|The most disheartening factors
concerning the end of the stock market mania have been the many recent
confirmations that the mania was just not possible without concerted efforts
by key participants to coerce small investors by any means possible, including
malfeasance, conflicts of interest and even outright frauds. As in
the South Sea Bubble and other manias, a repeat of history. We maintain
our position that Enron represents a watershed event, the only possible
"new paradigm" that could have come out of the insanity that drove prices
to levels that discounted impossible rates of economic and corporate growth.
new paradigm and new economy that professionals touted never was.
And as we have shown in our newsletter commentary and charts in recent
months and show again a few paragraphs below, investors have not benefited
from participating in the mania. Question: who did benefit?
Answer: the large Wall Street firms that pushed high flying stocks and
initial public offerings at prices that defied reason, the analysts who
parlayed their supposed skills into investment banking relationships that
presented the worst conflicts of interest, and especially the insiders
of some publicly traded companies that abandoned fair play in the quest
to engineer earnings in order sell their own inflated shares acquired via
options. The inside truth is that insiders have been selling shares
at a pace that eclipses their purchases by a factor of more than 100!
This mania can only end the
way all prior manias have ended - with public distrust of the very professionals
that coerced them into the madness the first place.
Human nature is what
it is and allows history to repeat.
We are still awaiting the
final GDP figures for the 4th quarter of 2001, but our latest estimate
for Dollar Trading Volume represents a rather sharp drawdown from the peak
of 322.4% in 2000. Our best judgment is that 2001 ended with DTV
at "only" 218.1%. As a reminder, even in the insanity of 1929, DTV
was substantially lower, at 133%. Does this mean the mania is totally
at an end? Given the crisis in confidence, it certainly appears that
the mania has been mortally wounded. However, we must still bear
in mind that even our initial estimate for 2002 finds investors trading
$1.95 for every dollar generated in GDP. Thus, stocks are still
the most important facet of the economy and because they are, the crisis
in confidence is far more important than the financial industry believes
and the crisis has the power to completely unwind investor trust, much
as it did after the debacle in 1929.
an assault of sobriety and reality is only slowly setting in.
Two year wealth losses continue
to be highly significant and are second only to the massive losses incurred
after the 1929 crash. Clearly, wealth losses were at least partially
responsible for the economic depression that followed in the early-1930's.
That current wealth losses are not a major consideration in the prognostications
of economists and strategists is likely a manifestation of complacency
at best and utter ignorance at worst. Total stock market capitalization
has declined by at least $5 trillion since the March 2000 peak and represents
nearly half the country's GDP. It was not until 1932 that losses
were worse than they are now. The inside truth is that the financial
industry does not want you to know and continues to cheer on the long term
We are somewhat encouraged
by our present economic resilience and believe that a similar worst case
scenario to the 1930's will not necessarily play out, nevertheless, we
see every reason why the damage done to wealth and confidence will lead
to a protracted and deep secular bear market at the very least.
The wealth already
lost will likely remain lost for at least several years to come.
Much of the following commentary
appeared in prior issues of Crosscurrents. We feel it is important
for us to reiterate these views and disseminate this article as widely
We were shocked while sauntering through the S&P
Marketguide database, when we discovered a group of ten passably representative
high tech companies that witnessed huge insider sales. The group
included Microsoft, Intel, Cisco, IBM, Hewlett-Packard, EMC, Amazon, Sun
Microsystems, Dell and Yahoo. There were 87 sellers and only 3 buyers.
Sort of spoke volumes about the lack of fair valuations, we thought.
But we wondered whether we might just have hit a dry zone for insider enthusiasm
and perhaps we shouldn't have just focused on high tech or sampled so few
companies. So we consulted our database and performed a similar exercise
for all the 30 Dow Industrial companies and what we found was truly astounding.
on to your hats. The most bullish perspective we can provide
is that there were buyers at 15 companies and sellers at 28. Only
two companies had no sellers, Int'l. Paper and Honeywell, but IP had no
insider trades at all (hence we removed them from the charts) and there
was only one buyer at HON. There were 23 buys overall and 141 sales
for a 6.13 sell/buy ratio, as shown at left below and as huge a gap between
the two as we have ever witnessed.
