push more bellwether measures beyond their 2004 highs, to prevent important proxies from failing at critical levels, the market sure could have used the positive juice it usually gets from an expiration. It did not receive it last week.
Following is a summary of how last week's close shaped up against my seven-measure tracking group's 2004 highs, all set in late December. Those highs also were recovery highs, from respective lows established in 2002.
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SELECTED STOCK-MARKET RETURNS
-------------------------------------------
02/18 2004
2005 High 02/18 Vs.
Close Close /Date 2004 High
----- ----------- ---------
NYSE Comp. 7287 7254 12/30 +0.5%
DJIA 10785 10855 12/28 -0.6%
S&P 500 1202 1214 12/30 -1.0%
Wilsh. 5000 11842 11988 12/30 -1.2%
Value Line 394 405 12/30 -2.7%
Russ. 2000 630 655 12/28 -3.8%
NASDAQ 100 1515 1625 12/29 -6.8%
-------------------------------------------
Average -2.2%
Median -1.2%
-------------------------------------------
* Isolating just last week, the tracking group was down an average 0.4%. Six of the seven components fell, with the NYSE Composite being the exception. It rose 0.4%. Declines in the other measures ran in a range of 0.1 for the DJIA, to 1.0% for the NASDAQ 100.
* The numbers in the above table certainly are a good indication of the critical levels at which these key measures remain. Any pullback of significance from around this area certainly could take on the appearance of an important "fail."
* The piece de resistance in establishing that the secular bear market remains intact and has reasserted itself would/will be a challenge, then violation, of 2004's closing lows. These were set around 8/12. From last Friday, a challenge would require respective DJIA, S&P 500 and NASDAQ 100 sell-offs of 9.0%, 11.5% and 13.9%. There surely is a dearth of pundits at present who believe something like this is in the cards.
* First things first, though. The market's first order of business is to expunge the November-December rally. For this reason, I've calibrated all of the tables referenced below to values running from late October through last week. This makes it easier to assess the erosion of the November through December period, if/as it occurs.
* Major market bellwethers have not been at or below their respective 200-day moving averages since late October. Revisiting this key measure makes for a logical initial objective. To accomplish this based on last Friday's closes would have required respective DJIA, NASDAQ Composite and S&P 500 declines of 4.1%, 3.6% and 5.1%. Since the week ended October 29, these proxies' maximum end-of-week apogee from their 200-day moving averages have been 5.7% (week ended 12/24), 10.4% (week ended 12/31) and 7.4% (week ended 12/24), respectively. (See Table 1 in appendix.)
* Let's next look at sentiment, which remains at very optimistic levels. CBOE put/call ratios are bullish, as is a VIX sitting at 11.18, not materially higher than its multi-year low of 10.90, set on 2/4. (Remember the contrary nature of these data, to wit: bullish is actually bearish.) In my view, these numbers are not likely to get much better, thereby leaving the other direction as the increasingly more probable outcome. In turn, this would require lower prices to accomplish. (See Table 2.)
* At times, my two-week rate-of-change series can be helpful in detecting approaching short-term price swings. (I calculate and maintain these data for the DJIA, S&P 500 and NASDAQ 100.) After two consecutive positive weeks for the S&P and NDX, and three for the DJIA, the S&P and NDX swung back into negative territory last week. As the table below shows, zero percent price changes this week would keep all three measures in negative territory, an additional suggestion that a more important swing was in progress. (See also Table 3.)
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DJIA, S&P 500 AND NASDAQ 100 -- TW0-
WEEK COMPOUND ANNUAL RATES OF CHANGE
------------------------------------------------
PROJECTED VALUES TO 02/25/05 FROM 02/18/05 CLOSE
------------------------------------------------
Projections to 02/25/05
From ------------------------------------------
02/18 2-Wk. S&P 2-Wk. NASD 2-Wk.
