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Summary
Roughly a month ago -- February 21st, to be exact -- I issued a "Red Alert" on the stock market. Lots of water over the proverbial dam since then, to wit: An immediate, large sell-off, followed by a "breakout" that wasn't, followed more recently by something that looks to me like a serious, genuine breakdown. Thus, I am taking this opportunity to review what has taken place since 2/21, as well as to reaffirm an outlook that remains at "Red Alert" status.
I will also paraphrase a recommendation contained in the 2/21 piece: If you are holding substandard cash reserves to weather the continuation of the secular bear market, do something about it! And I would not tarry, either.
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Foreword
Before getting started, an important housekeeping chore. I want to reaffirm in the strongest terms my long-term pessimism on stocks. I continue to believe, as I have since 2000, that the equity market is in a secular bear episode, and I continue to suspect it has years yet to run.
Moreover, I now think there is a decent chance that the cyclical bull market that commenced during the summer to fall of 2002 is over. If so, this will have been nothing more than a predictable cyclical bull embedded in the secular bear. And if the duration of the secular bear is as long as I think it might be, there are likely to be more of these cyclical bull episodes to come.
For additional perspective on this, readers might want to glance at a detailed piece I wrote in March 2003, entitled: "Do Stocks Have Life After War?" This article contained a good deal of information on a prior secular bear, the 1965 through 1982 period.
Onward
My 2/21 missive ("Stocks: My Near-Term Outlook Moves to a More Ominous 'Red Alert'") began:
"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!"
February 21st was a market holiday. The following day, stocks got clipped pretty badly. That was the day the DJIA took a 174-point hit; the S&P 500 and NASDAQ 100 were down 17 and 21 points, respectively.
While the 2/21 missive certainly expressed some major and growing concerns about the stock market's relatively near-term prospects, believe me, it was not the very next day I had in mind! Nevertheless, I'm not looking a forecasting gift horse in the mouth.
The 2/21 missive went on to say:
"While you surely don't hear much about them on CNBC and other similar venues, there are fundamental reasons coalescing to 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.'"
Before "looking ahead," let's first recap what took place from 2/21 forward.
Tuesday, February 22nd, was a wretched day. Overall, my seven-measure tracking group was down an average 1.5% that day. (See Table 1 in the appendix.) The catalyst was a story out of South Korea that the Korean central bank had decided to begin diversifying its foreign-exchange holdings. In other words, less dollars, more of something else.
Although the US stock market was successful after 2/22 in shaking off the licking it took that day, the market's behavior on the 22nd indicated to me a strong propensity to react badly to a bad piece of fundamental news.
But it certainly takes more than one piece of sour news to sour the CNBC crowd. About two weeks later, the stock market was knocking on the door of new recovery highs. In fact, there were some.
Three of the seven components in my tracking group did set recovery closing highs: The Wilshire 5000 (on 3/7, by 0.7%), the DJIA (on 3/4, by 0.8%), and the S&P 500 (on 3/7, by 0.9%). "Breakout" was the chorus ringing loudly from certain venues (want to guess which ones?).
However, four of the components did not make it to the promised land, setting up a negative divergence, and the three that had succeeded in making it, did not make it by much -- surely not enough to constitute a legitimate breakout. Nor did they get much of a chance to follow through.
As of the recent highs (3/4, 3/7), the tracking group, on average, missed taking out the 2004 closing highs by an average 0.8%. And remember, this average included the three components that did marginally take out their prior closing highs. The four measures that missed, missed by an average 2.0%, a reasonably sizable number.
(NOTE: As previously reported, my model equity portfolio established an S&P 500 short position on 3/4, at 1220.38. This short was equal to about 10% of the account's total value. In turn, this is about 25% of the total short position permitted. The account's investment guidelines limit total short positions to 40% of account value. It remains my intention to expand this short position.)
As of yesterday's close, the entire tracking group stood, on average, 4.5% below respective 2005 closing highs. Declines ran in a range of 4.2% for the NYSE Composite and the S&P 500, to 5.1% for the Russell 2000.
