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This Bull Swing Will Only Die in Exhaustion

(January 18, 2004)

Dear Readers:

All the major stock market indices closed at 52-week highs this week, including the DJIA, the NASDAQ (both the Composite and the 100) the S&P 500, 400, and 600 (both of the latter closed at all-time highs).  Only the DJTA lagged, but even there the DJTA was only a mere eight points below its 52-week high.  Breadth has continued to be impressive, as evident by the following A/D charts of the NYSE and the NASDAQ:

NYSE Advancing-Declining Issues ($NYAD) Nasdaq Advancing-Declining Issues ($NAAD)

After a brief pause in speculative activity on the NASDAQ, investors and traders alike are now getting their feet wet once again.  In short, the author cannot find any fault with the market, despite its current overbought conditions.  Last week, I conjectured that the beginning of the earnings season may bring about a correction, but the market has just continued to steadily grind higher.  It is now obvious that the traditional overbought indicators are not working - despite their usefulness over the last few years.  The fact that many financial articles and financial analysts alike are calling for a correction right now just makes this much more unlikely.  Like Lawrence McMillan stated last week, it is just impossible to pick a short-term top, so as long as your stocks are performing well, buyers should stay with their current stocks until the volatility gets too difficult to handle or until their stocks issue an actual sell signal.

I mentioned last week that because of the current overbought conditions of the market, this rally is either the strongest rally we have seen in years (with much more room to go) or that it is about to topple over.  I am now convinced that it is the former and I am listing my reasons below (in no particular order):

1) The major stock market indices made new rally highs this week AT THE SAME TIME that breadth on the NYSE and NASDAQ made new rally highs.  There have been many cases where breadth has topped out before the stock market indices made a top, and fewer cases where the stock market indices made a top before breadth made a top.  But never has there been a case where both the stock market indices and breadth made a top at the same time.  They will have to diverge in action for a significant period of time before there is even a hint of a top in the stock market.

2) Lowry's (the oldest and one of the most reputable technical analysis services on the Street) issued an intermediate term buy signal as of March 17, 2003.  They have been right on since then, and a major buy confirmation was issued two weeks ago, when its Buying Power Index crossed over its Selling Pressure Index for the first time in four years.  This indictor has been virtually flawless since Lowry's began its service in 1939, and it currently implies that the market still have much further room to go on the upside in at least the next three to six months.  The author personally does not have the entire record of this indicator dating back to 1939, but I do have it dating back to 1987.  Following are instances from 1987 where Lowry's Buying Power Index crossed over the Selling Pressure Index:

  • January 1987
  • February 1988
  • January 1989
  • June 1990
  • February 1991
  • December 1992
  • August 1994
  • April 1995
  • September 1996
  • May 1997
  • January 1999
  • July 1999

The task of interpreting the subsequent stock market action after these instances is left up to the reader, but the author can say that with the exception of the August 1994 and the July 1999 signals, all of these signals would have been (some hugely) profitable for the investor who bought stocks immediately after these signals were issued.  The author believes that the fact that there has been more than a four-year drought before the latest signal makes this current signal significantly more bullish.

3) At the bottom in July and October of 2002, I know of a significant number of people who could not stand the stress, capitulated, and sold out all their stock market holdings (including their 401(k) positions).  This was something I had never heard of during the entire bear market that began in March of 2000.  Obviously, there was a bit of exhaustion (even though valuations of the major indices were still sky high) during those two months, and this was confirmed in March of 2003 when Lowry's Selling Pressure Index rose to a multi-year high.  I believe that this current bull swing will only end the same way - in exhaustion.  I am not stating that the current and any upcoming rallies will be a mirror image of the bear market from March 2000 to late 2002 (only on the upside), but I will not be surprised if we see some rampant speculation again in the next six to twelve months.  For those of you who believe that investors have learned their lesson: Just witness the spectacular rallies seen during the 1932 to 1937 period and the 1970 to 1972 mania in the "Nifty Fifty" stocks during the bear market of 1966 to 1974, before they all collapsed again (see below for three examples of the performance of the Nifty Fifty stocks).

Disney (Jan 1970 to Dec 1974) Coca-Cola (Jan 1970 to Dec 1974) IBM (Jan 1970 to Dec 1974)

We may not see new highs in the S&P 500, but we are already seeing new all-time highs in the S&P 400 and 600.  Frankly, I will not be surprised if the NASDAQ goes back to the 3,000 area before this is all over.

