Is Stock Market in Distribution?

One of the worst things an analyst or investor can do is try to call a market top, especially if an all-out mania is underway, as is presently the case. Unless clear-cut reversal patterns are forming in the averages, it is best to leave trying to pinpoint the top alone. That said, however, it appears the U.S. equities market is running out of steam. This does not mean a reversal is nigh at hand; to the contrary, it could be several more weeks or even months before the market finally turns over decisively. But for now, evident signs of distribution abound and we believe the topping process may have started.

For the week, the Dow Jones Industrials closed at 9281 (as of Thursday, Jan. 28), up from last week's close of 9120. The Dow Jones Transportations closed at 3078, up marginally from last week's close of 3063; and the Utilities closed at 303.19, down from last week's 308.73. From a chart pattern perspective, what this all boils down to is a market in consolidation, most likely distribution on the part of insiders to the more gullible investing public. This is seen most clearly on the charts for several major U.S. stocks, specifically the indicators showing distribution, On Balance Volume and money flow. Thus far, liquidity has been geared at certain white-hot NASDAQ issues.

At this late stage of the secular bull market it becomes very difficult to interpret market direction based on sentiment and technical indicators. This is due to the extreme readings in mass psychology (i.e., "irrational exuberance), heavy volatility and outright manipulation. From a Dow Theory perspective one would ask if this market has the character of the third and final primary leg of the market, where, according to Dow Theory, stock valuations are based on irrational hopes and expectations rather than reasonable earnings potential, or whether there is more substance to this market than we give it credit for. The simple answer to this question—at least for now—is that we do not know.

The best advice we can give to position investors is to stay long, or at least avoid going short, until intermediate support at DJ 9100 is broken. This is really what it all boils down to: as long as 9100 holds in the Dow, the bull market should stay intact. Below 9100 we would not want to be long equities.

It would take a close above the previous all-time high in the Dow to turn us firmly bullish again. Short of this, we could end up witnessing a sideways Dow for the next several weeks. A point well worth noting was made by Alan Newman, in the Jan. 25 issue of Crosscurrents. Said Newman: "There are two stock markets: one comprising the stocks that constitute the indexes and one that comprises everything else. These two markets have been moving in opposite directions since the secular bull market began to unravel big time last year. We'll say it again. The divergences visible here are probably the worst of all time, certainly at least equivalent to the divergence that appeared before the top in 1929…

"The annualized rate of net cash inflow into mutual funds has fallen from $223.7 billion in July of 1998 to $175.3 billion last month, based upon our generous estimate of a net cash inflow of $20 billion for the month of December. July's net cash inflow represented about 2.03% of total market cap, December's inflow represents about 1.35% of market cap. In other words, overall buying power has fallen substantially."

Action on the Dow has been representative of nothing less than a classic bull/bear fight. One day the bears prevail, the next day the bulls prevail, back and forth in a pattern that underscores the distribution effect of insider unloading of stocks to gullible "dumb money" investors. At least that is our take on this consolidation. Only time will tell for sure.

Trading volume on the NYSE was fairly heavy last week, with net advancing volume days and net declining volume days pretty much balancing out. The one exception was the ratio of new highs/lows on the NYSE, which has turned decisively negative for the first time since last year. This is not true, of course, for NASDAQ issues, but is quite clearly the case on the NYSE.

Bullish complacency is the rule of the day. The latest numbers released by Investor's Intelligence reveal that the number of bullish advisers has moved up to 60.3% bullish, with bearish advisers dropping to 28.9%. Of course, many investment analysts and newsletter writers have pointed out that these bullish readings have not been this high since the weeks preceding the October 1987 stock market mini-crash. Bert Dohmen of the Wellington Letter, however, puts this into perspective by pointing out that while the bullish readings may be high, the percentage of bearish investment advisers is equally high and should be below 20% before a cause for concern is sounded. He predicts bullish sentiment will reach 70% before the market finally sees another major correction. Frankly, we are not sure what to think since sentiment readings are practically useless in the mania stages of a bull market due to extremes in mass psychology. We suspect, however, that Dohmen is correct.

One thing that has become abundantly clear is that as the Year 2000 draws nearer, frightful scenarios of a Y2K computer crisis will be served up by newsletter writers who seek to profit from the public's fears. We were dismayed to receive a mass mailing recently from a highly regarded international investment adviser who propounded on this Y2K scare scenario in an attempt at gaining more subscribers. It is our studied opinion, cultivated from over two years of careful research, that the Y2K "crisis" is entirely overblown and will not be the disaster being predicted by scores of newletter writers.

Already, the markets seem to have discounted the possibility of a widespread Y2K crisis; certainly, the information surrounding the Y2K problem has been widely available for years and the market has had plenty of time to assimilate and react to this perceived threat. The overwhelming verdict of the market seems to be one of blithe unconcern. Apparently, the market sees something that the masses of investors do not see concerning Y2K, else it would have reacted negatively long ago and we would probably already be in the midst of a severe bear market.

Anything can happen, though, and perhaps the Y2K crisis will later be discovered to pose more of a threat than initially thought. We are certainly not suggesting that investors play ostrich by completely ignoring the issue. However, serious investors should never allow peripheral issues like Y2K to dictate investment decisions unless the market itself reacts negatively to such issues. The key to investment success is to let the market be your guide (i.e., the charts) and not outside events that may or may not have a bearing on stock prices.