Is A Big Market Sell-Off Coming?

Updated 2:55 PM ET August 7, 1999 By Pierre Belec

NEW YORK (Reuters) - The market is incredibly overpriced and Federal Reserve Chairman Alan Greenspan stands ready to knock the legs out from under the longest-running bull market. But Wall Street bulls say stocks are not in a crash mode.

"Stay bullish, if you can take the risk," the experts say.

The economy is still in great shape and with corporate profits expected to be up more than 20 percent in the second half of this year, the stock market should be able to extend its winning streak -- even if the Fed raises interest rates a notch or two, the bulls say.

And, they view the guesswork on when the "Big One" will finally send the market crashing in flames as just a crazy exercise that's failed to hit the bull's eye for nearly five years.

Only recessions and financial crisis have been known to cause tremendous stock market upheaval. So far, there is no evidence that either will slam stocks.

Greenspan, who has been trying to talk down the market since December 1996, when the Dow Jones industrial average was nearly half today's level, sees stocks as one of the greatest manias ever.

The Federal Reserve's own market valuation model says stocks are overvalued by an eye-popping 40 percent.

The model, which compares corporate earnings with the 10-year note yield, reached a record 48 percent in July, when the Dow and other indexes zoomed to new record ground. The model has come down from its peak due to the market's recent pullback and a jump in bond interest rates to almost two-year highs. Despite the bearish signals, the Dow index is still up an impressive 17 percent for the year while the Standard & Poor's 500 index has gained nearly 7 percent and the Nasdaq Composite index is up 17 percent.

Greg Smith, chief investment strategist for Prudential Securities, says the Street should not lose sleep over the Fed's market model. The trouble with the Fed's stock gauge is that it may be oversimplifying the market's valuation.

"I strongly suspect that, historically, the largest and probably the best companies in America have been awarded premium valuations when the economic climate has been very difficult," he said.

During the global financial crisis that rocked markets worldwide in 1998 as Asia slid into recession, investors ran to the relative safety of U.S. companies with the biggest capitalizations, the smartest managements, greatest market positions and predictable earnings. The goal was to ride out the tough economic times.

Asia, Latin America and Russia are now back on their feet. Analysts are predicting solid gains in almost all Asian markets next year as investors flow back into the region.

"'Very difficult' certainly would describe the climate in 1998," Smith said.

"But in the current stock market's climate, a mere 50 stocks represent well over half of the S&P 500's entire capitalization," Smith said. "So those 50 stocks' valuations have a very heavy influence on the valuation of the overall market."

Smith is telling his clients to stay bullish with an asset allocation of 75 percent stocks, 10 percent bonds; 5 percent real estate, and 10 percent cash.

"If the market makes it through August, we feel it will be poised for a rally and that it might be a pretty good one," he said.

What about the threat that the Fed may unleash a series of interest-rate increases after raising the fed funds rate by a quarter percentage point in June in a preemptive move against inflation?

Interest-rate increases, which the Fed uses to keep the economy from generating too much inflation, can be deadly for stocks, and they have been known to stop raging bull markets in their tracks.

But the experts say the stock market seems to be overly obsessed about inflation and the fears have been overblown.

Sure, commodity prices are rising again, but investors need to realize that commodity markets are just simply recovering from the deeply oversold conditions of two years ago, when nearly half of the world was on the verge of collapse.

"What we're fighting, in some ways, is the unsustainably low numbers that were experienced over the last couple of years as the world financial crisis pushed prices down below anything that would be healthy or sustainable," said Smith.

Meanwhile, the interest-rate watch continues. In June, the Fed telegraphed plans to raise the cost of borrowing, but investors are now less certain about the central bank's next move at the Aug. 24 meetings of its policy-setting group.

The uncertainty has sparked a rise in bond interest rates and boosted the costs of such things as mortgages and personal loans.

Home mortgage rates, which have risen to 8 percent, are expected to slow home sales and drive first-time buyers out of the market.

Critics say inflation is not a problem.

The Fed is worried that wage-led inflation could be a threat to the economy after the Employment Cost Index in the second quarter rose 1.1 percent -- the biggest leap since 1991 -- amid the tightest labor market in decades.

