Mostly Stocks

By: Douglas R. Gillespie | Mon, May 10, 2004
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Summary:

Several weeks ago, I opined that domestic and international political considerations were likely to begin to exert an increasingly negative influence on stock prices. I also warned that growing inflation concerns were likely to put some serious upside pressure on open-market interest rates. And here we are!

MARKET SUMMARY -- WEEK ENDED 05/07/04
  05/07
Close
-- Change --
Week YTD
90-Day T-Bill* 1.05% 8bp 13bp
02-Yr. T-Note 2.62% 32bp 80bp
05-Yr. T-Note 3.95% 34bp 70bp
10-Yr. T-Note 4.77% 27bp 52bp
30-Yr. TBond 5.47% 19bp 40bp
DJIA 10117 -1.1% -3.2%
S&P 500 1099 -0.7% -1.2%
NASDAQ 100 1406 0.4% -4.2%
Dollar Index 91.13 0.7% 4.8%
CRB Index 273.53 0.4% 7.1%
Crude Oil@ 39.93 6.8% 22.8%
Unl. Gasoline@ 1.3386 7.4% 41.0%
Gold@ 378.70 -2.3% -8.9%
Silver@ 5.59 -8.1% -6.1%
* Coupon-equiv.   @ Near-month contract.

A Quick Look at Interest Rates

This missive is entitled "Mostly Stocks," since it is impossible at the moment to discuss the equity market at the exclusion of interest rates. And as to rates, an inflection point of sorts was hit last week, with the equivocal statement coming out of the FOMC after its policy meeting on 5/4. I've commented on this in earlier work, but as a graphic example of what has happened to market expectations since then, one only need look at the run in federal funds futures.

FEDERAL FUNDS FUTURES -- 05/07 VS. 05/03*
Contract 05/07
Close
05/03
Close*
BP
Chg.
Scheduled
FOMC Meetings
May '04 1.01% 1.02% -1 May 4
June '04 1.03% 1.03% 0 June 29-30
July '04 1.23% 1.11% 12 No Meeting
Aug. '04 1.45% 1.27% 18 Aug. 10
Sep. '04 1.62% 1.39% 23 Sep. 21
Oct. '04 1.75% 1.51% 24 No Meeting
Nov. '04 1.93% 1.68% 25 Nov. 10
Dec. '04 2.10% 1.83% 27 Dec. 14
Jan. '05 2.21% 1.94% 27 NA
*Day before latest FOMC meeting.

To see a longer-term perspective on the rate situation, have a look at Table 1 in the appendix at the end of the text. This exhibit traces changes across the Treasury yield curve from 6/13/03 through last Friday. June 13 of last year was just about the low in yields for the current interest-rate cycle.

You will likely recall that the June '03 trough resulted from Greenspan's expression of deflation concerns in the statement coming out of the May 2003 FOMC meeting. I labeled this as a ruse at the time, merely an attempt to precipitate a major decline in rates to trigger yet another massive mortgage refi binge. The maneuver certainly worked, but at what longer-term cost?

In the present setting, Greenspan and his colleagues are clearly behind the curve. Now, more and more people realize it, notwithstanding Alan Greenspan and his colleagues, of course! But their heretofore cavalier attitude might very well give rise to a growing perception that the central bank not only will have to hike the fed funds rate at the FOMC's June meeting, but that the increase might have to be a half point to quell the bond market's angst.

New Lows in Stocks

For weeks now, and very much against the grain of consensus thinking, I've been calling for lower lows in the bellwether stock measures. Using my tracking group as a proxy, the lows in question were set on 3/24 (on 3/23 in the case of the NASDAQ 100). And as of last Friday, three of the seven measures in the group accommodated, with the remaining four within spitting distance.

SELECTED STOCK-MARKET MEASURES
(Ranked in Order of 05/07 From High)
  05/07
Close
Recent Highs Recent Lows % Change
To 05/07 From
Close Date Close Date High Low
S&P 500 1099 1158 02/11 1091 03/24 -5.1 0.7
Wil. 5000 10686 11314 03/05 10663 03/24 -5.6 0.2
DJIA 10117 10738 02/11 10048 03/24 -5.8 0.7
NYSE Comp. 6364 6780 03/05 6364 05/07 -6.1 0.0
Value Line 355 387 04/05 355 05/07 -8.3 0.0
Russ. 2000 549 606 04/05 549 05/07 -9.4 0.0
NASDAQ 100 1406 1554 01/26 1370 03/23 -9.5 2.6
  Average -7.1 0.6
  Median -6.1 0.2

As you would expect, accompanying the recent slide in prices has been a large deterioration in the market's technical indicators. For instance, we've now had two consecutive weeks of more than 10,000 NYSE declines (weekly sum of daily data). In addition, NYSE 52-week highs last week were a mere 202, versus 1,362 52-week lows (again, the weekly sum of daily data). As recently as the week ended 4/2, there were 1,262 highs and only 55 lows. (See Table 2 in the appendix.)

