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September 21, 2004

Gillespie, Why Do You Remain So Freaking Bearish on the Stock Market?
by Douglas R. Gillespie

Foreword

It's a strong bet these days that whenever I confirm that I steadfastly remain a secular bear on stocks, as I did in an article just recently, I can expect someone to get in touch inquiring why. A few days ago, I received an e-mail asking: "Gillespie, why do you remain so freaking bearish on the stock market?"

The question has a nice, to-the-point ring to it. Thus, I decided to use it as the title of this research piece.

I've purposely kept this missive reasonably short. I've also decided to keep it void of the many data tables I might otherwise employ. Moreover, much of the subject at hand is attacked in a bullet format. In fact and by design, the missive touches on a number of items that would/will make interesting follow-up research pieces.

Onward

Before going any farther, let's have a look at the sole table appearing in this article, which will place the market in a quantitative perspective through last Friday's close.

The stock measures in the table comprise my so-called equity-market "tracking group." I put this list together several years ago, exercising a good deal of forethought in the process. The mission was to construct a group adequately representative of the market but not overly large in the number of components. The list has served its purpose well.

The significance of these dates is mostly apparent. The recent closing lows occurred on 8/12/04, and I in my work, I use the October 2002 closing lows to mark the beginning of the cyclical bull market that is imbedded in the secular bear.

A number of importance that is not shown above is the return from the October 2002 closing lows through this year's closing highs. During this period, the tracking group was up, on average, 65.2% (median advance of 54.1%). Gains ran in a range of 92.6% for the NASDAQ 100, to 47.4% for the DJIA.

The "is imbedded in the secular bear" stated a moment ago actually is a misnomer. It really should read, "was imbedded in the secular bear," or at least this is how I currently see the situation. A few weeks ago, I opined that the market probably had reverted to the primary secular trend. Although the rally between 8/12 and last Friday might cloud the timing of this contention a little, it probably is only a little.

On 3/18/03, I published a rather good piece entitled, "Do Stocks Have Life After War?" The conclusion was that stocks would indeed have life -- lots of life. Which, of course, they did! It was a good piece not only because it was correct, but also because it was correct for mostly the correct reasons -- always an enjoyable experience!

That piece of writing, coming from me, surprised a lot of people, since it expressed a great deal of bullish sentiment on both the economy and the equity market. And as readers might recall, it came at a time when there was a paucity of bullish sentiment -- from bulls and bears alike! But as I pointed out at the time, you cannot have the secular bear episode I was and am envisioning without period bullish interludes of significance.

(For several reasons, it would be very helpful for people reading this missive to go back and read that one. For those wishing to do so, go to the Gillespie Research Associates website home page (www.gillespieresearch.com/). Then click the "Archives" link on the navigation bar, then click "2003." The piece in question, "Do Stocks Have Life After War?", is dated 3/18/03, and it is the only March 2003 entry currently in the archives.)

Where We Are

* The earlier table sums up what the tracking group's components have done over recent periods, as well as from their cycle-to-date lows, set in October 2002.

* Taking a longer-term perspective, the three proxies I regularly use to track the bear market are the DJIA, the S&P 500 and the NASDAQ 100. These measures set their bull-market closing highs in 2000, on 1/14, 3/20 and 3/27, respectively. Those numbers (rounded) were 11,723, 1,527 and 4705. From those highs through last Friday, their respective price-only declines were 12.3%, 26.1% and 69.7%.

Thanks to the magic (or the horror, perhaps) of reciprocal numbers, getting them back to their highs would require gains of a relatively modest 14.0%, a somewhat less modest 35.3%, and an absolutely obscene 230%. In other words, despite the 76.7% gain from its October 2002 low through last Friday, the NDX still needed well over a triple to get it back to where it was four and one-half years ago!

* Considering the bulls' great expectations as this year was beginning, it is hard to conclude other than that there is significant disappointment and frustration in this camp, vis a vis how the stock market actually has performed so far this year. As an example, back on 1/26, the date I use as the market's most significant 2004 momentum peak, the tracking group was up an average 4.9%. This was not even a month into the year, but the return certainly overshadowed the 0.5% average year-to-date gain as of last Friday.

What I Am Currently Looking For

* Among other things, the above-referenced March 2003 article lays out the history of the 1965-1982 bear market. It includes specific market levels at various stages, using the DJIA as the proxy. While I will not venture an opinion whether the present episode will last the 16 years, 7+ months of the 1965-82 episode, I do believe the current event has years yet to run.

