Cautious Confidence
by Trace Johnson
03-MAY-04
Geopolitics and interest rate fears pressured the market as April moved
forward, and impressive earnings news was not sufficient to change its
tone. All three indices were down during the month, though the NASDAQ
got hit particularly hard. Nevertheless, neither factor leads the Dow
Theorists to abandon their positions that we remain firmly in a bull
market. Read on to discover key levels on the Dow that would signal
conviction in its bearishness/bullishness and the best securities for
stock- pickers and market timers alike in the present environment.
Certain Targets in Uncertain Times
Jack Schannep, editor of the Schannep Timing Indicator and
theDowTheory , is a former West Point graduate who counts retired
Generals among his peers. He notes in his May letter that the mantra in
America moved from “It’s the economy, stupid” to “It’s the war, stupid.”
April brought the most prolific loss of American lives in the conflict
in Iraq and led many to label it a civil war. The dangers this poses to
the recovery and market are on several fronts. First, competition for
public funds between programs to stimulate the American economy and the
occupation grow as we spend over $4 billion a month in Iraq. That
government spending results in upward pressure on interest rates that is
not related to economic strength. Third, as the United States is forced
to adopt more violent methods to quell the insurgency, it risks
increasing the terror threat as well as risking a backlash among Arab
oil producing countries a la the early ‘70’s.
The other uncertainty that haunts the market’s dreams at present is
the inevitable interest rate reckoning day. What will the Federal
Reserve’s rhetoric reveal about its intention to raise interest rates?
The fear is that interest rates will have to rise north of 50 basis
points, or 0.5% quicker than the market expects. The market has never
been big on surprises. Realistically, rates will have to rise at least
75-125 bp; the question is of what increments and at what intervals.
In spite of both factors, rates and the potential unexpected and
surprisingly severe consequences of the occupation in Iraq, both Jack
Schannep, and Richard Moroney, editor of Dow Theory Forecasts , are
confident the market will put in solid performance in 2004. The two are
also looking at very key levels on the Dow Industrials and Dow
Transports for confirmation of bullishness or a turn to bearishness.
All of the major indices lost ground in April: NASDAQ – down 4.7%,
S&P 500 – down 2.2%, Dow Jones Industrials – down 1.43%, and Dow Jones
Transport – down 1.09%. However, Schannep and Moroney both focus on the
DJI and DJT, and are currently focused on their activities since October
of 2002, the previous bear market low. The Industrials hit their highs
on February 11th, at 10,737, while the Transports hit theirs on January
22nd, at 3,080. Schannep predicted the pullback and retracement of the
run up in the end of 2003 and beginning of 2004. The Industrials dropped
6.3% and the Transports 10.7%, and have rallied 5.2% and 9.3%,
respectively. Both are looking for the indices’ movement above or below
those turning points as critical litmus tests for its true conviction.
No one can predict what turn conflict and terror will cause the
market to take, though they will continue to monitor their timing models
as the best insight into the market’s true impression of those threats.
Both editors also feel comfortable with a rising interest rate
environment. Moroney feels that interest rates can rise from present
levels without endangering the earnings and economic recovery. Schannep
notes a recent piece by Paul Cherney of Standard & Poor’s that indicates
bull markets typically run up against higher rates in the second half.
According to Schannep’s research, bull markets tend to last 33 months,
on average, and this bull is in its 19th month.
Moroney utilizes his timing models to augment his stock-picking
strategies. Schannep is strictly a market-timer who uses in the index
tracking securities to reap the most market returns from the market.
Historically, he has utilizes the Spyders (AMEX: SPY ), which tracked
the S&P 500 and Diamonds (AMEX: DIA ), that follow the Dow Industrials.
Recently, the NYC i-Shares Trust was created that he says completes
index stocks for the timing models he applies.
Jack has a Special Report entitled, “After When, What and How Much?”
in which he discusses the add-on return that can be garnered from
focusing on the security that is most statistically attractive. He is
presently overweight DIA vs. SPY at a 2:1 ratio. Schannep’s strategic
moves between the stocks have been good for an extra 2.1% return
annually above holding equal allocations.
Deciphering the Market Message
Both Moroney and Schannep made notes about their appreciation of the
clear signal of the Dow Theory when the market experiences cross
currents. Either way, the Buy signal issued in October 2002 has not been
violated, and being in the market is not hurting many people. Following
earnings growth, though, remains a critical component to stock-picking,
but an eye toward economic trends and valuations is also important.
Trace Johnson is a market commentator for Zacks Investment
Research. He's also a regular contributor on WebFN, First Business and
CNBC-Europe.
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& TheDowTheory.com