But it gets worse! The average buy transaction
took in 3870 shares while the average sale dumped 241,057 shares, a ratio
of 62.3-1. It gets still worse! A grand total of 89,000 shares
were purchased versus a grand total of 33,989,000 sold, a ratio of 381.9
shares sold to each share purchased! We're not inclined to dispute
the S&P Marketguide numbers. The ratio of shares sold to shares
purchased is the most horrendous we could have imagined and clearly illustrates
that insiders - who are as acquainted with the current environs as anyone
- are abandoning their ownership at record speed. But then again,
we mused, perhaps this display of revulsion by insiders towards their own
shares might be influenced mightily by the honchos at Microsoft.
As previously revealed in Crosscurrents, Microsoft insiders made zero buys,
21 sales and 21.46 million shares were dumped, presumably many by Bill
Gates. Thus, we feel duty bound to present the Dow numbers minus
the one-sided influence at Microsoft. The tally: 23 buys, 120 sells
for a 5.22 sell/buy ratio, still the worst we have ever seen. Average
buy; 3870 shares, average sale; 104,450 shares. And as shown at right
below, total shares purchased 89,000, total shares sold 12,534,000.
Sans Microsoft, 140.8 shares were sold for each share purchased.
The Inside Truth:
No matter how we look at the
we see insider revulsion of
One of the principal reasons a bear market such
as the one we expect can unfold is that the majority of participants are
utterly fooled into believing it cannot happen. Just as delusions
prevailed at the very peak in March of 2000, delusions will prevail at
the peak of the corrective rally. The TRading INdex (TRIN), invented
by Richard Arms, has been throwing off the most bullish signals ever seen
for many months. Many players, including technicians of every stripe,
seem to be focused so heavily on this one indicator that we wonder if they
can see the forest for the trees. Clearly, in prior times when the
21-day indicator exceeded a very "oversold" 1.2, it was not long before
the bull resurfaced and strongly, at that. As well, with the exception
of what the crash of 1987 wrought, the indicator never remained above 1.2
for any appreciable length of time. Typically, an oversold market
is reversed rapidly. But in the present circumstance, the indicator
appears to be radically different from before. First, note the inclined
pattern of low readings maintained since the beginning of 2000. We
would also note that decimalization commenced at precisely the same time.
Is the effect of higher readings due to decimalization? Or perhaps
our very astute colleague Chris Carolan (www.calendarresearch.com)
is correct in assuming that the great number of interest rate sensitive
issues (45%) on the New York Stock Exchange have been responsible.
These issues typically trade on small volume and have been able to impact
the TRIN dramatically. Clearly, there is an effect and it has kept
the indicator above the 1.2 extremely bullish trigger point an amazing
48.7% of the time since the March 2001 peak!
Despite continuing high readings, the bull
has not returned.
The 34-day incarnation of the same indicator displays
equal bullishness for those who do not wish to analyze what is actually
at work here. The preponderance of bullish readings above 1.2 have
still not resulted in the takeoff anticipated by bulls and can only be
a result of a dramatic change in the indicator itself. Given that
a reading of 1 represents a perfectly balanced and normal market, it is
somewhat staggering to realize that the 34-day indicator has been below
1 on only two days (circled area) since January 1, 2001!
Continuing high readings are proof that the
character of the market has changed.
The Inside Truth:
The indicator does not signal that
the bull is ready to return.
Many technical indicators have been in typically
bullish territory for months. The Advance/Decline line and New Highs
are amongst the many indicators like the Arms Index, that appear to be
signaling an all clear. But these are not typical times! And
just as the mania produced convoluted rationales and allowed investors
to buy into the most egregiously overvalued market of all time, the end
of the mania must produce ways to fool investors into believing all is
at least, well. As our 10-day New High/New Low indicator clearly
illustrates, there are two totally different markets, one up to early 1998,
and the one thereafter. We have shown many times before how the peak
in the broad market occurred anywhere between October 1997 and April 1998,
depending upon which indicator we looked at. The picture at left
below is further proof. And despite an enormous rally from the September
2001 lows, New Highs minus New Lows has still provided a lower low than
in 2001 and is again, pointing down. We would also point out that
the bottom in 2001, which was due at aggravating circumstance, never provided
the type of oversold climax as was visible in October of 1998. The
inside truth is that New High and New Lows are nowhere near as bullish
as they were a few years ago.
