Four-Year Low Becoming Consensus

[HenryTo]

Ned Davis lending a voice of reason to bears out there:
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Is a Fourth-Quarter Rally in Peril?

By MICHAEL SANTOLI, ANDREW BARY and KOPIN TAN

Vital Signs

HIGH SCHOOL AND WALL STREET are more similar than not -- the cliques, the name-calling, the embrace of fleeting fads. But here's a difference: In high school, everyone wants to be popular, while on the Street everyone claims to have a misfit view that spurns the crowd.

So when the prom queen and the quarterback start echoing your market call, it might be time to start rethinking it. That's what's been going on among some sharp market observers, who had been calling for a nasty selloff and subsequent rally, to create a classic mid-term election year low in a "V" pattern.

Ned Davis of Ned Davis Research last week lent credence to the notion, aired here recently, that the "four-year low" thesis had become something of a comfy consensus. "The mid-term election year lows of the four-year cycle in October have gotten way too popular, and accounts have positioned themselves for such an event. The market rarely accommodates the majority view," he wrote to clients.

In a like vein, Robert W. Baird investment strategist Bruce Bittles says, "The wide media coverage of the seasonal tendency of stocks to underperform this month suggests this September could be an exception to the rule."

This implies that the August rally was mostly the market's way of confounding a buildup of negative investment sentiment and penalizing short sellers.

Last week's modest but rather desultory decline in the indexes didn't much alter the broad context. The Dow lost 72 to settle at 11,392. The Standard & Poor's 500 slipped 12 to 1298. The Nasdaq, resuming its pattern of underperformance after a few-week reprieve, fell 27 to 2165.

It was widely said that a swelling of wage inflation in the productivity data prompted the selling that began Wednesday. But if that were the case, the bond market would likely have been more perturbed than it was. If half the battle for investing success involves knowing what to fear, then anyone still believing the chief threats to stocks are inflation and a vigilant Fed might want to reconsider.

With the Dow transports (a pricing-power and economic-momentum gauge) weak even amid an oil pullback, with small-caps underperforming, with a strikingly inverted yield curve, with defensive stock sectors the only ones performing well, the markets are implying that a disinflationary growth-slowdown scare is at hand.

Merrill Lynch strategists last week pointed out that significant yield-curve inversion (with long-term rates below overnight rates) has presaged a decline in corporate profits every time it's occurred since 1970. Currently, aggregate analysts' estimates are calling for a 10% gain in profits in '07, from today's historic highs in profit margins. Someone's got it wrong -- either the collective wisdom of global bond markets or sell-side spreadsheet jockeys.

Another way Wall Street resembles high school is that soon after the school year starts, the kids start looking ahead to winter break. And so we've been hearing calls to prepare for a fourth-quarter rally, like the one we've seen in each of the last four years. It's plausible given recent history, but the crucial question is: A rally from what level?

So, sure, the short-term skepticism among investors probably insulates the tape from big, immediate losses, and there could be more upside, perhaps a challenge to the 2006 highs or better. Friday's spiffy little recovery from two ugly days hinted at as much.

But the sages shouldn't write off the chances of hitting that four-year low yet. Should it come, it'll probably be soon after the crowd becomes convinced that it has dodged September's bullet.

[rffrydr]

Bump.....'87 model?
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

http://siliconinvestor.advfn.com/readmsg.aspx?msgid=25479896

[Bob]

The same reason the popular expected cycle low was negated because of overwhelming negative sentiment could be the reason why a low could happen anytime, now that sentiment is so bullish. I find it amazing we ignore the really low VIX, bullish sentiment, plunging consumer credit, plunge in housing starts, rise in home foreclosures, and the decline in auto sales and retail employment etc…. . I think we tend to skew all news over to our market direction bias. The real reason to be bullish is that institutions are buying because the Fed's pumping in huge amounts of liquidity and accelerating M3! When expectations cause wealth to shift, where is it going to go next is what I want to know? This market is overbullish, overvalued, and overbought, but I’ll stick with it and keep my stops tight.


http://www.shadowstats.com/cgi-bin/sgs/data

[dash]

Carl Swenlin's latest thoughts on the 4-year cycle:

http://www.decisionpoint.com/ChartSpotliteFiles/061117_4yr.html

[HenryTo]

dash and rffrydr,

I think Ned Davis is a good, level-headed guy to listen to.

Let me take this one step further - and this will probably make the bears very unhappy. As I mentioned in my commentary this weekend, the latest Fed rate hike cycle has been about two things:

1) Preemptiveness (e.g. 1994 to 1995)
2) Very clear communication (uncharted territory)

The fact that everyone knew that there was a housing bubble and the fact that it only took a Fed Funds rate of 5.25% to pop the bubble is bullish - because if the bubble didn't pop a few months ago, the Fed will have gone on to a higher rate - perhaps 5.75% or even over 6% - and this will have choked off the rest of the economy - not to mention the stock market. Being an optimist, I also now believe the Fed will start cutting by December or early next year - which will make any rally that develop from here more sustainable going into 2007.

[dash]

The following market analysis is now a bit dated (Aug 1) but is still a good read with many of the general points, especially those related to pessimistic sentiment still relevant:

http://public.alger.com/Algerpub/docs/upload/msg/11359/Alger%20Mkt%20CommGEN%208.1.06.pdf

[rffrydr]

Time has a way of stretching opinions: check back, 4yr cycle low was consensus at the end of January.

The great thing about the market is that you can be wrong and right and loose money on both sides!

[dash]

Thanks for posting the article. I'd actually go beyond saying that the 4-year low has now become the consensus view, and add that it's also being discussed a very frequently. This, along with the observations that an inverted yield curve and the downturn in real estate are sure signs (because they always have been) of an impending recession and therefore stock market weakness are so widely held as gospel that I'd be astonished if they are not already incorporated in stock prices.

I'm so sick of seeing articles about how weakness in the housing market will inevitably lead to weakness in the economy, that I either gloss over or ignore them, and thus worry I might be missing some new information.

There must surely be a timeline (which is no doubt getting shorter and shorter) where themes like the 4-year cycle, inverted yield curve etc work when a select few observe and profit from them, and when they become common knowledge to the investing public at large, and either no longer work or become negatively correlated.