The market has become very choppy. In such a market the short-term models become ineffective, so I often wait on the sidelines. The price/volume pattern of the past few days is signalling an imminent downturn. Friday the market fell on high volume, Monday it retraced on much lower volume, today it fell on higher volume. This suggests that sellers are using any rallies as selling opportunities with the market at its current level.
The calm was starting to feel a bit eerie. But not for long! The market
ended the week with a very strong move to the downside on very high
volume compared with recent levels. For the tenth time in the past
year, buying stalled with the NYSE Index near 660. The 575 range has
been visited twice in the past year. Will it happen again?
The Wall Street Journal reported recently that the low volume
environment since the NASDAQ 35% decline appears related to there
being many stock owners who are looking for opportunities to sell.
So, each time the market rises a bit, they come into the market and
sell at the somewhat higher prices. Yesterday volume was high, but
the market barely rose, suggesting churning, where there are lots of
buyers but also lots of sellers. Today the sellers owned the day.
It seems quite unlikely that the Federal Reserve will raise interest
rates this month. After 6 rate increases, evidence that the economy is
ceasing its rampant growth is surfacing increasingly. Also, many of
the early increases by the Fed were merely catching up with rate
increases that had already occurred in the bond market. A further
increase by the Fed at this time would begin to put Fed rates out
of sync with the bond market. It is highly unlikely Alan Greenspan
will allow this to occur.
So, what would a 10% drop in the stock market do now? Further sap
speculation. Further damage the hopes of new companies (including
very deserving ones) to find the financing they need to move forward.
Begin to hurt the economy, perhaps: people will begin to reduce
expenses more, feeling that the "good times" are past. Which will
help us glide toward recession...
It is not a fun time to be investing.
Volatility is returning to near normal levels, while volume declines to
levels well below the recent norm. This suggests that for the moment
there is neither strong selling pressure nor strong buying interest. The
broad market NYSE continues to peak near 660, then decline. In the absence
of unexpected news, the market can be expected to plod along until
the Federal Reserve's next meeting at the end of the month.
A look at the recent NYSE price/volume pattern isn't encouraging. The
recent rise was on lower volume than the previous rise, suggesting there's
less and less interest in buying into the market at these price levels. That
made this drop that ended the week not very surprising.
Next week is a critical one for the NASDAQ and tech stocks in general. It
won't take a very big drop to put it below it's recent lows, and that
could cause yet another mini-panic as more people rush to the exits.
The NASDAQ's decline was due in part to over-valuation resulting
from too many people having decided that tech stocks only go in
one direction. There is no reason to believe the present decline
will damage the economy. At its current level, the NASDAQ is well
above where it was last year.
The NYSE remained above its recent lows as money poured out of the
NASDAQ and into stocks of older more established companies. Though
the NASDAQ's loss was substantial, almost double the 20% loss that
is defined as a "bear market", the NYSE's drop was under 10%, not
even a "correction" according to the standard definition.
Long-term bonds continued their recent positive trend, but there was
no sign of a massive rush to safety, as would be expected during and
after an actual stock market "crash". The dollar, too, maintained
its recent strength.
The conclusion? What happened appears to have been primarily a
correction of the huge divergence between the NASDAQ and NYSE that
had occurred from the end of last summer through February. The NYSE
was giving bear market signals while the NASDAQ soared. The start
of year bonus, pension, profit sharing, etc., funds were pumped
mostly into the NASDAQ in January and February, propelling the
NASDAQ above 5000. After that, investors with a long-term value
oriented perspective began taking NASDAQ profits and purchasing
undervalued NYSE stocks.
If it stops here, the economy should continue to chug along, with
inflation being the major near- and long-term concern.
I can't tell you what will happen tomorrow (Monday). However, I can
offer some strategies that could make the day a non-event for you
personally, even if the decline accelerates.
First, if you are a long-term investor, you are facing a difficult
decision right now. The NASDAQ is down 35%. It could drop another 35%
from here. What do you do?
As a long-term investor, tax considerations are paramount. If you want
to sell, sell anything where you have only a very small gain or a loss.
If you sell a stock where you have a big profit, look what happens.
Assume you bought SUNW at a split-adjusted $15. If you sell tomorrow at
$65 after a big downturn, you have a $50 taxable profit. You will pay
20% tax on these gains if you bought the stock more than one year ago;
you'll pay your marginal tax rate (28% or more?) if you bought the stock
less than a year ago. If you bought more than a year ago, to break even
on your sale you will have to buy back in to SUNW at $55 or lower. So,
you wouldn't want to sell SUNW at $65 tomorrow unless you felt pretty
confident you could buy back in at $55 or less. But how sure can you
be that you'll be able to buy in at $55?
That's what makes selling tomorrow a high-risk tactic for a long-term
investor. It's so easy for you to wipe out a portion of your long-term
assets. If you guess wrong, you may take a big tax charge and also have
to buy back in at a higher price than where you sold. So, if you feel
you must sell, sell anything where your profits to date are small or
negative.
However, depending on your situation, there may be ways to avoid whatever
happens tomorrow even without selling stock, without exposing yourself
to a hefty tax charge. You can effectively isolate yourself from whatever
happens tomorrow if you have excess cash in your broker account or if you
have a margin account. What you would need to do is sell a market index
substitute short in an amount that matches your stock ownership. In other
words, if you own $40,000 of stock, sell short $40,000 of market indices,
either SPY (S&P 500) or QQQ (NASDAQ 100) or some combination of these.
Note that these can be sold short even on a downtick, unlike company
stocks.
If you don't have a margin account, but you can purchase options, you
could purchase index put options (for example OEX) in an amount that
accurately represents your stock portfolio. If the market falls
substantially, your gains from the puts would offset your stock losses.
The NASDAQ is falling with increasing momentum on rising volume. This is a
crash-like pattern. Will investors jump in a second time at the 3700 level?
Suddenly it seems that earnings warnings are being issued by the major brokers.
Does this mean that the big brokers, seeing what's unfolding, want to be able
to say "We told you so?".
Whether or not this is the case, it appears clear that increasingly the
professional investors (pension funds, etc.) are shunning the NASDAQ in favor
of the old market stocks in the NYSE and bonds. A big drop by the NASDAQ
tomorrow morning could easily result in panic. In that case, all the internet
brokers' web sites will be flooded and very few people will get through,
resulting in even more panic.
But maybe, just maybe, someone will try to "rescue" the market tomorrow. It
can't be individual investors, though, because they are already fully invested
and heavily margined...
A correction is underway, surely. The models are all very positive,
since the NYSE is having a huge rally. Today's divergence of over
9% between the NYSE (+1.9%) and the NASDAQ (-7.6%) is a continuation
of a convergence that is correcting the NASDAQ's huge gains in the
past year as the broad market meandered.
Still, a big bear market in the NASDAQ would have serious implications
for the economy and the broad market as well. The paper wealth of many
investors will plummet, as stock options in new companies become
worthless. This will change buying habits. It will also give new meaning
to the debt overhang that has grown so large in recent years.
Though the models are quite positive, I went to the sidelines at the
end of the day, deciding to wait and see how this plays out over the
next few days.
16 June 2000: Ready for Another 10% Dip?
11 June 2000: Market Calms, Volume Declines
19 May 2000: Weak rally bodes ill for near future
23 April 2000: What happened?
16 April 2000: Advice for Monday
12 April 2000: Soaring NASDAQ Volume Warns of Possible Crash
3 April 2000: Can the NYSE Rally as the NASDAQ Crashes?