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Dow 2006 vs. Nasdaq 1999

by Michael Nystrom
Friday October 6, 2006
Cambridge, MA

In The Dow's Phony New High, I pointed out that there is ample reason to be skeptical of the Dow's recent advance. However, one cannot argue with new highs, and that is exactly what we have. If you recall, there were just as many, if not more reasons to be skeptical of the Nasdaq advance in 1999, but that did nothing to stop it from more than doubling in its final ejaculation into the year 2000. With each new high, this week's Dow action reminds me more and more of Nasdaq 1999. Now as then, phony or not, the market has the potential to move much higher, and very quickly. It forcefully declared its intention to do just that on Wednesday with its 123 point gain on strong breadth and volume.

Computer guided, program-based trading is momentum driven, creating a positive feedback loop that buys stocks at new highs, sends them higher and buys some more. Dips never have a chance to materialize. If you're a bear, get out of the way! If you need any incentive, take a look back at Nasdaq 1999. The market bounced around between 2,500 - 3,000 for most of the summer, and when it finally broke through 3,000 and to new highs, it barely corrected before hitting 4,000. Boom! 33% in two months. That was the work of the momentum buyers, creating new highs, buying the new highs, and preempting the dips before they appeared. The march upwards was steady, strong and breathtaking. Bears were shown no mercy. Timid bulls were given no pullbacks to establish positions. It was day after day of steady, momentum driven advances.

The chart speaks for itself:

If you recall late 1999, there were just as many skeptics as there were bulls: Only 3 years earlier the market had been trading at 1,000 - it had already come a long way without a correction. Nasdaq stocks had PEs over 100, over 200, over 500, if they had any earnings at all! Stocks would move 5, 10, 20% in a day! It was an unsustainable, unbelievable bubble, and bears knew it couldn't last forever. Many bears tried to hold out, but only ended up adding fuel to the fire by throwing in the towel, little by little as the pain became too intense. Who could blame them? What bear could withstand a 100% gain in under a year?

Back to the Future: October 2006

Which brings us to the present. History doesn't necessarily repeat, but it sometimes rhymes. I'm a big skeptic of these new highs and I know there are many more like me. The Dow's Phony New High has been one of my most popular articles. I got more email than ever, and my message board http://www.bullnotbull.com/blog/ is swarming with bears because of it. The fundamental problem the bears are having now is that we look at the big picture - the very big picture - and cannot believe how the market cannot see what we see. As one bear put it:
The economic news is BAD: Real estate bust. Consumer debt out of control. Government spending out of control. Government debt simply unpayable. Zero household savings. A hollowed-out American economy. An aging population. Baby boomers on the cusp of retirement. Etc. You know the story. How can the market go up in the face of all this bad news?
I sympathize completely. However, the bulls look at a much smaller slice of the pie: Interest rates are coming down, oil prices are coming down, the trend in stocks is up. Easy 1-2-3: buy stocks! It is a no-brainer. New highs? Buy more! This has been an effective strategy for the past quarter century, and this strategy looks like it'll continue to work for at least a little while longer. Plus, they'll never let this thing crash before the election!

The Dow has made new highs now for three days running, which is a reality that we bears have to deal with. This is dangerous territory if you're on the wrong side. The bulls have scored big and there is no telling how high they can take it, as Nasdaq 1999 reminds us. I was surprised to find that both the Wall Street Journal and Investors Business Daily have so far treated the new highs with a healthy dose of skepticism, actually even playing them down. The Money & Investing section of the Journal did have a goofy picture of a cartoon bull, lording over a knocked out bear, and red roses covering the page. But it was not all rah-rah. Under the fold, there was a very bearish story, Despite Blue-Chip Gains, Hedge Funds Increasingly Are Faltering and Closing. But I imagine the tune will change over time and turn into a breathless orgy before this is all over.

After the first new high, the Boston Metro, the free little daily newspaper digest that everyone reads on the subway was sanguine. It featured a bold headline about the new closing high, and went on to say:
[the new high] comes at a time when the stock market is more conservative, even more muted than the Wall Street of early 2000. Then, investors were still piling exuberantly into high tech stocks. In 2006, the market's gains come only after investors' careful parsing of economic data and corporate earnings reports...
Ha ha ha! Did you hear that? Are you investors out there carefully parsing economic data and earnings reports? No, I think it's more like: New highs! Yeah! Buy the momentum!

And thus again the similarity to 1999. This time investors are piling exuberantly into blue chips. Since its mid-July low, the market has seen very little in the way of pullbacks. The advance has been slow, steady, and methodical. Dips are bought before they even turn into dips. This market hasn't seen a 10% correction in over 3 years. Interest rates are coming down. The price of oil is coming down. Stock prices are going up and that is all that's necessary to start the positive feedback loop of higher prices.

As the great trader Jesse Livermore said, "There is only one side of the market - it is not the bull side or the bear side, it is the right side." Bears, we're coming up on the greatest shorting opportunity of a lifetime! Subscribe to my updates and learn how to turn this to your advantage. In the meantime, stand clear and keep your powder dry. Your turn is coming. Comments welcome here.

Announcement: The number of traders frequenting my site has recently increased dramatically, so I'll be doing more writing specifically about my own trading in the coming weeks. As I said, we're coming up on the greatest shorting opportunity of a lifetime. Positioning for it will involve some preparation, both practically and psychologically, and I'll discuss that in depth. If you'd like to be notified, please subscribe. Like all of the best things in life, subscription is free.

Turn off the TV and think!

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