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Ike
Iossif (President/C.I.O. of Aegean Capital
Group, Inc.) talks about the market's direction
the economy, and all of Aegean's proprietary
market indicators. MARKETVIEWS.TV
Interview
with Ike Iossif
By
Dan Bistline 10/26/2002
D.B.
Hi Ike, how are you doing?
I.I.
Fine, thank you.
D.B.
The last time we talked, on 9-15-02 , you had
opined that "it will get worse, before it
gets better!" At the time the SP was at
889, and NASDAQ was at 1270. Subsequently, they
fell to 768 and 1108 respectively. On 10-4-02 in
your weekly report you said that the following
week -although your intermediate term model was
still on a sell signal- your short term model
indicated that we should expect a rally between
10% to 15%. So, you were right with regards to
things getting worse before getting better, and
we have gotten a rally of 16.7% in the SP, and
20% in NASDAQ, which is just a bit higher then
what you were expecting, any thoughts on that?
I.I.
Yes, let's examine the last 5% of the advance.
As it can be seen very clearly, the gains of the
past 5 trading days have not been confirmed,
which means they are built on thin air. That
doesn't mean the market can't push a bit higher,
perhaps 925-930 in the SP, and 1347-1360 in
NASDAQ. What it means is, these gains will be
given up in any pullback. Moreover, because they
are built on thin air, they can be given up
rapidly, and much faster than people expect.
Charts
currently unavailable
D.B.
Can one interpret the fact that the indices
continued to advance in spite these divergences
as a sign of strength? I.I. Given that I have
designed these indicators, and I am fully aware
of what they measure and how, I can tell you
with absolute certainty, that NO this is not the
case! Gains in the face of these divergences are
NOT a sign of strength, they are a sign of
trouble to come, especially if the indices move
up to the targets that I just mentioned. Keep in
mind, that I have designed all the forecasting
models, and over 70% of the indicators that we
use in our decision making process in this firm
for the past 8 years. All in all,17 of them,
plus I have participated in numerous research
projects -over the same period- that we have
conducted over the years on behalf of our
institutional clients, so, I think I have pretty
good understanding of the inner workings of
markets. Based upon that understanding, I'll
tell you again that given the under the surface
action up to now -if the action changes going
forward, that's a different story- the rally has
been built on weakness, not on strength.
The last two and a half years, we have had two
similar rallies one that ended in September of
2000, and the other that ended in March of 2002.
Both of them were followed by devastating
declines. D.B. Can you elaborate more on this?
I.I. Absolutely! I think our listeners/readers
will understand what I am talking about by
examining how our intermediate market timing
models work, what they are telling us, and why.
My definition of intermediate term is somewhere
between 3-4 months. Our "market
timing" methodology is based on assessing
"risk" at any given time, and make
decisions based upon a "return to
risk" ratio. We rate the market based upon our
own "return to risk" ratios that
we have determined to be appropriate for our
investment objectives. First I would like to
explain the concept behind them, and then I'll
get into the details. The forecasting models
take current reading of our indicators, and
compare them to similar reading over the past 15
years of data that we have in our database.
Then, it tells us how the market acted 90-120
going forward, and from there we deduce what we
should expect for the future. To make it simple
to understand, I'll give a one variable example.
Let's say our system was based on just one
indicator (variable) the 14 say RSI. And let's
say today's reading was 11. Our system would go
back and examine what happened to the market
90-120 days later every time we had a reading of
11 over the past 15 years. Supposedly it finds
out that over the past 15 years, we had 10 such
incidents and in seven of those incidents the
market was up on average 10%, 90-120 days later.
In three of those incidents, the market was down
on average 6%, 90-120 days later. Thus we can
deduce that based upon the historical data that
we have, an RSI reading of 11 implies a 70%
probability of 10% gains 90-120 days later, and
a 30% probability of 6% losses 90-120 days
later. The overall estimated return over the
next 90-120 days is: Rest =
(.70)(.10)+(.30)(-.06) =5.2%. In addition, the
probability ratio between the
"bullish" outcome, and the
"bearish" outcome stands at 0.70% /
0.30% = 2.3. In other words, a reading of 11by
the 14 day RSI implies that the market is over
two times more likely to gain 10% over the next
90-120 days, than it is to lose 6% over the same
period. From that point, institutions/individual
can set their own parameters with regards to
their required return to risk ratio. In our
case, we want a better than 2:1 ratio, and an
estimated return above 10%, in order to go long
the market. Others can set more conservative,
or, less conservative standards based upon their
own preferences of risk tolerance.
