In my newsletter issued on June 5, 2000, I informed you that the DOW would top that day at 10,863.00 and a selloff to between 9,400 and 9,700 would occur by late June of early July 2000. In followup, the DOW topped on June 5, 2000 at 10,863 and proceeded to selloff to 10,359 by late June and early July 2000. Even though the selloff did not drop to my projected level, I generate a return for June of between 4.5 to 8.7 percent by using DOW/S&P 500 spreads to protect the DOW short position profits.
Currently, the DOW top is still holding on June 5, 2000 at 10,863. My wave pattern analysis is still projecting a decline in the DOW to between 9,400 to 9,700 with a revised time period of now late August 2000. Monday, July 10th will present investors with a good opportunity to take advantage of a short term high of around 10, 635.00 and reduce their stock holdings. With this in mind, along with the strong likelihood that a bear market has begun, it is important to position into types of investments where profits can be generated by either going long OR going short in the various stock indices, foreign currencies, and/or treasury bill markets.
Further fundamental information is continuing to justify the existence of a bear market, which is provided below for your review.
PRIMARY INDICATORS FOR THE ONSET OF A BEAR MARKET:
The Dow Jones Theory states that the primary trend of a market is determined when both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (Transports) move in the same direction, and must confirm each others new highs or lows.
On May 12, 1999, when the DJIA and the Transports both hit peaks, the Industrials subsequently hit several new highs, but the Transports did not. This non-confirmation is still in effect currently and strongly suggests the beginning of a bear market.
The following 12 key indicators are below their peaks, and do not appear to have the strength to break to new highs in the current market cycle, which is further indication of a bear market:
1. Daily new highs on the NYSE topped out at 631 on October 3, 1997.
2. The advance-decline ratio topped out on April 3, 1998.
3. The Dow Jones Transportation Average topped out on May 12, 1999 at 3783.50.
4. The NYSE Financial Average topped out on May 13, 1999 at 584.21.
5. The Dow Jones Utility Average topped out on June 16, 1999 at 333.45.
6. The Value Line (geometric basic) topped out on July 6, 1999 at 472.95.
7. The NYSE Composite topped out on July 16, 1999 at 663.12.
8. The Dow Jones Industrial Average topped out on January 14, 2000 at 11,722.98.
9. The Russell 2000 topped out on March 9, 2000 at 606.05
10. The NASDAQ Composite topped out on March 10, 2000 at 5,048.62.
11. The AMEX Index topped out on March 23, 2000 at 1036.40.
12. The S&P 500 topped out on March 24, 2000 at 1527.46.
The three phases of a bear market:
In the first phase, the market action is very deceptive. Individual stocks and sectors decline, some froth and excitement from the bull market top are erased. The market fluctuates below its highs, sometimes wildly, but the economy remains positive. This first phase is lasting longer than in previous corrections as a result of the wide spread level of participation, and it’s occurrence during an election year. Also, a new phenomenon, the Internet, has emerged and is obviously changing the world. This phenomenon has increased productivity without attendant signs of inflation. This new found efficiency is simply artificially supporting and/or postponing the market decline since the old/new economy theory will eventually merge back into one as investors regroup and justify stock purchases by viable levels of company earnings.
Furthermore, the current high levels of volatility have never been seen before, and are primarily due to the day-traders moving in and out of stocks. Also, the pattern toward momentum investing has further enhanced volatility causing exaggerated stock market moves.
So far this bear market is categorized as one of attrition, a deadening process that goes on and on. Stock after stock falls victim to the bear, but the action is subtle, and nobody seems particularly worried. The averages rally a bit, often on lower volume. They decline, they wonder aimlessly, but meanwhile selected stocks get hurt, and many are badly hurt.
As this bear market matures, attrition will give way to aggressive selling, big breaks in stocks and rising volume on the downside. We are not there yet. Meanwhile, is the bear playing with us? Is he trying to lull us into a false sense of security? Is he trying to bore us to death? Obviously, no one can be sure, but we do know this: The bear has time on his hands. He’s in no hurry. The bull certainly was in no hurry, and the bear is perhaps just getting even.
The reason that most investors either don’t see or won’t admit that we are in a bear market is due to a number of things. First of all, there is always a disposition in people’s mind to think that existing conditions will be permanent. When the market is down and dull, it is hard to make people believe this is the prelude to a period of activity and advance. When prices are up and the country is prosperous, it is always said that while preceding booms have not lasted, there are circumstances connected with this one which are unlike its predecessors and give assurance of permanency. Second, the one fact pertaining to all conditions is that they will change. Third, this first phase is occurring at a time where the first generation of investors in U.S. stock market history to never have gone through hard times. This big difference allows them to disregard risk.