For a while now, I've felt that respective 200-day moving averages were an inviting, minimum target for the major averages. Not long ago, I opined something worse for the NASDAQ Composite, though, since it was well ahead of measures like the DJIA and the S&P 500 in its downward journey. Here is what this situation looked like as of Friday's close, using the Dow, the NAZ Composite and the S&P as yardsticks.

200-DAY MOVING-AVERAGE VIOLATIONS --
VALUES PROJECTED FROM CLOSE ON 05/07/04
Measure 05/07
Close
MA Violation/
Resulting Price
% Decl/Gain From
05/07 Close At
Violation Of:
0% 3% 6% 0% 3% 6%
DJIA 10117 10030 9729 9428 -0.9 -3.8 -6.8
NAZ Comp. 1918 1947 1889 1830 +1.5 -1.5 -4.6
S&P 500 1099 1080 1048 1015 -1.7 -4.6 -7.6

The NAZ Composite finished last Friday below its 200-day average, and it is likely that the Dow and the S&P are going to visit if not violate theirs this week.

And a tough week it is likely to be. There are three inflation-related measures due for release this week -- the PPI, CPI and import prices -- and it is improbable these will reveal cheery news. (Or if they do, we might check to see if Betty Crocker spent time recently overseeing the preparation of these statistics generated by the Labor Department.)

And let's not leave out the Treasury's $54 billion May refunding operation this week, with auctions tomorrow, Wednesday and Thursday. Although one would assume that government bond dealers have put together a pretty good short position going into the refunding, which could stabilize Treasury yields around current levels for a while, additional inflation jolts could overwhelm this strategy.

And finally, Iraq-related news simply gets worse and worse. That there are growing demands for the resignation of a secretary of defense and the chairman of the joint chiefs while the United States is in the midst of war on several fronts is heavy duty stuff!

All this said, I continue to think the general scenario I laid out a while back remains operative. To wit: New lows (some are already in place), followed by a rally, the prototypical "sucker's rally," if you please, followed by a June-July period that, shall we say, is "troubled."

I'm not willing to say the market will put in the temporary bottom sometime this week, but it could. With the additional declines that are likely immediately ahead, the technical condition will be materially oversold. And one series I've used for years and like a good deal under certain circumstances is one measuring two-week rates of change. This often signals short-term turns when negative rates of change move into roughly the 60% to 80% area a couple times in a relatively short time proximity. As the following table indicates, we're nearing those parameters.

DJIA, S&P 500 AND NASDAQ 100
-- TW0-WEEK COMPOUND ANNUAL RATES OF CHANGE --
20 WEEKS ENDED 05/07/04
Week Ended DJIA S&P 500 NASDAQ 100
2004
05/07 -59% -62% -80%
04/30 -43% -47% -58%
04/23 +8% +3% +22%
04/16 -5% -15% -52%
04/09 +78% +106% +252%
04/02 +104% +110% +421%
03/26 -7% -25% -25%
03/19 -64% -66% -74%
03/12 -58% -43% -50%
03/05 -6% +33% -15%
02/27 -10% -2% -22%
02/20 +7% +3% -25%
02/13 +41% +40% -14%
02/06 +7% +3% -43%
01/30 -24% -18% -64%
01/23 +30% +57% +20%
01/16 +60% +107% +372%
01/09 +40% +84% +283%
01/02 +39% +60% +96%
2003
12/26 +106% +68% +62%

Please understand -- emphatically -- I remain solidly bearish. I just want readers to understand that out of all the current gloom, there might be a rally attempt that succeeds for a while. However, and more importantly, I want readers to know I continue to look for a lousy June-July period, so if you try to play the rally, you are on your own!

A while back, I suggested that the period ahead could well determine whether stocks might experience negative returns for all of 2004, an idea that was immensely in the minority. So far, though, things pretty much have worked out the way I suggested they might. Thus, the June-July part of my overall scenario remains the key to a possible negative 2004. And, of course, it also remains key to market-induced problems George Bush might have in avoiding the fate of his father vis a vis a second term.

TABLE APPENDIX

TABLE 1.
TREASURY YIELD CURVE AS OF 05/07/04
Date 90-Day Bill* 2-Yr. Note 5-Yr. Note 10-Yr. Note 30-Yr. Bond
05/07/04 1.05% 2.62% 3.95% 4.77% 5.47%
06/13/03 0.84% 1.07% 2.03% 3.11% 4.17%
BP Change +21 +155 +192 +166 +130
YIELD-SPREAD DIFFERENTIALS (Basis Points)
  90D->02Y 02Y->05Y 05Y->10Y 10Y->30Y 90D->30Y
05/07/04 +157 +133 +82 +70 +442
06/13/03 +23 +96 +108 +106 +333
*Coupon-equivalent yield.

