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(June 26, 1997) STOCKS: Here are the red flags: High tech stocks remain toppy, in distribution. U.S. investors have the equity portions of their stock portfolio at the highest percentage in 30 years, with 50% allocated to stocks. Overall portfolio liquidity is at a 28-year low. Microsoft and Intel account for 18% of the total performance of the NASDAQ. Ten stocks on the NASDAQ represent 29% of the total performance. The remaining 4,892 stocks represent the remaining 71% of activity. These ten significant stocks have rallied 81.5% since July 1996. If these ten are factored out, the NASDAQ has risen only 3.6%. Junior growth stocks are in distribution. The summer solstice's turning point led to a 193-point drop in stocks on Monday, June 23. What will happen in mid-July? The Dow is only yielding 1.6%. There are 29 listed golf stocks to buy, another sign of the end of an age. Technical indicators are way overbought. Uncertainty surrounds the June 30 transfer of Hong Kong to Red China. It'll be significant to see what happens then to the high-flying Hang Seng Index. Too many investment advisors are bullish on the U.S. stock market. Too few puts are being purchased presently. Buying pressure is weak despite the huge rally in stocks. The trading public is way too bullish on stocks. Positive signs are: The NASDAQ hit a new record close on June 19. The Investor's Business Daily Mutual Fund Index recorded a new high the week of June 22, finally exceeding the January 22 high and the May 22, 1996 high. The S&P Mid-Cap 400 Index is doing well. The Russell 2000 Index has moved up nicely. Small cap stocks have outperformed the S&P 500. The stock market is supported by the flow of funds into the stock market mutual funds, the increasing adjusted monetary base, increasing M2, and increasing loans.
Now we'll see what happens come mid-July. A weak close below 7600 by the DJIA turns the minor trend down. It will take a close below 7250 to turn the intermediate trend down. Strong support comes in at 7000 on the Dow. The DJIA has formed a minor top, the Transports an intermediate top.
RECOMMENDATION–Investors who desire to hedge against a bear market in stocks may hold positions in Rydex Ursa Fund (presently 5% of the Long-Term Investor's Portfolio), and may hedge stocks by purchasing and holding the likes of LEAP puts on the S&P 500, such as the December 1998 55 and 65 puts. Also put options may be purchased in December S&P futures contracts.
R.E. McMaster, Jr. Top
One New York Plaza, New York, New York
(June 30, 1997) STOCK INDEXES: “Fasten your seatbelts” aptly describes last week's action in the stock market, which saw intra-day gyrations each day that could take your breath away.
Monday–The first trading day after the triple- witching close-out, the Dow Jones Industrial Average opened lower and immediately proceeded to fall 192 points. The day's loss was second only to the 508-point decline in the October 1987 crash. At 2.47%, it also was the largest percentage decline since last July 15, when the loss was 2.92%.
Tuesday–Just to be obstinate, the market opened higher and rallied straight up to end the day with a gain of 153 points, the market's fourth-largest gain on record.
Wednesday–The Dow traversed 370 points by starting out 40 points lower, rallying to a gain of 50 points, plunging to a 130-point loss and finally charging to close with a loss of “only” 68 points.
Thursday–Similar thrills and chills were in store for the Dow, which traveled 325 points in a 135-point range before ending 13 points lower.
Friday–After a week of extremes, Friday's action seemed relatively calm. The Dow remained on the plus side all day, closing 33 points higher after being as much as 115 points in the black.
For the first week in history, the Dow traded in at least a 100-point range each day. After watching every market measure set all-time highs the previous week, last week was a period of consolidation and a retreat from the frenetic, record-setting advances from mid-April to mid-June that took the Dow 1450 points higher. For the week, the Dow ended with a loss of “only” 109 points while the S&P 500 index fell 11.4 points. These were the largest weekly losses since early April, which reveals the intense and consistent nature of market action over the last two months.
Last week's hesitation can be attributed to not only the expected “breather” that occurs following a triple-witching expiration, but also the bond market, which saw yields rise to 6.74% after having fallen as low as 6.65% the previous week. Also, there were negative pre- announcements ahead of the tide of second-quarter earnings reports that will begin in a couple weeks. The market weakened similarly during the first-quarter pre-announcement period in late Much. In that period, there were 315 negative previews; for the second quarter so far there have been about 125. These negative announcements clear the deck for potentially better readings, which could add fuel to the bullish fires next month.
The economic numbers released last week continued to show a moderate economic pace and probably did not justify the bond market's weakness during the first four days of the week:
–Consumer confidence for June rose to 129.6 from 127.9 the previous month for the highest reading since August 1969.
–The Johnson-Redbook survey of weekly chain store sales rose 1.6%.
–Durable good orders for May fell 0.6%.
–May existing home sales rose 4.4%.
–Weekly jobless claims fell 14,000 to 332,000, but the four-week moving average rose to 338,750.
–The University of Michigan Consumer Sentiment Index rose to 104.5 in June from 103.2 in May.
–The first-quarter GDP final revision was 5.9%, up from the prior 5.8%.
There were all sorts of supposed “explanations” as to why the bond market sold off in the early part of the week, defying the better-than-expected reception to the two- and five-year note auctions. The first explanation was an answer to a question posed to Japanese Prime Minister Hashimoto during his recent U.S. visit. He said: “The United States should engage in efforts to maintain exchange rate stability so Japan will not succumb to the temptation to sell off U.S. Treasury securities and switch our funds to gold.” This statement was later recanted, and gold ended the week at $335 per ounce, the lowest price in more than four years.
The second explanation concerned remarks two days later from U.S. Treasury Secretary Robert Rubin. He said he doubted that such a Japanese sale would take place, but that the market could absorb the supply if it did. The bond bears interpreted his answer as keeping open the “possibility” that such an event could indeed occur. Other bearish tidbits included a statement from the Bond Market Trade Association that positive economic growth in the United States should prompt some sort of rate hike by year end, predicting that the Federal Funds rate will rise to 6% from its current 5.5% level. As a result of these negative attitudes, the yield on the long bond rose to 6.77% on Thursday, the highest in a month, before falling back to 6.74% at week's end.
The record pace of mergers and acquisitions continues to fuel the bull market.
The real source of fuel for the bull market has been money flows into stock mutual funds, and the latest statistics confirm acceleration of this trend. For May, $20.1 billion was added to stock funds, marking the seventh-best month ever and the best since January. There is now more than $2 trillion in equity mutual funds, double the amount just two years ago, When all asset classes are considered, including stocks, bonds and money instruments, there is $3.9 trillion invested in mutual funds. For the first time since the early 1970's, more than half the total investment pool is in equity funds.
Technically, the Dow has failed three times when it climbed above the 7800 level; the S&P 500 has also failed three times above 900 on an intra-day basis. One can argue that a top is being built at these levels. But, if the July 3 non-farms payroll report is friendly and second-quarter earnings come in better than expected, as they did in the first quarter, then it would appear that these resistance points will eventually fall by the wayside.
Despite this week's setback, which was the first in more than two months, the market still appears poised for further gains. It is now generally assured that the Federal Reserve will not raise rates at this week's meeting. If so, then interest rates should be able to hold at least steady. The S&P market is not historically overvalued as it trades at 19 times projected 1997 earnings and 17 times projected 1999 earnings. We recommended a bull spread with the S&P options, buying the July 630 puts and selling the August 670 puts at a 35-point credit. If this week's non-farms payroll report is not interpreted negatively by the financial markets, we will advocate similar strategies, even in advance of the heart of the earnings season.
Don Selkin Top
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