The Interim Update will generally be posted every Thursday by 4.00am NY time (3.00pm HK time).

 

Interim Update - 27 Sep 00

Stocks

Although the major indices ended yesterday's trading virtually unchanged, Wednesday may have been a capitulation day for Internet stocks and the stocks of any companies involved in the telecom sector. A number of stocks experienced large falls on very heavy volume. For example, YHOO, CMTN and NT fell between 10% and 20% on at least three times the average trading volume and closed near their lows. There was, as far as we could tell, no news that would explain these sharp declines - there just appeared to be an increase in fear and a consequential rush for the exits. Wednesday's action may have marked at least a short-term bottom for many stocks as far as closing prices are concerned, although new intra-day lows during Thursday's trading would not be a surprise.

As stated in the latest Weekly Update, the market has become more 'oversold' than we had expected it would during the anticipated September correction. We were looking for a moderate 2-3 week pullback followed by a push to new all-time highs during the second half of October. An October high is still quite likely, although it may turn out to be a 'lower high'. The fact that the SPZ (the Dec S&P500 futures contract) has now managed two consecutive daily closes (Tue and Wed) below the up-trend line extending back to the 1998 low suggests that the bull market is on its last legs.

Over the short-term (the next 3-4 weeks) we are bullish. The 10-day moving average of the CBOE Equity Put/Call Ratio has just hit its highest value since October 1998, an extraordinary situation considering that the S&P500 is still within 7% of its all-time closing high. Other sentiment indicators are also showing a healthy degree of pessimism. Sentiment-wise we therefore have a solid launching pad for a strong rally over the next few weeks.

The catalyst for a rally will most probably be the end of the bad earnings news (pre-announcement season is almost over), with a flow of good news commencing once the companies that have made their numbers begin to report. With the market as oversold as it is, simply an absence of bad news would probably be enough to spur a rally.

The decline in the oil price and the recovery in the European currencies over the past few days has helped support both stocks and bonds, but a continuation of the recent moves is vital if these risks are to be taken out of the equation. At the present time the markets are clearly skeptical that lower energy prices and a weaker Dollar are anything more than blips in on-going up-trends. At least, this is what the Dow Transports and the Dow Utilities Averages seem to be saying. With the Transports continuing to decline and with the 'Utes' moving back up to the vicinity of their early September highs, the market appears to be forecasting a resumption of the upward trend in the oil price.

Gold

An article in yesterday's Washington Post described an error in the way that quality improvements are accounted for in the CPI calculation, resulting in the CPI being understated to the tune of about 0.1%. In our opinion the entire method of calculation of the CPI is wrong and the difference between the real level of inflation and the reported CPI is in the vicinity of 3-4% (that is, if the CPI calculation were done correctly it would have revealed an average inflation rate of around 6-7% for the past few years). In any case, we seriously doubt that this Washington Post revelation had anything to do with Wednesday's $4 bounce in the gold price. Gold is simply doing what it always does - trade inversely to the USD. Since 20 Sep, the day that the Dollar Index hit its closing high and gold hit its closing low, the Dollar has dropped by about 3% and gold has moved up by around 4%.

In the very short-term, gold's performance will probably be determined by today's Danish referendum on the Euro and the currency market's reaction to the referendum result. If the Euro continues to move up against the Dollar then gold should continue to firm.

If a gold rally has not already commenced, it should do so by the end of October. As usual the gold price will be determined, to the greatest extent, by the performance of the USD relative to the other fiat currencies. There is a definite possibility that the USD will experience one final rally into mid-late October, perhaps completing a 'double top' with its Sep 20 peak. If this is the case then the start of a substantial gold rally will be delayed for another 4 weeks or so. Alternatively, the Dollar may continue to decline, in which case a gold rally has most likely already begun. This Friday's close in the Dollar Index, being that Friday is the last trading day of the month and the quarter, will give us a clue as to whether the Dollar is capable of making one last upwards run.

Changes to the TSI Portfolio

Wednesday's panic-selling in the stocks of telecom equipment companies unfortunately stopped us out of CMTN (at $40). We see no fundamental reason for the sell-off and will look for an opportunity to re-purchase CMTN over the next few days.

