The Law Of Gravity
By James J Puplava CFP, March 24, 2003
The stock markets fell hard today reversing all of last Friday's gain. The Dow lost 3.6%, the S&P 500 fell 3.5%, and the NASDAQ dropped 3.7%. With the exception of the NASDAQ, the Dow and the S&P 500 are now back to being negative for the year. The early days of a quick victory are now giving way to reality. This war will be no cake-walk and the war could take much longer than anticipated. In fact, you could say that all hell is breaking loose. The outcome of this war is now uncertain, other than to say that the history of the region is being rewritten. Diplomacy may also take a turn for the worse. It now appears that Russia was in the business of selling Iraq advanced electronics equipment used to counter U.S. technology by jamming radar and bomb guidance systems. Russia was also selling Iraq missiles. France stands to lose its lucrative $70 billion deal with Iraq to administer food for oil program. It also looks like chemical weapons plants have been found that have yet to be verified to their reliability but may point to other areas where Saddam has weapons of mass destruction.
The Turks, on the other hand, along with the Iranians may be interested in reclaiming parts of Iraq, especially the region now occupied by the Kurds and home to large Iraqi oil fields. There were several conflicting reports over the weekend that indicates that Turkey may try to take advantage of the situation by moving its troops into Northern Iraq. According to news sources this weekend the Turkish government may be out of money and bankrupt by summer. Other news reports filtering in this weekend of possible Iraqi terrorists may have crossed US borders. The Washington Post reports that that al�Qaeda may be close to developing its own chemical and biological weapons, reporting that they have plans to develop salmonella, botulism, anthrax, and cyanide. The terrorist organization is now close to being able to produce its own biological and chemical weapons to supply its own cadre of terrorists. Suffice to say that in war things don't always go as planned, and sometimes there are unexpected surprises. The perceptions that this was going to be a quick and easy war evaporated this weekend as casualties mounted and serious opposition confronted the US and coalition troops in the region.
Now that the war isn't going to be a quick in and out battle like Gulf War I, traders and speculators seem to be reversing positions. Buying stocks on the basis of a quick war, in my opinion, just shows how out of touch most of Wall Street is with reality. I hate to sound like a broken record but in comparison to Gulf War I, the US stock markets and the economy are much more out of balance. There is considerably more debt in the system and stock valuations are where typical bear markets begin, not finish. Dividend yields were close to 4 percent, and now they are less than half of that. Price earnings multiples were around 15 during he last Gulf War; now they are more than double that. Mutual fund cash positions have all but been expended, 4.35 percent versus 11.4 percent.
In addition to valuations, the Fed has shot off most of its bullets. During the last recession and Gulf War we had interest rates that were close to 10 percent. Te Fed funds rate was high single digits, and there was considerably less debt in the financial system and in our economy. Consumers were paying down debt, increasing savings and acting with financial circumspection. Today we have the opposite conditions. The fact that Fed rates are at 1.25 percent doesn't leave the Fed much room to maneuver, so Washington is turning to fiscal policy in an effort to alter the business and trade cycle. In the process other distortions will be added to the financial markets and the economy. The latest stock market rally is just another sign that the markets are acting irrationally again. With economy weakening, job layoffs accelerating, and corporate profits at anemic levels the fact that stocks haven't gone even lower should be questioned. Today's fund managers and investors are still worried about the next bull market beginning and not wanting to be left out on the price action.
Judging by the sentiment of investment advisors, mutual fund cash positions, and the fall of volatility indexes and the CBOE put/call ratio, there is much more complacency today then there was in the past. The markets and investors have discounted all the bad news and have priced the markets for perfections. It is beyond the scope of most investors that any sort of terrorist attack may follow operations in Iraq much less the idea that the war may be much longer, bloodier and more protracted than expected. The history of the Middle East is full of wars and some of the bloodiest conflicts the world has ever known. To assume even a great military power can walk in without difficulties is na�ve. Even the Romans, one of history�s most long lasting and successful empires had difficulties in this region. The Romans fought differently and were less humane than the US.
