Pictures of a Stock Market Mania

We endeavor to present new views in each of our reports, but this month it seems appropriate to show most of the same pictures we presented in last month's report. Why? For comparison's sake. Comparisons with our prior report should accentuate, if not prove our point, that the U.S. stock market is in the grip of one of the greatest manias of all time.

The recent surge in volume and new price highs in Nasdaq clearly affected our updated estimate for Dollar Trading Volume. We had earlier estimated that the year 2000 might see DTV at 275%-280% of Gross Domestic Product, but the mania continues to grow to new extremes each week. If volume and price trends remain only static with the levels of early March, DTV will reach an astounding 332% of GDP this year. Some respondents have complained that since much of Nasdaq volume is double counted, these numbers are not an accurate reflection of total trading. There is no reasonable method of adjusting the data, which is drawn directly from Nasdaq's own statistics department.

The data we use has been published going back to 1926 by both the NYSE and Nasdaq and purports to be accurate. However, if for the sake of argument all of Nasdaq's DTV numbers going back to 1973 (the first year Nasdaq figures were published) were cut in half to account for double counting, the picture would remain that of a certifiable mania. In this case, our year 2000 estimate for total DTV would still stand at 223% of GDP versus the 133% achieved in 1929 and both the NYSE and Nasdaq DTV will exceed GDP on their own. At the current acknowledged pace, Nasdaq's DTV alone will double its DTV of 1999, which in turn doubled from 1998. Bear in mind, we are treating this estimate with current trends as status quo and no growth in either price or volume. If the current trends remain inclined instead, DTV will surge to a much higher reading.

No matter how we slice it, we see the quintessential snapshot of a stock market mania. We have already witnessed a day in which the trading for one stock issue alone equaled 85% of the GDP generated on that day. The principal business of America has become stock trading. The view of participants, that the future will be permanently forgiving and generous, does not admit to a mania in action. For those, we would simply ask, "If this is not a picture of a mania, what would be?"

The 21-day moving average of total NYSE Nasdaq volume surpassed 3 billion shares last week, nearly doubling from the doldrums of late September 1999. Volume has expanded ten-fold since 1993. In this same span of time, the Dow is up 3.3-fold and Nasdaq has risen 7-fold. However, as prices move higher, more money is required to support each dollar's advance. In general and over the long-term, prices cannot rise unless volume also rises. And prices cannot rise higher unless volume continues to increase. Trouble is, higher volume is generated for the most part by a larger commitment of public and private assets into stocks.

To date, the percentage of household assets in stocks is at an all-time high. Mutual fund cash levels are at 27 year lows. Margin debt and consumer debt levels are at record levels. These are the sources of increased volume. However, a saturation point is eventually achieved and volume can no longer increase sufficiently to support escalated prices. A correction begins. From the late August '92 bottom to the late May '96 highs, volume increased at an annualized pace of 38%, sufficient to drive the Dow higher by 77% and Nasdaq higher by 121%. From the early September '96 bottom to the early May '99 high, volume increased at an annualized rate of 44.5%, sufficient to drive the Dow higher by 91% and Nasdaq higher by the same 121%. The higher rate of increase in volume clearly aided the Dows price increase. For Nasdaq, it took a higher rate of volume to generate the same rate of increase in price. From the September '99 lows to the early March highs, volume increased at the spectacular annualized rate of 140%! Despite the monstrous amount of trading in recent months, Nasdaq has been enabled to rise by only 66%. Prices for the Dow have actually fallen by 4%.

The only way prices can increase from here is if volume increases at least as rapidly as before. It is difficult to imagine that firepower is not very close to at the very least, a temporary and significant period of exhaustion. Any decrease in volume patterns in the weeks or months ahead will very likely be accompanied by a substantial price decline.