* For those shocked at "years yet to run," consider this. The current bear market is roughly four and one-half years old. This far exceeds the length of a cyclical event. Therefore, it is difficult (as impossible) not to acknowledge that it already is secular in duration. (This said, I'm certain CNBC can find dozens, or hundreds, or maybe even thousands of "analysts" who would vociferously argue this point!)

* A question I'm asked frequently is whether the bellwether measures will make new lows. I simply don't know. My gut instinct is that in the absence of an exogenous event, such as another domestic terrorist attack, they likely will not make lows lower than those already in place. But at present, it is somewhat immaterial, since the established lows are far below current prices. For instance, the Dow would have to decline 29.2% to match its low. The S&P 500 would require a drop of 31.2%. As for the NDX, its magic number is a hefty 43.4%.

The 1965-82 experience might prove helpful in this regard. On 1/11/73, the DJIA set a then all-time high of 1,052. (Interestingly, this was a mere 8.5% higher than its close on 12/31/65, over seven years earlier.) People were gleeful, believing the allusive 1,000 had finally been scaled for good.

That was not to be, however. On 12/6/74, the Dow closed at about 578, representing a 45.1% bashing over that approximate 23-month period. But the December 1974 low did turn out to be the overall cycle low. Nevertheless, the bear market had the better part of another eight years to run. The Dow industrials made it all the way back to a 1,015 close on 9/21/76, only to fall back again to the final (but not new) low of about 777, set on 8/12/82.

How About the "Presidential Cycle?"

* How about it? Wall Street bulls have made this a cause celebre for many months now, suggesting that a Presidential election year is a virtual guarantee of an up market. In past work, I've pointed out that this is indeed not the case. In the eleven most recent Presidential election years of 1960 through 2000, the DJIA fell in three (27.2%) of them: 1960, -9.3%; 1984, -3.7%; 2000, -6.2%. And through last Friday, the Dow was down 1.6% for this year to date.

* And in the current situation, we cannot neglect the timing of the machinations of our old friend, Alan Greenspan -- AKA, "Bubblemeister" or "Uncle Al, Wall Street's Pal." It is entirely possible that when Greenspan did his highly obvious political flip in 2003, in thanks for the President's promise of a fifth term as Fed chairman 14 months before the end of the fourth term, Uncle Al juiced the system a little too much too soon.

Here's where an earlier stat I quoted may be highly germane. From the October 2002 closing lows through this year's closing highs, my stock-market tracking group was up an average 65.2%. However, 56.5% or almost 87% of the total gain took place between the October 2002 lows and the end of 2003. Remember, too, that the last of the 2004 highs occurred way back on 4/5 -- more than five months ago.

Speaking of Greenspan -- A Brief Aside

The Federal Open Market Committee, which really is little more these days than a Greenspan clone, conducts a policy meeting today. There is a modest disagreement about whether the FOMC will or will not hike the Federal Funds Rate another 25 basis points, to 1.75%. My own view is that it will, the result of the de facto announcing of monetary too far in advance. In other words, if you are the Greenspan-dominated Fed, you damn well better do what you've been advertising for months now -- whether or not it is the correct action!

And Where Is the Outrage?

* Call me old-fashioned, but one of the critical events I want to see before declaring an end to the secular bear market is legitimate public capitulation. Over history, the people helping make major market tops have also been the ones helping make the bottoms.

* So far, I haven't seen anything even approximating such a phenomenon, particularly considering how terribly abused the investing public has been. As I sense the current environment, the true "public" is back in a be happy, don't worry mode.

* As one key measure of public sentiment, there have been junctures at which there were net mutual-fund redemptions, but these have indeed been fleeting. Juxtapose this to the era of the 1970s into the early 1980s, for instance, when stock mutual funds suffered several years of net redemptions.

Terrorism

* I'm still of a mind that terrorist acts will again occur on US soil. And the clock definitely could be winding down in this regard. Al-Qaeda is approaching a point where it forced to do something here, simply to maintain the spirits and confidence of its own criminal filth constituency.

* Is the stock market ready for the next attack? With a VIX that traded down towards a reading of 13 last week, and with other sentiment measures showing not dissimilar ebullience, the answer is rather evident.

Conclusion

Within this overall topic, there's more to be said, of course, on items like valuations, economic considerations, the upcoming national election, etc. But when I take these areas into account, along with the material that has been covered here, I remain -- and comfortably -- a secular bear!

Douglas R. Gillespie, Sr.
Gillespie Research Associates
165 Sheridan Avenue
HO-HO-KUS, NJ 07423
201-447-5743

Doug Gillespie oversees his own financial-market and economic consulting firm, Gillespie Research Associates. For a complimentary sample of Dougs material, e-mail him at drgillespiesr@aol.com.

Copyright © 2004-2005 Gillespie Research Associates. All rights reserved.

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