New TSI Web Site to be launched soon!

At some point during the next few days (by the middle of next week at the latest) our current web site will be replaced with a new and (we hope) improved version. The new site will contain the main features of the existing site (the Weekly Market Update, the Interim Update, Charts and indicators, Stock Selections), as well as a couple of additional features, and will be a subscription-based service. We will add an e-mail alert function so that we can notify our subscribers immediately of any changes in our assessment of the markets that may occur between our regular updates, and we'll also be incorporating a "Letters to the Editor" section. We look forward to your continued interest in the TSI site and will do our utmost to ensure that our subscribers receive exceptional value for money.

 

Interim Update - 20 Sep 00

Stocks

Nothing has really changed since the latest Weekly Update when we wrote that any rally in the short-term would not be sustainable "unless we see an easing in Dollar strength (which, in turn, probably requires an easing in the oil price)". And "If pressures on the currency and commodity fronts can at least temporarily abate, then a strong rally from near current levels (perhaps following a mini-capitulation in the coming week) is likely."

Currency- and commodity (energy)-related pressures have certainly not abated and, in response, we have seen some very nervous selling, particularly in the large-cap 'old-economy' stocks. Technology-oriented stocks have fared much better during this week's market swoon because their financial results are perceived as being less sensitive to changes in energy prices.

A two-year up-trend line for the S&P500 futures (SPZ) is currently positioned around 1450. During Wednesday's trading the SPZ dropped sharply to this up-trend line and then bounced with considerable vigor, closing the day at 1469. In the absence of the above-mentioned pressures coming from other markets, we would consider Wednesday's action to be unqualifiedly-bullish. This is especially the case when the NASDAQ's reversal from down to up is also taken into account. However, the oil and currency pressures are still very much to the fore, thus leaving the door open for another test of major support around 1450.

This market is quite dicey for both bulls and bears and is unlikely to reward anyone who buys breakouts and sells breakdowns. For example, even a break below 1450 will not necessarily lead to something disastrous. It should be remembered that the most powerful rallies over the past few years erupted after the market temporarily broke below a level that, according to the vast majority of technicians, constituted critical support.

The bottom line is that Wednesday's come-back is certainly a very positive development, but the market will not be 'out of the woods' until the energy/currency pressures are reduced. If market participants do begin to see some evidence that the oil price has peaked, then we have the potential for a very strong rally.

In our Sep 11 Market Update we discussed how the utilities stocks, as represented by the Dow Jones Utilities Index (DJUI), have been transformed from interest rate plays to energy speculations. Below are charts showing the oil price and the DJUI over the past few months. Notice how the DJUI, during June, July and August, regularly bounced off strong overhead resistance in the 330-333 range. It wasn't until early August, when the oil price began the rally that would eventually take it to the highest level since the Gulf War, that the DJUI was able to break-out to the upside. The DJUI is presently showing signs of having made an important peak at around the 400 level and may be in the early stages of a downward trend. Unfortunately we have no way of knowing, at this time, if a breakdown in the DJUI will be a signal that energy prices are about to begin a prolonged retreat (bullish) or that long-term interest rates are headed much higher (bearish).

Gold

Upward pressure on the Dollar and downward pressure on the European currencies due to the surging oil price has finally taken its toll on the gold price with spot gold closing below 270 on Wednesday. We have the unusual situation at the present time whereby the stock market and the gold price will benefit from the same thing - a drop in the oil price.

The recent weakness in the gold price and gold stocks is not causing us a great deal of concern because we think the cause of that weakness (a very strong oil price and, consequentially, a very strong USD) will soon disappear. If the oil price stays at current levels or moves higher then the chances of recession, and hence reduced demand for oil, are increased. The market, being a discounting mechanism, will begin to price-in this reduction in demand in the futures market before any change is noticed in the physical market. As such, a rising oil price contains the seeds of its own reversal. Sometime in the near future, whether it be tomorrow or next week or next month, the oil price will fall sharply. At around the same time the Dollar will most likely begin trending lower and the gold price will rally.