The S&P 500 represents approximately 83% of total U.S. stock market capitalization. Despite the appearance of a bull market generated by record new highs in this index last year, it has been anything but a bull market for most of the constituents of the venerable index. In most of the last 14 months, more issues have fallen in price than have risen. However, since the index is capitalization weighted, some stocks have had a dramatic impact on the upside while others have had a much smaller influence on the downside. Given an environment in which momentum has become the key for most money managers, certain S&P names have been in the limelight and as their market caps have risen, index funds have had to keep pace by buying still more shares. This in turn, has kept the momentum managers on the straight and narrow, reinforcing the cycle of madness. In this fashion, Cisco Systems has become the second largest company in the world in terms of market capitalization and threatens to dethrone Microsoft, yet Cisco's sales and earnings are only a small fraction of General Electric, the third largest company in the index. Even more strange is the fact that the value of Employee Stock Options issued to Cisco employees now outnumbers the company's revenues. With it's aggressive ESOP plan, Cisco has managed to increase its own market capitalization and thus its sponsorship, led by index funds and momentum managers. Cisco's influence on the Index is becoming increasingly dependent upon its own ESOP!

In 1995, the mania for stocks commenced, but action was sufficiently broad to be bullish. 341 of the S&P constituents accounted for fully 100% of the index gains for the year.

The following year, only 216 issues were required to account for the year's gains and in 1997, 242 of the 500 were required to account for the year's gains. Then in 1998, the mania accelerated and the circle really began to narrow; the year's gains were generated by the upside action in only 89 issues. Last year, a mere 31 of the 500 accounted for all of the index gains. Clearly, the mania is running out of favorites.

The negative divergence of daily breadth continues to illustrate the worst overall market for stocks in history. No amount of inherent bias could possibly produce the crash in breadth visible since April of 1998 in the midst of a bull market. We reiterate, much of the move to the October 1998 bottom was not just down, but crash-like in nature. As well, much of the move since the July 1999 highs has the appearance of a crash.

Ironically, even as the Nasdaq indexes caught fire from the fall of 1999 and into 2000, Nasdaq breadth remained under severe pressure and consistently hit new lows even as the index registered new highs. On January 22, 2000, Nasdaq hit a record high. The next day, breadth registered a new low. On February 7th & 8th, Nasdaq hit a new record. On February 8th & 9th, breadth ran to a new low. On February 10th, while Nasdaq recorded a new high, breadth again made a new low.

The same pattern of new index high and new breadth lows occurred again on February 17th, February 23rd and February 24th. On March 9th, prices again went to a new high and the following day breadth succumbed to a new low. The process was repeated a day later. This is without a scintilla of doubt, the most amazing and negative divergence in stock market history.

Last week, the Dow staged one of its most powerful rallies ever, vaulting 8% in two days.

Despite the incredible reversal, 4536 issues finished lower for the week and only 4430 issues finished higher. This could not happen in a healthy environment, where continued gains would logically be expected.

Weekly A/D figures are exactly where you would expect to find them mired in the midst of a bear market. Clearly, this is one of the most shocking pictures to emerge from the mania.

The only meaningful definition of a bull market is "higher stock prices." An ongoing bull market is marked by still higher prices and by definition, must record new price highs for its constituents. The relationship has provided a near perfect alignment of new high/new low data and price data dating back for many decades.

One rises, the other rises. One falls, the other falls. A divergence of new high/new low data from price should be taken as an extremely reliable indication of a market's overall health. In the illustration presented here, high/low data has diverged negatively and very significantly since May of 1998, correctly anticipating a protracted period of weakness in the broad market of U.S. stocks. Most stocks were down in 1998 and again in 1999. Given the continued negative divergence of new highs/new lows, the rational expectation is that most stocks will be down again in 2000. The combined line for the NYSE - Nasdaq shown here remains under great pressure and signifies a continuing bear market. Given the enormous advance in Nasdaq's Composite Index since October 1999, one would expect a broad follow through of Nasdaq's constituents. Interestingly, despite the advance, the Cumulative High/Low line for Nasdaq alone (not shown) remains well below the May 1998 peak.

Margin debt again hit a new high in February and is now up 50% in six months and 87% over last year. A rising level of margin debt, while it lasts, is a bullish indicator for the short term. However, when the level of margin debt turns down, lower prices should be expected. To place the enormous increase in margin debt into perspective, total margin debt now exceeds last year's entire net inflow into mutual funds and total margin debt accumulated over the past year amounts to 53% of last year's net inflow into mutuals. Total margin debt now equals 2.63% of GDP, the highest since the Roaring Twenties. Although many bulls are quick to point out that the levels of margin debt compared to total stock market capitalization are far below what they were in 1929 and are therefore not dangerous (sic), this analysis does not factor into account that participants in the current era have easy access to a vest reservoir of borrowed funds via home equity lines of credit, credit cards, second mortgages and the like. In fact, one of the Federal Reserve's rationales for not raising initial margin requirements is that it would little impact since participants can raise money elsewhere. This admission means that the FRB has accepted the fact that far more borrowed money has come into the arena than seen in margin debt numbers. Last week, SEC Chairman Arthur Levitt said that he is concerned about the level of understanding many investors have about the workings of financial markets, suggesting many of them are overextending themselves. This is as near to a confession as you will find that debt has risen to a level that threatens the stock market.

