But first . . .

The only thing the press can focus on this summer is Gary Condit. But did you see Paul Krugman’s column in the Times Friday? There’s actually some hugely important stuff going on, as the Bush administration redistributes wealth to the rich and powerful and, separately (not part of Krugman’s column), puts the brakes on what it seems to view as all this silly concern for the environment. (Not that they’re not concerned; they just think the rest of the world’s concern is overdone.)

A recent e-mail I saw noted how much better the air and water are than they were 30 years ago, and I think the point of it was – I’m not quite sure – ‘so what’s everybody getting all crazed about?’ But to me what the nice improvements in air and water quality say is that the efforts we’ve been making pay off, and that it’s nuts not to keep leaning gently toward protecting and improving the environment. Yet there was the Bush administration – which had already halved the budget for alternative energy research . . . and which had put a hold on the new arsenic standard, 10 years in the setting, that matched the European standard of 10 parts per gazillion – now relaxing environmental rules for the gold mining interests. This is good for me, as a guy who owns a few shares in two gold mining companies (not my brightest investment, but that’s another story). But is our need for gold so great we should relax these rules? Gold’s value derives specifically from its scarcity. Lowering costs to encourage mining more of it only makes it less scarce. What is accomplished? Ah, but it’s good for gold-mine owners. This is a grand time to be rich in America.

But that’s not what the Krugman column was about – or this column, either.

Adam: ‘All the Solid Tech stocks have been slammed and I was thinking, pick them up and forget about them and I will make $$ down the road with them. Bottom line is there are no Bidders, why not get a Mercedes for cheap, what do you think?’

☞ What I think is: Be careful. It may well work with some stocks. I am all for buying stuff no one wants, when it seems to represent good value. But – to take just one widely known Solid Tech stock that’s been beaten down – even at today’s seemingly pathetic bargain price, Cisco is valued at more than four times General Motors . . . at double Ford and GM combined. So it’s not as if, even at 18 down from 70 a year ago, they’re totally giving it away.

In which context come two interesting e-mails . . .

Sergei Slobodov: ‘I came across this graph representing some 16 years of NASDAQ vs the Dow. In retrospect, one can easily identify the tech bubble (looking more like a volcano) of 1999/2000. It also shows that, historically, the NASDAQ and Dow go hand in hand, more or less, with deviations here and there. This may also suggest that the worst for the tech stocks is over, since the NASDAQ is back to the expected levels of parity with Dow. Of course, there is nothing to prevent the Dow dropping back to 7000 or so, as you caution, and taking NASDAQ with it.’

☞ True. Not that I am predicting 7000 (or lower), just that I’d be a lot more comfortable buying there than here. Short-term, stock prices need bear no relation to any sort of underlying value. Cisco at 50 a bit more than a year ago was cheap relative to the 70 it eventually hit – a quick 40% gain, for crying out loud! We were fools not to buy it! But were we really?

I do not claim to know what any given stock, or the market, is ‘worth.’ But I am old-fashioned enough to try to make some sensible guess. Others – who did very well for a while but have done less well lately – don’t seem to care much about that at all. They see it as more of a video game.

I am not accusing my pal David Durst of this. David is a sophisticated fellow with several years experience trading for top financial institutions. He suggested Safeguard Scientific (SFE) to me at $1.32. It went as high as about 100 a few years later, with some nice spin-offs along the way – it’s quite a feeling to make more than 70 times your money in just a few years – before slipping back to today’s $3.89 (no, I was not smart enough to sell most of it at 100, and, yes, I still have some at $3.89).

So I listen to David.

Last April 22, he recommended these 21 stocks: ARBA ARTG AVNX CATS EXTR FDRY FIBR GX INKT MRVC MFNX NTAP NOVL NUFO ONIS PRCM RBAK STOR TERN WFII XLA. I put $10,000 into each – hypothetically, not for real.

