wmeubank@ocp.kcmo.com
THE REAPER
P.O. Box 84901, Phoenix, Arizona
(October 23, 1997) STOCK INDICES: It has been the incessant flow of funds provided by U.S. investors into equity funds that has boosted the stock market, coupled with the surge of mergers and acquisitions, already well ahead of last year's record pace. Merger activity experienced a real flurry in October. Nevertheless, the stock market nose-dived October 23, following Hong Kong's crash, which in turn triggered stock sell- offs around the world. This has been a sobering wake up call for investors. It may have marked an important psychological turn. Technically, the stock market has been topping out since early July. A weak close by the Dow Jones Industrials below 7,750 will issue an intermediate sell signal. A major sell signal will be issued by a weak close below 7,600. December S&P closing on wide- range and heavy volume below 950 will issue an intermediate sell signal. A major sell signal is issued by a weak close below 900. There is still bearish divergence between the Dow Jones Industrials which have not made new highs versus the Dow Jones Transports and Dow Jones Utilities which have. A small double top may have been formed on the Dow Jones Transports. A toppy stock market with a put/call ratio this low, the lowest it has been for years, means no one is really all that negative on stocks. Buying versus selling pressure being sluggish also when the market is rolling over is a dangerous omen for the bulls. The median forward P/E ratio of the 1700 stocks on the Value Line is currently around 18 times, an all- time record. The median dividend yield of these same 1700 stocks is just 1.8%. Thus, overvaluation continues to be an ongoing problem. Earning paid out in dividends, the payout ratio, will go to an all- time low of 35% on the S&P 500 for 1997. Technology stock earnings have been disappointing. Transportation, aerospace and financial stocks, by contrast, have continued to do well, along with our REIT stocks, mining, oil, natural resource stocks, and utilities. Caveat emptor. Remember, a falling tide lowers all boats. This means a global stock market sell-off should pressure almost all stocks. So, at least a hedge position on the short side may be prudent. Our oil stocks have continued to perform well.
RECOMMENDATION–Up to 10% of the Long-Term Investor's Portfolio is invested in the speculative stocks discussed in each issue of this section of the Reaper including utilities, oil stocks, REITs, and natural resource stocks. Another 10% is invested in mining stocks. Investors who have hedged against a bear market in stocks generally hold a 10% position in the Rydex Ursa Fund. Cautious and speculative investors have also hedged stocks by purchasing and holding LEAP puts on the S&P, such as the December 1998 55 and 65 puts. High-risk speculators who expect a bear market in stocks before year end have purchased put options in the December S&P futures contracts, or have perhaps moved out into March 1998 put options in S&P futures.
R.E. McMaster, Jr.
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