Can the mania continue? Given the nature of the unfathomable personality of "maniacs," perhaps. Clearly, what remains to enforce the upside is the unfettered bullish attitudes of investors and speculators. The question is, "....have all the available resources to buy stocks been put to work?" When the answer is yes, the mania will end. In the closing paragraph of our March 13th issue, we said, "It is patently clear that borrowed money is funding far too much of the stock market's present inflows. In the past, similar shifts have resulted in much greater risks for a collapse of prices. In our view, time is running out for a contained deflation of the mania."

-- Look out below (@ .), March 21, 2000

Answers

The URL of the report above (with graphs)Cross Currents

-- Possible Impact (posim@hotmail.com), March 21, 2000.

The Contrarian: Market Rap

In the mania chronicles And speaking of MicroStrategy, today's mania chronicle illuminates the dark side of speculation and the dangers that marrying speculative securities and leverage can create. It's a bit X-rated, but I think it is worth noting that these kinds of problems do arise. I would like to make it perfectly clear that I am not rooting for bad things to happen to people in any way, shape or form. The focus of the Rap and my reason for highlighting the mania chronicles, has been to make people aware of the speculation that is going on and the dangers that exist.

When we misallocate capital, use lots of leverage and do things that are wrong, wrong, wrong - bad things happen. My feeling has been that if people are forewarned (prepared), it's the best defense against trouble down the road. Having said that, here is a very sobering example of the kind of damage too much speculation can do. Let's hope that this person came to his senses and didn't carry out his threats.

(The following is post from the Yahoo MSTR board):

"I bought MSTR on margin and lost $129,000.00 as of close today. Margined for half. Total loss. Margin was called late this afternoon. Lost everything I worked 21 years to save. This is nice for those who enjoy the suffering of others. Tonight may be my last night of life. I never thought one could lose like this. Yet, there are those here who enjoy my losses. I am drinking now, to gain courage to meet my losses like a man, and move onto another world where no one will care. I am not married and have no children so my absence will mean nothing to anyone. I see no other avenue of escape. I cannot live with my stupidity and I cannot live with losing everything. I am leaving for awhile now. God bless others who lost. I will pray for you."

That was just one high-flying tech stock (MicroStrategy or MSTR) tanking. This is sad beyond words...

-- DeeEmBee (macbeth1@pacbell.net), March 22, 2000.

DeeEmBee:

Holy Crap! When was the message posted on the Yahoo MSTR board? Did anyone know who this guy is and, if so, did they call the police? This sounds like a real serious suicide threat. Do you have any other info?

-- Jim Cooke (JJCooke@yahoo.com), March 22, 2000.

The poster's name is Nazdick. Someone said that his post was exposed as a hoax. It doesn't sound like a hoax to me.

-- Debbie (dbspence@usa.net), March 22, 2000.

by: nazdick 3/21/00 11:40 am
Msg: 8200 of 9186
On my lunch hour and wanted to thank
all the kind people that were here for me last night.
It was the worst day of my life, but I received comfort from many of you, strangers, people who care.
Thankyou, that made the difference. I have no immediate family and my friends are mostly from work.
I could not discuss this loss with them
I must live with my own stupidity.
I will go on however.
I am sorry to see that there are still people posting, who enjoy the terrible losses many have felt including myself.
I basically lost all my money yesterday and I am now too old to earn that kind of money again.
My stupidity will plague me for life. A constant reminder will be the way I will now be forced to live.
Well, I have to get back to work.
Thankyou again, you know who you are. God bless you.


-- Debbie (dbspence@usa.net), March 22, 2000.

How many more are out there that will suffer this same kind of loss? Tens of thousands? millions?

So, so sad. I am scared particularly for the elderly and retired.

nancy

-- NH (new@mindspring.com), March 22, 2000.