That Don’t Impress Me Much

IBM has a good first quarter, reaffirms guidance for the year, meets all expectations – it then sells off. SanDisk met top line earnings expectations, was “optimistic for the 2nd half of the year – and promptly lost 15% in value. Stocks that do not exceed expectations – or heaven forbid, disappoint (i.e., Nokia or Lexar Media) – get utterly and relentlessly slaughtered.

To us, this reveals a marketplace that has baked in a robust economic recovery and improving end user demand. Many of the “Goldilocks” metrics – which have thus far stimulated the economy – are heading the wrong way, in our opinion. The dollar is strengthening; interest rates are rising, new mortgages slowing. Economists believe that, regardless of who wins the 2004 Presidential elections, taxes are likely to rise to combat the wartime budget deficits. Add to that the elimination of easy year-over-year comparisons going forward – Q2 2004 will be the last such lay up quarter.

The technical picture is not offering a very clarifying view. Since bottoming on an extreme spasm of fear the week of March 22nd, the markets ran up too fast, getting rapidly overbought. Nasdaq gained nearly 100 points in 8 sessions, while the Dow rose 500 points. In our opinion, this is not a sustainable advance, coming on top of the 2003 rocket launch.

Unlike during recent trading periods, none of the metrics we track – fund flows, momentum, sentiment, support levels, valuation measures, money supply, earnings momentum, etc. – are at extreme or predictive levels. Instead, we see a frustrating ‘tweener zone with little conviction in either direction. In light of this, the market has been range bound. With little directional conviction a retracing of recent gains (see nearby chart), is no surprise. We believe sitting on your hands more and trading less to be a good approach until the picture clarifies.

Finally, we must comment upon what seems to be passing for conventional wisdom lately: Time and again, we hear or read that “the underlying fundamentals are very strong – more good earnings and a clear upturn in employment will remove any final doubts about the sustainability of the economy.” We totally agree with Ned Davis’s observation:

“I invest based upon the supply and demand for stocks, and once there are no doubts left about the economic expansion, you are likely near extreme optimism. Extreme optimism means demand is largely satisfied and, almost by definition, the top is the point of maximum optimism.”

That’s an intelligent warning for anyone hoping to make trading profits on the economic recovery at this late stage.