Divergences: Reflections from the Beach
By James J Puplava CFP, August 14, 2002
First Come - First Served
I decided to head to the hotel gift shop early today. Lately it has been a struggle to get there in time in order to procure a copy of IBD. As I headed towards the newsstand, another individual approached ahead of me from the opposite direction. We both looked at each other as what appeared to be only one copy of IBD remaining on the shelf. He got there first and grabbed it. To my good fortune, there was one last copy remaining. This has been the pattern throughout this vacation. The business newspapers sell out early. Copies of the New York Times or Los Angeles Times remain on the newsstand throughout the whole day. As I have said in previous missives, the hotel guests may be on vacation, but everyone is still watching their money.
As the other guest picked up his copy of IBD he turned and remarked "I'm afraid to look at the results." The Dow had lost over 200 points the day before and was already down over 100 points at the time I headed to the newsstand. He looked worried which explained his accelerated steps ahead of me in what appeared at the moment to be the last remaining copy of IBD.
Exiting the gift shop, I overheard a conversation between several men at one of the outside café tables. According to this expert, the war in Iraq was an attempt by the US to get the oil, same as the last war. Another couple talked about an upcoming cruise they were going on this fall. While at another table there was talk about this year's upcoming football season. Life seemed normal in this seaside resort. Laughter and gaiety observed everywhere. The only telltale signs of fretting seemed to be the early disappearance of financial newspapers. Tomorrow's plan of attack: make coffee first, then head for the newsstand with breakfast afterwards.
A Turnaround Day To Be Sure
As it turned out, my newsstand acquaintance had nothing to worry about. After dropping below a key support level of 8,400 and dropping close to 130 points, a rescue operation was in the works. The Dow's recovery began where it usually does during these one-day, one-hour wonders in the futures pits. In the final hour and a half of trading, prodigious buying turned a 130-point drop into a 260-point gain, a turn around of close to 400 points. The pattern has become all too familiar to many observers. Just when it looks like the markets are heading into the abyss, a rescue in the futures markets begins in the final hours of trading, turning back the tide. There was also key buying in the large cap weighted and price weighted stocks of the Dow, S&P 500, and the Nasdaq such as Wal-Mart, Intel, Microsoft, Citigroup and Home Depot. In the case of Intel and Microsoft, they are included in all three indexes.
Market commentators attributed the miraculous turn around to investor relief over the SEC deadline for companies to certify their financial results. The story goes this way today: now that most companies have certified their results, the accounting scandals, which have plagued the markets this year, are over. Despite the certification, we are still dealing with funny numbers. As long as companies, analysts, and anchors use pro forma numbers instead of earnings according to GAAP, investors will still be getting CRAP. The GAAP numbers don't look so good, especially with companies such as Applied Materials warning about sales and profits for the next two quarters. It is the reason why there is so much obfuscation over the bottom line.
If the real numbers were talked about, investors would be bailing. Despite the hype, that is what I think they are now doing. Nobody is buying the one-day wonder stories. The constant rise and fall of stock prices is making most investors nervous. Fidelity just reported the outflow of many of its funds. Magellan, the company flagship fund saw redemptions of $1 billion last month. As markets gyrate, investors are slowly looking at the exit gate. This is what Wall Street fears the most. This explains all of the clamor for the Fed to bail out the markets again. If the Fed moves to lower rates, it will mean there is trouble in the capital markets.
Rumblings in Washington
Speaking of the Fed, the adulation over the Fed Chairman is starting to wane. This morning's Washington Post ran a story "Give Greenspan's Fed Its share of the Blame." The Mises Institute also ran a story "Assigning Blame". The Mises article, much to the lament of Democrats, assigns blame at the steps of the Fed. Hillary Clinton and Al Gore have been giving speeches blaming our current problems on Bush's tax cuts, which have been modest and delayed over a decade. Instead of tax cuts, the Mises article blames the problem on the unwarranted expansion of credit by Greenspan under the Clinton Administration. The Post goes on to talk about the relentless expansion of M2 and M3 beginning in 1995. The article gives more pertinent information over debt expansion during the Clinton years. Household debt grew by 46.4 percent, corporate debt by 62.8 percent, and state and government debt by 19.5 percent. Mortgage debt grew by a whopping 94 percent.
The Anderson story in the Post goes on to say that Bush inherited a recession, a financial bubble from the Clinton years. So it is disingenuous for Gore or Hillary Clinton to lay the blame on the Bush Administration. But Anderson is also critical of the Administration whom he says lacks anybody with an understanding of the Austrian business cycle Theory. Instead of explaining the bubble, the President is acting more like Herbert Hoover with tariffs, stimulus spending packages and bogus tax cuts.
Both the Mises and Post articles lay a good portion of the blame for the mess we are in at the Fed's doorstep, which, in my opinion, is where most of it belongs.
The markets are rising against a backdrop of growing bankruptcies and credit defaults. US corporate bankruptcies are setting new records this year. Assets of publicly traded companies filing for Chapter 11 bankruptcy have surpassed $267 billion. Credit spreads between corporate bonds and Treasuries keeps widening. Moody's estimates that junk bond defaults, running at a 10.3 percent rate, will continue to rise well into next year. Rumors are circulating that several large hedge funds have bet the wrong way and are now in trouble.
Market commentators are still talking about a market bottom. They seem clueless to a key technical theory in the markets. Although the Dow Industrials, and the S&P 500 have risen in a summer rally, the Dow Transports have failed to confirm the movement in the Industrial Average. The Nasdaq has also been unable to breakout of a pattern of lower lows and lower highs. The Transports and the Nasdaq have been diverging. Any good technician knows that unless the Industrials and the Transports confirm each other the primary trend remains in place which is a bear market. The reason that the Transports haven't been rising is because of all of the troubles within the transportation industry, in particular the airlines. UAL announced after the markets closed they may file Chapter 11 this fall.
As far as the markets rushing to conclude that this divergence in the major averages as a bullish sign of a new bull market, I conclude with something written back in 1948 in the classical technical treatise by Edwards & Magee "There is an unfortunate tendency in the 'Street' to overstress any such divergence, particularly when it can be twisted into a favorable sign. The fact is that, in Dow Theory, the refusal of one Average to confirm the other can never produce a positive signal of any sort. It has only negative connotations."
Time for a good flick. Tomorrow I have to beat the crowd to the newsstand.
Reporting from the beach,
© 2002 James Puplava