Close DJIA ROC 500 ROC 100 ROC
------------------------------------------------
+5% 11324 246% 1262 230% 1591 174%
+3% 11109 110% 1238 101% 1561 67%
0% 10785 -3% 1202 -7% 1515 -23%
-3% 10462 -56% 1166 -58% 1470 -65%
-5% 10246 -74% 1142 -75% 1440 -80%
------------------------------------------------
* Tables 4 and 5 break out various NYSE breadth measures of interest and importance. All of these are at some level of overbought technical condition -- some, at highly overbought levels.
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Table Appendix
Table 1.
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DJIA, NASDAQ COMPOSITE AND S&P 500 CLOSING PRICES ON
SELECTED DATES VERSUS RESPECTIVE 20-DAY, 50-DAY AND
200-DAY MOVING AVERAGES (Percent or Portion Thereof)
----------------------------------------------------------
DJIA Vs. NAZ Comp. Vs. S&P 500 Vs.
--------------- --------------- ---------------
Date 20D 50D 200D 20D 50D 200D 20D 50D 200D
----------------------------------------------------------
2005
02/18 1.4 1.2 4.6 -0.1 -1.8 3.8 0.8 0.7 5.3
02/11 2.1 1.6 4.9 0.9 -1.2 4.9 1.6 1.1 5.8
02/04 1.8 1.1 4.2 1.2 -1.0 5.6 1.8 1.1 5.9
01/28 -1.1 -1.6 1.5 -1.7 -3.6 3.1 -0.8 -1.5 3.2
01/21 -2.3 -2.0 1.2 -3.6 -4.0 3.0 -2.0 -1.8 3.0
01/14 -1.3 -0.3 2.8 -1.8 -1,3 5.8 -1.0 -0.3 4.6
01/07 -1.1 0.5 3.3 -2.6 -0.9 5.9 -1.3 0.1 4.9
2004
12/31 0.9 2.9 5.1 1.1 4.0 10.4 0.9 3.0 7.3
12/24 2.0 4.4 5.7 1.1 4.8 10.1 1.4 3.9 7.4
12/17 0.9 3.3 4.1 0.4 4.5 9.0 0.5 3.1 6.1
12/10 0.2 2.7 3.1 0.8 5.1 8.8 0.3 3.2 5.8
12/03 0.9 3.7 3.6 2.8 7.5 10.0 1.1 4.1 6.1
11/26 1.1 3.4 2.9 2.1 6.4 7.8 1.3 4.0 5.5
11/19 1.8 2.9 2.2 2.3 5.7 6.3 1.5 3.4 4.4
11/12 4.3 4.0 3.0 5.0 7.5 7.0 4.3 5.2 5.7
11/05 3.9 2.7 1.5 4.5 6.3 4.6 4.0 4.1 4.2
10/29 0.4 -0.8 -2.1 1.9 3.8 1.3 1.2 1.3 1.1
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Table 2.
