Agora Outlook

Publisher Ken Davidson                                                                                                                              Fax 250-860-2051
e-mail davidson@silk.net                                                                                                                    www.agoraoutlook.com

Davidson’s View

So the Dow is almost back to where it was before the correction began in July. Since its low on October 8^th we have seen a huge move upward. Earlier this week the Dow actually made a new high. Using monthly updated data on the relationship between earnings, dividends, interest rates, and price corrections since 1980, analysts estimate the S&P 500 is now overvalued anywhere from 6% to20%,

While the correction was going on in July the bulls went into hiding but are once again calling for Dow 10,000 by the end of this year and claiming we’ll see 12,000 next year. The bears are now the ones to timid to step out and make any predictions. For the bears though, it is a cause of fear, not because stocks could go higher still, but because the market could simply be setting itself up for another collapse. The bears say the recent recovery is nothing but a trap, the same sort of trap that led investors back into stocks during a rally after the great crash of 1929, and ended with the longest and most grinding bear market of this century. The Dow fell 48% from 381.17 on Sept. 3, 1929, to 198.69 on Nov. 13, according to Ned Davis Research. Then they rallied back 48% to 294.07 by April 17, 1930, only to fall a thudding 86% over the next two years, finally bottoming out at 41.22 on July 8, 1932. The bears see that happening again, complete with a depression and bank closures. The bulls argue that any comparison at all to the excess speculation of 1929 is preposterous. This rally, they say, is based on real gains in corporate profits and in productivity. Thanks to Federal Reserve interest rate cuts, the economic environment is improving, they say, and baby-boomer retirement money is already pouring back into the stock market which helps explain the big rally.

The Investment Company Institute, a mutual-fund industry group, says that cash levels at stock mutual funds rose to 6.2% in September, from 4.8% in April. And organizations that track mutual-fund flows say that, although people did pull some money out of stock mutual funds in August, they put it back in in September. Initial estimates also suggest that investors pulled money out of stock funds in the down days of early October, but then put it back in later in the month. People are used to the market rallying after it goes down, so individual investors are now more willing to hang in there.

Bearish investors now expect bonds to soar again as panic resumes and investors again run for cover, moving money to investments they consider safer. The bulls on the other hand, see signs that the shift into stocks and out of bonds has just begun. The biggest turning point for the stock market came on Oct. 15, when the Fed unexpectedly cut its target interest rate. Investors concluded that the Fed would do what it could to keep the U.S. economy from falling into recession, while at the same time seeking to help foreign economies by keeping U.S. demand strong.

As October wore on, momentum took over in the market. The more stocks gained, the more fund managers, who are rated on monthly performance, felt the need to join in. After the Fed cut rates on Oct. 15, many fund managers who had been skeptical about the market turnaround jumped back in, fearful of being left behind.

Stocks are starting to hold back as worries that the market and the economy have now rebounded so strongly the Fed could decide not to cut rates further at its next meeting in December or early next year. The next big negative in the market's backdrop is the earnings outlook, as companies will begin issuing fourth-quarter predictions next week. Warnings of profit shortfalls typically hurt the market in the best of times, and after four straight quarters of disappointments the roster of companies coming up short will probably run to the high side once again. With momentum starting to wane this could be the week for a correction to start. 1929 once again? I don’t think so, but it is prudent to be alert!

Tuesday

U.S. economic growth rebounded strongly over the summer despite overseas financial turmoil, but profits at the nation’s corporations fell sharply. The gross domestic product, the sum of all goods and services, surged at a robust 3.9% seasonally adjusted annual rate in the July-September quarter. Estimates for the number were at 3.3%. The deterioration in the nation’s trade deficit was not as severe as first measured. Also, consumers purchased more trucks and used cars than originally counted. However, in its first look at third-quarter profits, the department said after-tax earnings fell 1.8% to a seasonally adjusted annual rate of $473.2 billion. It was the third quarterly decline over the past year. Profits are down 6.2% from the same quarter a year ago, the worst drop over a year since 1989. The report raises questions about the sustainability of the stock market rally, which on Monday pushed the Dow Jones average of industrial stocks to a new high: 9,374.  A wave of mergers has powered the latest rally, but many manufacturing companies are facing a profit squeeze. They must pay higher wages because skilled workers are scarce but they can’t raise prices in the face of competition from Asian nations trying to export their way out of their economic doldrums.  Though overall economic growth was strong in the third quarter, coming after an anemic advance at a 1.8% rate in the second quarter, it contained the seeds of the slowdown that economists expect for 1999. Consumer spending, which accounts for roughly two-thirds of economic activity, increased at a 4.1% annual rate. Purchases of big-ticket durable goods rose at a moderate 2.4% rate, even with the GM strikes. But, a pileup of unsold goods in inventory accounted for nearly a fourth of overall growth. Business investment in new equipment fell 1.1% after a run of stellar growth. It was the sector’s first decline in nearly seven years. Also, American export sales declined for the third consecutive quarter for the first time in 40 years. Still, the latest drop, at a 1.9% rate, was milder than the 2.9% first reported. Meantime, imports of foreign goods and services rose at a 1.3% rate, again not as severe as the 3.4% in the initial estimate last month. Inflation, as measured by a price gauge tied to the GDP, hit a 35-year low. Prices rose at an 0.8% annual rate. 