TABLE 2.
NEW YORK STOCK EXCHANGE BREADTH MEASURES
Week
Ended
Volume* Issues 52-Week
-A-
Total
-B-
Advan.
B/A -A-
Adv.
-B-
Decl.
A/
A+B
High Low H/
H+L
2004
05/07 7.855 3.320 0.42 6401 10180 0.39 202 1362 0.13
04/30 8.124 2.332 0.29 6073 10321 0.37 393 853 0.32
04/23 7.627 3.964 0.52 7538 8919 0.46 560 494 0.53
04/16 7.124 2.965 0.42 6841 9735 0.41 475 537 0.47
04/09# 5.423 2.389 0.44 5545 7597 0.42 716 119 0.86
04/02 7.148 4.995 0.70 10473 5901 0.64 1262 55 0.96
03/26 7.140 3.267 0.46 7876 8427 0.48 469 91 0.84
03/19 7.181 3.204 0.45 8010 8351 0.49 920 56 0.94
03/12 7.658 2.228 0.30 6795 9665 0.41 872 49 0.95
03/05 6.842 3.924 0.57 9780 6574 0.60 1588 21 0.99
02/27 7.017 3.696 0.53 9220 7094 0.57 822 30 0.97
02/20# 5.688 2.452 0.43 6072 7023 0.46 958 16 0.98
02/13 7.061 3.810 0.54 8944 7381 0.55 1627 20 0.99
02/06 7.568 4.043 0.53 8713 7637 0.53 917 37 0.96
01/30 8.324 3.613 0.43 7122 9278 0.43 1362 23 0.98
01/23# 6.550 3.429 0.52 7524 5589 0.57 1968 6 0.99
01/16 7.896 4.678 0.59 9415 6976 0.57 2096 7 0.99
01/09 8.185 4.705 0.58 9344 7068 0.57 2402 28 0.99
01/02# 4.007 2.450 0.61 7680 5279 0.59 2062 38 0.98
2003
12/26# 3.219 1.970 0.61 7615 4996 0.60 1478 21 0.99
* Billions of shares.   # Four-day trading week.

TABLE 3.
THE BEHAVIOR OF CBOE SENTIMENT-RELATED MEASURES
AND THE S&P 500 FROM 12/26/03 THROUGH 05/07/04
Date or
Week Ended
CBOE
VIX*
CBOE Options
Put/Call Ratios
S&P 500
All Equ. Ind. Tot** Close Vs.
Prior Week
Cum.
10/9/02
= 100
2004
05/07 18.13 1.01 0.79 1.77 0.84 1098.7 -0.8% 141.46
04/30 17.19 1.02 0.95 1.44 0.84 1107.3 -2.9% 142.56
04/23 14.01 0.70 0.63 1.16 0.85 1140.6 +0.5% 146.85
04/16 14.94 0.77 0.61 1.69 0.84 1134.6 -0.4% 146.08
04/09 16.26 0.74 0.59 1.42 0.83 1139.2 -0.2% 146.67
04/02 15.63 0.63 0.53 1.62 0.83 1141.8 +3.0% 147.01
03/26 17.33 0.77 0.62 1.46 0.83 1108.1 -0.2% 142.67
03/19 19.15 1.03 0.89 1.60 0.83 1109.8 -1.0% 142.89
03/12 18.30 1.05 0.82 1.70 0.84 1120.6 -3.1% 144.28
03/05 14.48 0.79 0.61 1.50 0.83 1156.9 +1.0% 148.95
02/27 14.55 0.72 0.59 1.40 0.83 1144.9 +0.1% 147.41
02/20 16.04 0.86 0.66 2.02 0.83 1144.1 -0.1% 147.30
02/13 15.58 0.76 0.59 1.58 0.81 1145.8 +0.3% 147.52
02/11@ 15.39 0.68 0.56 1.19 0.82 1157.8 -- 149.07
02/06 16.00 0.63 0.46 1.72 0.82 1142.8 +1.0% 147.14
01/30 16.63 0.81 0.71 1.30 0.83 1131.1 -0.9% 145.63
01/23 14.84 0.77 0.60 2.17 0.82 1141.6 +0.2% 146.98
01/16 15.00 0.51 0.35 1.95 0.85 1139.8 +1.6% 146.75
01/09 16.75 0.65 0.45 1.75 0.84 1121.9 +1.2% 144.44
01/02 18.22 0.75 0.53 1.94 0.83 1108.5 +1.1% 142.72
2003
12/26 17.45 0.57 0.38 2.91 0.82 1095.9 +0.7% 141.10
VIX Highs and Lows (Including Intraday)
  Year High Date Low Date  
2004 22.67 03/22 13.80 03/05
2003 41.16 03/12 14.83 12/15
2002 56.74 07/24 18.87 03/28
@ S&P high close since 10/9/02.

 

Douglas R. Gillespie

Author: Douglas R. Gillespie

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.

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