17 March 2000: Volatility Concerns?
A huge rally is always welcome. But is increasing volatility something to
be concerned about? The current volatility level has been exceeded only
twice in the past 10 years. In both cases, increasing volatility came to
a head with a very large drop. This time, the volatility has peaked on
a huge rally. But that's the question: has today's volatility actually
peaked, or are we merely building up to an even bigger move? And if so,
in which direction?
All of the models did a quick about face after yesterday's big rally and
so participated in today's incredible upturn. Model #17, which was invested
200% using margin, gained over 9% for the day! All the models continue
to be extremely positive.
This type of explosion from a low sometimes signals the start of a new
bullish phase. The NYSE was below its July 1998 level two days ago. Will
it now begin a sustained climb that finally brings it to a new record
high and well beyond?
That's hard to say. One very unusual fact is that volatility is now at
levels seen very very rarely over the past 30 years. But in all the other
cases, volatility at these levels accompanied a steep market decline.
As of today, volatility has reached a new high on a huge rally. What
does this mean?
Frankly, I have no idea. I'm just watching the statistics and reporting
them to my loyal members and visitors. We've got bad things coming up,
like perhaps another interest rate hike by the Fed. But for now, even
the long-term Model #3 is fully bullish. The NYSE crash has been dodged.
But, that doesn't mean there won't have a painful NASDAQ bear market over
the coming months. As always, it will be interesting to see what happens!
The models are in agreement: the current situation in the broad market
(NYSE) is very bad. Overall, the trend and volatility indicators
suggest the current market is as risky as it has been at any time
since the 1987 crash. The strength of trend indicator is near the
level it attained during the 1998 plummet. This means we are in a
market that is very capable of building up momentum quickly and
lurching in one direction or another. But of course, the strongest
of lurches are always those born out of fear. Maybe the NASDAQ
investors don't know fear -- but if you're in the broad market,
invested in old economy stocks, and you're seeing your retirement
melt away, genuine fear may be just around the corner.
Couple that with articles like "Big-Cap Tech Stocks Are a Sucker Bet"
on today's Wall Street Journal editorial page (page A30), and you've
got a reason for panic. The article concludes that the following
stocks (among others) have unsustainable valuations (1999 P/E is listed
in parenthesis):
For you old-timers: remember when we thought the Japanese were crazy
in the late 1980s for continuing to buy stocks in a market where the
average P/E was 60?
The broad market paused and rose barely enough to turn some of
the models barely positive. A strong gain on Thursday would suggest
a market that is divided between the bullish and the bearish, a
positive development in the light of the 17% DJIA decline from
it's all-time high.
The volatility and trend indices are now at extreme levels. A
very volatile, strongly trending market, within the context of
a declining near-term market pattern, adds up to a very high
risk situation. The NASDAQ may be setting new records, but the
NYSE is exhibiting the trading patterns that precede a crash.
The current level of risk is extremely high.
The models took profits today, after a very nice run-up.
What's next? The next few days will tell. Today's drop wasn't
large enough to undo the positives engendered by last week's
sustained rally. But a substantial drop that gives up most of
last week's gains would be a bad sign.
Might today's rally have what it takes to continue for a while? Today's
burst flipped all the short-term models to positive, with patterns that
look more bullish than anything we've had in the past few weeks. Only the
long-term Model #3 is unimpressed: it continues to consider cash a better
investment than stocks.
Clearly, the broad market has fallen far enough to warrant at the very least
an upward "correction" within a longer term downtrend. Since there was no
major news behind today's rise, it has to be considered nothing more than a
reaction to last week's heavy selling. A reaction to prior selling doesn't
change the fundamental trading environment. But buying on top of buying can
change everything. The question is, does anyone have cash to buy with, or
has all of it already been plowed into the market?
The next few days will be very interesting indeed!
Is there any doubt at this point that the broad market is in a bear market? The
DJIA is down 15% from its peak, the NYSE is below it's July 1998 level. The models
have voted cash and bonds as being better investments than stocks for almost all
of the past month. The NASDAQ surge appears to be drawn in part from money being
withdrawn from the older, larger company stocks. This may continue for some time,
but it can't go on forever, because the big old companies are the customers of
the high techs. If a negative outlook for the broad market becomes reality for
these large companies, who will the high techs sell their products to? Then the
NASDAQ would inevitably crash.
The stock market was unable to hold recent gains. Today's decline pushed all the
short-term models and the intermediate model into a negative stance. In addition,
the market is becoming so choppy that no trend can be detected. If this continues,
the models will stay in cash, waiting until the markets to calm.
A big rally, such as took place today on the NYSE (up 1.88%) usually has good
follow-through. However, the more volatile the market, the more likely an
upward spike that immediately followed a downward spike is simply a 'relief
rally'. The fact that volume was lower on today's up move than it was on Friday's
down move certainly casts doubt on today's gains. Risk remains higher than
average, and the intermediate trend is still down.
The broad market NYSE and bonds appeared to be the beneficiaries of NASDAQ selling
today, suggesting that professional managers are increasingly leery of the high-tech
sector and are moving funds into the more traditional and more conservative investments.
If the NASDAQ continues to fall, this trend could be amplified.
The NYSE rise was enough to turn the models very positive, resulting in a repurchase
of FFIDX at 41.24, which is 1.6% lower than the price at which it was sold last week.
