How Hot is Hot?
(December 19, 2003)
My partner will be on vacation in Toronto starting
this weekend, and since he's the technical guy that handles everything from
developing economic models to web mastering, we would not be updating our website
until he comes back - sometime the first week of January. Today I will write
an abbreviated commentary, since everyone is in vacation mode and there have
been no surprises in the market during the last two weeks.
How hot is hot? This question was first asked by
Robert Rhea, the famous Dow Theorist who traded the markets back in the first
30 years or so of the 20th century. He avoided the crash of 1929,
and bought the market within a few days of the 1932 bottom. This question was
first asked by him in regards to the bull market of the 1920s - towards the
end of 1928, it was obvious that the speculation in the stock market was reaching
an euphoric stage, and that a top and the subsequent crash was pretty close
by. Valuations were outrageous and public participation was rampant. But just
how hot is hot? How can we determine when we should exit? Or even short?
Alan Greenspan stated as early as 1994 that there was a bubble in the stock
market, and only when he got tired of calling it a bubble, did the bubble finally
burst. Bernard Baruch and Joseph Kennedy exited the markets in late 1928 or
the summer of 1929, and Jesse Livermore already started planting short positions
in the same summer (Livermore noted that breadth was getting worse even as the
stock market was making new highs and shorted the weak industries and maintained
long positions in the strong industries).
Bears have been so used to the "straight line" decline
from 2000 to late 2002 that they now have a trouble in seeing just how far this
rally can go. Sure, valuations are still ridiculous and the employment situation
has not been getting significantly better. But we have had a vicious non-stop
bear market for three straight years - why can't we give the bulls a break for
I know of several people who actually capitulated
and sold all their mutual funds and stocks in the July and October 2002 bottoms
- something that I really have not witnessed in past declines during the last
few years. It is now obvious that we have had a pretty big swing and there
are still no signs of a top. Optimism is building, however, but the obvious
question is: how hot is hot? Bill Miller
Sir John Templeton last week, stating: "Bull markets are born on pessimism,
they grow on skepticism, mature on optimism, and die on euphoria." (Never mind
that Bill Miller misquoted Templeton - Templeton is a big-picture guy and does
not even come close to thinking that this secular bear market is over. What
Bill Miller is talking about is probably just a bull swing within the secular
bear market we are currently in.) He stated that we are still in the skepticism
stage, and I think he may have a point.
Optimism is building, however. The IPOs and secondary
offerings are all coming back, and equity inflows continue to roar into the
market. CTRP had a double the first day (on an intraday basis), something which
we have not seen in an IPO since November 2000. Margin debt during October
on the NYSE had its first significant increase for the longest time. The VIX
is at a very low level of 16 (very low relative to the post 1998 period). But
all around me, I still see traces of skepticism in the latest rise of the stock
market, and if you tell them that the market may probably go back to 8,000,
they are still not calling you an idiot -- yet.
Sentiment-wise, I still do not see signs of a top,
and neither do I see it in the breadth figures, even though the NASDAQ may be
somewhat lagging here. (Volume was actually okay yesterday and breadth was
impressive, by the way, with the A/D line on the NYSE making a new high.)
The big news yesterday was the yield of the long bond
declining below 5% yet again - the housing boom continues to march on. Any
fears of an adverse impact on the stock market caused by higher interest rates
have also been alleviated. But consider this:
This is a chart that I posted a couple of months ago comparing the CRB index
to the yield of the 30-year Treasuries. At the time, I stated that if the 30-year
Treasury yield moves above 6%, then the downtrend is probably over. Since the
yield declined below 5% yesterday, we are still safe for now - but note the
relationship between the CRB index and the yield of the 30-year Treasuries (please
see the September 28, 2003 commentary). Something has to give here. Either
the CRB index will have to break down or yields will have to move up. That
being said, the CRB index may actually have a breakout failure here - any failure
to break out above 260 in the next couple of months may actually have some pretty
bearish consequences on the index. Conversely, if the CRB index can break out
above 260 and convincingly stay above 260 for the next couple of months, then
yields would most probably move back up.
More cautious investors should also consider this:
Since March, hedge funds have
piled in about $200 billion into the market -- with some of them now fully long
or even leveraged on the long side.
Since March, pension funds have
put in about $100 billion -- with most not planning to make any significant
contributions next year. The ones with a 1/1 plan year (most of them have a
1/1 plan year) would make regular quarterly contributions if they are not highly
funded, and their first contribution would be 1/15 and then nothing afterwards
Since March, individuals have
piled in about $130 billion into mutual funds, with an unknowable amount into
stocks. At the same time margin debt has gone up about $27 billion on the NYSE
(and even more on the NASD) from March to the end of October.
IPOs and secondary offerings should be more prevalent
next year with insider selling continuing its current brisk pace. From then
on, the individuals may be the sole supporters of the stock market - unless
insider buying comes back or if foreigners start buying our stocks again. Ultimately,
this may depend on the performance of US$ going forward.
Should I Short?
Shorting is an inherently difficult
business. When a short-seller tries to make some money on the short side in
the general market, he or she usually will need very good reasons for it. Do
I see a good reason right now? Probably not. I don't think I can say with
confidence this move is nearly over until I have seen more speculation or euphoria
in this market. I believe this up trend will only die in exhaustion. So just
how hot is hot? I believe once the last person gets on the bus (the ones who
got out of the market in July 2002 or October 2002) then there will be no one
left to support the market. A lot of this evidence will probably be anecdotal.
Let me know if you know anyone who got out at that time last year and watch
him or her like a hawk. Once that person buys stocks again, then we will start
shorting them all.
Or in the words of 'Sell'em' Ben
Smith: "Sell'em all! They are all going to zero!" (spoken in the days of the