Broker Check

Market Update for 3/31/2002

The first quarter ended and it was really boring. Up a little bit, down a little bit, and so on. How can we make money and still have some fun in this kind of market? Well, one of the things I like to do when the market gets boring like this is to investigate low-priced stocks. Many good companies have seen their stock price crushed. So, I will sort through the entire database and look for stocks that went from under $5.00 to over$5.00 within the last 10 weeks. Then I will sort them according to their financial strength. I like to call these my “Five Dollar Flyers.” This search and sort of the database may sound crazy, but I want to find the stocks that are flying the highest. This strategy gave a 70.27% gain in 25 weeks when I used it from 8/96-2/97 and again from 4/99-10/99 when the market conditions were very similar to these. Show Me The Money! This is what real buyers will be saying before they commit sizable capital to this market. With the first quarter earnings cycle only two weeks away the uncertainty about results is keeping the volume very low. The markets are trending down despite the economic headlines. In Greenspan's speech last week he mentioned the quality of corporate earnings several times. With the Enron, Global Crossing, Network Associates and Waste Management accusations still flying regulators are questioning new accounting rules. Some of these rules would seriously cripple "earnings" for many tech stocks. A P/E of 50 could become a P/E of 200 overnight if the rules were changed. This accounting cloud will depress the markets for some time yet. Speaking of clouds there is a huge thunderstorm brewing in the deep south. DEEP South. Argentina is quickly self-destructing. This has been underway for some time but it is quickly getting worse. The currency is barely suitable for wallpaper and unemployment is well over 20%. The government is in chaos and has no plan. One analyst indicated the current civil unrest is likely to turn into serious trouble soon. Because this has been coming for many months most of the impact to the U.S. markets has already been seen, factored and forgotten. However the severity of the current crisis appears destined to impact all the surrounding countries even more than previously anticipated and that could ripple all the way back to Wall Street. Several multinational companies have already warned that the economic weakness in South America would impact their 2002 earnings and more will follow. I don't think the Argentina crisis is over for us. What does all of this mean to us as investors? Several problems lay in our path. The April earnings reporting cycle kicks off with the first Dow component, Alcoa, next Friday, April 5th. However, the rush does not begin until the week of the 15th when the trickle turns into a flood of hundreds of announcements. Still, next week should provide several more earning warnings now that the quarter is officially over. As Thursday was the end of the quarter, we are now open to exposure from portfolio stripping. What I mean is that the portfolio window dressing over the last two weeks may turn into undressing as mutual fund managers dump those same stocks to prepare for the summer doldrums. With the market setting up for a possible fall, these managers will be looking at buying these stocks back cheaper in the future. According to there was another inflow of cash into stock mutual funds in the week ended Wednesday of $2.8 billion. This makes three weeks of substantial positive cash flow--but the markets have not been able to breakout of the current trading range. Beginning next week we will start seeing money leave the markets and head towards the IRS. With tax day only 19 days away there may be a steady outflow of cash to pay the taxman. Many traders, optimists all, wait until the last minute to close positions in the hopes of profits to help defer the tax payments. But what was depressing to most of us portfolio managers was the –146 point drop on Monday coupled with the -100 point drop on the Dow from the highs of the day on Friday to close negative. The talking heads on CNBC kept repeating the fact that 77% of the S&P-500 was over its 50-Day Moving Average and the majority were over their 200-Day Moving Averages as well. This has only happened five times since 1996. What they left out of the story was that each time it occurred it ended with a dramatic slide. Couple all of this together with the Volatility Index (VIX) hitting a new 52-week low on Friday of 18.87 and I think you would agree that we are not looking at the Yellow Brick Road ahead. In fact, there could be big problems ahead. The break under 19 is a clear warning indicator. But most investors feel the markets will go up as the recovery continues. They are just divided on when that recovery will occur. Most analysts are now pointing to 2003 instead of 3Q/4Q this year. This is major complacency—and it comes from indifference. Despite the increase in the NASDAQ short interest it appears that most investors are content to just sit on the sidelines and wait. Their volatility is zero. Others are content to simply nibble on every dip and slowly add to their portfolios, confident in a future recovery. Their volatility is minimal. This picture is vastly different from the February bounce when optimism abounded. Reality is slowly sinking in and investors are beginning to realize the rebound may be lethargic instead of robust. The lack of buyers is simply due to a lack of interest. Historically a sell off occurs between April-15th and May-15th more often than not. Recently 52-week lows on the VIX produced a -10% to -20% drop in the S&P over the next 45 days. Let’s see, can this happen again? Last three 52-week VIX lows: 8/28/00 18.13 S&P = 1523 dropped by -218 (14%) to 1305 in 45 days 7/16/99 17.70 S&P = 1418 dropped by -151 (11%) to 1267 in 23 days 7/17/98 16.78 S&P = 1188 dropped by -249 (21%) to 939 in 43 days (7/2/2001 low was omitted due to 9/11 distortion but 13% drop had occurred prior to attack) The first key point here is that extreme complacency is followed by prolonged selling. The second key point is that we only know these were 52-week lows by looking backwards in history. The current VIX at 18.87 is still above these historical numbers but is still dropping. This means we have not hit the bottom on the VIX yet. It could be next week or it could be next month, we don't know. This is exactly what large institutional investors are waiting for. They pay millions for long term technical analysis in order to time their entries into the markets. That technical analysis is suggesting that a better entry point lays ahead. Therefore they are content to sit and wait. It is interesting to note that the VIX low may be occurring significantly earlier this year than in the last four years due to the recession impact and positive investor expectations. Does that mean it could drop below established norms? Could be. Armed with the above knowledge what should an informed investor be doing? Protecting long positions and waiting patiently for the coming entry point. Until then should a rally break out we need to wait for confirmation before boarding the train. That confirmation would be a break above 10500 on the Dow, 1875 on NASDAQ and 1155 on the S&P 500, none of which is likely to happen next week! So, I am very hesitant about opening new long positions at this time. The Dow broke above 10500 by a whopping two points and for an eternity of two minutes on Friday before dropping –100 points to close back near 10400. The S&P came within .55 cents of hitting 1155 before falling back at the close. The NASDAQ did not even get close to the 1875 entry point. I think you can see by these numbers EXACTLY where price resistance is and where any rally next week could fail. Don't get me wrong. If an upside explosion occurs we want to be on it. But until that happens, I will remain cautious or even establish more short positions if the S&P drops below1140. Have a Happy Easter! Mark Pivan