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THE BEHAVIOR OF CBOE SENTIMENT-RELATED MEASURES
AND THE S&P 500 FROM 10/29/04 THROUGH 02/18/05
----------------------------------------------------
S&P 500
Date CBOE Options -------------------
or Put/Call Ratios Vs. 10/29/04
Week CBOE -------------------- Prior 1130.2 =
Ended VIX* All Equ. Ind. Tot.@ Close Week 100.00
----------------------------------------------------
2005
02/18 11.18 0.86 0.59 1.76 0.88 1201.6 -0.3% 106.32
02/11 11.43 0.86 0.66 1.44 0.88 1205.3 0.2% 106.64
02/04 11.21 0.75 0.49 1.65 0.88 1203.0 2.7% 106.44
01/28 13.24 0.77 0.61 1.19 0.88 1171.4 0.3% 103.65
01/21 14.36 0.87 0.64 1.91 0.87 1167.9 -1.4% 103.34
01/14 12.43 0.72 0.58 1.19 0.89 1184.5 -0.1% 104.80
01/07 13.49 0.97 0.78 1.60 0.89 1186.2 -2.1% 104.95
2004
12/31 12.73 0.66 0.45 1.68 0.88 1211.9 0.1% 107.23
----------------------------------------------------
12/30#12.56 0.86 0.60 1.85 0.88 1213.6 - 107.38
----------------------------------------------------
12/24 11.23 0.84 0.57 2.19 0.87 1210.1 1.3% 107.07
12/17 11.95 0.84 0.54 2.10 0.86 1194.2 0.5% 106.66
12/10 12.76 0.63 0.47 1.34 0.88 1188.0 -0.3% 105.11
12/03 12.96 0.74 0.54 1.60 0.88 1191.2 0.7% 105.40
11/26 12.78 0.73 0.58 1.76 0.87 1182.7 1.1% 104.65
11/19 13.50 0.81 0.52 2.53 0.89 1170.3 -1.2% 103.55
11/12 13.33 0.76 0.64 1.15 0.88 1184.2 1.5% 104.78
11/05 13.84 0.69 0.51 1.32 0.88 1166.2 3.2% 103.19
====================================================
10/29 16.27 0.73 0.60 1.32 0.88 1130.2 --> = 100.00
----------------------------------------------------
VIX Highs and Lows (Including Intraday)
---------------------------------------
Year High Date Low Date
---------------------------------------
2005 14.75 01/24 10.90 02/04
2004* 22.67 03/22 11.14 12/23
2003 41.16 03/12 14.83 12/15
2002 56.74 07/24 18.87 03/28
----------------------------------------------------
*New series, all of 2004 forward. @All
products. #High close during period.
----------------------------------------------------
Table 3.
------------------------------------------------
DJIA, S&P 500 AND NASDAQ 100 -- TW0-
WEEK COMPOUND ANNUAL RATES OF CHANGE
-- 18 WEEKS ENDED 02/18/05
------------------------------------------------
Week S&P NASDAQ
Ended DJIA 500 100
------------------------------------------------
2005
02/18 18% -3% -28%
02/11 147% 110% 70%
02/04 122% 116% 70%
01/28 -28% -25% -65%
01/21 -41% -33% -65%
01/14 -42% -45% -62%
01/07 -42% -41% -55%
2004
12/31 38% 47% 49%
12/24 100% 62% 15%
12/17 15% 7% -51%
12/10 5% 12% 55%
12/03 40% 58% 362%
11/26 -4% -3% 39%
11/19 19% 10% 57%
11/12 265% 236% 240%
11/05 408% 405% 360%
10/29 28% 67% 170%
10/22 -54% -46% 14%
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Table 4.
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NEW YORK STOCK EXCHANGE BREADTH MEASURES
----------------------------------------------------
Volume* Issues 52-Week
---------------- -------------- --------------
Week -A- -B- -A- -B- A/ H/
Ended Total Advan. B/A Adv. Decl. A+B High Low H+L
----------------------------------------------------
2005
02/18 7.409 3.464 0.47 7594 8844 0.46 1289 69 0.95
02/11 7.303 3.750 0.51 8778 7678 0.53 1297 69 0.95
02/04 8.094 5.354 0.6610937 5580 0.66 1520 47 0.97
01/28 7.968 4.030 0.51 8688 7691 0.53 516 117 0.82
01/21#6.425 2.566 0.40 6175 6982 0.47 464 83 0.85
01/14 7.381 3.697 0.50 8885 7519 0.54 351 88 0.80
01/07 7.871 2.385 0.30 591610549 0.36 346 59 0.85
2004
12/31 4.429 2.433 0.55 9263 6994 0.57 1231 38 0.97
12/24#5.182 3.192 0.62 7758 5350 0.59 1141 33 0.97
12/17 8.896 4.895 0.55 9295 7132 0.57 1234 62 0.95
12/10 7.302 3.158 0.43 7719 8609 0.47 750 80 0.90
12/03 7.747 4.075 0.53 8437 8067 0.51 1727 43 0.98
11/26#4.379 2.791 0.64 8699 4486 0.66 1250 21 0.98
11/19 7.346 3.436 0.47 7929 8489 0.48 1311 40 0.97
11/12 7.140 4.355 0.61 9922 6501 0.60 1484 53 0.97
11/05 8.203 5.409 0.6610388 6109 0.63 1614 49 0.97
10/29 7.737 4.842 0.63 9850 6375 0.61 804 174 0.82
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*Billions of shares. #Four-day trading week.
