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February holds the key to investing in 2005
If the major averages reverse their recent drubbing this month, put on your party hat. If they don't, get out your hard hat. Here's why.
By Jon D. Markman
Everyone seems to have a theory on why stocks fell so much in January, but the bottom line is this: Sellers were more aggressive than buyers. For every person who wanted to buy stocks, there was someone who wanted to sell them a little bit more.
Who were those sellers, what was their motivation and what does their current and past sentiment tell us about the rest of the year?
First of all, we know that a lot of them were owners of mutual funds, as the month saw a record number of fund redemptions, or outflows, for a January. And we know that many put their money in jumbo certificates of deposit and money-market accounts, as the Federal Reserve reports the numbers weekly -- and they jumped sharply at the start of the year.
More specifically, we know that a lot of them were corporate insiders -- continuing a wholesale dumping of stock that began in 2004. Last year was the second-most lucrative on record for insiders; they sold $41 billion worth of their shares to the public, up 40% from 2003, according to Thomson Financial. In contrast, insiders were buyers of only $1.45 billion worth of stock -- the second-lowest annual level since 1996. That 28:1 ratio was the most bearish Thomson has recorded since the company started tracking the figures in 1990.
Insiders accelerated their sales in the final three months of last year, dumping $12.8 billion worth of stock on the public while buying just $342 million -- a stunning 37-to-1 ratio. And then when January started, they upped the pace. Although the final month-end numbers won't be out for a couple of days, massive sales in just the past week include 300,000 shares of Apple Computer (AAPL, news, msgs) by Chief Software Technology Officer Avadis Tevanian. That netted $21.3 million and left him with just 1,252 shares of Apple common, according to Thomson figures. In the oil patch, CEO Thomas Edelman dumped 232,500 shares of Patina Oil & Gas (POG, news, msgs), netting $8.4 million; in consumer services, CEO Micky Arison sold 124,100 shares of Carnival Cruise Lines (CCL, news, msgs), netting $6.9 million; and in technology, two officers of financial computing services provider Jack Henry & Associates (JKHY, news, msgs) sold 200,000 shares each, netting $8.2 million.
Now that these folks have got all this selling out of their system, what about February and beyond? In the short term, it's important to note that Februaries tend to bring about reversals of Januaries. That sometimes happens in very dramatic fashion. In 2001, January started off with a 20% advance in the Nasdaq Composite ($COMPX). And then February kicked investors in the face as the tech-heavy index plunged 21% in day-after-day selling.
The fine market-timing engineers at Lowry's Reports in Florida, whom I have featured in the past, believe that such a reversal and march to new highs is imminent -- though they caveat that happy news with the admonition that it could be preceded by a vicious one-day wipeout.
Even if it were to occur, however, it seems that the odds are being stacked against bulls. In addition to the usual laundry list of unpleasantness that is trotted out by bears -- the massive U.S. budget deficit, an increasingly shrinking dollar, the softness in industrial production, the persistent lack of job growth and the steep current account deficit -- there is the delicate matter of sentiment cycles now gnawing at the foundation of the market.
For just as there is a predictable expansion and contraction in the economy, as explained amply by Lakshman Achuthan of the Economic Cycle Research Institute with his weekly leading indicators, so is there a regular expansion and contraction of human emotions. From 1965 to 1982, as the economy sailed along just fine, investors swung from fear to greed and back again without ever accumulating quite enough greed to push the Dow Jones industrials ($INDU) up above the 1,000 level. That level was touched six times in 17 years without being crested.
It's hard to imagine, but the same really could be happening now. Except that we might substitute the 10,000-11,000 level of the Dow for the 1,000 level. The magic five-digit level was first hit in March 1999, and 11,908 was reached as an intraday high almost a year later. Several attempts to surpass that record were made later in 2000 -- and then again in early 2001, 2003 and 2004. (The Dow's intraday high in 2004 was 10,895.10 on Dec. 23.) And so you have to guess that, given the indifference among insiders in the past year, any attempts to summit even last year's 10,800 mark over the next few months may well be rejected.
One overlooked problem, according to some experienced observers, is that deep fear is the well from which gigantic positive moves are sprung -- and yet even after five years in the wilderness, well off the market's highs, not enough of it has pooled up.