Another move to at least the levels of September
2001 could easily be in the cards.
Bulls have been hanging onto all kinds of historical
factors, including the seasonal tendency for stocks to gain ground during
the months of November through April. We have discussed this phenomenon
in detail on several occasions and months ago alluded to the conclusion
that the current "favorable" period need not turn out well. The period
has been down in two consecutive years only once, in 1973-1974, and bulls
are arguing that one down period is sufficient. We demur. Although
down November-April periods only occur roughly one-quarter of the time,
there were sixteen consecutive years of up performance. Given history,
the odds of such a string is 73-1 (less than 1.4%). There is no reason
why a repeat down performance cannot be in store again for the six months
ending April 2002. Also, last year's "dip" was below average at minus
2.2%. The average for the 12 down periods has been minus 4.9%, which
would imply Dow 8630.
In our view, the implied Dow 8630 "target"
is eminently doable.
At left below, you see a view that has only been
seen in Crosscurrents (January 22, 2002) and nowhere else. As always,
we strive to present the most original and powerful research and commentary.
The chart illustrates how dollar cost average investment in the S&P
500 has performed over the last five years and two months including dividends,
a view that Wall Street has endeavored to keep you from seeing. Incredibly,
an account utilizing everyone's favorite strategy was actually in the loss
column after 58 months and yielded a paltry 1.7% compounded (monthly basis),
even under performing the money markets over five years. After the
full 62 months shown (through February '02), total profits came to only
$162.28 on $31,000 invested! Although our comparision uses average
money market yields of 3% going back to 1997, in reality, even cash at
1% turned out to be king! Given the better part of the mania for
stocks, one would be excused for believing the results for stocks might
have been a lot better.
The buy-and-hold mantra was and is clearly
a myth perpetrated by ignorance.
As we see here, the money market investment comparison
made 62 months ago at Dow 6448 has outperformed stocks by so much to date
that Wall Street's insistence upon the long term mantra is truly laughable.
After 62 months, the meager profits of $162 for Dollar cost Averaging (as
of 2/27/02) prove that the common wisdom is worthless. Wall Street
has pushed Dollar Cost Averaging for years as a sure fire method of acquiring
wealth, citing the logic of buying more shares at low prices as a mathematically
valid proposition. We agree in theory. However, in practice,
the only methodology that works is reason. If prices are too high,
stocks should be sold and not bought. The proof is in the pudding.
The Inside Truth:
Over the last 62 months, stock
investors have clearly been losers.
Given the history of an entire century, prices
are still too high! Ten year annualized returns for the Dow Industrials
are still hovering above 12%, far removed from the historical norm of 5%.
Could the huge increase in returns signify the vaunted new era? The
huge increase in returns certainly prodded similar thoughts in the 1920s
and 1960s, yet both those eras witness regressions to reality and the norm.
If anything, the current era stretched further in price and time than at
anytime before and may need to be unwound in similar fashion - a deep and
protracted secular bear market. The returns we show are without dividends,
which have averaged over 4% over time. Thus the true return for stocks
is roughly 9%. However, even when you consider that dividends throughout
the mania have been extremely low, returns have still far exceeded the
average. We expect that returns ex-dividends will drop sharply and
that corporations will be forced to raise dividends as a result, to keep
shareholders content. So, in both regards, we expect a regression
to the norm. Clearly, returns ex-dividends have been under 5% more
than half of all ten year periods and a similar retracement at this juncture
would be a totally normal outcome. This, of course, might take years
to unfold and the regression can occur in either price or time. For
instance, if the Dow were to remain mired at the 10000 mark, the regression
would be achieved in November 2006. If the Dow were to decline modestly
over time to 8000, the regression would be reached by December 2005.
