Crosscurrents October 6/04
October 6/04
by Alan M. Newman
Remember before the stock market top in 2000 when we commented about the number of surveys of investors, the vast majority of whom expected returns to continue in double-digits out as far as the eye could see? Sentiment is a strong driver and when everyone is convinced that prices will continue higher, that is typically a very convincing signal of a major top. Amy Feldman reports In Money Magazine that "A survey of nearly 700 [home] owners in Boston, Milwaukee, San Francisco and California's Orange County by Karl Case of Wellesley College and Robert Shiller of Yale finds that the average person in counting on double-digit growth each year for the next 10 years." Wow, that sounds almost exactly like what we heard for stocks in March 2000. Perhaps it's just a blip, but sales of existing homes fell 3% in July from a record pace in June. In many of the "hot" areas, such as Orange County and Las Vegas, all of a sudden the supply has grown while demand has dried up. Given $6.8 trillion in total mortgage debt, Feldman points out that "....banks now own 45% of our homes, the highest level on record." And then of course, there's Fed Chairman Alan Greenspan's bafflement some months back that more Americans had not taken advantage of lower rates for adjustable rate mortgages (ARMs). Well, maybe they did. ARMs accounted for 19% of mortgages in 2003. They will account for 32% of mortgages financed this year. Just in time for the rise in interest rates!
Merrill Lynch strategist Richard Bernstein recently
warned that "Consumer staples' negative earnings revisions may be the
ripple preceding a tsunami of downward revisions among more cyclical stocks."
Bear in mind that disappointing earnings news has already surfaced from
giants like Colgate-Palmolive Co., Coca-Cola Co., General Mills Inc.,
Cadbury Schweppes Plc, and Unilever Group. Throw in Merck's withdrawal
of Vioxx and a significant impact on earnings. Toss in higher oil
prices and higher costs in raw materials. The end result?
Earnings may be MUCH lower than expected. Reuters reported that
amongst the S&P 500, forecasts have swung towards the downside for
five consecutive weeks. As well, the ratio of upward revisions to
downward revisions for September will probably be the lowest since March
2003. Very recently, there were 26 positive forecasts versus 46
negative forecasts, a ratio of 0.57. The September ratio will be
closer to 0.55. The few winners will likely turn out to be "basic
materials" and "energy related" companies, which certainly shouldn't be
a source of confidence for the overall economic picture. If a tsunami
is indeed, on the way, it may easily wash away any hopes for higher stock
prices in its wake.
Today's featured chart measures the absolute levels
of cash reserves for mutual funds versus the Dow Industrials. Note
that cash reserves soared to as high as $256.7 billion in October 2000
and the cash-to-assets ratio ballooned to 6%, yet there was not sufficient
firepower to stem the tide of selling that eventually took Nasdaq down
78% and cut the S&P 500 in half. Cash levels are now $163.5
billion, up nicely from the lows of February 2003, when they were only
$109.1 billion. The infusion of cash undoubtedly was a principal
factor in the bull advance into early 2004. But since then, $129
billion in net inflows have bought no gains at all - only a sideways to
lower march for much of the year. If $256 billion in reserves could
not drive stocks higher in the fall of 2000, can the $129 billion in inflows
and $163 billion in cash reserves drive stocks higher now, especially
in the light of the extremely low 4.3% cash-to-assets ratio?
Take a peek at the three largest equity mutual funds of all, Vanguard
500 Index, Washington Mutual and Fidelity Magellan as of the end of July;
Vanguard 0.3% cash, Magellan 0.8%, Washington Mut. 2.8%. Yes, of
course, the Vanguard is stocks only, but that's precisely the point!
No cash reserves equates to all risk. At least those funds with
cash reserves have a cushion when prices fall and can take advantage of
lower prices. As the last four years have amply proved, prices do
not always go up! But even counting the considerable clout of Washington
Mutual and Magellan, the cash-to-assets ratio for the $228 billion under
management of these three funds is an infinitesimal Why is there so much
confidence? Blame Wall Street strategists and the buy-and-hold thesis.
While it is true that allocations to stocks have decreased and the portion
set aside to "cash" has risen on average over the last few months, we
do not see the type of behavior that would mark a sufficient draw down
in strategist sentiment to be even remotely bullish. This week's
reported stance in the Wall Street Journal places 13 top "name" strategists
at an average allocation of 62.7% for stocks and 9.9% for cash.
However, we hasten to remind that back in May of 2000, the same panel
suggested allocations of 63.6% for stocks and 11.1% for cash, roughly
equivalent to today. By the way, the S&P 500 traded at 1420
when the May 2000 recommendations were made. Just a tad away from
the 776 closing low achieved a couple of years (plus change) later.
Although a sizeable bottom did occur in late 2002 and early 2003, it clearly
had nothing to do with strategists, who remained in bull mode for the
entire trip down. Let's face it. Wall Street needs investors
to buy stocks and can only do so if the picture they paint has bright
colors and attracts investors. That's why the buy-and-hold theme
is so prevalent. If you haven't yet read our commentary piece at
www.cross-currents.net/commentary.htm, please do so before October 22nd,
when a new commentary will be posted. And to fortify the presentation
of our case presented on the web, consider that as of 1997, there were
only 74 companies in the 500 stock index that had been in the index 40
years earlier. In other words, 85% of the listed issues had been
dropped, stocks every index fund holder would have owned. Incredibly,
of the 74 survivors, only 12 outperformed the index over the 1957-1998
time period. It is primarily "survivor bias" that provides the supposed
proof for the buy-and-hold thesis, an idea that does not work except for
those who are fortunate enough to buy at the right time and who eventually
sell when the going is good. Buy-and-hold?!
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published 22 times per year and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
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