D.B. I hope
by now, all of our listeners/readers have
understood the concept behind the model. Now
let's get into the details, into the
"mechanics" if you will.
I.I. Our
intermediate term model is comprised of two
variables, a "technical" one which
carries a weight of 65% in the equation, and a
"fundamental" variable which carries a
35% weight in the equation. In addition, more
recent outcomes carry higher weight than more
distant outcomes. Everyone, would understand
that how markets acted 6 months ago based on the
same data, is more relevant to how they acted 15
years ago, based on the same set of data. The
"technical variable is comprised of a few
"sub-variables" such as our 30 day
Buy/Sell equilibrium Index, the 50 day Summation
Indexes, the SI25s, the Quantifiers, the
Aggregate Bullish Sentiment Indicator, and a 2-3
others that I do not wish to mention. The
"fundamental" variable is comprised of
the rate of change of few
"sub-variables" as well, such us:
ECRI's L.E.I., the "Help Wanted"
index, the M.L. High- Yield Master II index, the
I.S.M. Index, the Consumer Confidence index, and
the federal funds futures. Last time we talked
which was on 9-15-02, we had a target -over the
following 4 weeks- for the SP500 of 740 (+/-1.%)
and a target of 1080(+/- 2%) for NASDAQ. The SP
reached 768, and NASDAQ reached 1108, I would
call that pretty darn close! Not to mention that
our model has earned us a spot among the
"Top 10 Timers" (as per "Timer
Digest") for the last 14 consecutive
months. I do not recall anyone else who has been
among the Top 10, for longer period, over the
past 2 1/2 years, so, we must be doing something
right! However, the interesting part is that
after reaching those levels, our intermediate
term models indicates that the risk is still on
the downside, even after the advance of the last
3 weeks. In fact (see page 2) our model is
forecasting an estimated ROR of -7.1% for the
SP, and -7.3% for NASDAQ.
Charts
currently unavailable
The obvious
question, is why our intermediate term model has
continued to give a sell signal, even though our
short-term model forecasted a 10%-15% advance.
The answer is simple: as I explained in the
beginning, our model compares current technicals
and fundamentals with previous ones and it has
seen no difference what-so-ever between the
current readings, and the readings we got during
any of the rallies of the past two and half
years, which resulted in lower prices 3-4 months
down the road! So, what the intermediate model
is telling us, is simply that unless the
underlying technicals and fundamentals change
rather quick, three months from now the market
will be lower than where it is at
presently.
D.B.
Can we dissect that?
I.I.
Of course we can. Let's take a look at a few
things that everyone can understand. Bear market
rallies are characterized by low volume, in fact
every single one of the rallies that we had
since the beginning of the bear market has
shared this characteristic. The current rally
-as the charts indicates- does too, in an
undisputed way. Notice that not only volume has
been decreasing on the way up, but also the only
time it increased, was on Thursday 10-24-02,
when the market fell! That's not what you see at
the beginning of intermediate term rallies. We
are only 10 trading days into it, and the market
is running out of fuel, how is it going to
continue at this rate for another 3-4 months?
For example notice that the volume on the Dow
was 410 million shares on 10-15-02, it has been
decreasing steadily at an average rate of 18.8m
per day! On Friday it hit a nine day low of 242
million. Theoretically
speaking, just to drive home the point, If the
rate of decrease continues at the same pace of
18.8m shares per day, in 13.4 days there will be
no more volume to trade! Is that what you
see at the beginning of intermediate term
rallies? can one expect the market to be higher
3-4 months later under these circumstances? I do
not think so, and you do not need a fancy model
to figure that out.
Charts
currently unavailable
The
next charts come courtesy of my good friend Mr.
Carl Swenlin, of www.decisionpoint.com By
the way, once again I want to give Carl credit
for his immense contribution to technical
analysis, his charts are simply second to none.
The first chart is the percent of stocks that
are above their 200 day moving average.
Charts
currently unavailable
As
we can see very clearly, despite the robust
rally of the past few days, the percentage of
stocks that are above their 200 day moving
average is back to where it was at the last
three major lows! In other words -so far- the
emphasis on "so far" this rally has
been the narrowest we have had since the
beginning of the bear market. One can argue that
given that we had three major rallies every time
the percentage of stocks below their 200 day
moving avg. got that low, we may again be at the
same point, and the rally instead of petering
out, it may accelerate. That I agree, it could
happen. However my analysis is not based on
speculating what may happen, it is based on the
facts of what is happening right now, and right
now nothing is happening, the majority of stocks
is not moving. Is that what you see at the
beginning of intermediate term rallies? I do not
think so!. Next we got three other terrific
charts from Carl illustrating the Participation
Index (click here <http://decisionpoint.com/prime/HistCharts/PIfiles/AboutPI.html>
for a complete description) Basically, the PI
measures short-term price trends and tracks the
number of stocks pushing the upper or lower edge
of the short-term trend envelope. Notice that as
the major indices have mover higher, lesser and
lesser number of stocks have been participating
in the move.