U.S. consumer confidence snapped back in November, reversing a four-month decline, promising robust Christmas sales, and heralding another year of economic growth.   Economists said the stock market recovery from its summer woes and Federal Reserve interest rate cuts that helped restore investors' confidence also buoyed consumers' mood.   Consumer spending accounts for about 2/3rds of the nation's Gross Domestic Product (GDP). The consumer confidence was one of many recent economic data showing that the economy remains healthy. However, most economists expect growth to slow in 1999.   After four straight monthly drops, in which it lost nearly 20 points, the widely followed Conference Board Consumer Confidence Index rose 6.7 points in November to 126.   Especially significant was November's nearly 11-point jump to 99.5 in the Conference Board's Expectations Index which measures consumers' outlook for the next six months.  The index gauging consumers' assessment of present economic conditions, which had only slipped slightly in the last four months, inched up to 165.7 in November from 165.2 in October.

As economists have said, the stock market's rise and the interest rate cuts that prompted the rally nourished consumer confidence. The November rebound in confidence was concentrated on consumers' assessment of the future, sentiment that is very closely tied to the stock market. Behind the stock market's rally was the Federal Reserve's rate cut on Oct. 15. That Fed action, the second of three rate cuts the last two months, ignited a market rally that sent major stock indices to record levels.  The gap between the number of those who consider jobs hard to get and those suggesting that jobs are easy to find continued to narrow in November, suggesting that the labor market is not as buoyant as it was a few months ago.

The Conference Board's annual holiday spending survey, released last week, projected American families will spend a record level of nearly $500 each on holiday gifts this year, up from $465 last year. Retail sales are expected to climb six to seven percent this holiday season from a year ago, moving into the $50 billion range.  In the Conference Board's most recent Consumer Confidence Survey, more people said they would buy a home or a major appliance in the next six months and more consumers expected business conditions to improve.

Orders for costly manufactured goods fell in October as demand for machinery and heavy equipment plummeted. New orders for durable goods fell 1.7% to $189.49 billion on a seasonally adjusted basis. That followed an upwardly revised 1.3% rise in September. October's fall was the first monthly drop since May. Economists in a Reuters survey had expected durable goods orders to fall 0.7%.

Durable goods include items such as cars and appliances that are meant to last three years or more. Monthly orders figures tend to be highly volatile, making it hard to draw conclusions about the broader economy. However, the sharp October drop in the industrial machinery component probably reflected weakness in demand from Asia and other foreign economies that have been hit by the global financial crisis. The department said orders for industrial machinery and equipment decreased 8.4% last month following a 4.2% gain in the prior month. Defense orders were off sharply, falling 9.8% in October.  The transportation sector also saw a decline in orders. The department attributed that to a fall in orders for railroad equipment and shipbuilding. Demand for electronics goods, such as cellular telephones and laptop computers, soared in October.

Wednesday

Americans spent more than they earned again in October, borrowing and dipping into their savings, mutual funds and home equity to maintain their standard of living. The U.S. personal savings rate, (savings as a percentage of after-tax income) was minus 0.2% last month, following a rate of minus 0.1% in September, it was the worst since 1959, when the government began tracking the figure on a monthly basis. On an annual basis, the rate hasn’t been negative since 1933, at the depth of the Depression. But the reoccurrence of a negative savings rate doesn’t mean the country is sinking into recession, economists said. More likely, it shows people are spending some of their gains from the strong stock market. Negative savings also occurs when spending is financed by borrowing and people withdraw savings or cash out part of their home equity when they refinance a mortgage. But that can’t go on forever either, analysts warn. Sooner or later, growth in consumer spending must slow to match income growth. Since consumers account for roughly 2/3rds of economic activity, U.S. economic growth should slow significantly next year, they believe. So far this year, economic growth has remained strong thanks to the consumer, even though the U.S. trade deficit has been climbing toward a record. Some analysts had feared the sharp stock market drop from mid-July through September would dampen consumer spending but the market has recovered and the Dow set a new record on Monday.

