The Bearish Bungee Cord

• July 22, 2002
• Peter Navarro

Market Trend: Down

Market Outlook: Bearish

Sectors Long: None — Cash is King

Sectors Short: Utilities

David’s Picks: American Electric Power

(
AEP |
Quote |
Chart |
News |
PowerRating)

Peter’s Picks: Level 3 Communications
(
LVLT |
Quote |
Chart |
News |
PowerRating)

Dominant Position: Cash  

The Broad Market Outlook:
The Bearish Bungee Cord

Panic is finally in the air
as the bad news about stock
market has now filtered down to even the local TV news — hey, they love to cover
train wrecks. The question now on both Wall Street
and
Main Street mind is whether
we will finally get the final crash a.k.a.
market capitulation. To
answer this, we first have to understand why that much-awaited capitulation has
eluded us. With a drum roll please, let’s unveil a little economic theory based
on the concept of “rational expectations.” 

Rational expectations is a
concept that teaches us the obvious — that people observe patterns in the past
and base their expectations on the future about what they have seen. In this
case, market participants have learned that the stocks market
typically
has a panic and a crash to clear out all of the uncommitted investors and then
builds a new bull market on this final capitulation. 

Now here’s the problem: More
and more investors have built this idea into their investing strategies so that
whenever we get close to a bottom, they jump into buy,
thinking they’ve cleverly timed the bottom.
And in the
past, they would have
been right. But the
irony is that this behavior makes it very difficult for the market to actually
reach
that bottom.  So instead of a quick, steep, and sickening market-crash followed
by a rebound, we get the

“rolling capitulation” that we discussed in last week’s column.

The point: It is time for the smartest of
investors — those with rational expectations — to understand this new pattern
and not
get sucked into any Houdini market bear rallies and instead be patient.

It will require a
lot of patience this
week as the action is likely to be fast, furious, and for many, quite literally,
sickening. Accordingly, if you are in cash, stay there. If you are one of the
suckers who have held on to your stocks for more than two years thinking that
they were going to rebound, please don’t finally jump on the panic train and
sell these losers now. And if you think you can outwit this market by going
short, have at it, but know that the Bearish Bungee Cord could snap the market
up quicker than you might be able to cover.

Now the other BIG POINT to consider is
this: We suggest looking at the current market as a three-legged stool with the
Nasdaq, S&P 500, and the Dow.  We continue to believe that the Naz has reached a
bottom, based on our belief that macro factors finally suggest an uptick in
business investment — which will most benefit the tech-heavy Naz.  Note,
however, that if a panic ensued, the Naz, too, will be drawn in to the action
BUT likely bungee back the fastest.

As for the Dow, it is clearly the weak
leg of the stool — and for good reason. For lo these many months, investors have
fled to “quality” — which for many has meant bonds BUT for many more has meant
the largest-cap, bluest-chip stocks. For this reason alone, the Dow should
always be the last to hit a bottom. BUT the other problem with the Dow is the
Camelot factor — the old order changeth and giveth way to the new. In this new
century, it will be the small- and mid-cap stock that will grow the fastest and
at least some of them will eclipse the current blue-chip titans — as it has
always been and always will be.

The bottom line: Look for the Naz to be
much more resilient than the Dow as panic buffets the market (more about Buffett
later).

The Macro Data Market
Movers

The Macroeconomic
Calendar

* Potential
major market movers in red

A little-or-nothing week on the macro
data front will do little to assuage — or fan the flames of — market panic. Look
for any negative surprises on the home sales front to further batter the
increasingly battered housing sector — with many stocks now well off their
52-week lows. Look for the Employment Cost Index to offer reassurances of low
(wage) inflation. Friday’s consumer sentiment will be important but it’s hard to
imagine any further erosion from the steep drop we got the last time it was
reported. (If there is, Katy bar the door.)

That leaves the WorldCom bankruptcy and earnings news left to dominate the
market action — together with random scandal, subpoena, and investigation. More
about the bankruptcy below. 

As for earnings news, the big names include Tyco and Texas Instruments,
Colgate-Palmolive and Haliburton, Wyeth and Starbucks, and Viacom.  It will be
interesting to see if Starbucks gets a nice upside surprise from the depression
in coffee prices. 

The Broad Market Technicals: S&P
500

The S&P 500 finished the trading week down 74 points at 848.  We
cautioned in the

previous column that it was going to be a volatile week and that “cash would
be king,” and there you go. If you are trying to swim against this tide, you are
getting a (well deserved) boot to the derriere!  The “trend still remains
your best friend.” 

