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Today's Market WrapUp 01.15.2008 Mon Tue Wed Thu Fri Barbera Archive Bear Market In Force
-- C-YA! More bad news, another brutal day in the markets, and no end in sight. Bear Markets make life impossible in a hurry for those fighting the downtrend and unwilling to step out of the way. They are equal opportunity killers, indifferent to whose money is being lost and indifferent to any set of positive fundamentals that may be in place. Back in the late 1990’s, as the bull market moved into its final throws with NASDAQ pushing above 5,000 in early March, 2000, I did a full week-long special on why investors should be selling Technology stocks as the NASDAQ romped up above 5,000. My call in writing at the time was for the NASDAQ to drop 2,000 points into an April low, and lo behold, it happened. The hedge fund I was working for at the time made a killing shorting technology stocks, as we had more puts than we could really keep an eye on. PMC Sierra, JDS Uniphase, Human Genome Sciences, Broadvision and Inktomi -- we were short the lot of them. As time proved out, most of those companies had over-hyped fundamentals which were nowhere close to being able to sustain 50, 60 or even 90 times P/E multiples. For the next two years we surfed the NASDAQ on the downside shorting stocks, and then shorting more. At some point, it started getting ridiculous as names that had been $100, $90, and $70 turned into $10, $5, and lower, enough to leave even the most ardent and steadfast bear wondering, “How low can it go?” I can remember like it was yesterday, working with my partner at the time, we were looking at a Telecomm company that had been disassembled, the stock had gone from $50 down to $9. My partner, a top notch fund fundamentalist and a very good friend to this day, told me, “You know, I think we need to cover this short, because the Book Value of the company is $8.85, and how can this thing go below Book Value?” A big discussion ensued; could this company's stock price actually fall below its “book value.” It was a formidable concept at the time, but in the end, it did. Not only that, it fell all the day down to $1.10 in a long tortuous decline, that I am sure made every shareholder puke. That’s the thing about Bear Market’s. They are the corrective mechanism that counter balances man’s inherent tendencies toward great excess. They are the purging function of markets. Now I have to admit, when my partner came to me that day and told me, “Frank, the stock is X, and the Book Value is Y and there’s nothing more to squeeze out,” for awhile, at least 15 to 20 minutes, I really thought about covering the short and then I thought, “Nah, this thing is going to zero”. At the time, it was a luxury of being in a position where everything we were short was hugely profitable, and I really didn’t care if I ended up getting nicked a bit on one position. However, the point here is that everything about this climate screams “Bear Market.” Yesterday in watching the S&P, I noted that bulls and bears had fought one another to a near standstill over the last six to seven days. As a bear, I am long an ETF which rises as the stock market goes down. Yesterday, I pondered the question of adding more to the existing short position knowing full well that Citicorp would be coming out with negative news today. I thought, this news will be ugly, and perhaps the stock will go down; but maybe, just maybe, it might shake off the bad news and instead advance after all the stock is depressed and this is a former market darling. These were the usual mental gymnastics, back and forth, back and forth, that any trader agonizes over endlessly. The more I thought about it, the more today’s market reaction shaped up in my mind as a kind of referendum on the market. Would the Fed be tempted to come in with a surprise intra-meeting rate cut to gain extra bang for the rate cut buck on a day when Citi was out with negative news? Would the market digest Citicorp’s negative news and then push the substance of the news aside, and rally the stock on the assumption that the ‘worst is over’? That may sound crazy, but that type of whitewash on bad news has been the order of the day for the stock market now for some time. “Buy bad news and assume the worst is over.” In the end, I decided to wait and hold off on adding any more to my short position, as I thought, ‘let’s see how the day goes.’ In my view, the day turned out to be an especially telling day, as the news from Citicorp was negative, but more importantly the market was unable to shrug off the negative news. In the past, on countless occasions, we have seen companies come to the market with very negative news, only to see the share price move higher on the basis that the worst of the news was now out in the open. This reaction, today’s reaction, was something quite different. There is a key measure of defining a market climate and that is, how a market will react to news events. In healthy bull markets, good news serves as an excuse for a party and a huge rally, while bad news is shunted aside with prices refusing to go down very much at all. In Bear Markets, precisely the opposite psychology comes into play, as prices ignore good news and fall out of bed on bad news. In my view, today’s market is one of the first times in years that the stock market has really reacted in a strongly negative fashion to bad news that was telegraphed in advance. That makes today a doubly negative day as it really suggests that a psychology of fear is now taking control and in command of the equity market. Now, does this mean that the market is going straight down and that we may not see a bounce? Clearly not. Bear markets are littered with sharp counter-trend rallies, and often, these rallies compress a bigger price move into a shorter period of time, so trading in a Bear Market means having the skill set to survive in an inherently treacherous environment.. Using ‘stops’ when trading on the short side is not an option, but an abject necessity. Still, for the majority of investors who have no interest in attempting to trade a bear market, today’s decline would seem to be communicating a powerful message -- that of a market that is now seriously beginning to discount even more bad news. To this end, it means we all need to be even more careful about making assumptions, about presuming in advance how the market will react. Oh, it's fine to come to some ‘basic conclusions,’ but in Bear Markets, the question of how low is low is never an easy question to answer. In bear markets, most technical indicators are able to press down to much lower levels before a market response is generated. In fact, very often, deep oversold values can be sustained for some time, with prices falling further the whole time before any kind of material bounce is inspired. Taking a look at the current market, while there are some short term gauges that have recently become “oversold,” for the most part, the stock market is presently still nowhere close to the kind of serious oversold readings that would be needed to put in an important bottom under Bear Market conditions.
In the chart above, I show my CBOE Cumulative Options Advance-Decline Line reported each week by the CBOE. This gauge computes the number of advancing Calls plus the number of declining Puts and calls that Advances, while at the same time, computes the number of declining Calls and advancing Puts and calls that Declines. The next step is then a cumulative tally of each week's NET Advances-Declines figure. For good measure, I then compute a two year moving average on both the CBOE Options A/D Line and the S&P 500. Looking back, it is not uncommon for this gauge to break below the 2 year moving average even ahead of the S&P. Once both the indicator and the index are below the 2 year moving average, there is little doubt that a bear market is in force. As can be seen over the last few weeks, the CBOE Options A/D Line has broken down in decisive fashion, strongly hinting that a major down turn is now underway. Pressing the analysis a bit further ahead, I also like to watch this gauge comparing the CBOE Options A/D Line and its 39 week, or 200 day moving average. By Detrending the data, we arrive at a medium to long term overbought/oversold indicator. At present, while the indicator has dipped into negative territory, with a reading of –43.92 last Friday, the gauge remains a long way from fully oversold values which are reached with readings below –100.
Looking back over the last 24 years, we find that in Bear Markets it is not at all uncommon to see this indicator dip down to values below –150, or even –200. From left to right, some of the more prominent former lows were: 7/27/84 –154.58, 11/27/87 –168.84, 10/26/90 –225.04, 10/05/01 –191.52, and 08/02/02 –249.32. In one stretch of time during the last bear market, this gauge remained BELOW –150 for 19 consecutive weeks, spanning the period of time between June 2002 and November 2002. During this one stretch of time, the S&P lost 25.76% of its total value, so a lot of price damage can be inflicted even once the indicator is hitting ‘oversold’ values for the first time. This is an important lesson to remember when we loosely speak of the market as ‘oversold.’ Yet another avenue which is often seen as potentially helpful in assessing the termination point for a declining market is market sentiment. In this case, extra caution is required as Sentiment indicators normally trough well BEFORE final price lows. During a Bear Market, in the early and middle stages of a move, the Bears are always correct, and prices fall. Only toward the latter phases of a Bear Market do we see sentiment coming into the picture as a potential contrary opinion gauge.
