November 29, 2002
No Bull: Despite Recent Gains the Bear Market is Intact
There are two interrelated reasons to speculate on why the great bear market has not yet had its last growl:
1) Those stocks that had (have) high short interest are leading the current rally, not necessarily those companies that should be rallying the strongest given the widespread expectation for an economic turnaround.
2) The Nasdaq breakout rally has not been confirmed in other averages.
Short Sellers Pounded
One of the main reasons why tech stocks have rallied the strongest as of late is because short sellers previously ganged up on tech stocks. To be sure, if blue chip stock Philip Morris has 0.6% short interest (as a percentage of its float) and Amazon.com has 20% short interest it is not a stretch to assume that a widespread stock market rally will fuel more short covering in AMZN than in MO. Additionally, and given that the current rally has lasted many weeks, it is also not a stretch to assume that many short sellers have been ‘squeezed’ – or forced to cover due to margin constraints.
That said, short covering has not been isolated to tech stocks. Rather, heavily shorted auto stocks like GM and Ford previously leapt ahead by 10+% in a single session for virtually no reason, and other heavily shorted stocks in virtually every industry have seen oddball gains that smell of short covering.
Dow Shorts
Dow components with short interest of or below 1.2% (float - as of Nov 8), have rallied by an average of 6.5% since the Dow’s intraday bottom on November 13, while Dow components with 1.3% or higher short interest have rallied by 10.6%.
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As for tech stocks, the trend has been much the same: the greater the short interest the greater the rally. (Nasdaq 100 -- Snapshot -- % Change From Nov 13)
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Granted, the above (tech) data is not complete, and we will not know until mid-December how many shorts covered (by then the data will be dated). Nevertheless, that tech stocks, which had more short interest, have rallied the strongest during the current rally is not a coincidence.
In sum, a short induced stock market rally could certainly lead to something larger. However, a market supported by shorts can also presage an abrupt fall in prices due to lack of buying support (if, and when, the squeeze ends).
Nasdaq All Alone
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The Nasdaq has beaten its August lows with a authority, and the average is now within reach of its 200 DMA (this could be good or bad news dependent upon your outlook). However, that no other major average has confirmed the Nasdaq rally could mean that the current rally, like each bear market rally since March 2000, does not have staying power.
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The key group to watch is bank stocks. The BKX is a stones throw away form both its 200 DMA and its August highs. If the U.S. economy is about to embark upon a sustained recovery bank stocks will, eventually, take the lead...
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The Rotation Factor
In the last 5-days 18 industries, including Tobacco, Water Utilities, Personal household products, Crops, Retail (drugs), major drugs, and gold and silver, have lost ground even as the main indices have posted strong gains. By contrast, in the last 5-days 9 industries, including computer storage devices, semiconductors, computer networks, airlines, and auto and truck manufacturers, have seen gains of 10+%. Needless to say, anyone who has watched the markets knows why people were (are) heavily short in airlines and auto manufactures (fear of bankruptcy and pension/slowing auto sale worries). By contrast, the onlooker also knows why Tobacco, water utilities, drugs, gold and silver, etc, have performed well for much of the bear market (high dividend yields, stable revenues, and crisis protection).
Point being, that many of the previous bear market leaders have stalled while beaten down groups have rallied strongly suggests rotation, not necessarily a new, powerful influx of capital.
Conclusion
The media and Wall Street tell us that investor’s are feeling increasingly cheery, yet scant new money is reported moving into stocks....is the truth not that fund managers and those already invested in stocks are the ones feeling extra cheery?
Regardless, it would not be a shock if the Dow (9,129) joins the Nasdaq back above its August highs: while it is difficult to foresee retail investors taking on more equities exposure it is certainly possible. What is worth remembering is that the economic recovery could not have looked any better than it did during January-March 2002, and, as it turned out, the early 2002 ‘recovery’ was extremely short lived.
In sum, given that shorts have been covering at a faster pace than at any other time during the bear market it is reasonable to conclude that the shorts have helped turn what would otherwise be a solid rally into a spectacular rally. Are the shorts done being squeezed? This is a question not easily answered. Only one thing is for certain: a strong rally in tech stocks does not a new bull market make. Rather, and unless we are in another ‘jobless’ recovery, a ‘borrowless’ recovery, or a hip new ‘default’ recovery, banks stocks should be leading.
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