Bernstein on Stocks

In the last issue of BOS (and for many weeks now) I have stated clearly and without hedging my comments, that new all-time highs were likely in stock prices, particularly if interest rates were raised slowly over a period of time. I further stated that "the real issue is whether investors can still achieve a healthy return on stock holdings compared to passbook interest and/or other forms of pure interest yield plays."

The market followed my forecast, as new all-time highs were made in all major indices other than the Russell 2000. While there is some concern about the fact that the Russell (broad-based index) has not made new highs, the odds are that all indices still have higher to go and that a top has not yet been made.

The monthly Russell 2000 chart below, however, does show some reason for concern. As you can see from my analysis on the chart, a potential head-and-shoulders type top is developing. The traditional method of timing a potential top of this type is when (and if) prices decline below the so-called "neckline" which I have marked with an "N." At this time the name of the game is to sit and watch and wait for signals.

boschart.jpg (45327 bytes) The significance of the Russell 2000 not making new all-time highs is, of course, the fact that this broad-based index is hesitating. The average investor has been making money since late 1998 but not nearly as rapidly or as much as was made from 1995 through early 1998.

My conclusion is that although the market is still attractive, there may be less on the upside in stocks than there was 5 years ago. Based on my analysis at this juncture, the stock market still appears attractive to many individual investors and professional money managers. As long as there is more return to be gained from stocks compared to interest-rate vehicles. The difference in the character of the market during rising interest rates will be that of selectivity. In order to profit you will need to be more selective and discerning in your choices. There will be fewer and fewer quality stocks that can meet the demanding criteria of "good investments." Yield and earnings will be the name of the game for savvy investors while the public continues to take chances in essentially worthless stocks on the hope that earnings will follow. But the hope will not likely materialize in many cases.

I advised you also that once the bearish news of an interest-rate hike was out of the way, stock prices would likely move higher since markets act on anticipation, and then, once the anticipated news becomes fact, prices often move opposite from what the general public expects. Hence, the sideways to lower trend in stocks for the last few months was an advance indication of expected interest-rate increases. When these expectations become reality, the market moved higher and made new all-time highs as predicted.

The Next Bearish Hurdle

There is always another bearish hurdle that markets must overcome on their way to Nirvana. The bearish-seasonal pattern that tends to develop in S&P from approximately 7/15 until 7/23 will soon come into play. This key-date bearish pattern was shown in tabular form on page 1 in the last issue. I refer you to it again and refresh your memory. The listing shown last week indicates that there has been a tendency for S&P prices to be lower than the close of trading on 7/15 than on the close of trading on 7/23. This pattern has been correct over 76% of the time since the start of trading in S&P futures. It is worthy to note that the largest winning year EVER for this trade was 1998 in which the trade gained nearly 3600 points on the short side. Does this mean that the decline will happen again this year? We can't be certain, however, there is good reason to be cautious.

It is very likely that the stock market will be vulnerable to a decline during this time frame, as it has been in the past. Caution is strongly recommended. Since the average gain in this trade is 1.37% you can determine the approximate size of the move by multiplying the price of S&P futures by 1.37% on the entry date of 7/15 to get a possible projection of the decline.

Bullish & Bearish Factors Reviewed

Here is my current analysis of the bullish and bearish factors and forces in the context of recent market developments and fundamentals:

Bullish Factors & Forces

n Interest rates are still low on a long-term basis, in spite of pending increases. Money managers and investors are still interested in keeping funds in stocks to obtain the higher (although more risky) yields. Likely increases in interest rates will not be a major issue unless they are raised repeatedly or in large steps (i.e., + of 1%).

n Inflation remains relatively low. With a few exceptions a number of commodity prices are at lows dating back over 20 years. This, combined with the low cost of money to support a very healthy environment can cause corporate profits to grow strongly -- which, in turn, boosts the price of stocks.

n Economic conditions in some Asian economies decreases the possibility of default on loans, thereby adding stability to the stock market and international currencies. In addition, the market will also see the settlement of tensions in Yugoslavia as a positive development. As the peace continues optimism will grow and international conflict will not be a serious impediment to higher prices.

n A strong U.S. dollar attracts more capital into the country and into U.S. stocks, thereby boosting demand and providing stability and support. Higher U.S. interest rates will be seen as a further positive for U.S. dollar strength. As we go to press the U.S. dollar remains strong as European currencies decline to new lows for the move.

n Federal Reserve Policy at this juncture is to keep interest rates reasonably low, not increasing them unless absolutely necessary based on inflation indications.

Bearish Factors & Forces

n Excessive speculation of inexperienced traders may well increase the possibility of panic liquidation in the event of a large sell-off. There has been only a minor decrease in speculative activities. Hence, it still poses a threat to market stability.

n High P/E ratios in many stocks, as well as high prices for stocks that have essentially no earnings creates a speculative market environment that cannot last for too long. The Federal Reserve may act to curb such speculation by raising interest rates. This trend continues and may become worse as marginal firms will need to pay more to borrow money, thereby increasing their costs and cutting into their bottom line profits.

n A low in interest rates has likely been made. FOMC policy is clearly to raise rates in order to stave off inflationary pressures. A possible lengthy rise in rates has probably started.

n There are signs of price inflation in petroleum, lumber and copper. This could seriously affect corporate profits.

n The excessively high price of many stocks and the possibility that a correction to more rational levels is necessary if the bull market is to continue. The new all-time high this week, per my forecasts, may exacerbate an already overdone situation on the upside.