Of equal interest to me, though, is where the group stood vis a vis respective 2004 closing highs, all set near the end of the year, and all representing recovery highs for the bear market to date. The following table provides the answer.
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SELECTED STOCK-MARKET RETURNS
(Ranked from 2004 High to 3/23)
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03/23 2004 11/02 To 03/23 From
2005 High 2005 -------------
Close Close /Date Close '04 Hi 11/02
----- ----------- ----- ------ -----
S&P 500 1173 1214 12/30 1131 -3.4% 3.7%
Wilsh. 5000 11560 11988 12/30 11075 -3.6% 4.4%
DJIA 10456 10855 12/28 10036 -3.7% 4.2%
Value Line 385 405 12/30 366 -4.9% 5.2%
NYSE Comp. 7127 7524 12/30 6701 -5.3% 6.4%
Russ. 2000 612 655 12/28 585 -6.6% 4.6%
NASDAQ 100 1472 1625 12/29 1495 -9.4% -1.5%
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Average -5.3% 3.9%
Median -4.9% 4.4%
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An average 5.3% decline below last year's highs is surely significant from a statistical perspective. But what this has done is the important message contained in the far right-hand column in the above table.
As of yesterday, the tracking group, on average, stood less than 4% above respective closes on 11/2, which was Presidential election day. In turn, 11/2 became the inflection point for a very major rally -- the so-called "Bush relief rally." I've debunked that concept a few times in earlier writings; I won't rehash it here.
But the rally from 11/2 through the 2004 closing highs saw the tracking group up an average 9.6%, with gains running in a range of 12.3% for the NYSE Composite, to 7.3% for the S&P 500. Remember, too, that this rally represented a huge portion of all of last year's gains. So if/when you expunge it entirely, by dropping below the 11/2 levels, you will have taken several bellwether measures' price-only performance to zero or less for more than a 12-month period of time.
Conclusion
I believe the stock market is heading somewhere worse than this -- maybe much worse. I also believe that time is quickly running out for the market to stage any decent, sustainable rally. I have placed the 11/2 levels in play now, since I view them as the market's next major downside objective.
NOTE: Five data tables follow that supplement the above text.
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Table Appendix
Table 1.
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KEEPING TRACK OF 2/22/05 (Respective Point Changes
on That Date, Plus Cumulative Results Going Forward)
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Stock Prices
------------
Wilsh. NYSE NAS. S&P Russ. Value
Date 5000 DJIA Comp. 100 500 2000 Line
--------------------------------------------------------
2005
02/18 11842 10785 7287 1515 1202 630 394
--------------------------------------------------------
02/22
Close 11665 10611 7211 1494 1185 618 388
Change -177 -174 -76 -21 -17 -12 -6
Change -1.5% -1.6% -1.0% -1.4% -1.4% -1.9% -1.5%
--------------------------------------------------------
03/23
Close 11560 10456 7127 1472 1173 612 385
Cum. -20 -11 43 -9 -2 -3 0
Change -2.4% -3.1% 2.2% -2.8% -2.4% -2.9% -2.3%
--------------------------------------------------------
Interest Rates (US Treasury Yields, %)
--------------------------------------
Date 90-Day 2-Year 5-Year 10-Year 30-Year
-----------------------------------------------
2005
02/18 2.59 3.43 3.86 4.27 4.65
===============================================
02/22 2.62 3.42 3.87 4.28 4.68
Cum. 3 -1 1 1 3
-----------------------------------------------
03/23 2.82 3.82 4.27 4.59 4.85
Cum. 23 39 41 32 20
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Table 2.
