Pump, Dump & Spin
By James J Puplava CFP, February 18, 2003
The experts are calling it a relief rally. The possibility that war will be postponed, or temporarily delayed was the reason given behind today's stock market rally and the continuation of last week's staged upturn. I say staged because I believe this rally is being artificially driven. As shown in the graph of today's Dow & S&P 500 the rally began as it always does when you see flagpoles in the futures pit at the Chicago Mercantile Exchange. March futures contracts rose 13.50 at the open to 850.50. March futures on the NASDAQ 100 index rose 26 to 1011. Once the flag was raised it was kept there all day as strong buying in the futures pit and arbitrage between spot and futures drove the cash market (the actual indexes) up.
This market has become a casino driven by large players and technical trading. There is nothing in the realm of fundamentals that can help explain the market's rise. What you often hear as reasons is nothing more than hype and spin designed for public consumption and a masquerade for intervention. For the army of new readers to this site I would like to explain the four-step intervention-rally process. The four steps are as follows:
Intervene in the market (done by buying futures)
2) Higher stock prices through intervention forces short covering
3) Stock prices that lurch higher brings in momentum players
4) If the rally lasts long enough, John Q may move money into mutual funds. This happens just about the time the rally fades
The rallies usually begin with intervention that comes in to support and prop up the market at key technical support areas. The danger technically is that with so many eyeballs and computer screens watching, the same technical charts breaching key support areas would generate further selling pressure. Falling through key support areas generates more selling that takes indexes down to even lower levels until the next area of support is found on a chart. Therefore, intervention seems to come anytime key support levels are in danger of being violated. You can see this pattern repeated consistently since last summer's nadir in the markets. The markets are driven up violently in sudden surges that take place on a few major days of trading. They then seem to consolidate until additional intervention is brought to bear on the markets. However, beyond the few days of intervention that generate the four-step rally process you can see momentum indicators begin to decline. What is clearly transparent is that there are no follow through rallies that come from widespread public participation. John Q is slowly exiting the market. The exit traffic is small and building momentum. This is one reason you can see a clear trend in the major averages of declining volume that has been evident since last summer and continues on to this day. Even on a day like today, volume slipped by close to 8% from its three-month average with less than 1.2 billion shares trading hands on the NYSE.
As the next chart of the S&P 500 illustrates, the market rallies have been repelled at the neckline level of the S&P 500. The head & shoulders pattern is one of the most reliable of all technical patterns. The downside potential of the market is measured from the peak of the head (top of the chart) to the neckline of the S&P 500. What this shows is, if you do this measurement, that the bear market in stocks still has a long way to go before we hit bottom, which should take the S&P 500 down to the 350 level.
Despite all of the balderdash coming from the Street and its media outlets, we haven't hit bottom and aren't even close to getting there. As far as all of the spin about stocks being cheap, forget it as nonsense and hype designed to keep you fully invested and hopefully buying stocks. As a point of reference we will now start featuring real and pro forma earnings for the S&P 500 in our Market Section, which will get more facelifts in the weeks ahead. The final number for Q4 earnings hasn't been completed. As soon as it is complete, we will post the new numbers so that you can value whether stocks are cheap or not. The numbers you currently want to use is the trailing earnings for the S&P 500 as of the end of Q3. Those numbers indicate that the S&P 500 is selling at a current P/E ratio of around 46 with a dividend yield based on today's close of around 1.87%. I hate to sound repetitious, but when I hear anchors and analysts tell viewers that stocks are cheap, a reminder of the facts is warranted. The plain truth is that stocks aren't cheap, that they are still extremely expensive, and merit a sell and not a buy.
The Usual Suspects
Coming back to today's markets the rallies took place in the usual areas of speculation. Tech stocks such as Cisco, Oracle, Microsoft, Intel and Sun rallied back above their 50-day moving averages. The SOX got a nice bounce but fell short of reaching its 50-day line. The rally in stocks and bonds is helping the dollar and hurting gold. The gold markets have been trading in opposite directions. I believe this rally will be short lived due to deteriorating US economic and earnings fundamentals, as well as the eventual outbreak of war and the terrorist attacks that will follow.
War & Terrorism
As far as the delay in war, it is only temporary. The US was attacked and forced into its present position not by its own design, but by the carefully planned and orchestrated attacks by Al-Qaeda. If the US withdraws from its plans for war, Al-Qaeda will not reciprocate. In fact Al-Qaeda along with any other terrorist group will only be emboldened even more by the appearance of weakness. Terrorists only understand strength--not weakness. Anyone who has studied warfare and terrorism knows this. Appeasement didn't work during the 1930's, it didn't world during the 1970's, and it will not work during the first decade of this new century. Despite the good intentions of those who would wish and pray for peace, we now live in a world at war. This war will grow and get larger as the decade wears on. This decade will be marked by a growing desperation of nation states trying to acquire access to raw materials. Water, oil and food will be behind much of this new decade�s regional and global conflicts. Unlike the past, armies won't gather and face each other on grounds that are suited for war. The new battlefield will become the skies and cities and it will be fought by unconventional means. Innocent blood will be shed by those who care nothing for their own lives, much less those innocent victims whose lives they destroy. Much like the Soviet invasion in Afghanistan during the 1980s, the US will be compelled to act. Its real purpose will be to stage a base camp in which to take on terrorist groups and their cells operating in and out of the safety of rogue states.
