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A Buying Opportunity?

(July 28, 2004)

Dear Readers:

Due to the immense, positive feedback that I received about my last market commentary, I have decided to break my weekly schedule and write a quick, interim update for my readers. Of course, the state of the market has something to do with it as well, but I definitely do appreciate the support.

I want to begin my commentary by reaffirming what I said on Sunday evening. I am now bullish - not only because the market is oversold and not only because the cyclical bull market is not over yet, but because liquidity indicators are bullish as well. Buybacks are increasing, and insider selling has and will be muted for the next weeks. We are seeing more evidence of this everyday. For example, Comcast just announced a $1 billion share buyback today. My cash and margin debt data also directly reflects the immense liquidity available to the market. Why do I make this statement, you may ask? I am making this statement since there have been numerous analysts over the past few years (especially the bear market of 2000 to 2002) who cited the bullishness of things such as the amount of money market funds in retail or institutional accounts - stating to the effect that this money has to go somewhere and it may as well be the market. Please keep in mind that no scientific studies have been done on this kind of indicator, but let me present to you the following chart:


Please note that when the bull market peaked in early 2000, the amount of money in institutional and retail money funds were over $1.5 trillion. Cash in money funds continued to increase even as the bear market dragged on in 2000 and 2001, and yet the market continued to decline. Moreover, if one bases his of her liquidity analysis on this indicator, he or she would now be bearish. My point: The amount of cash in money funds cannot be used as a reliable stock market liquidity indicator, since participants have a wider number of options with their money in these accounts.

Like I said above, the amount of cash in institutional and retail money market funds cannot be used as a direct or reliable stock market liquidity indicator - precisely because cash in these accounts do not need to go into the stock market - similar to money in checking or time deposit accounts. During 2000 or 2001, traders who used this indicator in their analyses would have been bullish - and wrongly so. Over the last 18 months as the S&P 500 rose over 30%, the same trader would have been bearish - and again, wrongly so. Presently, this same stock market trader would still be bearish - which conflicts immensely with the cash and margin debt indicator that I presented in my last commentary. I believe I am presenting my point in a correct way, precisely because cash in these accounts are intended for investment in the stock market; and not for other investments (or for spending).

Now, let's talk about the Dow Theory in a classic (and purely technical) sense. Following is an updated daily chart of the Dow Industrials vs. the Dow Transports:

The Dow Industrials is still below the down trend line that dates back to February - but the Dow Transports STILL simply refuses to confirm on the downside - despite an oil price that touched an intraday level of over $43 a barrel today.

What is this chart saying? First, we note that the Dow Transports STILL simply refuses to confirm the Dow Industrials on the downside, despite an oil price that surpassed $43 a barrel in intraday trading earlier today (and despite the US$ making a new rally high!). In terms of the oil price, we are simply in uncharted territory, and yet the Dow Transports simply refuses to confirm. Before I go, let me reiterate something: The chart above is not saying that oil prices will go back down, it simply says that the transportation companies are able (and projected) to make decent profits in this high oil price environment. Whether the Dow Transports is discounting a lower oil price or the conjecture that the transportation companies can pass their higher fuel costs to their customers is a question that I cannot and am not qualified to answer.

I believe the above chart is stating that the window of opportunity is running out for the bears. If the Dow Transports does not confirm the Industrials on the downside by the end of the week, then I believe the major market indices will head higher.

The cautious investor may now ask, why do you think we are still in a cyclical bull market? My answer: I have provided numerous reasons in my previous commentaries (see archives), such as the fact that we are nowhere close to the typical lifetime of the cyclical bull markets of the 1966 to 1974 secular bear market, and the fact that speculation (and margin debt) are again, nowhere close to those at the top in the cyclical bull markets of the 1966 to 1974 bear market. But if you are not convinced, I present further evidence - courtesy of - the following chart tracks the lag time between the troughs of the Fed Funds rate to the subsequent tops of the S&P 500 for the last 40 years. Please note that the two cyclical bull markets within the 1966 to 1974 bear market took 16 and 10 months to top (after the trough in the Fed Funds rate), respectively. If we are to maintain a similar schedule today, then the current cyclical bull market (as measured by the S&P 500) will not top out until April 2005 to October 2005.

Months to S&P 500 Peak after a Fed Funds Trough. Major troughs in the Fed Funds Rate have typically preceded major stock market peaks by several months.

The chart of the relative strength in the Bank Index also tells the same story. The market has not topped out yet as relative strength of the Bank Index is still high - this and the fact that it simply refuses to break its recent support level. Please note that the decline in relative strength of the Bank Index during the latter part of 1998 and 1999 perfectly "predicted" the huge bear market of 2000 to 2002. The Bank Index has traditionally been a great leading indicator of the broad market.

The decline in relative strength of the Bank Index after LTCM and Russia crisis and during 1999 suggested tougher timers ahead for the U.S. stock market - and in retrospect, it was cold-bloodedly right. Relative strength of the Bank Index now still has not violated support - suggesting we may have at least one more rally.

One of my readers remarked that all is well and great, and that although prices are very tempting now, he would wait for the October period to buy since it is "traditionally" when the market bottoms; also, he argues: by that time, the uncertainty surrounding the current Presidential elections would have lifted. Please note that I have mentioned this before: when it comes to the stock market, nothing is certain. The successful trader will have to take what the market gives him or her; and the market certainly does not care what you or I think or predict. Traders or speculators who are going to wait until October to buy may have to start buying in at higher prices. Again, the following chart courtesy of provides a great illustration of this argument, as the market tends to bottom in the June to July period during the average election year:

The stock market has had a tendency of being somewhat choppy during the first five months of an election year, but prospects tended to improve (on average) as the November election approached.

Now, back to the topic of high oil prices: Lowry's has been looking for panic selling in the face of bad news in order to achieve a sustainable market bottom. Today, we got it in the YUKOS news and the resultant record high oil prices. However, the market did not come close to panicking today. While this may not be a sustainable bottom, the author believes that it is pretty close. The majority of traders or analysts rarely get what they wish for, and this may be one of those times. The author maintains that we are in a cyclical bull market, and any further declines here should be minimal - either in the number of points or in the length of time until the bottom.

Signing off,

Henry K. To, CFA

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