Could the Stock Market Crash? Everyone Says “No”
by Martin Goldberg CMT. December 4, 2003
Congratulations to the traders who rode this market rally up from what Larry Kudlow refers to as "the mother of all bottoms". The rally appears to be in full bloom and stockowners are happy. Any one suggesting that a crash is possible would be dismissed as a nut case. Yet that's exactly what I am going to suggest in this article. So you may want to dismiss me now and move to the "chart section" below.
Once again, nobody cares that stock investing consists of owning shares in businesses. No one cares that any purchase of a business should be viewed as an investment, and should provide earnings, growth prospects, and dividends to justify the purchase. Today's market is speculative and prices are being determined purely by happy feelings and emotions. There is a gigantic discrepancy between intrinsic values of most companies' stocks and their stock market prices. In many companies, wealth continues to be transferred from its shareholders to its management via stock options and share buybacks of stock market-overpriced businesses (the chart of Autozone is featured below). Shareholders don't have a clue or even care. At the margin where prices are being determined, shareholders are not shareholders at all. Consider two of the top performing stocks of this year, Cisco and Amazon.com. An average share of Cisco changes ownership every 5 months or so, and the average share of Amazon.com changes hands every month! Imagine any company that is under new ownership every month! Under these "hot-potato" share-trading schemes promoted by Wall Street and practiced by many well respected money managers, would the shareholders care about the long-term prospects of the company? Of course not. Most are only trying to roll triple hearts at the slot machine.
I believed that throughout this rally, the stock market has had the potential to crash. It hasn't yet, but when the market does crash, it may crash in a devastating manner. You should consider the question of, "If the market goes down, HOW would it go down?" The questions that are explored in the mainstream financial media, TV, and Internet, deal with IF and WHEN the stock market can go down. They rarely explore the question of, HOW it may go down? How far, how fast, how devastating? The dumbed-down public does not consider this question because in their collective minds, we have already seen the answers to these questions in the stock market from March of 2000 to October of 2002. The answers in their minds are VERY far, PRETTY fast, and by in large, NOT TOO devastating. By in large, they think we are now in a new bull market.
But the facts are that the market is valued similarly to October 1929, Wall Street chicanery is at peak levels, consumer debt is at record levels, corporate debt is at record levels, the dollar is plunging, and the trade deficit is rising along with the Federal budget deficit. The Federal budget deficit doesn't scare any one any more. Why? The public remembers how it was extinguished in the late '90s. They are thinking, "No problem. If it was paid off before, we can do it again". What very few people think about is the fact that the elimination of the deficit was largely a result of capital gains taxes that the government enjoyed from the late 90s stock market bubble. They don't see this as an, (aha' hem), "one-time event". The current Federal budget deficit can only be extinguished again if we can manage to create a bigger stock market bubble than before. My money says it can't. In the absence of another stock market bubble we will have to pay the money back. This will have to be achieved through the sweat equity of our children and us or from inflation, which will dilute (reduce) our wealth.
Every casual stock market participant is now bullish. Everyone KNOWS that the stock market is going up. Greenspan will continue to keep any crash from happening. Corporate management will continue with the positive press releases that "beat-by-a-penny", and are "better-than-expected". Mark Haynes, and Joe Kernan will continue to joke, and Sue Herrera will continue to smile. Stimulus-induced government economic data will continue to be positive (yet unsustainable). William O'Neil will continue to tout the speculative favorites in spite of irrational valuations, and Investors Business Daily (IBD) followers will continue to bid these stocks up. Merrill Lynch and others will continue to issue analyst upgrades, and the public will continue to listen to them and gap up these stocks. In short, the game will continue! (Nasty but truthful e-mails from Wall Street analysts about suspect companies will not continue though!)
Overvaluation, chicanery, and everybody thinking alike suggest to me that all the ingredients for a stock market crash are in place. The only thing missing is the catalyst, and there are a variety of potential ones on the horizon. The risk (of a crash) greatly outweighs the marginal gains that can be made at this point.
What most people are thinking is typified in the Charles Schwab commercials:
"The market has changed and this time we're going to change with it."
I think Schwab's use of "change" is code language for knowing that the rally will end and Schwab investors should know when to bale out when they see market weakness. There is a serious risk that this will not be possible, though. Almost every one is thinking the same thing at the same time. When the time to exit arrives, the hatch may be too small to let the public out in time. There is every reason to believe that a crash may ensue.
There are additional reasons for a crash such as an overactive public. Momentum investing has never been more popular with the public than it is now. Chat boards are once again ablaze with the number of postings from the "lunatic fringe". Momentum-based IBD has raised the price of its Monday issue (with the "IBD 100") to $2.00. There is a 2-hour radio call in show here in Philadelphia on a station catering to the elderly that consists of mostly momentum-based stock trading. The radio program also promotes a $15/month web site, where "investors" can get stock tips that "make money" from a local stock personality (with a New York accent). I've noted similar radio programs elsewhere. Now there is a TV commercial where an actor appearing as a typical citizen complains, "All the ideas I give to my broker, he should be paying me!" The Yahoo! Finance home page is loaded with momentum-based technical analysis articles. New mutual funds are once again starting up. Once again CNBC plays at the local bistros. The game has become easy again.
More reasons a crash can occur: Visions of 1929 and 2000. Margin debt is again on the rise as it was in 1929 and 2000. It rose to $26 billion in July. This debt, which is secured by the stock shares purchased on margin, represents additional potential energy in fueling a crash. Just curious. I wonder how many shares of insider's stock were sold to buyers who were using margin? There's a lot of insider selling and negligible insider buying. (Of course, all of these insiders are simultaneously trying to diversify their personal portfolio holdings. What a coincidence!)