In my work, I track all four major sentiment polls: MarketVane, Investors Intelligence, AAII and Consensus Inc. I weight all four the same so they are an evenly weighted input. The polls cover different opinion setters, from retail investors, to futures traders, to newsletter writers. Here again, while we see that the Sentiment Composite has come down off its highs, (above +20% = excess bullishness, below –15% equals excess bearishness) with a current value of +10.39, it is still a country mile away from coming anywhere near the kind of values that would be “oversold” for a Bear Market.
Because every bear can vary in its overall severity, I also like to look at my various sentiment gauges using dynamic platforms. I am a huge fan of the work done my Cynthia Kase, who wrote an excellent book several years ago entitled, “Trading with the Odds.” Her work successfully moves the realm of technical indicators, momentum gauges, breadth gauges, etc. onto a dynamic platform where indicators are only oversold once they have moved by a certain statistical increment such that they are the rough equivalent of three standard deviations from the norm. The Kase ‘PEAK OUT’ line provides a dynamic, moving target for an indicator to reach to become ‘oversold’ and thus, is an improvement over the more garden variety static interpretation that drives most of the thinking on Wall Street. Employing her approach to the Investors Intelligence Survey data shown above, we are still closer to Overbought conditions than oversold. The downside risk here is potentially still enormous in the stock market, and as I see it, the S&P could easily decline another 20% before we start seeing the kind of truly oversold values that would put in an interim bear low.
Finally, another favorite tool of mine is, and has been, the ARMS Index, renamed after its inventor, one Richard Arms. Back in the 1970’s ARMS came up with a formula that correlated Up Volume and Down Volume to the number of issues rising and falling each day. A true gentlemen, ARMS called his indicator the TRIN, or Trading Index and computed various moving average lengths to decipher whether or not the S&P was near a high or a low. In my work, I have isolated my universe of stocks to 1500 operating companies, and thereby cut out a lot of the superfluous noise which has corrupted the ARMS Index data based on the Associated Press figures. The result is an indicator as clean as can be, which is oversold above 1.15 and overbought below .90. This gauge is more medium term oriented and less long term oriented, and during a bear market can be expected to spike on several different occasions, highlighting the intense selling episodes within a down market. On Monday, the ARMS Index closed at 1.10, and is still not close to the 1.15 upper oversold minimum benchmark. Will we see readings on this gauge above 1.15 in the future? My answer: you can count on it, and we may well see readings as high as 1.25 to 1.30. Under today’s price condition, that still allows for a huge degree of additional downside, far more than most conservative investors are willing to cope with. To this end, while earning 4% in a money market account may not sound like any great shakes, when you stack that up against the prospect of losing 20 to 30% of total capital, all of a sudden a 4% return looks pretty nice. That, and remember, that in a bear market the mantra of the day: every day has to be, ‘he who loses least –wins!” Eventually, the cascade of selling will cease, prices will bottom out, and for those savvy enough to have preserved capital during the bear phase, a bonanza of bargain priced stocks will await, allowing strong hands to reap huge gains in the next bull market. For now, Cash is anything but Trash. At the close, the S&P slumped by 35.30 index points to end the session at 1380.95, a loss of 2.49%, the DJIA ended down 283.70 or 2.20% to finish at 12,494.45, while the NASDAQ ended at 2417.88, down 60.42 index points or 2.44%. From the 52 week high, the S&P is now down 11.76%, the DJIA down 11.74%, and the NASDAQ down 15.45%. Gone is the incessant cheerleading of CNBC, and mercifully those ridiculous flashing banners of DJIA 14,000 (every 30 seconds), and gone is the inane cheerleading and one-sided table pounding of arrogant news anchors, and unbelievably, politically biased economists, to use the term lightly. I turned the volume off on my set years ago, and along with doing your own homework, that’s probably my single best advice to readers of this column. A public note of ‘Thanks’ to Peter Schiff and David Tice, the only two serious bears who ever had the stomach to deal with the incredible bias at CNBC. Thanks for the ‘sanity’ checks all these years, -- without you guys, I probably would have lost it years ago… That’s all for now, Frank Barbera Copyright © 2008 All rights reserved. CONTACT
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