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(April 30, 1997) STOCKS: Stocks have become a trader's delight, and investor's nightmare. The Dow Jones Transports are at new highs.
The Dow Jones Industrials are challenging their old highs after a 10% correction. The stealth bear market continues in the NASDAQ, over-the-counter, Russell 2000, Value Line, and small-cap stocks.
The Investor's Business Daily Mutual Fund Index is still below its May 1996 high. What's important to remember is that what happens in the stock market is dictated by the futures market in the S&P 500, and the New York Composite Index. What it took for stocks to rally is exactly as discussed in the April 9 Reaper, "The best hope I can see for stocks rallying will be if June T-bonds could close on wide range and heavy volume above 108-00. A rally in the interest rate futures, in other words, would be supportive for stocks." The June T-bond close above 108 occurred on April 29 and stocks exploded higher that very day. While there may be more gusto upside, concern over the May 20 FOM meeting may cause choppy price action in stocks and bonds. This acts like a bear market rally in the DJ Utilities.
...Margin debt on the NYSE is the highest in history, rising to $100 billion in March. The advance/decline ratio on the NYSE is bearish and speaks of losses in a majority of stocks. The S&P 500 dividend yield is less than 1.94% and the price-to-dividend ratio is at 51. Many small cap stocks, the Russell 2000, AMEX and NASDAQ have given back nearly all of their past year's gains. Total dividends paid by the S&P 500 companies have been lower over the past half year. More investment clubs have been created in the past two years than were in existence two years ago. The number of index funds has increased by 72% while the number of all equity funds has increased by 126% over the past three years. NASDAQ had over 200 stocks hitting new lows for 20 straight sessions. These are all signs of a mania in stocks and a stealth bear market, both at the same time. Federal Reserve data shows that corporate buying, not mutual fund inflows, have been the real source of funds propelling the stock market higher. This is like eating your own tail when you are hungry. The Japanese stock market, the Nikkei Dow, is steady to higher, but losses have accrued due to the weak yen/strong dollar.
The emerging stock markets of the Far East are toppy and have rolled over to issue a sell signal. Singapore is the most bearish of the Far East stock markets. Even the strong European stock markets, the best of the bunch internationally, have retraced a bit, weakened in dollar terms. This is primarily a U.S. blue chip stock rally. But U.S. corporations, hit with higher interest and wage costs, will squeeze their profit margins. For the record, the American Century Equity Growth Fund topped in early December, 1996.
The mining stock indices are bearish too with a weakness in gold, silver, and the Bre-X fiasco. U.S. stock funds hold 5.7% of their total assets in cash. The stock market correction resulted in almost a 50% reduction of money flowing into stock market mutual funds in March from investors. Technology and biotechnology are overvalued and may be short sales on this rally. Energy funds and growth funds have turned negative. Financial funds, health funds, small company funds, utility funds, Pacific funds, Latin American funds, international equity funds, are all toppy to bearish. Sir John Templeton is putting his money in U.S. T-bonds. All told, look for choppy distribution in the stock market into possibly the fall of the year, possibly new highs and new lows, a megaphone-type formation. Ned Davis' favorite stock groups are the food producers, retail sector, such as retail-general merchandise and retail- apparel groups, and transportation. Big international money I interface with are holding natural resource companies that are involved in aluminum, gold, silver, copper, forestry, and agriculture, because of their fundamental favorable supply/demand characteristics long term.
RECOMMENDATION--Holdings in Rydex Ursa Fund in the Long-Term Investor's Portfolio should be maintained at 10%. Long-term investors who are hedging by purchasing and holding other instruments (LEAP puts) used to short the U.S. stock market on scale-up strength--hold (LEAP puts on the S&P 500 such as December 1998. 55 and 65 puts).
R.E. McMaster, Jr.
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