by Barry Ritholtz
June 18, 2001

Up . . . Down . . . Up again . . . Down again. I'm sure the market is driving your average CNBC watching investor crazy.

The confession season only adds more fuel to the fire. Companies that know they will not meet earnings projections must 'fess up. The last two quarters played havoc with peoples' expectations -- and this quarter will be no different.

I find it intriguing that whatever curveballs the market throws, the media manages to trot out a "usual suspect" to explain the action. After Intel's conference call 2 weeks ago, (which I discussed in the "D-Day" email) the "PermaBulls" were brought to the fore. Dusted off from exile was Joey Baggadonuts -- Mr. "Buy-the-Nasdaq-5000-with-both-fists;" Apparently, losing a trillion dollars for viewers is not enough to keep you off of television. So out he comes, talking his usual BULLISH game.

Then Juniper preannounces. Then Nokia, JDSU and Nortel, making the perma-bulls look foolish. Out they trot the "Perma-Bears," who insist that Armageddon is now at hand . . . So what happens next? Oracle beats by a penny, and mgmt says that they see a bottom to the order slowdown.

But please do not think I'm blaming the media -- they are doing their jobs telling you yesterdays events! They consistently act as a lagging indicator telling us what already happened -- not what is going to happen. That's why you cannot invest by watching television.

Remember the magazine cover indicator's signal during the week of March 22? While the mag cover indicator has not appeared, the level of backwards looking negativity is again very high. Today's New York Times, The Wall Street Journal, and Investors Business Daily each had a very prominently placed story on the fiber optic debacle. And take a look a this Reuter's quote from Monday, June 18, 2001:

"Wall Street is in for more pummeling this week with no relief in sight from the steady drone of corporate profit warnings and signs the U.S. economy is sputtering . . . "The Nasdaq market had its worst week of the year last week as a barrage of companies announced they were still feeling the pinch from the economic downturn, raising fears it may take even longer than expected to turn profits around, and analysts say there is probably more to come."

Note that the writer of this "news" quote has little to say factually, and has reflexively allowed an historical looking negativism to creep into "reporting."

"More pummelling? No end in sight?" Is that negative enough for you? That's Bullish too me!

-------------------------------------------------------------------------------------

OK, enough trash talk. Where are we now, and how do we approach the next three months?

The past two quarters have demonstrated that the tail end of the pre-announcement season -- the last 10 days of the quarter -- is an ideal time to deploy (and redeploy) capital. Prior intermediate lows in the major indexes were revealed the last two weeks of the Fourth Quarter (December 20, 2000) as well as the last two weeks of the First Quarter (March 22, 2001). There is no reason to suspect that this quarter -- the Second Quarter -- will deviate significantly from that script.

Here was our plan from that Intel "D-Day" missive I sent out two short weeks ago:

"We watch the 2300 area on the Nasdaq, and if we fail to thrust through, we trim back tech positions (a small portion of our overall holdings) and look for better entry points."

That is what happened, and what we did. We punted a number of poorly behaving stocks, got stopped out of others, and now are ready to deploy more capital, unless the road signs suggest the rewards are outweighed by the risks.

You read that correctly, into this mess we scale into positions, expecting to be fully invested by July 4th weekend.

Need more convincing? Lets check our market signals to determine how aggressive a position we should adapt. Since I wrote 10 Reasons to Start Getting Bullish back in late March, we have seen the market make a new bottom, and rally 30-40% off those lows. Since hitting those peaks, we have retraced 40 - 50% of those gains -- a normal part of the back and fill process.

Almost all of the indicators I used last time are now lining up again. The positives far outweigh a few negatives, giving me a Bullish posture. Here's my top ten list:

1. The Calendar:

-- First, preannouncement season will end sometime next week. With that out of the way, frightened buyers will start tiptoeing back in.

-- Second, end of the quarter activity ("Window Dressing") has a tendency to push the indexes, and widely held holdings, higher.

-- Third, 40 to 50 Billion dollars in tax rebates should hit the US consumer within the next 90 days. The mere anticipation of that will help retailers, consumer durables, travel and entertainment companies.

-- Fourth factor: Microsoft's appeals decision is imminent. Most legal experts expect the conservative DC Appeals Court to render a decision favorable to the software giant. I personally think both MSFT and the rest of the world would be better off if they were split in two (See Can Bush Save Microsoft? Don't Bet On It) but that is a decidedly minority viewpoint. Appeals decisions are usually released on Tuesdays & Fridays.

2. The Fed -- continues cutting interest rates. A quarter point cut is a gimme on the 27th, and there is a slim chance of a half. I do wish more people would keep their predictions of a 1/2 point rate cut to themselves. Remember the prediction Bear Stern's Wayne Angell? (Last time around, he set up the short term disappointment when it did not happen -- Blah! -- lets not see a repeat of that).

3. AAII Sentiment readings are once again approaching too Bearish. The American Association of Individual Investor’s (AAII) bullish sentiment dropped from the 60% level of a month ago to 30.5%. Another strong sentiment indicator suggesting an overdose of pessimism.

4. The Arms Index has given its highly correlated buy signal. It has nearly revisited the levels it hit back in the lows of March. The Arms Index has in the past given you a heads up that the next rally is 20 days or less away.

5. Defensive issues are weakening Softness in Tobaccos, Railroads, and Oil Service bode positively for a rotation into the more aggressive stocks, such as bio tech, software, etc.

6. The put/call ratio hit a peak of 80 on Thursday -- well over the reading of 72 we use as a sign of excessive pessimism. Another positive for the start of a near term rally.

7. Bad news is fully priced in? When the market is in the midst of a short term upswing, it's vulnerable to big earnings warnings. Once stocks have backed off, the market absorbs the fallout a lot better; I suspect that Earnings warnigns before any runup will be better handled than those after a leg up. (Something to think about instead of chasing ORCL's conf call higher).

8. According to CNBC, today marked the first time since 1998 that we have seen the Nasdaq fall 7 consecutive sessions. Again, this suggests excessive levels of pessimism and fear.

9. Volatility index is falling, but may not have bottomed. A short term bottom is out there, but may not be firmed up for a few weeks -- I suspect sometime between now and early July.

10. Yield Curve: "Inverted yield curves (short-term rates higher than long-term rates) are always a harbinger of a slower economy," wrote one commentator whose work I like. Last year's inverted curve proved a forewarning of the economic slowdown. The inversion is now gone, replaced with a steep yield curve -- usually a harbinger of stronger economic growth.

All these factors make me cautiously Bullish. Look for gains across the boards, but especially in Software, Biotechs, Semis, Manufacturing, Retail, Hospital & Health Care, and Cable, amongst others.

Come September, we may see a very different story unwinding as the Street gets wise to this pattern, and other factors come to the fore. But in the meantime, we are looking for a very tradeable rally lasting at least until deeper into the Summer. And as always, of the market does not play out as we envision, we use our stops to limit the damage and wait for the next opportunity to redeploy . . .

Copyright © 2001 Barry L. Ritholtz, All Rights Reserved worldwide. May not be copied, stored or redistributed without prior, written permission. Home

---