Could the
stock market crash?
Everyone says "No"
Martin Goldberg,
MS, P.E.
Financial
Sense
written Dec 4,
2003
posted Dec 7, 2003
Congratulations
to the traders who rode this market rally up from what Larry
Kudlow refers to as "the mother of all bottoms." The
rally appears to be in full bloom and stockowners are happy.
Anyone suggesting that a crash is possible would be dismissed
as a nut case. Yet that's exactly what I am going to suggest
in this article. So you may want to dismiss me now and move to
the technical analysis section below.
Once again,
nobody cares that stock investing consists of owning shares in
businesses. No one cares that any purchase of a business should
be viewed as an investment, and should provide earnings, growth
prospects, and dividends to justify the purchase. Today's market
is speculative and prices are being determined purely by happy
feelings and emotions. There is a gigantic discrepancy between
intrinsic values of most companies' stocks and their stock market
prices. In many companies, wealth continues to be transferred
from its shareholders to its management via stock options and
share buybacks of stock market-overpriced businesses. Shareholders
don't have a clue or even care. At the margin where prices are
being determined, shareholders are not shareholders at all.
Consider two
of the top performing stocks of this year, Cisco and Amazon.com.
An average share of Cisco changes ownership every 5 months or
so, and the average share of Amazon.com changes hands every month!
Imagine any company that is under new ownership every month!
Under these "hot-potato" share-trading schemes promoted
by Wall Street and practiced by many well-respected money managers, would the shareholders care
about the long-term prospects of the company? Of course not.
Most are only trying to roll triple hearts at the slot machine.
I believed
that throughout this rally, the stock market has had the potential
to crash. It hasn't yet, but when the market does crash, it may
crash in a devastating manner. You should consider the question
of, "If the market goes down, HOW would it go down?"
The questions that are explored in the mainstream financial media,
TV, and Internet, deal with IF and WHEN the stock market can
go down. They rarely explore the question of, HOW it may go down?
How far, how fast, how devastating? The dumbed-down public does
not consider this question because in their collective minds,
we have already seen the answers to these questions in the stock
market from March of 2000 to October of 2002. The answers in
their minds are VERY far, PRETTY fast, and by in large, NOT TOO
devastating. By in large, they think we are now in a new bull
market.
But the facts
are that the market is valued similarly to October 1929, Wall
Street chicanery is at peak levels, consumer debt is at record
levels, corporate debt is at relatively high levels, the dollar
is plunging, and the trade deficit is rising along with the Federal
budget deficit. The Federal budget deficit doesn't scare any
one any more. Why? The public remembers how it was extinguished
in the late '90s. They are thinking, "No problem. If it
was paid off before, we can do it again." What very few
people think about is the fact that the elimination of the deficit
was largely a result of capital gains taxes that the government
enjoyed from the late 90s stock market bubble. They don't see
this as an, (aha' hem), "one-time event." The
current Federal budget deficit can only be extinguished again
if we can manage to create a bigger stock market bubble than
before. My money says it can't. In the absence of another stock
market bubble we will have to pay the money back. This will have
to be achieved through the sweat equity of our children and us
or from inflation, which will dilute (reduce) our wealth.
Every casual
stock market participant is now bullish. Everyone KNOWS that
the stock market is going up. Greenspan will continue to keep
any crash from happening. Corporate management will continue
with the positive press releases that "beat-by-a-penny,"
and are "better-than-expected." Mark Haynes, and Joe
Kernan will continue to joke, and Sue Herrera will continue to
smile. Stimulus-induced government economic data will continue
to be positive (yet unsustainable). William O'Neil will continue
to tout the speculative favorites in spite of irrational valuations,
and Investors Business Daily (IBD) followers will continue to
bid these stocks up. Merrill Lynch and others will continue to
issue analyst upgrades, and the public will continue to listen
to them and gap up these stocks. In short, the game will continue!
(Nasty but truthful e-mails from Wall Street analysts about suspect
companies will not continue though!).
Overvaluation,
chicanery, and everybody thinking alike suggest to me that all
the ingredients for a stock market crash are in place. The only
thing missing is the catalyst, and there are a variety of potential
ones on the horizon. The risk (of a crash) greatly outweighs
the marginal gains that can be made at this point.
What most people
are thinking is typified in the Charles Schwab commercials:
"The market
has changed and this time we're going to change
with it."
I think Schwab's
use of "change" is code language for knowing
that the rally will end and Schwab investors should know when
to bale out when they see market weakness. There is a serious
risk that this will not be possible, though. Almost everyone is thinking the same thing at the same time. When the
time to exit arrives, the hatch may be too small to let the public
out in time. There is every reason to believe that a crash may
ensue.
There are additional
reasons for a crash such as an overactive public. Momentum investing
has never been more popular with the public than it is now. Chat
boards are once again ablaze with the number of postings from
the "lunatic fringe." Momentum-based IBD has raised
the price of its Monday issue (with the "IBD 100")
to $2.00. There is a 2-hour radio call in show here in Philadelphia
on a station catering to the elderly that consists of mostly
momentum-based stock trading. The radio program also promotes
a $15/month web site, where "investors" can get stock
tips that "make money" from a local stock personality
(with a New York accent). I've noted similar radio programs elsewhere.