While the above lists are general and based on a variety of expectations, these are clearly two sets of opposing factors that must be considered in evaluating current market conditions. Based on my evaluation of both factors I still see more all-time highs to be followed by a considerable downside correction. Beware also of the coming seasonal decline as noted earlier (and in the last issue).

Conclusions

The bearish and bullish factors and forces as outlined above and in the last few issues have been in balance until recently. The ability of prices to move to new all-time highs sets the stage for another leg up, however, the bearish seasonal hurdle will need to be cleared first. Follow through to recent all-time highs is necessary subsequent to any major fundamental or technical development.

Forecasts and Expectations

>My long-term objective remains approximately 11,600 Dow. This has been my forecast for many months and it has not changed. This level could be attained before September if interest rates remain stable at current levels. Upside follow through is necessary if a strong rally is to continue. My forecast may change as a function of developing market conditions and technical indicators as noted above. My advice on S&P has also been correct. The market declined to support and has rallied to new all-time highs per my forecasts. I advised you to trade for short-term market turns only, buying at or near support and selling at or near resistance. This has also been the correct strategy. My advice was to expect new highs and they have come.

The market remains in a highly volatile state. Current market conditions are still best suited to the skill of accomplished short-term TRADERS as opposed to investors or new traders. Investors are urged to await buying opportunities that are likely to develop if a severe and/or extended drop to long-term technical support develops on the weekly and daily charts. This has not yet happened, although it may come with the July seasonal decline as noted earlier.

NASDAQ: The NASDAQ index made new all-time highs per my forecast. The important technical support levels I discussed several weeks ago have held. The developing chart pattern is one of a classical distribution top. New all-time highs were expected prior to the market making a long-term top. A serious decline could follow.

There is still plenty of buying power left in this market. Therefore, prices could rally strongly, even to make new highs, before another leg to the downside develops.

DOW JONES: The Dow has also rallied to new all-time highs as expected. My long-term objective is approximately 11,600 Dow. This is subject to change as a function of market conditions. (See previous comments about the importance of follow through.)

GOLD: My intermediate-term technical timing indicators and projections for gold stocks and gold futures tell me that the market is at or close to lows. The decline continues with gold likely to drop to its next level of long-term support in the 250 area. Bearish news typically comes at market bottoms. The decline has been persistent and unyielding. GOLD IS NOT DEAD no matter how strongly its detractors may wish to kill it. Much to the surprise of many investors gold will rally again and the rally will be dynamic. But it will take time for this move to begin. Sentiment is pervasively bearish and there is still more selling of gold reserves that will push prices even lower before a major low has been made. Bearish news and bearish sentiment abound. It is entirely possible that a drop to the 233 level may develop before a bottom is made.

I believe strongly that gold will be an excellent hedge against potential Y2K problems as well as inflation. The intermediate- and long-term patterns continue sideways. I advise a longer-term buy position on gold and gold mining shares. I recommend accumulation of positions for a major bull market that has NOT yet started. I also advise accumulation of long positions in Homestake Mining and/or ASA Limited. Both stocks are very cheap. And there are many others that are worthy of your attention. Such stocks should be bought and held as part of a long-term dollar cost averaging program as explained in previous issues. In addition, I advise you to consider the accumulation of bullion gold coins as part of your protective portfolio.

Summary & Recommendations

n Stocks: Support will likely continue at the January through June lows. Watch for a possible seasonal decline as stated earlier. AVOID SPECULATIVE TRADING in Internet stocks unless you're an experienced trader who knows how to sell short! I warned you repeatedly that trading these stocks could prove costly to most investors. Buy high-quality stocks but only on strong drops to technical support. New all-times highs were expected and made.

n Gold: Hold protective long positions in gold coins, mutual funds, stocks or futures for the long-term as previously recommended. Use a dollar cost averaging strategy to accumulate your position. The intermediate-term trend is turning bullish or, at worst, sideways. Add to existing long positions but only on strength. The 233 level is likely to be tested.

If you have not yet started a buy-and-hold strategy for gold, then this is a good time to begin a dollar cost averaging strategy until you have established your core position. Gold coins are recommended as a reasonable risk alternative to gold shares.

n Interest Rates: I advised you to prepare for an upmove in long-term interest rates -- my forecast was correct. I advised you to lock in long-term borrowing needs -- my forecast was correct. My forecast is now becoming a reality.

n Inflation: Watch for a major CRB (Commodity Research Bureau) cycle low. Indications of a new round of inflation are increasing. The CRB and commodity prices are at 20+ year lows, hence the potential for a major rally in commodity prices remains strong. The index has declined to test support but is still in a bottoming phase.

Bernstein on Stocks

Editor and Publisher: Jake Bernstein 831-430-0600 1-800-678-5253
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