The NASDAQ is like a shark. If it stops swimming, it will suffocate. Without any resemblance to fair deal valuation, the primary reason people are buying and are long the NASDAQ is simply because its going up (swimming). Once the NASDAQ stops going up, there will be no reason to buy and/or hold these stocks. The shark will suffocate. (So far the shark has devoured many value-minded stubborn short sellers. It's been like the first hour of Jaws, so mind your stop losses.)
Finally, additional fuel for a rapid stock market crash may be provided by the potential public outrage from scandals involving mutual fund crime. So far no one cares about such trivia because after all, everyone is getting rich "on paper" in the stock market. When the market changes, everyone will be outraged. Remember Enron?
All this smells like fish to me. The public and its short memory are being set up again!
In summary, the stock market is set up in a similar manner as in 1929; however unlike 1929, most people have 2000 fresh in their minds. A lot of people all thinking the same thing at the same time. It's a formula for a devastating crash. Remember what legendary trader Jessie Livermore said in the 1930s:
"The biggest stock market gains are made by the public on paper, and that's where they stay."
If you take issue with this article, send me an e-mail. I'm very interested in the logic behind being long this market. (But please, spare me the "Wall of Worry" cliché. I'm just not in the mood.)
Now for some more positive thoughts, let's look at some bearish stock charts.
Can you change a leopard's spots? Eastman Kodak stock has been a money loser since it peaked in the market-mania year of 1999. Since then, it has broken many hearts, both bulls and bears. A step back at the long-term chart indicates that Kodak's stock behavior followed some very linear patterns. The nature of the long-term chart alone should make any potential owner of shares skeptical. It also presents an opportunity for short selling should the general market trend confirm its move from Up to Down. If this happens, Kodak is vulnerable. That is, unless you believe in a serial acquirer with a shrinking core business and a bad balance sheet. This Christmas you can buy a 3.2 mega pixel camera for less than $200, and there are a vast variety of brands available. You then will not have to purchase film for any future snap shots. Kodak claims that after a late start, they are going to find their pot of gold in digital. But perusing any on-line electronics site easily reveals that digital cameras are rapidly becoming commodities. It's a tough road ahead for Kodak.
The 18-month chart below reveals Eastman Kodak as one of the few winning shorts in this mother of all secondary corrections. Kodak traced a multiple head and shoulders pattern. Both necklines were broken and the ultimate drop to 20 and change produced a loss that was equal to the 30% "measurement formula" (M-1) for head and shoulder patterns as described in Technical Analysis of Stock Trends. It didn't stay there long though.
A look at the Eastman Kodak 3-month chart (above) shows a couple of key features of note:
- Early in September Eastman logged a greater than 10% gain over the course of 2 days for no apparent reason. For shorts, this was a study in the perplexing and dangerous nature of shorting against the overall market trend.
- The stock caved from the high 20's to the low 20's on the news of a poor outlook, a 70% dividend cut, and the announcement that Kodak is among other things, entering the lucrative and non competitive business of ink jet printers. These guys are brilliant!
- For no apparent reason except for blind buying via the Dow Diamonds (DIA) the AMEX exchange traded fund during a market rally, Eastman Kodak mounted a dead cat bounce back to over 24 and change as the general market rallied.
- Then there were 2 press releases regarding investor Carl Icahn meeting with Kodak management. CNBC, and Bloomberg radio and TV were on this like flies on garbage. (Like Icahn would actually telegraph any future investment in Kodak. Gullible crowd!) In spite of the Icahn publicity and meetings with Kodak management, the stock did very little.
- Kodak announced on Tuesday 24 November that they would acquire Scitex digital printing unit for cash at a premium. Scitex has a P/E of "not applicable".
- Wednesday before Thanksgiving, Standard & Poor's Ratings Services revised its outlook on Eastman Kodak Co. to negative from stable. (Not a good sign.)
- In most markets Eastman Kodak may be considered for removal from the Dow Jones Industrial Average (DJIA) since it distorts the DJIA as an index of the general economy. Such an action would eliminate a lot of the blind buying (and selling) of Eastman Kodak stock via the Index-traded fund. Removal of EK from the DJIA would have an immediate negative impact on its shares. (Although this probably won't happen in the short term.)
In summary, Kodak looks like a pretty good short, even in this market rally. (A stop loss in the high 25's is in order.) Even though it is not tracing any important technical patterns at the present time, the long-term trend is down. The recent rally was on diminishing volume and did not seriously challenge the resistance in the low 25's, in spite of such optimistic press releases with a rising general market trend, the stock has done nothing except for a low volume dead cat bounce.
During the market rally, Autozone lagged its peers. The year-to-date chart indicates that Pep Boys, O’Reilly Auto Parts, and Advance Auto parts advanced from 65 to 80% compared to Autozone with a 35% gain. Autozone is a laggard in an advancing sector. I don't think that the auto parts retail sector will advance forever. Therefore, Autozone deserves some attention as a short sale, if the overall market turns down.
If we take a step back and look at the long-term chart below, there are some interesting features:
- In April 2001 to the fall of 2001 the stock was on a tear. Autozone traced flag pattern. "The flag flies at half-mast". This technical rule held exactly for Autozone.
- Autozone then traced a broadening pattern. A sharp chart reader could have sold Autozone at about 90 in October of 2002, and bought it back below 60. Whether the broadening pattern holds, remains to be seen. The pattern has extended beyond its normal duration.
A look at the short-term chart below shows that Autozone is in the midst of completing a head and shoulders pattern. This suggests patience as the traders wait for the neckline to be broken (at about 91). The measurement rule suggests a price objective of about 73 for Autozone stock if the neckline is broken.
Have a great evening!
© 2003 Martin Goldberg