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[TTHQ Staff]

BEING STREET SMART
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Sy Harding


THE ANSWER IS NOT IN SURROUNDING CONDITIONS! September 10, 2004.
One by one the consensus explanations of what was keeping the market in such a flat, low-volume trading range since April have fallen by the wayside without spurring the stock market to move out of its summer doldrums.

In the early spring the market was supposedly only being held back by the situation in Iraq, primarily the lack of progress in formation of an Iraqi government as the deadline approached for the U.S. to turn over political control. But the turnover took place. And the market yawned. Then it was supposedly held back by the warnings from Washington that major terrorist attacks would surely take place during the Democratic Convention, the Olympics, or the Republican Convention. However, as each of those took place uneventfully, the market again yawned and paid no attention. Some then thought the market only needed to see the Fed raise interest rates, to show it has faith that the economy is recovering nicely, that the long period of easy money is no longer needed. But the Fed raised interest rates twice this summer – but the market was unable to rally.

For awhile it was supposedly inflation worries that were holding investors back, after both the Producer Price Index and the Consumer Price Index spiked up alarmingly for several months. But for the last couple of months those gauges of inflation have been basically flat. On Friday came the report that the Producer Price Index, which measures inflation at the producer level, actually fell 0.1% in August. No response from the market on any of those low inflation reports.
Then the problem was sharply rising oil prices, with the market moving down on that concern. But it took only a couple of weeks for the market to get used to oil prices over $40 a barrel, and the market has rallied back for a couple of weeks.

After such a long-period of going nowhere in either direction, it’s increasingly difficult to remember that the market’s normal pattern is to be in a long-term trend, in either a bull market or a bear market, and within that long-term trend to cycle back and forth between intermediate term rallies of three to four months duration, and intermediate-term pullbacks or corrections, those intermediate-term ups and downs combining to keep the market on whatever is its long-term trend. But instead, here we are midway through September, with the S&P 500 within 3% of where it was in early April, and exactly where it was on December 31.

So what will the catalyst be that finally breaks the market out of this directionless meandering?

I am sticking with my opinion that the market’s low for the year should be seen in the October to November time-frame, with that low being followed by a typical ‘favorable season’ intermediate-term rally.

You can guess forever as to what the catalyst for that rally will seem to be from among the various surrounding conditions that may be in place at the time; the election, the direction of interest rates or inflation, the situation in Iraq, oil prices, or whatever. But, the actual catalyst will probably be seasonality, the rally created by the large amounts of extra money that flow into the market beginning each fall and lasting through the winter. Those chunks of money come from distributions from mutual funds, which take place in November and December, most of which are automatically re-invested in the market, year-end corporate dividends, employers’ contributions to their employee’s profit sharing plans, 401K plans, IRA’s, etc., Christmas and year-end bonuses, income-tax refunds, etc. Amounting to many billions of dollars they provide a huge amount of extra fuel for the market, extra fuel that produces a substantial market rally in a similar time period almost every year.

Of course when that rally begins, seasonality will not get the credit. After the fact, analysts and pundits will credit whatever surrounding condition happened to turn more positive at the same time. But as we have seen with all the previous worries this year that were supposedly all that was holding the market back, the improvement in those situations are not usually able to sustain a rally. What it takes are huge chunks of extra money flowing into the market to provide fuel, and that flow of extra money does not begin until sometime in the October to November time frame. A notable exception was last year when the unprecedented stimulus package from Washington, in the form of tax rebates, tax cuts, child care bonuses, etc., combined with extremely low interest rates that prompted folks to take the equity out of their homes by refinancing mortgages. That flow of extra money into investors’ hands created a market rally in the summer last year. But that was an unusual event, as was the unprecedented stimulus package.

So this market that goes nowhere in either direction will end, as such periods have in the past. However, it is not likely to take place until the usual seasonal flow of extra money gets it started out of its doldrums.

But first the market must make it through the rest of its unfavorable season.

Sy Harding is president of Asset Management Research Corp., publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.