But the jury is still out on whether workers' wages are starting to explode. The second-quarter rise came on the heels of small increases in the earlier two quarters.

A closer look at the second quarter's labor cost numbers also shows that the biggest factor in lifting the index was a jump of 3 percent in the volatile sector of the ECI for finance, insurance and real estate after a drop of 0.73 percent in the first quarter.

Another reason to believe that inflation is not a problem is that with productivity gains of 2 percent per year, U.S. companies will be rich enough to cough up wage increases of 4 percent while keeping the price of their goods stable.

The bulls say the earnings story also looks good, at least, through the next half-year.

The Index of Leading Economic Indicators, which gives a window on the economy for the next six to 12 months, rose 0.3 percent in June after a 0.3 percent gain in May. The index has racked up an impressive string of eight gains in nine months, extending the economy's expansion that began in March 1991.

Some experts say it's almost a sure thing the Fed will move rates up later this month.

"The 25-basis-point rise in June was not expected to make much of a difference to slow the economy, and for that reason, people should expect further action by the Federal Reserve," said Allen Sinai, chief global economist and a Fed watcher at Primark Decision Economics Inc.

He said the Fed would need to raise rates between 50 basis points to as much as one full point in a 12-month period to have a significant impact on the economy's growth.

So, why don't investors see some risk in owning stocks?

Don Hays, chief investment officer for Wheat First Union in Richmond, Va., said Wall Street still needs to be convinced the Fed is not kidding about jacking up the cost of borrowing money so as to slow the economy's growth.

"Typically, it takes three rate increases to do the job, which has led to the old Wall Street rule, 'Three steps and a tumble,"' he said.

This would mean that stocks will get hit by three consecutive rate increases before heading sharply lower. Why does it take three interest-rate moves to jar the market?

"When the bull market momentum builds up, people become so positive, it's hard to kill their enthusiasm," he said. "Investors get the feeling that nothing can hurt them and the market is unstoppable."

An overly positive market mentality may now be the thing that is supporting the market.

"Investors view any market pullback as a buying opportunity, even after the Fed has raised rates," Hays said. "Now, they are waiting for the second Fed move, which will probably cause a little selling reaction before it comes back up again."

The third rate increase may send a loud wake-up call for Wall Street and there will be some "serious selling," he said.

For the week, the Dow Jones industrial average was up 58.88 at 10,714.03. The Standard & Poor's 500 index 28.43 at 1,300.29 and the Nasdaq Composite index was off 90.52 at 2,547.97. (Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com).

Analysts Predict Blue Chip Drop

Updated 10:44 AM ET August 7, 1999 By John Hanley

NEW YORK (Reuters) - Prices of shares in America's biggest corporations are poised to drop between 3 percent and 5 percent in coming weeks -- historically a very weak period for the stock market -- as a sell-off from the last two weeks gathers steam.

That, at least, is the prediction of technical analysts who forecast price activity based on past performance, and who have the luxury of ignoring fundamental factors like interest rates, corporate profits and the fickle mind-set of day traders.

"We're not out there screaming bear market," said Louise Yamada, a director of research and senior technical analyst at Salomon Smith Barney,

However, she said, "You have to consider it was up 42 percent since October. It is due for a good consolidation ... I think at some point we are going to move higher but I think you have to get through this unsettled period."

The bluest blue-chip index, the Dow Jones Industrial Average, could fall to previous lows near 10,400 touched in June, chartists said. That translates into a 7.8 percent correction from a record high of 11,252.27 hit July 19.

Ten percent is a so-called "normal" correction that may mark a bear market. However, analysts said that even if a 10 percent sell-off from its record highs did occur, bringing the Dow to roughly 10,000, that would be a bottom for the index.

In midday trading Monday, the Dow industrials rallied 123.16 points, or 1.2 percent, to trade at 10,778.31. The 30-stock index includes some of the nation's most well-respected companies, including General Electric Co., Coca-Cola Co., International Business Machines Corp., and Wal-Mart Stores Inc. .

The index is still up 16 percent so far this year -- and 32 percent higher than where it traded a year ago -- but it has fallen like a stone the past two weeks, losing 5.2 percent.