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SELECTED NYSE BREADTH MEASURES --
WEEKLY & CUMULATIVE DATA (12/31/04=0)
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Adv - Dec UVol - DVol 52W H - L Closing Tick
Week ----------- ----------- ----------- ------------
Ended Week Cum Week Cum Week Cum Week Cum
----------------------------------------------------------
2005
03/18 -2689 -37 -1.02 -2.99 115 7898 493 20058
03/11 -3428 2652 -2.55 -1.97 682 7783 1327 19619
03/04 1989 6080 0.61 0.58 1228 7101 2733 18292
02/25* 1961 4091 0.98 -0.03 622 5873 514 15559
02/18 -1250 2130 -0.29 -1.01 1220 5251 1559 15045
02/11 1100 3380 0.35 -0.72 1228 4031 2894 13486
02/04 5357 2280 2.74 -1.07 1473 2803 4005 10592
01/28 997 -3077 0.21 -3.81 399 1330 1773 6587
01/21* -807 -4074 -1.19 -4.02 381 931 1980 4814
01/14 1366 -3267 0.14 -2.83 263 550 1689 2834
01/07 -4633 -4633 -2.97 -2.97 287 287 1145 1145
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*Four-day trading week.
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Table 3.
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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)
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DJIA Vs. NAZ Comp. Vs. S&P 500 Vs.
--------------- --------------- ---------------
Date 20D 50D 200D 20D 50D 200D 20D 50D 200D
----------------------------------------------------------
2005
03/23 -2.7 -2.0 0.8 -2.6 -3.2 -0.2 -2.3 -1.8 2.0
----------------------------------------------------------
03/18 -1.4 -0.4 2.5 -2.0 -2.5 0.8 -1.2 -0.4 3.5
03/11 -0.3 1.0 3.9 -1.0 -1.3 2.5 -0.6 0.5 4.4
03/04 1.6 2.6 5.7 0.3 -0.4 4.1 1.5 2.3 6.6
02/25 1.2 1.7 4.9 -0.0 -1.1 3.9 1.1 1.4 5.9
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
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Table 4.
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THE BEHAVIOR OF CBOE SENTIMENT-RELATED MEASURES
AND THE S&P 500 FROM 12/31/04 THROUGH 03/23/05
----------------------------------------------------
S&P 500
Date CBOE Options -------------------
or Put/Call Ratios Vs.
Week CBOE -------------------- Prior 12/31/04
Ended VIX* All Equ. Ind. Tot.@ Close Week = 100.00
----------------------------------------------------
2005
03/23 14.06 0.83 0.52 1.62 0.88 1172.5 -1.4% 96.75
----------------------------------------------------
03/18 13.14 1.27 0.72 2.95 0.88 1189.7 -0.9% 98.17
03/11 12.80 0.99 0.62 1.97 0.88 1200.1 -1.8% 99.03
03/04 11.94 0.81 0.61 1.31 0.86 1222.1 0.9% 100.84
02/25 11.49 0.81 0.63 1.32 0.88 1211.4 0.8% 99.96
02/18 11.18 0.86 0.59 1.76 0.88 1201.6 -0.3% 99.15
02/11 11.43 0.86 0.66 1.44 0.88 1205.3 0.2% 99.46
02/04 11.21 0.75 0.49 1.65 0.88 1203.0 2.7% 99.27
01/28 13.24 0.77 0.61 1.19 0.88 1171.4 0.3% 96.66
01/21 14.36 0.87 0.64 1.91 0.87 1167.9 -1.4% 96.37
01/14 12.43 0.72 0.58 1.19 0.89 1184.5 -0.1% 97.74
01/07 13.49 0.97 0.78 1.60 0.89 1186.2 -2.1% 97.88
====================================================
2004
12/31 12.73 0.66 0.45 1.68 0.88 1211.9 0.1% 100.00
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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.
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Table 5.
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DJIA, S&P 500 AND NASDAQ 100 -- TW0-
WEEK COMPOUND ANNUAL RATES OF CHANGE
-- 12 WEEKS ENDED 03/18/05
------------------------------------------------
Week S&P NASDAQ
Ended DJIA 500 100
------------------------------------------------
2005
03/18 -53% -50% -62%
03/11 -15% -22% -31%
03/04 45% 55% 9%
02/25 12% 14% -6%
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%
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