Going Out At The Top
If you had asked any market pundit last March how they would have liked the markets to finish the year I doubt you would have gotten our current results from anybody. Any professional who suggested on March 12th (7416) that we would see a +40% gain in the Dow by year end would have been laughed off the planet. Well at Friday's close we are up +38.59% from that March low. Add in a +55% jump in the Nasdaq and you have a spectacular year in normal market terms. Nothing like finishing the year on a high note and going out at the top. Wait, you mean the year is not over yet?
Dow Chart - Daily
Nasdaq Chart - Daily
While the year is not over according to the calendar it is over as far as traders are concerned. The option expiration climax last week was the crowning touch. On Friday the Dow came VERY close to 10300 (10293) and very close to not only the very optimistic upper end of my range but well over most estimates for the year.
Remember our Guess the Dow contest last January? The average entry for the high of the year was 9878. Pretty close on the surface but the range of estimates was from 6970 to 13000. 40% of the readers had estimates for the year's high over 10,000 and only 13% had estimates under 9000. Over 45% of our readers expected a close under 9000 on 12/31/03. Only 14% expected a year-end close over 10,000.
Any way you cut it the end of 2003 has definitely surprised the majority of investors. Nobody is complaining but the next question is where are we going in 2004? The short story from the bullish analysts you see on TV is a gain of +10% to +12% for the year. With the Dow at 10275 today that would give us a range from 11,300 to 11,700 for the end of 2004. I don't know about you but that +1000 to +1400 point gain would be very boring after the gains in 2003. Assuming the Dow went straight up it would only need to gain 5.5 points per day to hit the 11,700 level by year end. Obviously this is not going to happen. To put this in perspective the average gain since March 12th 2003 has been 12.3 points per day and the markets have been very bullish. For 2004 bullish analysts are looking for a +4.5% GDP and about a +12% earnings growth for Q1 and Q2. Those earnings estimates are trending down slightly. They are also well below the Q4-2003 estimates of +21.7%. Get the picture?
The bearish commentators range from a 7500 Dow close for 2004 and 9000. I do not believe anybody has a crystal ball that allows them to see in the future so it is up to us to decide what we believe.
I think the key above is the 4.5% GDP and 12% quarterly earnings. Compared to this year those earnings are positively sparse. The last two quarters we have been growing at +16% (Q3) to +21% (Q4) for the quarter. How? Because the comparisons to 2002 were so bad. Any improvement over 2002 where losses instead of earnings were common produced a strong percentage gain. With the strong bounce in 2003 Q3/Q4 it is going to be very hard to produce any strong gains in 2004 Q3/Q4. It will be easier in the other quarters but the bar is still a lot higher.
The main things investors are going to be focused on in 2004 is the economy and the Fed. According to all the recent reports the economy is alive and well and actually picking up speed. We just do not know if this is seasonal 4Q speed or a real pickup in the economy. Neither does the Fed. Based on their latest statement they are far from convinced the economy is exploding. The comments about no sustained pickup in employment until late 2005 is very telling. The considerable period statement has moved the potential for a rate hike to June according to the Fed Funds Futures. The Fed has effectively stepped aside and turned us loose to make it on our own. Just like a dad running beside a kids bicycle the first time without the training wheels they have turned us loose. It is up to business now to maintain balance and speed. The administration has provided us one last burst of momentum with the $165 billion tax stimulus in the Q1-2004. The equivalent of the dad pushing us off over the top of a hill to help with our momentum. It is entirely up to us to add enough to that momentum to climb the next hill.
Tthe range of movement from last year is probably a larger range than we could expect for 2004 but at least a starting place. 2002 closed at 8341. We are up +23% from that close and at the lows were down -11%. Considering it was the end of a bear market that -11% drop was not bad. If we were to see a corresponding -11% drop in 2004 that would target 9144 as a low using Friday's close as a starting point. A 23% intra year bounce would take us to 12,638. I think even the most ardent bulls do not expect another +23% after our +38% rebound from the lows already. (+23% for the year). I also think all but the most leading edge prognosticators also expect that we could see more than -11% downside on a temporary basis.
Normal bull markets have normal corrections of -5% or more on a routine basis. We have not had a -5% correction in more than ten months. We are long over due for any serious profit taking. Using the estimates above and assuming that most analysts hedge on the upside and downside to avoid looking stupid later we can speculate on the ranges. The -11% drop in 2003 was the last gasp of a three-year bear market where we were already way oversold. This suggests that a profit taking correction at the end of a long bull run could be as much as 12%-15% of the index. The normal retracement level for a strong bullish run is -38.2% of the run. Using Friday's close a -12% dip would take us back to 9042. Using the -38.2% retracement bracket of the gains since the March low takes us to 9194. It should be stressed that any dip of that magnitude is still just a correction and not a failure of the new bull market. We are just speculating in order to avoid being surprised.
