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Market Wrap

Irrational Exuberance

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        WE 12-03         WE 11-26         WE 11-19         WE 11-12
DOW     11286.18 +297.27 10988.91 - 14.98 11003.89 +234.57  + 64.84
Nasdaq   3520.63 + 72.82  3447.81 + 78.56  3369.25 +148.10  +119.95
S&P-100   767.48 + 13.91   753.57 +  4.27   749.30 + 18.21  + 12.29
S&P-500  1433.30 + 16.68  1416.62 -  5.38  1422.00 + 25.96  + 25.84
RUT       464.58 +  5.64   458.94 -  2.33   461.27 + 11.58  +  7.28
TRAN     2928.80 + 19.64  2909.16 - 67.34  2976.50 -113.07  + 85.58
VIX        20.82 -  2.13    22.95 +  3.32    19.63 -  2.05  -   .38
Put/Call     .49              .42              .47              .51

Irrational Exuberance

The market rallied strongly on the employment numbers on Friday and the Nasdaq and S&P-500 both closed at new record highs. The Dow came within only a few points of the previous closing high of 11326. After actually trading as high as 11341 intraday the Dow retreated to a still respectable 11286 at the close. Most of the movement for all the averages came before their 11:00 highs and then faded going into the close. The relief rally, yes I said relief, came after the Nov employment numbers were announced. Unemployment remained at 4.1% and average hourly wages clocked in with only a +$.02 increase. New jobs were created at a +234,000 pace. Not too hot, not too cold. The reason I used the term "relief rally" was simply because there was no bad news in the numbers and the worry about the report and possible Fed reaction is over. The numbers were not good, they just were not bad and the Fed is truly in hibernation until next year.

The Nasdaq volume was the fifth heaviest on record again at 1.54 bln and the NYSE was also strong at over 1 bln. With the close at 3520 we are now half way to the next thousand mark of 4000 after only breaking above 3000 twenty trading days ago. Don't worry markets go up forever, right?

While you are still unwrapping your early Christmas present from the Goldilocks Economy, you are probably already counting your expected profits from the continuation of this rally. Things could not be better. A true Nirvana exists in the markets. 20 million new jobs have been created since Clinton took office. This is now the longest economic expansion in history. Wages are stagnant. There are no current wars. The Fed has gone into hibernation until spring in fear of Y2K. A recent survey shows they may be the only ones still concerned about a possible Y2K economic event with only 3% of the public expecting any kind of disruptions. With no rate hikes in our near future and the consumer spending money like there was no tomorrow, what could possibly hurt us now? Third quarter earnings came in at a record +22.7%. Fourth quarter earnings are expected to be strong with no Y2K slow downs in sight.

Don't get me wrong. I am as optimistic as anyone that the market will continue to go up into the first quarter of next year. BUT, when everything is too good too be true it is usually a sign that trouble is about to blind side us from somewhere. The Nasdaq is on track to post the biggest year on record with a 61% YTD gain. The previous highs were in 1991 for 56.8% (the biotech boom) and 1995/98 both posting 39% gains. Fund managers are buying champagne by the truckload with many funds gaining over 50% for the year and some with over 100% gains. They go to sleep at night with visions of dollar signs dancing in their heads from the expected year end bonuses. Do you think they may be worried a little by the ARMS index showing the Nasdaq is the most overbought since 1982. Do you think they might be ready to take some cash off the table the instant any Y2K weakness develops? Do you think they want to risk millions of dollars in personal bonuses because they hung on a week too long just trying for another couple of percentage points? When is enough, enough? Could the rally on Friday simply have been shorts covering in light of no bad news?

I am not saying the market will tank on Monday although some profit taking may appear on Monday or Tuesday after such a tremendous recovery from the lows last Wednesday. What I am saying is that we should not be expecting another +500 points in the last four weeks of 1999. It is entirely possible that we are setting up for a failed rally on the Dow. This is not what we expect but the Dow needs to close above 11326 to confirm this upward move. Lets look at some interesting signals on the Nasdaq using candlestick charts.

As you can see from this chart we have received about eleven strong buy signals on the Nasdaq since June 1st. Each is represented by the Hammer indicator. Almost every bottom for the last six months has been represented by this indicator. The reverse of this very bullish indicator is the Star formation. If you look at the chart you will only see a couple star formations. To be a true star the body of the star must not overlap with the body of the day before. The shadows (tails, sticks) may overlap but not the bodies. The distance from the previous day and the length of the stick is important to the strength of the signal. As you can see, the strongest moves are when the shadows on the hammers were longest and protruded into uncharted territory. The closest star to our current position was Friday the 28th, the day before the Nasdaq started its three day decline last week. The Key - if Monday is a down day for the Nasdaq the formation will become an evening star and very bearish. (see the definitions below for a better description)

If you only look at the headlines, "Dow up +247 points! Nasdaq sets another record high", you will miss the warnings that technical analysis will give you. How important are these warnings? When you consider that there are over 20 important economic reports due out in just the next two weeks it could be crucial. We have the Productivity report and Unit Labor Costs on Tuesday, Import/Export Prices, and Wholesale Inventories on Thursday and the big one for the week, the PPI on Friday. The very next week we have the CPI, Real Earnings, Retail Sales and Atlanta Fed index on Tuesday, Business Inventories, Capacity Utilization and Industrial Production on Wednesday. In just the next eight days we have a serious minefield to cross. I would be real surprised if the markets just kept setting new highs during this period. However, as long as Ma and Pa investor continue to Christmas shop for stocks, any pull back will be brief.

The wild card here is the shorts. I suspect that much of the buying on Friday was based on short covering after the bad numbers did not appear. There are rumors of large hedge funds that are extremely over extended after establishing short positions on every unstoppable wave of record Nasdaq highs. If the market does not relax in the next couple days these funds will be forced to start covering or face margin calls. This forced buying would again fuel the Nasdaq for another round of gains. How long can they hold out? Who knows but every day the Nasdaq stocks gain ground they get closer to their pain threshold. The lack of a Y2K sell off has prompted cautious buyers to come off the sidelines and add their cash to the already incredible fund inflows. The funds received about $34 bln in cash in November although the numbers did slow somewhat last week. A normal month is about $20 bln.

My educational article this week is called "Exact Instructions" This is the fifth in the series. Look for it on the website.

Have a safe week in the market. Watch for buying opportunities, pick your entry points VERY CAREFULLY and sell too soon.

Jim Brown
Editor

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