From the depths of darkness
October 25, 2001
The economic picture continues to get cloudier as things become clearer. Confused? Well, so is everyone else! In the midst of some of the worst earnings news imaginable, the market has managed to sustain a rally that has surprised everyone, and especially yours truly. Tech stocks have well outperformed everyone else. This move is classic contrarian material: just when no one expects a huge and sustained rally, we get one. It is also classic bear market material: bottoms of markets rarely get formed by rapid movements from the bottom without at least some form of retest. So, if you missed this past magical ride, don't worry, this will not be the last time you see these prices! Most telling is that the historical record shows that all except one time in stock market history has the market advanced over 5% in one day and not gone lower soon thereafter (I have the article if you want to read for yourself). This latest rally featured at least two days of 5%+ days in at least one of the major indices.
I wish I could go over the excruciating detail of evidence I have read that suggests this move is yet another phase of the bear market, but I will trust that those of you who are really into this stuff have already got your hands on such material. I will first point out to you that financial stocks are not rallying with the rest of the market and commodity prices have been crashing for months and are also not following the market up. Both these signal that economic weakness is likely to stay with us for some time ahead! Lastly, I will let it suffice to review some of the observations I attempted in the recent past:
1. October crash: Time is obviously running out on this one! I thought that we would crash under all the weight of the earnings season and the inflated valuations of stocks. But crashes happen when no one suspects them and certainly no one is talking market crash anymore (contrarian rules work in BOTH directions!). This tremendous rally has set up all the ingredients for a major market letdown-meltdown. However, the only reason for a crash to happen either Friday or early next week is that most of the earnings reports will be out and people will take pause to realize they better take profits quickly because near-term prospects for most of these companies simply looks terrible. We should also not bet on unpredictable external events like war or pestilence to make your market predictions come true. If a market crash is not imminent, we should be relatively safe until Spring, but we also are unlikely to make further major moves upward. Don't forget about the tax loss selling that will descend upon the market sometime in November and December. Traders should note that any heavy selling will set up great buying opportunities to play the classic "January effect."
2. Effect of financial and monetary stimulus: We must all continue to keep these huge injections of money into the economy in mind as we plan for our future. Currently, this infusion is providing extra fuel for people to speculate in the markets....not to mention that interest rates are so low now, that cash is definitely "trash" now and people are seeking higher returns elsewhere. Unfortunately, we are caught in a bind here. Either the stimulus will not work and the markets may crash upon that realization (if not October, then sometime next Spring), or the stimulus will work and we will face the real specter of inflation in 2002 and a Fed that is rushing to raise interest rates again (very bad for stocks!). To navigate this rock and a hard place will take a most amazing circus juggling act!!! Most importantly, the government is spending money like crazy and loading itself down with debt. We must eventually pay for all this largesse somewhere down the road (mind you, the Feds have no other choice right now!)
All in all, I continue to emphasize that we should significantly reduce our expectations of returns from the stock market for the near future. Unless you are a trader trying to beat the market, you should expect no more than 5-7% return for a while as the market wrings out the excess of the 90s and drives overall returns back to the historical norms of 10-12%. The economy should recover some semblance of life next year, but it will feel nothing like the roaring 90s! If you are nervous about the market, now represents an excellent time to sell off anything for tax loss purposes or to secure money you will might in the next 12-18 months or more.
As always, be careful out there!