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Summary

Not All Conditions Present For New Bull Move

(January 19, 2001) Over the short term we have seen market conditions improving as the broad market has begun to firm. The NYSE advance/decline line and the NASDAQ new low list (stocks making new 52-week lows) both bottomed in December, and over two-thirds of the S&P industry groups are trading above their 200-day moving average. These are all positives over the short term for the overall market. However, the strongest positive is the 50 basis point Fed rate cut which we experienced on January 3rd.

Historically, after a series of rate cuts stocks on average move higher. After 3 months stocks gain approximately +10.00%, after 6 months +19.00%, and after 12 months by +23.00%. However, we need to see more than just 1 rate cut, before the economy and the market can regain its momentum. Once the economy and the market begin to move in a particular direction, it can take months before a reversal can take hold.

This is especially true after experiencing a strong growth phase and stock market bubble as we had in 1999-2000. Investors should not look for instant gratification with the rate cut we have gotten or with another one at the January 31st Fed meeting. The Fed may be pushing on a string with their cuts as the economy and market will not turn until all of the downside momentum and excesses are wrung out. Even then do not expect a major bull move to start, although there will be a series of tradeable rallies which can be profitable.

In order for the next major bull move to commence we need to see the right combination of both monetary and fiscal policy. The right mix of conditions are the following: 1) A series of interest rate cuts; 2) Adequate liquidity in the form of the adjusted monetary base increasing by over 6%-7%, which will provide enough fuel for economic growth, compensate for inflation, and provide funds to invest in the stock market. Remember, the blow-off in 1999-2000 was in large part due to the money earmarked for Y2K finding its way into the stock market. When the Fed turned off the spigot, stocks fell (in other words Chairman Greenspan created most of the bubble then broke it); 3) Lower taxes (change in fiscal policy) to assist consumers/investors by offsetting the negative affect of higher energy costs and heavy debt loads; 4) Low and stable inflation. Although inflation rose 3.4% in 2000 (the highest rate in 10 years) it has not yet created a problem; 5) Falling energy prices; 6) Bearish investor sentiment in the form of outflows from equity mutual funds, as well as high cash positions in the funds themselves. This would signal that both investors and fund managers are bearish which normally signals a bottom; 7) A series of trading days in which up volume and advancing issues swamp down volume and declining issues. We are slowly starting to see this occur which is a positive sign.

The market suffered a great deal of damage in 2000, which will take time to repair. Eventually conditions will improve and the market will once again start its uphill climb.

Indicators

Monetary Indicators

Bullish--With the Fed having lowered interest rates by 50 basis points and poised to possibly lower them again by 50 more, my monetary indicators have turned positive. All major bull markets begin with falling interest rates. This is the first time in 2 years that the Fed has cut rates and the first time since 1991 by 50 basis points. This is a definite long-term positive for stocks.

Bond Indicators

Neutral--Bond market players have priced in an economic recession and aggressive easing by the Fed over the first quarter of 2001. The bond market will give us the first clue as to how much the Fed will ease at their next meeting. If we see a rally over the next several weeks, bond players will consider the Fed still behind the curve.

Momentum Indicators

Moderately Bullish--The broad market and the major indices have actually begun to stabilize which is a positive. In December both the NYSE advance/decline line and the NASDAQ new low list bottomed which means that the broad market is beginning to hold in the face of earnings disappointments and a weakening economy. This is a long-term positive.

Sentiment Indicators

Moderately Bearish--Investor sentiment is still too positive for a long-term bottom to be in place. Money flows into individual stocks and mutual funds have slowed significantly but as yet have not turned negative. A more positive environment would be for outflows of money as investors are washed out of the market, creating a bottom.

Market Notes

The year 2000 turned out to be one of the worst years on record for the major indices. For the Dow (-6.18%) the worst since 1981; the S&P 500 (-10.14%) since 1977; and for the NASDAQ (-39.29%) the worst year ever. Many investors felt that after such a bad year the market would have to advance after the first of the year. Instead, the S&P 500 had the 2nd worst opening day in history (since 1929) and the NASDAQ the worst day ever.

Trading Rules

14. Bull Markets Die Of Overweight--When prices get top heavy, be sensitive to bearish news. The perfect example is the NASDAQ over the past year. (Various sources)

Portfolio Strategy

Until the Fed lowers interest rates by at least another 50 basis points our allocation and defensive posture will remain intact. The worst of the economic and earnings news has not yet been factored into the market. Once market players throw in the towel we will then become more aggressive.

Model Portfolio: Balanced portfolio is now 68% stocks; 10% bonds; and 22% cash. Equity portfolio is now 76% stocks; and 24% cash.
 

January 19, 2001
Donald L. Sazdanoff
Sovereign Asset Management
2628 Trotters Way, Columbus, Ohio
419-884-8309

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