The Return of Exuberance?

An article appearing in the Wall Street Journal last week heralded the return of the speculative mania, stating that "exuberance is back." The article made reference to last week's surge of several broad market indices as they shook off the bearish pallor that had characterized the market over the past few weeks. When the Dow Jones Industrial Average managed to break decisively above near-term resistance of 8750-8800, investors rushed into the market in a feverish buying spree and snapped up as many "undervalued" stocks—mostly in the technology sector—as they possibly could.

By Thursday of last week, a major rally assault on the Dow's all-time print high of 9250 looked imminent - and investors, sensing the change in momentum, hastily jumped the stock market bandwagon in a resumption of the speculative mania that had recently experienced a temporary setback. Anything and everything in the high-tech sector was fair game, but Internet stocks were especially targeted. Microsoft, the "heart and soul of the bull market," traded at an all-time high on Wednesday, June 24. America Online rose 4 points on Thursday, June 25th to 108—an all-time high. And in what a Reuters wire story described as a "wildfire" buying spree, stock of the Internet company MindSpring Enterprises Inc. exploded upward by $15 last week after news of a planned three-for-one stock split, as Internet-hungry individual investors appeared willing to pay any price for the stock. After streaking to $96, the stock settled back to $94.25, up $13.875 on the day, by late-afternoon Thursday in active trading. The stock's previous record high was $85.25.

If this is not speculative frenzy run amok, we don't know what is. Plainly, we are at the pinnacle of the stock market mania and can expect the popping of the bubble at any time now. Mindless buying of severely overvalued technology stocks by investors from companies who cannot hope to live up to such high expectations, especially in light of the Asian crisis, and a developing slowdown in the tech sector, is living proof that rationality has been thrown out the window. And lately, most of the buying has been conducted by "individual investors," as Reuters noted in the case above, not by institutional buyers. The distribution phase we have described in recent weeks where "smart money" insiders have unloaded stock on gullible and unsuspecting "dumb money" general public investors is certainly nearing a culmination. The long and complex topping process evidenced in the DJIA and the S&P 500 indices is flashing a clear bearish warning signal and appears to have completed its formation.

The Dow Jones Industrials finished the day as of this writing (June 25) at 8935 after reachng an intra-day 9025, then falling back nearly 100 points. The Dow has had a very difficult time staying above the 9000 mark even when bullish fervor was at a peak in early May. Consecutive failures to close decisively above this level is a strong indication that ultimate resistance has been met.

The Dow's advance/decline ratio has been in negative territory for over a month now and even last week when the index managed to rally, breadth could not remain convincingly positive and by week's end resumed its bearish decline. Falling market breadth over a several week period almost always signals trouble ahead for the market itself in the near future. We expect this time to be no different.

The incredibly symmetrical formation in the DJIA that has been forming over the past two months seems to have completed its move and has formed a compact and near-perfect head and shoulders top (as we continue to point out in recent commentaries), with the neckline formed between 8800 and 8900. While the significance of this pattern (as well as the pattern itself) may be debated, there can be no doubting that it reflects a larger pattern of a rounding top—a bearish indicator. A failure to rally and hold above the previous all-time print high level of DJIA 9250 will signal the end of the bull market, near-term. Already, several aborted attempts at rallying to new highs have been made with each move registering a lower high and a lower low on the chart—yet another bearish sign.

NASDAQ experienced quite a bull run last week, led by Microsoft which registered an all-time high in its stock price upon news of its victory in an ongoing antitrust suit versus the U.S. government. Investors pushed the stock to $106 on Wednesday, only to see it fall over three points on Thursday as the initial euphoria surrounding the news inevitably wore off. By Thursday, NASDAQ had lost over 16 points for the day and market breadth was back in negative territory.

International stocks, as measured by the Dow Jones World Stock Index, appear to be registering a double top, though it is still too early to assert this with confidence. However, the deep V-shaped formation on this chart qualifies it as a likely candidate for a double top since the time elapsed between its May top and its initial top last July is sufficiently deep enough and long enough to meet the technical requirements of this particular formation. International stocks have fallen sharply since late May along with the recrudescence of the "Asian contagion." Expect this trend to continue throughout the summer.

We continue to urge investors to keep an eye firmly toward entering positions in the Rydex Ursa or Prudent Bear funds—both hedges against falling markets. A break of the Dow's near-term support at 8600 and a subsequent fall to 8000 or below should provide the investor with the perfect opportunity to purchase shares of either, or both, of these funds.