----------------------------------------------------
Table 5.
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SELECTED NYSE BREADTH MEASURES --
WEEKLY & CUMULATIVE DATA (10/29/04=0)
----------------------------------------------------------
Adv - Dec UVol - DVol 52W H - L Closing Tick
Week ----------- ----------- ----------- ------------
Ended Week Cum Week Cum Week Cum Week Cum
----------------------------------------------------------
2005
02/18 -1250 19803 -0.29 6.77 1220 16574 1559 34689
02/11 1100 21053 0.35 7.06 1228 15354 2894 33130
02/04 5357 19953 2.74 6.71 1473 14126 4005 30236
01/28 997 14596 0.21 3.97 399 12653 1773 26231
01/21* -807 13599 -1.19 3.76 381 12254 1980 24458
01/14 1366 14406 0.14 4.95 263 11873 1689 22478
01/07 -4633 13040 -2.97 4.81 287 11610 1145 20789
==========================================================
2004
12/31 2269 17673 0.54 7.78 1193 11323 1950 19644
12/24* 2408 15404 1.31 7.24 1108 10130 1767 17694
12/17 2163 12996 1.02 5.93 1172 9022 2087 15927
12/10 -890 10833 -0.85 4.91 670 7850 1265 13840
12/03 370 11723 0.45 5.76 1684 7180 801 12575
11/26* 4213 11353 1.27 5.31 1229 5496 2745 11774
11/19 -560 7140 -0.39 4.04 1271 4267 2523 9029
11/12 3421 7700 1.69 4.43 1431 2996 2835 6506
11/05 4279 4279 2.74 2.74 1565 1565 3671 3671
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SELECTED STOCK-MARKET MEASURES -- WEEKLY
& CUMULATIVE RETURNS (10/29/04=100.00)
----------------------------------------------------------
Week (10027) S&P (1130) (1487) Russ. (584)
Ended DJIA Index 500 Index NDX Index 2000 Index
----------------------------------------------------------
2005
02/18 10785 107.56 1202 106.37 1515 101.88 630 107.88
02/11 10796 107.67 1205 106.64 1531 102.96 635 108.73
02/04 10716 106.87 1203 106.46 1534 103.16 637 109.08
01/28 10427 103.99 1171 103.63 1499 100.81 613 104.97
01/21* 10393 103.65 1168 103.36 1504 101.14 611 104.62
01/14 10558 105.30 1185 104.87 1561 104.98 617 105.65
01/07 10604 105.75 1186 104.96 1565 105.25 613 104.97
==========================================================
2004
12/31 10783 107.54 1212 107.26 1621 109.01 652 111.64
12/24* 10827 107.98 1210 107.08 1614 108.54 649 111.13
12/17 10650 106.21 1194 105.66 1597 107.40 642 109.93
12/10 10543 105.15 1188 105.13 1605 107.94 632 108.22
12/03 10592 106.63 1191 105.40 1614 108.54 642 109.93
11/26* 10522 104.94 1183 104.69 1578 106.12 631 108.05
11/19 10457 104.29 1170 103.54 1552 104.37 613 104.97
11/12 10539 105.11 1184 104.78 1558 104.77 622 106.51
11/05 10388 103.60 1166 103.19 1525 102.56 604 103.42
----------------------------------------------------------
10/29 10027 100.00 1130 100.00 1487 100.00 584 100.00
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*Four-day trading week.
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