In October, spending grew at a moderately strong 0.5% rate, after solid gains of 0.7% in September and 0.4% in August. Spending in the last month was fueled by a 2.2% jump in spending on big-ticket durable goods, reflecting brisk auto sales. Incomes rose 0.45 in October after a weak 0.2% increase in September. The most closely watched component of income, wages and salaries, rose 0.5%. Wages edged down 0.1% in manufacturing, which has been hurt by loss of export sales to Asian and other countries undergoing slumps. But they rose 0.9% in services.

The University of Michigan's consumer sentiment index for November rose to 102.7 in a final reading from 97.4 in the final October index. The current conditions component rose to 115.9 in the final reading for November, from 112.8 in the final reading for October.   The consumer expectations index rose to a final 94.3 versus 87.5 in the final reading for October.

Jobless claims dropped abruptly last week to the lowest level in nearly two months. Claims fell –39,000 to 300,000 in the week ended Nov. 21, citing fewer layoffs in the auto industry and better weather. Initial claims were at their lowest level since the 290,000 reported for the week to Sept. 26. The four-week moving average, a better indicator of job market strength because it smoothes out weekly fluctuations, dipped to 318,500 in the Nov. 21 week, slightly down from 318,750 in the previous week.

Sales of U.S. existing homes rose 2.1% to a seasonally adjusted annual rate of 4.79 million units following downturns in August and September. We should close out 1998 at a record-setting level. The lowest mortgage interest rates in more than three decades will continue to drive first-time buyers into the market, allowing many trade-up buyers to make their move. The housing market is the most interest rate sensitive sector in the U.S. economy. Consumer confidence has also contributed to this year's housing boom. Happy consumers will have a more positive outlook in the future and that will make them more likely to buy a big-ticket item. A house is the biggest ticket item the family is going to buy.  The median price for an existing home was $130,900 in October, down from $131,200 in September but up from $124,400 in October 1997. Half of homes sold above the median price and half below.

Tuesday we get Construction Spending and the National Association of Purchasing Managers report. The NAPM number could be a market mover if it is fairly strong as were starting to get signals from the bond yield curve that there will be no more rate cuts this year. This number could help to confirm that. On Wednesday we get New Home Sales. Instead of wondering if it will be strong we should be wondering if it will be another record high! Thursday has Jobless Claims, Overall Chain Store Sales and Productivity and Costs. The PC number could be quite important as businesses are slowing and productivity levels are important. On Friday we get the all-important Unemployment report. This number has always been a market mover and this one could really rock the market if it doesn’t like the way it turned out.

Technically

Every market sell signal has been laughed at by the market. The current market action is pure blow-off and unpredictable so we are just waiting for reversal signals. Technicals have been overbought for some time so the entire strength in the market can be summed up in one word: Momentum. Average volume has contracted as relentlessly as prices have risen; advance/decline indicators have flattened and are rolling over along with the Mcllelan summation index; new highs have been lackluster; and the tick indicator has only rarely attacked the +1000 level. Even more rarely approaching the -1000 level that would usually be a springboard for the sustainability of such a strong rally. Sector rotation is all but nonexistent. But momentum is momentum, and we are getting signs that it is waning. The Hourly momentum chart has been going down all week so even this indicator is losing steam.

Short-and-intermediate-term technical indicators are overbought and have been so for the past few weeks. We still need a catalyst for sellers to push the market substantially lower, otherwise we’ll just see a modest pullback. The Dow has run up so fast that even if it pulls back to 8900-9000, no technical damage would be done. Besides momentum moving lower, the 5 and 10-day ARMS indicators have moved into overbought territory.   Longer term, you can also see that sentiment has moved to the extreme with a count of 59% bulls indicating there are to many bulls out there so the market will likely turn down soon.

Mclellan Oscillator: +34 -100 oversold +100 overbought
Summation Index: +2087

Five day arms: .78 .80 and below, overbought 1.00 and above, oversold
Ten day arms: .78 .80 and below, overbought 1.00 and above, oversold

Bulls: 59.8 previous week 57.0 50% plus overbought/bearish
Bears: 29.8 previous week 31.6 50% plus oversold /bullish
Correction: 10.7 previous week 11.4

Five day Qvix: 21.53

MARKET CLOSES

 Program Trades

This was an active week for trades as all of our futures trades were filled but we are still waiting to fill the Call cash trades. We still have the Short call trades on but we will continue to hold them on as the market will likely pull back this week as it is overbought, at new highs and fundamentals are pointing to a lower market. Premiums fell strongly this week even thought the market advanced once again.

Current Trades

Copyright © 1998. All rights reserved. The information contained in the AGORA OUTLOOK NEWSLETTER is based upon data that is believed to be accurate, but is not guaranteed, and subject to change without notice. All projections, forecasts, opinions, and track records cannot be guaranteed to equal our past performance. Persons reading this newsletter are responsible for their actions. Officers and employees of this publication may at times have a position in the securities mentioned, or related services.

2^nd month of trading