If analysts are hedging their bets on the upside then +12% may be light. Using a +15% gain from Friday's close puts us at 11,800. This may be very optimistic. Making statistical projections is one thing but when you compare them to the charts a different reality appears. That reality based on the charts shows 11000 to be very strong resistance. It held for over a year in 2000 with only three short spikes to about 11300 during that period. To move up from here the Dow has to break the resistance at 10300 and then even stronger resistance at 10650. Breaking through that 10650 barrier could be very hard and we should not expect a serious attempt until late March or early April at best. If it happens sooner then we are living a charmed life.
Dow Prediction Chart - Weekly
Merging the analysts estimates and the historical charts we end up with some glaring targets. It appears the downside risk should be contained in the Dow 9000-9200 range. The upside may be capped in the 11000-11300 range. Using the outside ranges that is a 2300 point spread. That is nearly double the average analyst estimate of the gain (+1200) for the year. Having the range at twice the gain makes perfect sense to me. Unfortunately the markets rarely make perfect sense and if it makes sense there is something wrong. The anchor on the upside is the election. Investors are cautious in second term election years because they are afraid of changes after the election. This historical trend for this predicts a flat to slightly up market for 2004. The offset for this trend is the strong economic reports of late and the Fed blessing for 2004. If the 1Q earnings in April are strong (over the +12% estimate) then the election curse could be broken. If they are only "ok" then the curse will probably prevail. Investors are aggressive when there are potential rewards. They tend to be conservative when the rewards are muted.
Many class the 2003 bull market as a flight to garbage rally. The stocks with the largest gains were the low priced, highly leveraged issues. Many of those were up +200% to +400% for the year. The blue chips did not join the rally until just recently, some as late as October. This cyclical rally added the extra boost we needed to break over the small cap resistance seen at 500 on the Russell-2000.
The last three weeks the small and midcaps have been lagging the blue chips as funds rotate into the more liquid blue chips for year end statements and January exits. Still the Russell has not died. It is only slightly off its highs and still very healthy. The value stocks are strong, cyclicals are strong and market breadth refuses to fade. We are only five real trading days from year end and four of those days are normally bullish.
The Dow only tacked on +30 points on Friday but was up +236 for the week. Compared to the weak performance for the Nasdaq at +2 and -1 for the Russell it was an amazing showing. The close at 10275 is right on the edge of my 10000-10300 range I was expecting for the rest of the year. With four of the remaining days (24th, 26th, 29th and 30th) bullish 65% of the time we "should" remain close to these highs. Dec-31st has seen the Nasdaq up 29 of the last 31 years but the Dow down 5 of the last 6 years.
The wild cards here are Monday and Tuesday. The last two days were up strongly on option expiration events with a help from some strongly bullish economic reports. Monday has no economic reports. Typically expirations with an upward bias tend to produce weak Mondays. Tuesday has a raft of economic reports including Chain Store Sales, GDP, Personal Income, Consumer Sentiment and Monthly Mass Layoffs. This suggests we could see some weakness on Monday that is bought on Tuesday in advance of the four bullish days to come. The key will be the depth of any weakness. I doubt we will drop far and would be surprised if we broke 10100.
A word of caution however. There were multiple terror threat warnings on Friday. Warnings against the northeast, including NYC and Boston. Warnings against the Vatican where intelligence suggests there will be an attack on Christmas. More warnings in Turkey and Saudi Arabia. The US is offering free flights out of Saudi for American government employees and recommending all Americans leave the country. Late this afternoon the number two man in Al-Queda released a tape claiming a major attack was coming on the American homeland. Analysts suggested this was more of a propaganda move than reality but you never know. What we do know is there is an attack in our future and the longer we go without one the closer it gets. I mention this because it could drag on the holiday markets. I do not expect it to push them down but it could keep them from moving up strongly.
We are setting up for a classic January move. The markets are poised to see some profit taking on Monday and then move up into the end of the year. Year-end retirement cash will begin to flow and hit the markets on the 4th-5th. This should setup a new market high the first week of January. The only reason it would fail to occur would simply be the acceleration of profit taking ahead of the normal average start on the 5th trading day of the year. Institutions count on this cash inflow to offset their profit taking and ease the impact of their exits. We have planned the trades in the Top-50 Stocks CD to take advantage of this dip as a buying opportunity.
I heard 2004 referred to by one analyst as the "Year of Living Dangerously". Most feel a lot of good news is already priced into the market and they are looking at January as a barometer of the rest of the year. According to statistics the first six weeks of the year normally sees the markets gain +3%. A remarkable achievement considering the average drop from the January opening high is -750 points over the last six years. Still +3% is +308 points over the next six weeks and that puts us right at 10600 with 10650 as strong resistance as we near the end of the Q4 earnings cycle.
I have vastly overstayed my welcome today and I am sure the numbers have all run together by now. I am not trying to scare anyone or produce a bearish outlook because that is not my desire. I am only trying to lead you through the possible outcomes for 2004 and more importantly the first six weeks because that is where the next money will be made or lost. Once into February we will begin speculating on March-April. You can't go on a road trip without a map. It is also foolish to worry about what turn you make onto aunt Martha's street when you are still 2000 miles away. Let's keep our eyes on the road immediately ahead and focus more on avoiding the potholes and finding the next scenic turnout than worrying about the +15% gain for the year.
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