The
outlook going into this week is: Bearish. Prices still
remain in a downtrend, and the markets appear to be headed lower going into this
week. This should continue to be coupled by a falling dollar and a run to
bonds. A look at the daily chart below of the S&P shows the 3-day is crossed
below the 7-day SMA with prices trending down, hitting a new 52-week low on a
“gap” down on Friday. Stochastics are pointed down, and the MACD is below the
zero line. Downside support on the S& P is around the 800 area. Upside targets
are:  881, 900, 998, and 1041-1054.

Nasdaq Composite Technicals 

The Nasdaq Composite closed the week down 54 points at
1319.  The outlook going into this week is: Bearish. The
daily chart of the Nasdaq Composite below shows the 3-day crossed below the
7-day SMA. Prices are trending down, and made a new 52-week low on a “gap” down
on Friday. Stochastics are pointed down, and the MACD is sloping down towards
the zero line. Downside targets on the Nasdaq are around the 1300 area, and then
1250, and 1200.  Resistance is 1357 and the 1400 area, and then 1500, 1549-1560,
and 1600.

 

Sector Watch:

Up — Going into this week,
the sector to go “long” is:
CASH

Down — Going into this week, the sector to go
“short” is: The Utilities Sector as
measured by the HOLDR. The daily chart below of
(
UTH |
Quote |
Chart |
News |
PowerRating) shows that prices
gapped down on Friday last week, and hit a new 52-week low.  The 3-day is
crossed below the 7-day SMA. Stochastics are pointed down, and the MACD is below
the zero line.  You can play this sector by shorting
(
UTH |
Quote |
Chart |
News |
PowerRating).

David’s Pick:

A Short in The Electricity Sector

Short American Electric Power

(
AEP |
Quote |
Chart |
News |
PowerRating). This one has got
a short — pardon the pun! 
(
AEP |
Quote |
Chart |
News |
PowerRating) is a weak stock in the weak Utility
sector. The daily chart below shows a runaway gap that was produced last Friday,
with prices hitting a new 52-week low. Stochastics are pointed down, and the
MACD is below the zero line.

Peter’s Picks: If
It’s Good Enough for Warren Buffett…

We are in the process of
conducting a more extended analysis of the wireless and telecom sectors, but for
now: Two macrowaves are poised to wash over these sectors in a beneficial way.

First, the lifting of the spectrum cap in January 2003 will allow the wireless
types to consolidate. This will help lower costs, improve the quality of the
networks (by reducing the amount of dead zones — CAN YOU HEAR ME NOW?), and most
of all, allow the merged entities to price more like oligopolists rather than
fragmented destructive competitors.

Second, should the FCC indeed allow a Baby Bell to acquire WorldCom — as its
free market Chairman Powell has indicated — it would be difficult for the FCC
to say “no” to other such mergers. In this scenario, we would have the
reformation of the old Ma Bell world where a single company — in this new
versions several single companies — provided the lion’s share of the combined
LOCAL and LONG DISTANCE service. This, too, would facilitate PRICING POWER — and
of course, when consumers get the shaft, higher profits and stock prices can’t
be too far behind.

As our column suggested weeks
ago, Nextel is moving smartly upward on such speculation. And the best part of
Nextel’s latest gap up was that it was on positive earnings news and a bullish
extended outlook. This means that Nextel should be able to hold on to its gains
and continue to build momentum on acquisition speculation.

As for our stock of this week, let me suggest a similar longer-term position
trade with Level 3
Communications
(
LVLT |
Quote |
Chart |
News |
PowerRating). As you can see from the gap up in the chart below, the stock has
moved smartly on news that Warren Buffett has chosen this has his very first
tech stock to speculate on. He and others are arming
(
LVLT |
Quote |
Chart |
News |
PowerRating) with a hoard of
cash to go out and buy other companies now at rock bottom prices in anticipation
of positioning themselves for a telecom bounce-back. This is sound strategy that
may well pay off big time.

If you have a
favorite macroplay or stock you would like us to consider in this column, send
an e-mail to

peter@peternavarro.com or go directly to

https://www.peternavarro.com.  We’d love to hear from you.   

David W. Aloyan is a technical analyst providing analysis of the markets and
securities. He manages his own private money fund for a select group of
investors.