HOME OF "PICTURES OF A STOCK MARKET MANIA" March 16, 2011
Alan M. Newman's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
Excerpts from our current issue
Rationales & Targets
Take your pick from the front page, this is not the typical wall of worry that bulls love to climb. There is potential here for some very nasty developments within the next few weeks and none point to higher stock prices. While many will point to last year’s May/June correction as all that was needed to reset the clock for the bull, history has shown amply that the corrective process does not depend upon wishful thinking. In the last century, corrections of 10% or more took place on average once every 1.44 years. Corrections of 15% took place on average once every 2.23 years. Thus, it would not be all that unusual for stocks to decline by as much as 15% here and now. We have already pegged major support at 10,930 (see Intermediate Term Conditions at right), and a correction to this level would be 11.8% from top to bottom, well within normal expectations. That said, we still see far too much optimism and complacency, the identical condition that presaged the last two major stock market tops. If anything, we fear we are not nearly bearish enough at this time.
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Last week, Pimco founder Bill Gross made huge waves saying the U.S. had no way out of the debt trap in which it now finds itself. Gross says, “Frankly, I think we’re at a tipping point. What’s my biggest single financial concern is the loss of the dollar as the reserve currency. I can’t imagine anything being more disastrous to our country than if the dollar lost its reserve-currency status.” (see http://tinyurl.com/4fj4dxt). And then, to back up his statement, Gross announced that Pimco had dumped their entire holdings of U.S. T-Bonds (see http://tinyurl.com/4eb4hec). Gross is arguably one of the three brightest analysts in the business and simply put, his logic is impeccable. Whether the Federal Reserve goes for a QE3 (or QE4 for that matter) or not, the harm has already been done. More QE can only wind up debasing the currency further, anathema to bonds, and sans more QE, there will be no place for interest rates to go but up.
Professionals Euphoric
The Investment Company Institute (ICI) recently reported $19.5 billion in mutual fund inflows for January, the largest inflows for any month since February 2007. We would caution readers interpreting the one month turn as the beginning of a new trend. Since February 2007, funds have suffered $213 billion in outflows, including January’s bulge. Of the 48 months, 25 have been graced by positive inflows, so positive is clearly not an unusual circumstance. However, given the endurance of the rally and the size of the move from the March 2009 lows, it is very strange that more folks have not seen fit to toss money at the rally. As well, for many years January and April have been far and away the best months for inflows, so if the pattern holds, the recent bulge is only temporary, perhaps to be followed by another bulge in April, but we do not believe the trend has at all changed. Investors are simply not interested. The twin busts of 2000-2002 and 2007-2009 remain strong memories.
Furthermore, as our chart below clearly illustrates, flows into domestic mutual funds remain pitifully below water and completely belie the action in the S&P 500. At the end of January, mutual fund assets represented close to 39% of the entire market capitalization of stocks. Thus, while the largest segment of invested funds continued to suffer from disinterest, prices continued to surge. The only explanation that makes any sense is the explosion in high frequency trading. By most accounts, HFT now comprises 70% of all volume and almost none of these transactions are dependent upon valuations in the traditional sense. If valuations do not matter, prices can rise to any level and still be valid for a bid that could conceivably be in place for just microseconds.
As well, professional sentiment is as optimistic as we have ever seen, clearly on a par with the monster tops of 2000 and 2007. A very similar peak in optimistic sentiment occurred as stocks peaked in January 1973 when it was widely believed that stocks could grow forever without any impediment. Euphoria at work. The cash-to-assets ratio fell to a then record low of 3.9% and over the course of the next two years, the S&P was crushed, down 45%. Euphoria was also at work in 2000 and in 2007 and precisely the same outcome took place as stocks were cut in half. We again see euphoria and the same possibility of a big crush here with the cash-to-assets ratio at only 3.5%. The March 2009 bottom is right in line with the three prior collapses from euphoria and we see no reason to rule out a full fledged retest. About the only positive statement we can make is we must grant this is a very worst case scenario. At the very least, we believe a peak in professional sentiment as we see today should catalyze a major reversal and for all intents and purposes a bear market, rather than a mere price correction. Since the popular definition of a bear market has come to mean a 20% downside, that would clearly satisfy the parameters we are looking for.
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
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