Equity Rollover Here to Stay

Q: Mike, the bond market has certainly been out of step with the Fed rate hikes. What do you make of its action?

A:It''s not the first time that you could have thought the bond market was out of step with whatever crosscurrents are affecting it. You could probably go back to the beginning of 2004 and come to the conclusion that there were some strange things going on in the bond market. So, now looking at the bond market it seems to me that the fact that it hasn''t broken down -- that is, rates haven''t taken off, the 10-year hasn''t gone over 4.50 -- there''s a fear out there that''s driving money into safety. I suspect at some point the economy will roll over and the bond market could already be discounting the next recession, or the next bout of economic weakness.

But I think right now it doesn''t look like there''s weakness on the horizon, not just yet, so what is the bond market discounting? I think it''s discounting money coming out of stocks and perhaps the fear of money not going into housing as much as it did. So if that''s the case, then maybe we are going for an inverted curve. The only thing in my judgment that would change that is if foreign purchases of treasuries really slowed down big time and/or if they became sellers. But right now I don''t think that''s a real fear.

Q: What are your thoughts with regard to the U.S. dollar?

A: From a technical perspective, from the high at the beginning of this year at nearly $1.37 against the euro, the dollar we came careening down to the July low of $1.18 1/2 or so. Since that time I don''t see that we''ve created a major bottom, I just think we''re working off the oversold condition in the euro. The euro has one more downleg -- the dollar one more blip to the upside -- and that will take it to $1.16, maybe 41.15, somewhere in there. At that point the entire decline from $1.37 will be over, and then you''ll have a massive rally in the euro, and I suspect that that rally in the euro will really start to grip the market in the first quarter of next year. Typically, whichever direction the currency is going heading into the 4th quarter, typically it gains momentum in that quarter. So my sense is the dollar will still have some steam on the upside, and the euro will still have a problem in the fourth quarter.

Q: So, gold, in turn, is not ready to rally yet?

A: Right. For the most part the euro is really the determinant of where gold goes?unless there is some extraneous event that triggers a move in gold and the dollar follows. But usually it''s the dollar first. If the dollar is strong into the end of the 4th quarter, then chances are gold is not going anywhere. The question is: Will it even go down? Frankly, I don''t see gold going below $435-430. If it does, then I think we have to re-look at things. But as long as it holds above $430, at some point it''s going to take off again right after that. So, if it goes sideways between $445 and $430 into the end of the year, then I think it can takes off after that and can go up a lot. I think it probably can go to $500 first and then we''ll see what happens after that.

Q: What do you think it is that has held the equity markets together for so long?

A: If you had told me in October 2002 when the S&P was at its lows down near 770 that we''d be nearly three years later and the S&P pattern would argue we''re still in a pretty powerful uptrend, I would have said, "No way!" From my perspective I thought the bear market started in March 2000. The first leg of it maybe ended in October 2002, and in the first quarter of 2004 I was pretty convinced the market wouldn''t go up any higher. The S&P had recovered from 770 to 1150-60. We pulled back into August 2004, to 1050, and that''s when I thought we''d start to accelerate to the downside, and we turned around and we''re still in that upleg from a year ago.

The last upleg really surprised me. And the move from the July 7 low a month and a half ago on the day of the terrorist attack in London really surprised me, too. We discussed last time we spoke that that upleg from 1180 roughly in the cash S&P to 1246 roughly was the final psychological move for bull market psychology in the August 2004 to August 2005 upmove. I think anybody who was not particularly bullish after July 7 jumped in and threw in the towel, so I think psychologically something ended in early August at 1246 roughly in the S&P, and we have started to and are continuing to roll over. There are two important levels -- one is 1200 and we''re getting near that. We had a bad week last week, and the low so far is 1204 and change. These are cash index numbers. So 1200 is important, and then you have the low from July 7, which is also important, at 1183 1/2, and then you have the trendline from last August, which cuts through at 1172.

So my sense is 1183 down to 1172 is the critical area in the bull move from the October 2002 lows. If that''s broken I think it''s over and out and we go down in a big way. Having said that, I also think that the bear market that started in March 2000 is not complete. We had a 2 1/2-year bear phase, then we had a three-year recovery phase, and now I think we''re going to roll over and have another 2-3 year relative problem in the equity side. Things tend to happen a lot faster, however, on the downside than they do on the upside. So it wouldn''t surprise me to have a nasty 4th quarter this year and do some serious damage to the market. Under 1170, you could go down to take out 1060 from last August and then you go to 1000. That could be a very fast move, and any rally in the 1st quarter of next year would just be a minor recovery rally before the final shoe drops.

If that sell-off is attached to the bear-market leg that started in 2000, then I think we go a lot lower than 1000 in the S&P and retest the October 2002 lows. In short, I think the equity side is going to slow down dramatically. Probably housing will be right in there with it if not leading it. The financials will be having problems, and the euro in the 1st quarter will be taking off and that will not help matters.

Q: Any parting observations?

A: I think crude oil is still really powerful, and is probably going to $80-85 sooner rather than later. That''s another factor that will impact equities, and even if oil was to roll over from let''s say $80 and went back to $50, I think it will be too little too late and we will have slowed down dramatically as an economy.