If instead, the Dow declined to the 6437 level at which Alan Greenspan
first suggested "irrational exuberance," it would only take until February
2005 for a return to "normal." Since the prior two huge bear markets
resulted in returns below 0%, prices could indeed go a lot lower
and the bear could extend a lot further out in time.
As far as we are concerned,
the regressions presented above represent
a best case scenario.
Investors have learned a harsh lesson in the mania.
The watershed events of Enron and Global Crossing represent patent proof
that the public's protection from harm is minimal. We are to believe
that both Kenneth Lay and Jeffrey Skilling, the Chairman and CEO of Enron
knew nothing of what was coming down the pike? If they were
that ignorant, how could they be in such responsible positions to begin
with? Instead we are to believe there was a "run on the bank?"
We believe there was a run on the truth.
By its very definition, a mania is a time of widespread
hysteria and faulty rationales. However, in order to believe, investors
have to be convinced that there is a rational basis to their actions.
This can only occur when certain participants are able to devise untruths
and cajole the public. A mania is a time of time of deceptions.
Clearly, the larger firm analyst community were impotent when the time
came for reality to surface. Even now, sell recommendations are for
the most part, anathema. Clearly, several investment firms themselves
parlayed their analyst relationships into lucrative investment banking
deals regardless of how silly the prices of their "product" might be.
Clearly, the insiders of several high-flying companies that engineered
an apparent growth, did so while carefully and willfully disguising inferior
results. But the most conclusive proof that valuations remain stratospheric
is patently evident in the actions of insiders who have been selling their
own shares at rates that belie the stated bullish outlooks for their own
And even now, as journalists have the opportunity
to tackle the truth and expose it for the public good, BARRON'S has elected
to show S&P 500 "operating earnings" instead of the "as reported" earnings
they have shown for years, resulting in a apparently favorable decline
in the S&P's P/E multiple from an obscene 44 to a still high, but far
more reasonable 28. We believe BARRON'S is doing investors a terrible
disservice by publishing "operating earnings" rather than the "as reported"
earnings they have shown for generations. And although we believe
they are only reporting the numbers handed to them by S&P, we guess
this is only another unsurprising development in an environment beset by
confusion, befuddlement and misconceptions.....
The Inside Truth:
Investors have no one to trust
If you wish to contact BARRON'S to
protest their use of "operating earnings." instead of "as reported," please
copy the following text or write your own letter to the Editors.
To the Editors of Barron's:
I am writing to protest your use of "operating earnings" instead of "as
reported" earnings for the S&P, the numbers you have previously reported
for decades. Using the "operating earnings" method makes things look
far better than they really are and can only serve to confuse and mislead
investors. The truth is more important and the truth is that writeoffs
of one kind or another appear year after year after year enabling "operating
earnings" to far exceed earnings "as reported." Your move to show
only "operating earnings" is a luxury we cannot afford at the end of a
veritable stock market mania. We need to be able to trust that Barron's
is wholeheartedly in the corner of investors.
A small portion of the charts and analysis
presented here are shown in our newsletter weeks and months in advance
of their appearance on this site. If you haven't already, we urge
you to take advantage of our FREE 3-issue trial (see link below).
We hit our targets for both 2000
and for 2001. Two updates ago, we said "The September 21st low was
very likely the low for the year....we believe the SPX could trade as high
as 1249 (1177 much more likely) before the end of the year." We pretty
much nailed the top print which came in at SPX 1173.62 on December 5th
and actually called for a December 6th high in our newsletter. As
it turns out, the high since the September low has been 1176.97 registered
on January 7th, only .03 from the "much more likely" high we had initially
pegged. Our initial downside targets for 2002 have been altered from
our last update only for the S&P 500 and Nasdaq; upside possibilities
remain the same.
Our downside targets
for 2002 are as follows (2 in 3 odds):
Dow Industrials 7400-8200
/ SPX 800-890 / Nasdaq Composite 1210-1370
Our best case scenario
for 2002 is as follows (low probability):
Dow Industrials 11000-11080
/ SPX 1249 / Nasdaq Composite 2260-2300
Alan M. Newman, March 3, 2002
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