"We're in a pullback phase," said Jonathan Dodd, technical strategist at Morgan Stanley Dean Witter. "It has gotten a little less bullish because this last move up to new highs was not as strong and we've got some divergences. The breadth of the market has not made new highs and is below the May lows."

He said the New York Stock Exchange advance/decline line, or the number of advancing stocks versus declining ones, was showing signs of weakness.

Chartists also pointed to other factors for their cautious outlook.

The Dow industrials' last push to record highs in July was not accompanied by equivalent strength in the broader markets, meaning the rally was very narrow. The index has a seasonal tendency to hit a peak in July-August and then sell off into the fall. It is currently trading below its 30- and 50-day moving averages, a bearish momentum sign.

If Monday's rally continued, the Dow would find resistance near last week's highs at 11,031, analysts said. But by early afternoon it had not even hit Friday's high of 10,825.80.

"April to October is a particularly weak period for the market and within that you ride the seasonal waves," said Elaine Yager, senior technical analyst at Herzog, Heine, Geduld.

Indeed, the tendency for stocks to fall in late summer is convincing.

For the broader S&P 500 index, September is the worst month of the year and the index's performance from May to October pales in comparison to its gains from November through April, according to a leading historian on the stock market.

Yale Hirsch, editor and publisher of The Stock Trader's Almanac, a bible of facts and figures that is now in its 33rd edition, said that $10,000 invested in the S&P 500 in 1950 in the better-performing period would have generated a profit of $340,250.

For the other six months, the same $10,000 investment would have yielded meager earnings of $11,138 since 1950, he said.

Likewise, the Dow industrials gained a total of nearly 9,500 points in the November-April period since 1950, but it racked up a gain of only 1,120 in the other six-month period, Hirsch said.

"Everything seems to be geared toward the end and beginning of the calendar year," Hirsch said. He cite

-- Forum regular (economy, for wh@t.it's.worth), August 07, 1999

Answers

The biggest stock market crash in history is ripe to fall.

Don't be a fool. Get out while you can.

When the rest figure it out, then it will be TOO LATE!

I sincerely hope you readers are prepared.

-- Randolph (dinosaur@williams-net.com), August 07, 1999.

I agree Randolph, but have you considered shorting the market instead via BEARX and USPIX? Then get out before rollover...

-- Andy (2000EOD@prodigy.net), August 07, 1999.

From gold eagle...

ARCH CRAWFORD UPDATE--THE END IS NIGH, BROTHER, THE END IS NIGH Aug 07, 14:54

Arch called the Oct. 79 "massacree" and the 87 top. Contemplating the imminent appearance of a not seen in two thousand years "Grand Double Cross", he says that the next 60 days will make previous crash calls "look like a walk in the park". Arch uses such terms as deadly combination and apocalyptic to describe the coming period in the financial mkts. I saw this in the Investors Intelligence newsletter I received today. Ricard Russells letter was featured and Richard was quoting Arch.

-- Andy (2000EOD@prodigy.net), August 07, 1999.

"...Contemplating the imminent appearance of a not seen in two thousand years "Grand Double Cross"...."

...and now you will please explain to us all what the heck THAT is.

Thanks in advance.

-- still in the market (and@pretty.nervous), August 07, 1999.

Ok - I'm nervous too buddy...