Last week's sale, then, was a success.
For the second time this month, the stock markets are in a sharp decline. The
NASDAQ recovered from the first decline to post new highs, but the broad market
NYSE hasn't reached a new high since last July. More than 60% of the stocks on
the NYSE lost ground last year.
Volatility has been rising since the New Year. For a time, the market was a bit
choppy, but that seems to have ended. A downtrend is clearly in place on the NYSE,
and today the NASDAQ joined in, on its highest volume ever.
The models provide no guidance as to where the decline might end. If you invest
short-term, the advice is to step aside and wait for the next buying opportunity.
The NYSE today fell slightly on very high volume, while the NASDAQ rose 1.1% to
yet another record high. The NYSE has approached, but not yet surpassed, its
all-time high of just over 660, set last July. In the months since then, daily
volume on the exchange has increased steadily, from a typical 700 million shares
per day last summer to a typical 1 billion shares per day this month. In a normal
bull market, increasing volume fuels rising prices. This week, however, volume
has risen while the NYSE index has meandered downward.
A market churning on high volume, poised near its all-time high, reminds me of some
of the days in August 1987, when it seemed everyone knew the market could only go
up, so everyone was piling money into the market. But bonds were declining, starting
to look like a good value to more conservative professionals. So, no matter how much
money was pumped into the market, it seemed unable to move higher, it became sluggish
on some days, volatile on others. This is what the NYSE reminds me of today.
Then there's the NASDAQ. By now everyone knows the NASDAQ gained 80% last year, so
what better place could there be than the NASDAQ for your year-end bonus, profit-sharing,
401k, or pension distribution? That's what's fueling these daily 1% NASDAQ gains, as
well as the NYSE's mushy zig-zags.
But what will happen when all the year-end money has been pumped into stocks? What
will happen to this market after mid-February? That, for me, is a scary question.
The conservative Model #3 doubled the gains of the
NYSE in 1999, despite being in cash 61% of the year. The model's maximum
drawdown was 3.2% (vs. 13.1% for the NYSE), and the model's risk-adjusted
return (based on comparative volatility) was 61.4% vs. 9.1% for the NYSE.
Returning to action that was common in the last months of 1999, the NYSE and
NASDAQ moved in opposite directions: while the NYSE was losing 0.90%, the
NASDAQ was enjoying a 1.64% rally. In total, the two markets diverged by
2.54% in a single day. New money from retirement and bonus distributions is
flooding into the market, and apparently going straight into the NASDAQ.
Meanwhile bonds plummetted, with the 30-year Treasury bond rate topping 6.7%.
The 30-year rate has now risen 0.7% in the past two months, and about 2% since
October 1998 (at the peak of the world financial crisis).
Alan Greenspan warned last week that today's market could be another of the
"euphoric speculative bubbles" that have dotted human history. The Wall
Street Journal today devoted most of the "Money & Investing" section to a
series of articles titled "Market on a High Wire" and subtitled "The bull
market in stocks has defied skeptics, but we are now where no bull has gone
before."
16 March 2000: Models Agree: WOW!
14 March 2000: Models Agree: Watch Out!
8 March 2000: Possible Reversal?
7 March 2000: Crash Risk Heightens
6 March 2000: Profit-Taking
28 February 2000: Rally To Continue?
25 February 2000: NYSE Bear Market Continues
9 February 2000: Stock Market Becomes Choppy, Bearish
31 January 2000: Stocks Rally, but Volume Declines
26 January 2000: Broad Market Stabilizes
24 January 2000: Volume Rises and Trend Strengthens
21 January 2000: Churning NYSE Sends a Warning
20 January 2000: Model #3 Performance in 1999
18 January 2000: Market Divergence Returns
14 January 2000: Volatility Rise Raises Doubt
Volatility has risen sharply in the new year. The meaning? Rapidly increasing uncertainty in the marketplace. The NASDAQ had another huge gain today (2.7%), but it is still below where it ended 1999. Bonds rose early today, then had another sharp drop. It is a time for caution. Note that the last time 10-day volatility was this high was during the 13% NYSE decline last fall. Sudden high volatility is often a precursor to a correction.
The choppiness indicator used in the models doesn't yet suggest that a full exit from stocks is warranted. Today confirmed yesterday's gains. Nonetheless, the sudden rise in volatility is something to be watched carefully.
Has somebody finally noticed that the markets have been out of kilter in
recent months, or was today just profit-taking? Has the November-January
Effect had its run for this year? Quite possibly. Now that Y2K worries are
past, investors suddenly noticed that the Fed will be raising rates this
year if the economy continues as it has been. I believe the economy will
actually heat up even more, as companies place the orders for new and
upgraded software and hardware that were postponed in late 1999 due to
Y2K fears. Interest rates are in a firm upward trend, and that can be
expected to continue.
The impact on the NASDAQ, before today, has been minimal. But, perhaps with
the new year, professionals are reassessing the relative values of high-tech
stocks (NASDAQ), the broad market (NYSE), and bonds. Today's conclusion appears
to be that it's time to run for safety, take the 80% profits you made on the
NASDAQ stocks last year, and sock it away somewhere safe, like in Treasury
bonds.
I went to cash today. My November-December run-up in FDEGX was quite nice,
and I'm content to wait and see where this bottoms out.
4 January 2000: Time to Reassess?