As far as oil is concerned, if the real intention of this war were oil, it would be far easier to invade Venezuela. The US gets far more oil from Venezuela than it does Iraq. Furthermore, in the past Saddam has offered to ship more oil to the US on favorable terms. Getting oil through negotiation would be far cheaper than mounting a war expedition. There is a tendency to over simplify geopolitical situations and nowhere is this more evident than the coming war with Iraq. The world says little about the fact that France and Russia have lucrative commercial and oil interests with Iraq. Nor is it mentioned that Iraqi oil provides much of the gasoline that goes into French and German gasoline tanks. I would wonder what the response in those countries would be today if their own landmarks and people were destroyed in the same way as what happened here on 9-11. We are a world at war and Europe is the least prepared for it. In the US I expect more deadlier terrorist attacks to follow with or without war. The main goals of Al-Qaeda are to unite the Arab world in a war against the west. They will use terrorist attacks as detonators to steer the world towards its goals of global conflict. If my suspicions are correct, the next attacks will be deadlier than the first. They will not come in the way we expect or at targets that we defend. We are set up to defend against a plane or missile attack against prominent landmarks and surrounding civilian areas. I believe the next attack has already been planned for a long time and is waiting only for the appropriate time to execute.
They will come at a time we least expect and be aimed at targets that will be designed to do the most economic damage and inflict the greatest loss of human life. Like it or not we are a world at war. War is coming to the Middle East and from there it will spread as nuclear, biological, and chemical weapons are used by terrorists to assuage their inner conflicts of rage. Intelligence sources from Jane�s to Stratfor.com have recently published stories on missing nuclear materials from the former Russian Republic of Georgia. In addition to missing nuclear material, nuclear warheads are unaccounted for along with suitcase nuclear weapons. It is widely speculated that many of these missing bombs and materials are now in the possession of the terrorists. I believe we will soon find out if indeed this is true.
The possibility of another deadly terrorist attack has not been priced into today's overvalued stock markets in the US. If you trade this market, do so carefully. Unless you are in full control of your emotions, have adequate capital, and are an expert in technical analysis and trading systems, you may find yourself confronting the unexpected. Ten-sigma events cannot be read on any chart. No chart can forecast them. We live in a nonlinear world where the unexpected is occurring and becoming more commonplace. The norm is what is not normal. The tails or the outliers on the edge of the curve are what is commonplace. This adjustment process has not been factored into most trading systems or models on Wall Street. It is going to be a painful lesson to learn and even more costly given the current state of leverage in the financial system and the markets. More will be written on this very subject matter as Ten-Sigma is put to pen beginning this week and the weeks ahead as it will be quite lengthy. It will be aimed at destroying many of today's shibboleth's left over from the bull markets and era of peace of the last two decades of the 20th century.
The tech sector flew as spec buying in the futures pit helped to generate buying and short covering. Technology, financial, and healthcare led the rally. The rally in stocks took place against a backdrop of deteriorating economic and financial reports. More companies, such as Reuters, reported losses. Reuters will now lay off more workers to help stave off further losses. Debt burdens continue to grow a the consumer and corporate level that will prevent any meaningful recovery from occurring. The bigger the debt burden and the faster it grows, the worse it will be when the eventual day of reckoning arrives. Volume was weak -- a trend that continues to worsen. Breath was positive by almost 3-1 on the NYSE and by 2-1 on the NASDAQ. The VIX fell 1.54 to 35.56 and the VXN advanced .02 to 48.40. Complacency still reigns over the markets.
European stocks rose amid optimism a war against Iraq may be delayed or prevented. The Dow Jones Stoxx 50 Index climbed for a third day, led by Siemens AG and Allianz AG. the Stoxx 50 added 1% to 2277.58 in London for a three-day rise of 5.2%. The Stoxx 600 Index climbed 1% with 176 of its 18 industry groups advancing.
Japanese stocks fell as Sumitomo Mitsui Financial Group Inc. led declines among banks on concerns its plan to $2.5 billion in preferred stock will curb returns for investors. The Nikkei 225 Stock Average slid 0.9% to 8692.97. The Topix Index shed 0.6% to 856.70 with banks accounting for more than a quarter of the drop.
© 2003 James Puplava