Peter Eliades, author of the Stockmarket Cycles research service since the mid-1970s, elegantly quantified this intangible factor in his Jan. 7 report. He said he believed that this year would turn out to be the first ending in the number 5 that had not ended positively in over a century due to the amazing recent complacency of market participants.
Eliades pointed out that the 100-year string of positive years ending in 5 had occurred in no small part because years ending in 4 had typically been so rotten and riven with fear that the 5s were ripe for a psychological reversal. In contrast, he notes that 2003 and 2004 were among the rare two-year periods in which there was not a single week of a preponderance of bears over bulls in the surveys taken by Investors Intelligence.
That survey, conducted continuously since 1965, has only witnessed one other period in which two years went by without a one-week surplus of bears over bulls, and that was 1999 and 2000, just prior to a 32% 22-month decline in the Dow industrials. Before that, the only single years without a week in which bears outnumbered bulls was 1972 and 1976 -- just before monstrous declines of 30% and 20%, respectively, in the following years -- and 1983, just prior to a modest 10% five-month decline in the Dow.
In contrast to the lack of bearishness in 2004, Eliades points out that, as the year 1974 ended, there had been 42 weeks in which Investors Intelligence's survey showed bears outnumbered bulls. In 1984, there were 20 weeks of bears beating bulls. And by the end of 1994, there were 47 weeks of bears over bulls.
What's really interesting is that the spectacular 1998-2000 advance had so thoroughly brainwashed people into thinking that the market could never go down that even in mid-2002, with the Nasdaq 80% off its all-time high, there weren't more than two weeks in a row of bears over bulls in the Investors Intelligence survey. In 2001, following the quick recovery in stocks after Sept. 11, there were only a couple of weeks of more bears than bulls -- nothing like the months and months of absolute despair found at real market bottoms in the past.
Eliades admits to a tendency toward gloom that has cost him plenty of upside. But he believes that, if a decline really gets rolling this time, it won't stop at the October 2002 lows. Instead, it will keep on rolling until the average dividend yield of Dow Jones industrials' stocks is nearly equivalent to the average of their price/earnings multiples -- a pairing that has occurred at every other major bottom. In 1982, just before the big bull market started, the Dow yield was 5% and the PE was around 6. At present, the average yield is 1.5% and the Dow P/E is around 20. So they have a long way to go if that level of despair is to be matched.
How to proceed? It would be nice if it turns out stocks were just feeling queasy after the big run-up in November and December, and needed a little rest. One statistical quirk that has worked since 1968, according to Eliades, is that February has tended to tell the story of the year. If the February high surpasses the January high, then you can put your party hats back on because the year is likely to turn out OK. But if February turns down again or rallies without surpassing the January high (1,202 on the S&P 500 or 10,800 on the Dow), then put on hard hats instead.
Many readers have asked for the opinion of Mr. P, the director of research for a major U.S. hedge fund who occasionally offers his view on timing in this column. Last fall, on Oct. 13, he told readers here ("11 stocks for a lurking bear market") that he believed stocks were due for a 20% drubbing in the first half of 2005. Over the weekend, he said he's sticking with that forecast, with the additional warning that if or when the Dow industrials slip below the level at which they closed on the day after President Bush was re-elected, or 10,137.05, then he would feel even more confident in his forecast. That's about 50 points below the Jan. 28 close.
Fine print
To learn more about the Investors Intelligence research service, a product of Chartcraft Inc., visit its Web site. A description of the company's market-timing services is offered here. The Investor's Intelligence survey is also published on Wednesdays in Investors Business Daily, while Barrons Online publishes three sentiment surveys on Saturdays (subscription required). . . . To learn more about Peter Eliades' Stockmarket Cycles newsletter, visit its Web site. . . . To learn more about economic cycles, visit the ECRI home page. . . . Some readers have inquired about the current stance of Robert Drach of Drach Market Research, whose sharp-eyed timing views I have featured in the past. The gruff veteran has moved from 98% negative at the start of the year to neutral this week, which means he's on alert to start buying his short list of high-quality stocks if the market sinks more steeply in the next few weeks.
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