 

Interim Update - 13 Sep 00

Stocks

In the latest Weekly Market Update we said that "...any further decline over the next few days should hold in the 1480-1500 range, basis the Dec S&P (Friday's close was 1519). For the NASDAQ, a fall of around 5% from current levels would probably complete the pullback. If the downside can be contained as mentioned above, then the ensuing rally into mid-October could be quite substantial." During Wednesday's trading the Dec S&P (SPZ) hit an intra-day low of 1495 and the NASDAQ Composite an intra-day low of 3794 (a 4.6% drop from Friday's close). The market has therefore met our downside objectives for this correction. There is no technical evidence that the lows are behind us, but with the CBOE equity put/call ratio hitting a market-bottoming 0.58 and the NASDAQ100 put/call ratio hitting the extreme level of 4 (4 puts traded for every 1 call) on Wednesday a reversal to the upside could occur at any time. We suspect that the market will experience a decent bounce into Friday's 'triple witching' (expiration of options, futures, and options on futures) and then probably drop back at the beginning of next week. If yesterday's (Wednesday's) lows hold on any pullback over the next week then we would be very confident that the post-Labor-Day correction has ended.

The US presidential cycle always exerts a strong influence on the financial markets, particularly the stock market. Below are charts of the S&P500 during each of the presidential election years that have occurred during Greenspan's tenure as Fed Chief, excluding the current year. The following points are worth noting in relation to these charts:

If the market can reverse higher over the next few days and avoid taking out this week's lows on any subsequent pullback, then a 1988-style scenario becomes likely (a peak around mid-October). If we do get an October peak then we will make an assessment at the time as to whether it represents a long-term peak or just a short-term top within a continuing up-trend.

The final 2 days of this week will see the release of some high-profile economic indicators. The August PPI and retail sales figures will be reported on Thursday and the CPI on Friday. Unless any of the figures are much stronger than expected they should have minimal impact on the stock market.

We'd be remiss if we didn't mention the proposed merger of JP Morgan and Chase, the two US banks that have accumulated the largest notional values of derivatives (primarily OTC interest rate derivatives). The total notional value of derivatives contracts for the combined entity will be around $23 trillion dollars! This compares with Bank of America's $7T and Citigroup's $4.7T. JPM Chase will hold, in terms of notional value, about 60% of the total derivative exposure of the US banking system. Needless to say, we would stay well clear of this behemoth as far as stock market investments are concerned. (Thanks to www.contraryinvestor.com for the derivatives data).

Gold

In order to figure out what the gold price is going to do we firstly need to figure out what the Dollar is going to do, which means we also need to understand what is happening with the Euro and the oil price.

The action so far this week has provided some evidence that last Thursday gave us the closing high for the oil price, perhaps for several months. If this proves to be the case and the oil price steadily declines over the coming weeks and/or months (we don't expect a large drop - probably just a slide into the high 20s), then one source of downward pressure will be removed from the European currencies. As soon as the market begins to realise that oil is not going to continue its upward surge, we will probably see a recovery in the European currencies and a consequential lift in the gold price.

Another ECB meeting gets underway later today. On a short-term basis the market is susceptible to any positive news on the Euro so the ECB has an opportunity to bring about at least a temporary reversal in the Euro's trend versus the Dollar. An ECB decision to intervene in the market to support its currency would demonstrate that, in the eyes of European officialdom, the Euro's decline has gone far enough.

With the oil price perhaps having peaked and the Dollar having experienced an almost parabolic rise, the currency market is certainly ripe for a reversal. Another point worth noting is that the Dollar's last meaningful correction began on May 25, the day after the stock market reversed higher. Although Wednesday's (Sep 13) reversal in the stock market was nowhere near as pronounced as the May 24 affair, it has the potential to be quite important if there is some further upside over the next 2 days.

Gold has out-performed the European currencies on the way down and we expect it to do the same on the way up.