From an Arch Crawford post on Silicon Investor: Major Instability by Arch Crawford Editor, Crawford Perspectives The world will get a strong dose of Millennial Madness during the coming eclipse series. Political, military and social unrest at maximum with economic and financial repercussions aplenty! There may be surprise attacks across national borders, possibly involving Israel, and assassination attempts on world leaders, possibly including the U.S. We do not say these things lightly. This sequence of T-squares and Grand Crosses among the "wandering stars' is unprecedented in our lifetimes, and maybe for Millennia! Do you think we are alarmist? Can we frighten you into taking some modicum of defensive measures, personally and financially? If you're waiting for greater proximity to Y2K before tightening up, don't! Whatever you might be coerced to do for your own safetydo it now! Remember that we have a long history of predicting dates of astronomic moments which have often coincided with monstrous world events! Not all of these predicted events affected our markets. Many did. Among the greatest planetary alignments we brought to readers' attention were: Top day before the "October Massacre" of 1979, biggest point decline in history (to that date) in 1986, exact date of the Challenger explosion, exact high day before 1987 crash, exact day of Kobe earthquake, Lunar Eclipse conjunct Pluto 2 days before Chernobyl explosion, Lunar Eclipse forming Grand Cross when Saddam Hussein attacked Kuwait, Saturn square Neptune date of "Hunt Debacle" Saturn square Pluto date of Chiapas Uprising, Saturn semi-square Neptune date of Peso devaluation, Saturn/Neptune conjunction opposed Jupiter 2-3 days before Berlin Wall came down, exact date of drowning of 900 in ferry accident, date of Diana's deathand many more! The next 60 days will make all these look like a walk in the park! Never, ever, have we observed combination after deadly combination culminating one after another in a truly apocalyptic sequence. To those among the spiritual or religious communities, some of whom are planning gatherings for the Solar Eclipse, I give this advice: "Start sooner and pray harder!" To those who believe in nothing, I give this advice: "If there's something you have really wanted to do and haven't done yetdo it now!" If there is someone you haven't told "I love you!" best to do that now, as well. Although the sequence has already begun building, it can be observed openly by July 18, and even the dull- witted will become aware by July 21 that something is amiss. The biggest events will most likely occur Monday, July 26 when the first T-square forms involving Sun/Mercury conjunction opposing Neptune, all square Jupiter! This is extremely inflationary and will disrupt currencies and financial markets. Possibility of chemical spills, deception, germ warfare and tragedies at sea. Then comes the Lunar eclipse on the 28th conjunct Neptune and square Jupiter = more of the same! The third T-square reaches maximum energy on Saturday, August 7th. This combination of Sun opposing Uranus, both squaring Mars symbolizes open, In Your Face Confrontation, Warfare, Explosive Tempers, Explosive Hardware! August 11, 1999! This is The Big One, the MOTHER of all Solar Eclipses about which the 16th century seer, Nostradamus wrote: "A King Of Terror will come from the skies" Ebertin's Combination of Stellar Influences says of Mars/Saturn = Uranus: "The ability to give as well as to take under provocation, the inclination to apply brute force, a test of nervous strength, the intervening by higher power, separation, death. Dell Horoscope magazine opines: "This eclipse might augur a paradigm shift of global proportions." Richard Giles, writing for Gordon Michael Scallion's Earth Changes Report writes: "What's at stake hereis the basic stability and strength of the free market system. Struggles for control of the world economy and issues of ownership of the world's resources are in balance. War over land and rights to resources are very likely. Neptune in Aquarius will foster a mystical and humanitarian revival of the world at a mass level, offering many people their first transcendental glimpse of the planetin late July expect people claiming to be a messiah to emerge. This energy also favors sudden reversals of fortune in the markets." The greatest after-shocks are triggered with the formation of a second Grand Cross on August 16-17, involving Jupiter, Neptune, Mercury and Moon. How many thousands of years since we have encountered a Double Grand Cross? The Pluto station on the 18th will aggravate underground movement and, likewise, the realignment of power structures, physical and social. Further powerful astronomic hits on August 24, 26 and 29 add to the general chaos of this intense period. Editor's Note: Arch Crawford is editor of Crawford Perspectives, 6890 E Sunrise Dr., Ste. #120-70, Tucson, AZ 85750, 1 year, 12 issues, $250. Published since 1977, Crawford provides quinessential market timing by planetary cycles and technical analysis. A 900 Hotline service is available at 10 a.m. and 2 p.m. EDT for $4.30 total per 2-3 minute call 1-900-776- 3449.

-- Dave (dannco@hotmail.com), August 07, 1999.

-- Andy (2000EOD@prodigy.net), August 07, 1999.

I predict this will be wrong.

Zev

-- Zev Barak (zev@msn.com), August 07, 1999.

Great astrology. Now I'm convinced

-- kozak (kozak@formerusaf.guv), August 08, 1999.

Damn. Above posting should reflect HEAVY sarcasm.

-- kozak (kozak@formerusaf.guv), August 08, 1999.