In the second phase, business conditions really start to deteriorate. Stocks go down further as they discount this climate. Corporate profits decline, and the effect of the battering stocks have taken so far is reflected in corporate earnings. For this reason, the public relates much more to what’s happening is the second phase, and optimism begins to turn to questioning and even gloom. This usually is the longest phase, and it is when the public finally really realizes that something is wrong.
The third phase is sometimes referred to as the “capitulation phase” since people dump stocks to just be out of the market. Extreme fear is prevalent. At this point further fundamental reasons will exist to justify the bear market, and stock market analyst as well as financial news stations like CNBC will be broadcasting these reasons in great detail. At the conclusion of this phase, we will have the highest level of pessimism, which characteristically offers a great buying opportunity for the next bull market cycle.
Further characteristics of the second and third phase will be provided later as the market cycle proceeds into these two distinctive bear market environments.
Additional reasons for a bear market scenario:
It would appear that the dollar is topping out and consumer spending, which accounts for a big percentage of gross domestic product (GDP) could continue to slow down.
Obviously, raising interest rates are a negative for the stock market and the economy. The Fed is in a bind and has decided to leave the Fed Fund rate at 6.5% on June 28th due to the most recent economic data released. The Fed has been playing it very cute by gradually raising rates, but by also allowing money supply to expand. Thus, the Fed has tried to put a ceiling on the market with rising rates while at the same time putting a floor under the market with a lot of cash. Unfortunately, in the end, we may get the worst of both worlds — a slowing economy and rising inflation.
The net result of the Fed’s manipulations are extending the stock market lengthy topping-out process. The Fed objects to the “irrational exuberance” of the stock market, but at the same time is afraid to let it go into a major decline.
Key Dow Industrial Average (DJIA) levels to monitor:
Currently, we have a key pivotal point for the DOW at 10,759. The DOW for the past several months has been fluctuating around this level, and if it can hold above this level, there is a chance it could rise, allowing the DOW to retest it’s prior high. However, if after all of this fluctuation, it can’t settle above 10,759, then the odds are that it will sink, taking the DOW to the lows set at 9,731.81 on March 8th 2000. If this occurs, then, the second and longest phase of the bear market will begin.
In addition to the above key pivotal point, we need to monitor at what point the DOW closes for the year. Not since 1982 has the DOW closed a calendar year below its low of any day for the prior year. The 1999 low was at 9,120.67 in January, and if broken at the end of this year, it would serve as further confirmation of the bear market.
Even with yesterday’s release of the non-farm payroll number showing only 11,000 new jobs, and a sign that the economy is starting to slow, the unemployment situation still remains low at 4.0%, which is starting to put pressure on wages and various price components. It appears that there is about a 40% chance that the Fed’s will raise interest rates at their next FOMC meeting on August 22nd by 25 basis points with the further attempt to slow the economy down to an annualize growth level of around 3.0 percent.
We are continuing to build a bear market scenario, and could see the economy eventually slow, but inflation still remains a major problem. I would suggest that stock and real estate investors reposition their investment portfolio to a more defensive posture, and consider allocating between 10 to 20 percent towards diversification and/or hedging in the derivatives/futures market.
In the past, the average bear market has lasted between 2 to 5 years and has seen stock indices decline between 30% to 67%, which will also effect residential and commercial real estate values as the economy slows and investors have less purchasing power. There have been occasions where the various stock indices remained within a wide trading range for several years before finally beginning the bear market decline. This period of congestion and subsequent decline could last 5 years or longer.
This months newsletter is being written to serve as a “wake-up call” for investors and provide them with a cautionary outlook that will enable them to not only protect, but add to, wealth created over the past 18 year bull market cycle. Those who make decisive adjustments now in their investment portfolio will actually profit from the upcoming stock market and real estate market decline, and will be rewarded with a stronger level of purchasing power (net worth) at the completion of this bear market.
In conclusion, human history tells us that there are and will be market cycles, swings from pessimism to optimism and back to pessimism, then back to optimism. It is important to recognize these market cycles and take to appropriate action at these key levels to maximize the continued positive growth of an investor’s net worth.
If there are any questions regarding the information discussed within this newsletter or how the profits were generated in the DOW/S&P 500 spread, please feel free to either call or send me an e-mail to the number and e-mail address provided below.
John T. Moir
Wavetech Enterprises, LLC
Phone: (775) 841-9400