Now there is a TV commercial where an actor appearing as a typical
citizen complains, "All the ideas I give to my broker, he
should be paying me!" The Yahoo! Finance home page is loaded
with momentum-based technical analysis articles. New mutual funds
are once again starting up. Once again CNBC plays at the local
bistros. The game has become easy again.
More reasons
a crash can occur: Visions of 1929 and 2000. Margin debt is again
on the rise as it was in 1929 and 2000. It rose to $26 billion
in July. This debt, which is secured by the stock shares purchased
on margin, represents additional potential energy in fueling
a crash. Just curious. I wonder how many shares of insider's
stock were sold to buyers who were using margin? There's a lot
of insider selling and negligible insider buying. (Of course,
all of these insiders are simultaneously trying to diversify
their personal portfolio holdings. What a coincidence!).
The NASDAQ
is like a shark. If it stops swimming, it will suffocate. Without
any resemblance to fair deal valuation, the primary reason people
are buying and are long the NASDAQ is simply because its going
up (swimming). Once the NASDAQ stops going up, there will be
no reason to buy and/or hold these stocks. The shark will suffocate.
(So far the shark has devoured many value-minded stubborn short
sellers. It's been like the first hour of Jaws, so mind your
stop losses).
Finally, additional
fuel for a rapid stock market crash may be provided by the potential
public outrage from scandals involving mutual fund crime. So
far no one cares about such trivia because after all, everyone
is getting rich "on paper" in the stock market. When
the market changes, everyone will be outraged. Remember Enron?
All this smells
like fish to me. The public and its short memory are being set
up again!
In summary,
the stock market is set up in a similar manner as in 1929; however
unlike 1929, most people have 2000 fresh in their minds. A lot
of people all thinking the same thing at the same time. It's
a formula for a devastating crash. Remember what legendary trader
Jessie Livermore said in the 1930s:
"The
biggest stock market gains are made by the public on paper and
that's where they stay."
If you take
issue with this article, send me an e-mail. I'm very interested in
the logic behind being long this market. (But please, spare me
the "Wall of Worry" cliché. I'm just not in
the mood).
NASDAQ Fan
Pattern Update
With the identification
of the fan pattern last Monday, I suggested shorting the NASDAQ
on weak rallies with a stop loss at 2,010. Technical Analysis
of Stock Trends indicates,
"The rule
is that when the third Fan line is broken downside, the high
of the Intermediate Correction has been seen."
On Wednesday
at about lunchtime EST, the NASDAQ broke through its previous
high of 1,992, and barely made it to 2,000 before reversing and
closing down 19 points on the second highest trading volume in
the last six months. So by reaching 2,000 it would seem that
the Fan Pattern was violated. Yet as I write this, the NASDAQ
is right around the L-3 trendline. So was the L-3 trendline violated?
Was the fan pattern broken? I think the answer is that it was
not. I will reference Dr. Alexander Elder in Trading for a Living,
Page 88, "How to Draw a Trendline."
"Most
chartists draw a trendline through extreme high and low points,
but it is better to draw it through the edges of congestion areas.
Those edges show where the majority of traders have reversed
direction. Technical Analysis is poll-taking - and poll-takers
want to track opinions of masses, not of a few extremists. Drawing
trendlines through the edges of congestion areas is somewhat
subjective."
That is why
I subjectively suggested setting the stop loss at 2,010 and not
a few ticks above 1,992. I figured that there would be a lot
of "ballyhoo" as NASDAQ 2,000 approached, including
some short stop losses kicking in, and momentum players buying
at what seemed to be a breakout to new highs. So with the afternoon
reversal on very high volume, I think that the apparent break
of the L-3 trendline was merely measuring the opinions of "a
few extremists." If NASDAQ 2,010 is broken, decisively,
I'll throw in the towel. Until that time, the "Fan Pattern"
remains valid in my view.
For ready reference,
I have updated last Monday's "Fan Pattern" NASDAQ chart
below.
Today's
Market
All three indices
were up only marginally today. Considering that the most popular
brokerage (Merrill Lynch) upgraded the most popular stock (Cisco),
this was a moral victory for the NASDAQ bears. The NASDAQ rallied
toward the end of the day, probably on rumors that Intel would
"up" their sales and earnings guidance at their mid-quarter
update. They did not, and Intel is selling off in after hours
trade. The more speculative small caps and smaller NASDAQ stocks
under performed the broader market, indicating that some fast
money may be leaving. The 10-year note finished up 8/32 to yield
4.37%. Gold was down $0.60 per ounce. Let's see how the market
reacts to the positive economic data tomorrow.
Have a great
evening!
Martin F. Goldberg, MS, P.E.
Email: mdelmgoldberg@comcast.net
December 4, 2003
Market Analyst
Archives (Financial Sense)
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321gold Inc Miami USA
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