Looking At The Evidence

• August 12, 2002
• Dave Floyd

These bear market rallies sure can lead people to
some rather glorious conclusions. Witness the headlines, the banter
on the financial channels and the one that takes the cake, Barron’s
headline which was something to the effect of "Time to Buy Tech Stocks
Since They Are A Bargain". Granted, this is the first significant market
downturn I have experienced in my ninth year as a trader, but I have been
fortunate enough to have read an ample amount of market history to know that all
this bantering is just that, bantering.

The media, and the public in general, seem to have a fixation on believing
that the good old days are just around the bend. For a nation that is a world
leader, you would think common sense would be in greater supply. It is not.
Human emotions, mainly greed and fear, take precedent over intellectual
capacity. The market will have some glorious runs in the months to come. Bear
market rallies are spectacular, but they only lure in hard-earned capital,
typically near the top, and then decimate it. If you bought the dips in the
Nikkei over the last 10 years believing it was the bottom, you have decimated
your net worth.

So let’s cut right to the chase. There is no bull market right around the
corner. In fact, things will get worse before they get better. My opinion?
Hardly. There is enough evidence which supports a prolonged period of either
sideways movement, or another leg down. So, while this may not have much to do
with the usual theme of my columns, it does go back to a point I have made
several times as it relates to placing your income from trading in appropriate
long-term investments. Do not fall for that "invest for the long term"
mantra. In the long run you will be dead, and half of the so-called long-term
total returns people talk about came from something called a dividend, a nearly
extinct financial byproduct of soundly run companies. One would think that in an
industry supposedly dominated by the best and the brightest, there would exist
advice that actually made sense. Instead we get the same old stories. That is OK,
though. These rallies simply allow for observant traders and investors to
reestablish short positions

There are two major themes developing which will prevent our markets from
significant upside progress. Yes, there will be wonderful long opportunities for
traders, but if you are seeking a buy-and-hold strategy, cash is king right now.
Why not bonds? First, bonds have had a tremendous run, and that is not to say
they cannot run further still. I have been long bonds for about six months now,
but I see potential troubles ahead. The Fed has just been too reckless is
providing liquidity to the market. This easy money stance by newly knighted Sir
Alan, or as people are calling him now, Sir Prints A lot, may have disastrous
consequences down the road. Rather than a recession with a deflationary bias,
look for a recession with inflationary characteristics. Raw materials and select
commodities are already trading higher off 25-year lows. So, if you are in bonds
or looking to buy them, bear this in mind.

Tech Stocks Cheap? 

Based on closing prices from Aug. 3, unless I am missing the big picture,
these stocks are not cheap. With cap-ex spending continually being pushed
forward, tremendous overcapacity, and bankrupt telecoms, these stocks will only
be more expensive. So, you be the judge. Call the tech bottom or allocate
capital somewhere else.

Source:  The High Tech Strategist

For comparison purposes, at the end of the bear market in 1982 the PE ratios
for the then-dominant tech players were:

IBM                                    
9.4

Digital Equipment              
11.4

Hewlett Packard                
14.6

Wang Labs’                        
17.4

Prime Computer                 
16.0

The bloated SOX trades at twice the level
it did in 1995, despite the fact that combined estimated revenues for all
the SOX components is less than what it was in 1995.

The point is simple. Valuations will not matter till they do matter, and at
some point everyone is going to throw their hands up and say, get me the hell
out. Just wait till all these sheep portfolio managers realize the mess they are
in and need to liquidate, that is when you want to have some cash on the
sidelines to pick these issues up. In the meantime, trade ’em or short ’em into
rallies (what I am looking to do), but do not invest in them.

And on a final note, under-funded pension plans. It is a problem here as well
as the UK. During the bull market, companies did not need to worry about making
contributions, the capital gains took care of that. However, the nasty selloff
over the last three years has left many companies with their back against the
wall. Consider this:

• As of the end of 2001, under-funded defined benefit plans reached a $111
  billion shortfall, a 425% increase from 2000. It would be safe to say that
  the number is higher as the major indices are once again lower on the year.
• The good news is corporations are taking the necessary steps to restore
  these plans. The bad news is that cuts into cap ex as well as earnings.

The Housing Bubble

Despite what many say, I believe there is a bubble brewing in the housing
market. First of all, I m no real estate expert. My points here are purely my
observation with a few statistics thrown in. But let’s use recent history, i.e.,
the Nasdaq bubble, as a guide for what a bubble looks like and what causes it.

Back in 1999 and 2000, there was every reason in the world for the market to
continue higher, and as stock prices marched higher, the theories kept coming.
Taxi drivers, celebrities, etc., all had the keys to the holy grail. I see that
now. In fact, I heard the following the other day:

"There is simply no other place to put my
capital, so I will put it in real estate." 

Whoa boy, does that bring back memories. Secondly, existing home sales are
far outpacing new home sales, another sign of froth. However, this can go on an
on until there is some catalyst. The catalyst can be one of three things or a
combination thereof:

1. Higher interest rates
2. Affordability
3. Financial intermediaries turning off the easy money tap

This last reason is probably the one that will be the fly in the ointment. If
there were ever a time when credit was the sole driver of housing, it is now.
The average down payment on a home nowadays is 3% compared with 10% a decade
earlier. Also, homeowners are now tapping into their equity with a vengeance to
maintain their spending habits since virtually nobody saves anymore. Equity
today stands at 55% vs. 70% in 1982. Look out if prices start to drop.

With all the trouble the major banks seem to be in currently via their
dealing with now bankrupt telecoms and energy companies, it won’t take too many
defaults on mortgages for them to tighten the requirements. Delinquencies are
already on the rise.

A good friend of mine recently scaled back from his veterinary practice
pursue real estate speculation full time. He is a smart guy and has done his
homework, but it reminds me of 1999-2000 when I had friends contacting me to see
if I had any seats in the office so they could trade. We know how that turned
out.

Another friend who is relocating to Seattle from here in San Diego had her
townhome listed for less than one day and received multiple offers above the
asking price. So despite what I may say or others, the housing market is alive
and well, just keep an eye open. 

The Day Ahead

As of 5:30 AM PST, the futures are off a bit, with the S&Ps trading below
900. I expect the morning to be active as has been the case lately, but with the
FOMC meeting tomorrow, I do not expect much of an afternoon session. However,
given the gyrations of the markets in recent weeks, nothing is out of the
question.    

Last week’s rally left most tech stocks behind. A quick look at the daily
charts will show clearly how badly they performed relative to the market. If the
markets experience some softness today, that will be the group to focus on both
intraday and from a position standpoint.

Intraday Setups

Texas Instruments
(
TXN |
Quote |
Chart |
News |
PowerRating): A close
above 21.09 will fill gap from Aug. 2. look for entries long or short in this
area. Congestion areas can be found between 22-22.10 and 20.36-20.42.

IDEC Pharmaceuticals
(
IDPH |
Quote |
Chart |
News |
PowerRating): We’ve
been calling IDPH to the long side every day during the last week for over 7
points. I really hope you grabbed some of it. IDPH is dealing with heavy
resistance at 47.45 and support at 45.35 and 44.11. 

Merrill Lynch
(
MER |
Quote |
Chart |
News |
PowerRating):
A break below 32.84 would be good for the bears and would indicate move back
towards the lows from late July.

(To see some of the setups from last week, click
here.

Key Technical
Numbers (futures):

S&Ps	Nasdaq
923	964
918	956
911 (confluence)	947 (confluence)
898.75	930
891-93	917
880-83 (key level)	905
868 (confluence)	898
	888

As always, feel free to send me your comments and
questions. See you in TradersWire.

Dave