Charts
currently unavailable
So,
not only the current rally lacks volume, not
only it lacks broad participation by the overall
market, it even lacks participation by the
stocks in the indices that have been leading the
rally!. Is that what one would expect at the
beginning of intermediate term rallies?
Definitely not! My point here is that the
technicals -so far- are not supportive of an
intermediate term rally. Unless they improve
90-120 days days down the road the market will
be much lower than where it is at now, that is
why our intermediate term model has remained on
a sell signal. I do not know whether the
background will change for the better, or,
worse. What I do know, is that this is not a
background supportive of sustainable bull moves,
and if it does not change quick the rally will
collapse. Now let's take a look at the
fundamentals. Every rally we have had the past
two and a half years has taken place during
earning seasons under the premise that
"things are so bad, they have to get
better!" I took issue in the April
2001 newsletter with Mr. Jonathan Joseph
-the semiconductor analyst at Smith Barney- who
at the time upgraded the chip stocks, because
according to his rationale "things were so
bad, they had to get better!" For somebody
who draws a seven figure salary you would expect
more sense and analytical integrity, but of
course these are qualities that Wall Street
can't be bothered with, or, nurture in its
corrupted environment. By the way Mr. Joseph's
number one recommendation at the time was -guess
what? KLAC! Because of course "things were
so bad, they had to get better!"
Unfortunately, the fundamentals anyway you look
at them are deteriorating at an alarming rate.
First off all, in the technology sector and more
so in the semiconductor sector , overcapacity
has actually increased over the past year due to
the fact that the "tech geniuses"
(especially the know-it-all folks at Intel)
stubbornly added capacity in 2000, in 2001, and
yes again in 2002, foolishly attempting to spend
their way out of the tech downturn. At the end
of downturns, overcapacity ceases to exist, at
the moment it is just as bad, and in some tech
sectors even worse, than it was at the beginning
of 2000! Is that a recipe for a recovery? I do
not think so! NASDAQ has outperformed the rest
of the indexes in this recent rally, however
according to a study done by John Mauldin
(www.2000wave.com "...15 largest companies
on the NASDAQ, which represented at that time
about 37% of the NASDAQ market value. For the
group of 15 firms, total 2001 pro forma earnings
added up to $25 billion. Real earnings were
about half, or $13 billion. But total option
expenses for the 15 firms were $12.5 billion.
That means pro forma income was cut in half, and
real, Honest-to-Pete profits were a mere $423
million, give or take a few million. Earnings
Before Interest and Hype These 15 firms had a
total market cap of roughly $750 billion (the
total value of their stock). That means the
combined P/E ratio based upon 2001 earnings
which deduct option expenses, and using their
stock price today, is a little north of 1,789!
If you take away Microsoft, the combined
earnings of the remaining 14 is a NEGATIVE $3.5
billion. That means 14 of the largest NASDAQ
firms could not combine to make a profit, if you
deduct the expense of their options. Seven of
these firms had negative earnings once options
were deducted." Moreover, we are now
entering the period after the bubble burst when
consumer spending should indeed begin to decline!
Both in the 1930s, and in Japan recently,
consumer spending did not begin to deteriorate
until 2 to 2 1/2 year after the stock
market bubble has burst. We are beginning to see
this in the deteriorating retail sales, in the
durable orders, and in the reluctance of
corporations to hire new workers due to lack of
final demand. Thus, our model sees even weaker
underlying fundamentals, than the ones the
previous bear market rallies were built upon,
and thus it deduces that in the next 90-120
days, stock prices will be lower than where they
are now. When we look at the current technicals
and fundamentals, we conclude that U.S. equities
have neither investment, nor, speculative merit
in the intermediate term. If the technicals were
to improve, signaling a rally similar to the one
coming off the September 2001 lows, then
equities will develop speculative merit, and in
that case our model would give an intermediate
term buy signal, but that's not the case as of
now. Now let's move on to part B, so we talk
about what it would take "technically"
for the market to develop speculative merit.
Now let's
take a look at the technical condition of the
equity markets.
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