It should come as no surprise that markets pulled back at the first sign of difficulty. Now the reality should start to set in. However, I believe intervention will keep the markets from going through a drawdown, so expect days like today to be followed by rallies that take place on the most inane reason--an economic report that is worse that comes in better-than-expected, or an earnings report that beats estimates. I expect to see more flagpole rallies as this market works its way down with more miracles occurring at key support levels.
From a technical aspect each bear market rally has four distinguishing features to it:
levels never reach levels of previous rallies.
Advancing issues over declining issues, the A/D line gets weaker
The VIX and the VXN remain complacent during downturns.
Rallies occur in a few 3-4 days of violent rallies
If Wall Street wants to bring back the public it is failing to convince them that the markets are a safe place to be. All the Street has done is to convince the public to hold on to their portions even while their life savings are destroyed in the process. The only excitable bunch in these short bear market rallies have been the traders and momentum players who trade in and out of sectors. Most of these rallies and downturns see only the hedge fund, mutual fund, and trading community participate in what has become a casino. The public, judging by mutual fund outflows, has been using the rallies to slowly exit the markets. The exit levels are still at a trickle state and haven't developed into a full-fledged panic. I expect that will take place when the unexpected surprises come in either a large financial mishap or some unexpected geopolitical event that takes place.
After today the Dow and the S&P 500 fell below their 200-day moving averages while the Nasdaq is sitting right on the border of breaking. I expect the bad earnings news coming out of the tech sector this quarter should play hard on the expectations that have been built into tech stocks. There are a lot of high hopes for this sector that aren't based on reality. We should start to get a glimpse of this over the next few weeks. Already HP, Dell, Applied Materials, and Gateway Computer have given warning that things aren't looking rosy this quarter. Many companies are refusing to give guidance because they simply don't know and can’tsee the forest through the trees at the moment. It will be the job of analysts to lower expectations so low that when earnings come in they look much better. The only problem is after playing this game for the last four years they are finding fewer suckers. The earnings game is becoming an insider and professional game played only amongst the pros and the trading crowd. Widespread public participation has evaporated, so the analysts and the anchors are speaking to smaller crowds. I noticed that a few of the financial anchors have now moved on to other types of news coverage.
In today's market, the dollar is falling, stocks are down, and commodity prices, especially gold, are reasserting themselves. Gold got a nice bounce today as the dollar fell in overseas trading. Crude oil jumped 7 percent today to $28.66, heating oil is up 4 percent to $78.37 and natural gas is back over $5.25. In other words, the primary trends seem to be reasserting themselves: a bear market in paper and a bull market in "things."
For today's market it was the worst drop of the year so far. Market breadth was terrible with loser's beating out winners by a 25-7 margin on the Big Board. Volume came in at 1.27 billion on the NYSE and only 1.42 billion on the Nasdaq. The VIX jumped 1.58 to 35.20 and the VXN edged up .58 to 46.36.
European stocks slumped, sending the Dow Jones Stoxx 50 Index to its biggest one-day drop in five months, on concern the war in Iraq may last longer than investors expected last week. Club Mediterranee SA and British Airways Plc led declines among travel-dependent businesses. Semiconductor-related stocks including Infineon Technologies AG and ASML Holding NV fell as analysts said the companies may not be able to raise prices. The Stoxx 50 tumbled 4.5 percent, its biggest one-day decline since October, to 2204.38 as all of its member-companies fell. The Stoxx 600 dropped 4.2 percent.
Japanese stocks rose, driving the Nikkei 225 Stock Average to its biggest gain in four months. Canon Inc. and other exporters climbed after the dollar rallied on Friday, promising to boost the value of their overseas sales. The Nikkei jumped 2.9 percent to 8435.07, the largest advance since Nov. 28.
Chart courtesy of StockCharts.com
© 2003 James Puplava