Changes to the TSI Portfolio

So far this week we have purchased CMTN at $50 (on 11 Sep - probably a few days too early because it dropped to around $43 on 13 Sep) and PSIX at $15 (on 13 Sep). PSIX may have experienced a selling climax on 13 Sep since it made a new 52-week low (based on a brokerage downgrade) before closing with a small gain on high volume. If it closes the week above $15.56 then a low is most likely in place.

We have removed our sell-stops for LHG and PFG. Both stocks are currently trading at, or just below, their stop-out points.

 

Interim Update - 6 Sep 00

Stocks

The correction we have been expecting is now well underway with the September S&P500 having fallen by 40 points from its Sep 1 intra-day high to its Sep 6 closing level. In terms of points the pullback is probably more than half complete, with a spike down to the 1475-1485 range perhaps completing the downside. In terms of time we suspect that the market will remain choppy for the coming week or two with a bottom being reached some time next week.

If any further downward thrusts can be restricted to the 1475 level or higher then the ensuing upswing has the potential to be quite substantial. We are still looking for an important top in October, although we are certainly open to the prospect that this cyclical bull market could extend as far as mid-2001. In fact, the on-going strength in the Utilities Index, the NYSE Advance-Decline Line and the bond market are suggesting that we are at least several months from a major peak.

There are, of course, risks. The oil price is still moving higher and the Dollar is experiencing an almost parabolic rally. As we mentioned in an article a couple of weeks ago ("The Dollar, the Euro and Gold"), extreme Dollar strength is not bullish for the US stock market due to its adverse impact on the earnings of multi-national companies. The Dollar's powerful rally may also be pointing towards a currency crisis centering on Europe, a decidedly-bearish scenario for equity markets throughout the world.

Gold

The strength in the oil price seems to be related, in some way, to the strength in the US Dollar and the corresponding weakness in the European currencies. The following chart clearly shows that the crude oil price (in US Dollars) and the SF have tended to move in opposite directions over the past two years.

At the same time as crude oil broke its down-trend and commenced a major up-trend in early 1999, the SF broke below a short-term up-trendline and embarked on a major down-trend. Over the past 2 months the relationship has become even more marked with a collapse in the exchange value of the SF occurring in parallel with a surge in the oil price.

The weakness in the SF (and the Euro) as the oil price has strengthened may be coincidental, but we think not. It is more likely that the US economy is perceived as being robust enough to cope with a high oil price whereas a high oil price is seen as presenting a serious risk to European economic growth. These trends can become self-sustaining in that a weakening currency increases the burden imposed by a higher USD oil price which, in turn, generates the concerns that lead to an even weaker currency. In a way, Europe is now paying the price for trying to use a weak currency to stimulate economic growth. It is also paying the price for the massive expansion of credit within the US economy (a significant contributor to the oil price rise) and the ability of US officialdom to paint a picture of the US economy that appears, at first glance only, to show surging productivity growth and low inflation.

Since gold tends to trade with the European currencies and inversely to the USD, the oil price strength has indirectly placed downward pressure on the gold price. As such, gold may not be able to mount a substantial rally until we see a reversal in the existing trends, that is, until the oil price stops rising (and starts to fall) and the European currencies stop falling. The good news, for those who are long gold, is that the recent price action in the energy and currency markets looks a lot like capitulation (by the 'shorts' in the case of oil, by the 'longs' in the case of the Euro and the SF). Capitulations are usually followed by sharp reversals.

Changes to the TSI Portfolio

We will add Lucent (LU) and Liberty Digital (LDIG) to the Portfolio and use Wednesday's closing prices for record purposes ($41.63 for LU and 25.63 for LDIG).

LU will be spinning off its Enterprise Network Group (business telephone networks, voice and data switches, voice messaging systems) on 30 Sep via a stock dividend to shareholders of record at 20 Sep. The new company, to be called "Avaya", will initially have annual revenues of about $8B. Of more interest to us is a future spin-off (probably during the first quarter of next year) of its Microelectronics and Communications Group (integrated circuits, optical and opto-electronic components, optical fibre). We see LU as providing minimal downside risk with the spin-offs potentially providing some interesting upside.

 

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