4) Like I have said before, I believe this current bull swing will only die in exhaustion, and I do not believe we are anywhere close to that yet.  Pension funds are still contributing money to their plans, and individuals have not started actively trading their e-Trade or Waterhouse accounts just yet.  Foreigners have also just started buying U.S. assets again, as evident by the following news clip: Flows shock gives dollar faint stabilization hope.  The Central Banks of the world have also been very loose in their monetary policies, especially the Central Banks of the U.S., China, and Japan.  The money supply growth in China was over 20% last year, and the BOJ have been very aggressive in buying dollars and selling yen in order to curb the rise of the yen (thus flooding the system with yen).  The Federal Reserve of the U.S. has maintained that they will keep interest rates low for an indefinite time until they see more evidence of job creation.  Make no mistake, the world is now flooded with an immense tidal wave of liquidity.  Rumors are that the European Central Bank may try to curb the strength of the Euro, and if this happens, then the stock markets of the world (not to mention real estate) will most probably explode to the upside.  A lot of analysts are calling for the Chinese bubble to burst which may bring an end to the current rally, but the fact that so many analysts are trying to pick a top here suggests that we are nowhere near close to the top.  As a rule, do not ever, ever try to pick a top!  Following is a couple of charts from the Bank Credit Analyst suggesting that we are nowhere near a top both in Chinese economic growth and in the Chinese IPO market.  The chart on the left shows that both the money supply and bank credit growth is not anywhere close to slowing down, and the chart on the right compares the performance of the current Chinese stocks to that of the Red Chip stocks (Hong Kong companies that derive most of their business from China) during their meteoric rise of 350% from January 1996 to August 1998.  The Bank Credit Analyst suggests that the current rally in Chinese stocks still has much more room to go, as evident by the recent hugely oversubscription of the Chinese IPO stocks (which far outmatches the oversubscription of even the most popular internet stocks during the late 1990s). 

China: Broad Money (M2) Growth vs Bank Credit Chinese IPO stocks

5) Capital spending has also begun to pick up, as evident by the recent Verizon announcement of a $3 billion infrastructure upgrade (including a $1 billion plan to upgrade its wireless network to comply with the "3G standard") and now a potential bidding war to acquire AT&T Wireless.  This is significant in light of the fact that the entire telecom sector pretty much froze capital spending and mergers & acquisitions during the last few years.  Also, the fact that most telecom analysts on Wall Street are still bearish on the overall sector makes this significant development doubly bullish.  And this just in: IBM has announced plans to hire 4,500 workers in the U.S. during 2004.  The author believes that as the year marches on, the term "jobless recovery" will fade from our collective memories.

6) Short interest on the NYSE remains near its all-time high while the short interest on the NASDAQ actually made an all-time high in mid-December.  Never mind that short interest was also at a record high at the top of the November 1929 to April 1930 rally and at the top of the June 1949 to January 1966 bull market.  The current rally is broad in strength, and so the fact that short interest remains high is a bullish sign.  Just witness the recent action of RIMM and Friday's action of JNPR and you will get an idea of what I mean.  RIMM's short interest as of November 8, 2003 was 8.45 million shares.  On December 8, 2003, it was 10.79 million shares, or nearly 20% of the float.  Since that time, the price of RIMM has nearly doubled, and God knows how many more hedge fund managers or individual traders shorted that stock between December 8, 2003 and last Friday.  The situation in JNPR is similar, as people thought it was overvalued at $15 a share in October 2003.  Friday's action (the day after earnings) saw the stock go up by over 30% to close at $29.93 a share.  Following is a chart showing the NYSE short interest vs. the Dow Jones Industrial Index and a chart showing the NASDAQ short interest vs. the NASDAQ Composite:

NYSE short interest vs. the Dow Jones Industrial (November 15, 2000 to December 15, 2003) Nasdaq Short Interest vs. Value of Nasdaq (September 15, 1999 to December 15, 2003)

As one can see, the short interest on the NYSE is now in a downtrend - coming down from recent all-time highs.  This is bullish, as short-covering propels prices higher.  This may also suggest that more short-covering on the NASDAQ is not far behind, and there is probably enough "fuel" here to propel the NASDAQ back to the 3,000 level before this is all over.

To conclude, I sincerely hope that everyone who is currently bearish on the market will at least reconsider and think about the bullish position (and listen to the bullish arguments).  Based on my above reasons, I believe that the current rally is not over yet and things will most probably get more speculative on the upside before we can reasonably call a top.  By then, everyone who is currently short will be decimated.  Make no mistake, however; while I believe this is a major bull swing, I do not believe that the bear market is over yet.  The bulls should do well this year, and may be okay again next year.  But like I stated last week, the primary trend cannot and will not be denied, and sooner or later, we will see stocks selling at "great values" and the public swearing off stocks (again) before the bear market is over.

By the way, I am providing an update of the earnings calendar (up to January 27, 2004) that I provided in my last commentary (Intel and IBM changed their earnings date and I sincerely apologize that I inadvertently left out GE).  Please note that I have only included the stocks that I feel is significant (which reflects only my opinion and therefore it is not a "complete list" by any means).  However, I do not believe that this is too important at this point, unless one is heavily concentrated in certain stocks (which is a big gamble, anyway).  I also do not believe that trading on news is a wise idea.  Since the intermediate trend is bullish and does not show any signs of ending, earnings should ultimately turn out to be a non-event.

Signing off - Henry To, CFA

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