A mere four months later they were down an average of 50%. Of my hypothetical $210,000, I had lost $105,000. (A bit of that hypothetical loss was trimmed Friday.)

Last week, he wrote with a bullish case for stocks, and even included 20 recommended names. I’m not buying them myself, even though some of them are so much cheaper than they were four months ago, because I don’t now enough about them. I am definitely not recommending them to you either. Nor do I picture the market jumping 25% any time soon, as David argues it may.

But I was wrong about Cisco when, at 50, I thought it was overvalued and it jumped to 70 – so who knows? Maybe the market is overvalued here as I think it is but will jump 40% anyway.

At the least, if I hadn’t already, I would probably be scared enough by David’s message to cover most of my shorts.

David writes:

When we last “spoke” back in early June, I was focusing on the fact that the market had rallied 40% off the April-4 low on the NASDAQ. Well, we’ve given back about 2/3rds of that gain and everything looks pretty scary right now. Most of the folks that I am speaking to are happy to be just sitting on the sidelines and waiting for better news. To be sure, sitting on the sidelines has been a comfortable position over the last year. On September 1, 2000, almost exactly one year ago, things looked pretty good. The NASDAQ was sitting at 4235. The dot-com bubble had burst months earlier, but the rest of the market was looking OK. The NASDAQ index was off a mere 17% from it’s all time high of 5132, and at the time, things were looking quite rosy. Then came the earnings warnings. [Today, the NASDAQ is around 1900.]

Ooohh, those August turnarounds!

So what’s in store for the market right now? Well, there is a technical indicator that is screaming BUY right now and I think that it bears watching. As you know, I don’t think much of technical analysis. It’s not that charts don’t have any value; it’s just the question of how to read them. There is an old saying: “Give the same chart to five analysts and you are likely to get at least 10 opinions” …and some of them just might be correct! But there are some indicators that have an uncanny record. One of these is the ARMS (aka TRIN) index. A market technician by the name of Dick Arms came up with this little formula sometime in the mid-1970s and its simplicity is beautiful.

The math goes like this:

Divide the actual number of rising stocks by the actual number of declining stocks.

Next, divide that number by the number you get by dividing the advancing volume by the declining volume.

Here is an example:

DAY 1: 2000 stocks advancing (total volume 600m shares). 1000 stocks declining (total volume 300m shares).

2000/1000 = 2
600/300 = 2
2/2 = 1.0

So the ARMS index for that day is at 1.00 — which indicates neutral market action. The interesting part of this indicator is that it can easily read neutral, despite the fact that the market probably went up a whole lot on the day in question. (Notice that there were twice as many rising stocks as decliners). The reason it reads neutral is that the ratio of up volume to rising stocks is perfectly correlated. Twice as many rising stocks, twice as much volume in those stocks … pretty much as you would expect.

Of course, there are times when that doesn’t happen. Here is another example:

DAY 2: 1500 stocks advancing (total volume 300m shares). 1500 stocks declining (total volume 600m shares).

1500/1500 = 1
300/600 = .5
1/.5 = 2.00

In this example the ARMS index for that day reads 2.00 — which indicates a bearish (down) market. It is true that there were the same number of stocks declining as advancing (and the averages were probably flattish on this day); but since the total volume in the declining stocks was double that of the total volume in the rising stocks, the underlying activity indicates selling pressure, and this is significant . . . and often overlooked. The action on this day was clearly concentrated on the declining stocks, even though there were an equal number of stocks rising as falling.

This indicator is great because it gives an indication of buying pressure vs. selling pressure — regardless of market direction, and irrespective of how large total volume is on any given day. It enables you to evaluate where the real sentiment of the market is. A reading above 1.00 indicates selling, and a reading below 1.00 indicates buying. After a long, relentless move in one direction, the market usually reverses direction. The most important thing about this indicator is that it rarely goes haywire. There are lots of market indicators that are giving buy and sell signals back and forth every few weeks. Most of the time, however, this indicator reads pretty close to neutral. It’s value to us on a day to day basis is really not great. I know that a number of futures traders and day traders use this as a very short term indicator for overbought/oversold markets; but these guys are in and out of the market every 10 minutes and that has little to do with us. Instead, I look at the 10-day moving average of this indicator for the NYSE. I didn’t figure this out myself. A while ago I saw Dick Arms interviewed and he pointed out that this is the best way to use his famous indicator. The problem with following this 10-day moving average is that it is not very exciting. There are years, DECADES even, where it hangs out in neutral territory. But on those occasions when it gets extreme, boy, is it important. This is one of those times.

The ARMS index 10-day moving average moved over 1.50 on Aug 15th and stayed there for 5 consecutive days – hitting a high of 1.66 on Aug 17.

Over the last 30 years, I have calculated that the 10-day moving average has gone over 1.50 only four times; each of those times was a phenomenal buying point. In each case, the stock market rallied at least 25% over the next 9 months. Looking at recent history: The ARMS index 10-day moving average rose over 1.50 in Oct 1997, and the DJIA rally from trough to peak over the next 9 months was 31%. (The NASDAQ rallied 38%.) Again in Oct 1998 the index gave a buy signal and by the following May, the DJIA was up 49%. (The NASDAQ rallied 111% by the following July). The last time that the 10-day moving average rose over 1.50 was in March of this year. It’s difficult to remember, but we actually did have a huge rally after that reading was recorded. In fact, between April 4 and May 22 of this year, the NASDAQ rallied 44% – while the DJIA rose 25% between its March 22 low and the May 21 high.

So what now?? I am going for broke (and will probably end up that way) but I am fully invested and even leveraged up right here and now. I recognize that the market can and may take another big hit over the next month or two. This ARMS index reading doesn’t necessarily mean that the market will rally immediately. In fact, in most cases, the market has gone a fair bit lower before beginning to move up. But it’s just too difficult to time these things precisely.

Market sentiment right now is incredibly bearish. The put/call ratios (another good contrary sentiment indicator) are saying that we are due for a rally soon. Trading volume is low and nobody is really paying attention any more. These are all classic signs of a major market bottom. The FED started cutting rates 9 months ago, this is going to start to affect the economy soon. The US Dollar has weakened a bit and that will help earnings for companies doing business overseas. Finally, the huge write-offs that so many tech companies have taken over the last few quarters is setting them up for a great 2002. There was an article in the Wall Street Journal last week that showed how all the technology company profits made between 1995-2000 were wiped out in the last 18 months of losses. That is true because of the huge asset write-downs that were taken this year, not because of actual cash losses. What most people are forgetting is that these managers are setting themselves up to be heroes next year. They are bringing expectations down. They are writing off assets at an almost ridiculous rate. On July 26, tech powerhouse JDSU announced a 2001 loss totaling $51 Billion. The vast majority of this loss was due to write-offs associated with acquisitions made over the last few years. But what this effectively does is set themselves up for a great 2002. Most managers realized long ago that its better to get all the bad news out of the way all at once, and then show the world (or at least Wall St.) how brilliant they are by managing to snap back so quickly. It’s a very old game. I think that they are playing it to the hilt right now.

Finally, and in no particular order, here are my twenty favorite stocks right now:

WFII STOR NUFO MRVC LMNE INKT FIBR AVNX AVCI ONIS AMCC BEAS EXTR NTAP EMC TXN NSM CREE GLW SSTI.

So there you have it. I think David did a terrific job laying this out for us. But at the very least, promise me you won’t buy any stocks or mutual funds on margin, or before paying off all your high-interest credit-card balances. Because you’ll notice that no place in the ARMS analysis is there a calculation of ‘value.’ And in the long run, value is probably what matters most.

And don’t forget Paul Krugman’s column

Tomorrow: A Tiny Column By Way of Apology for Taking So Much of Your Time Today

 

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