The Balancing Act

For the last twenty-six months, the stock markets have looked more like a three-ring circus than equity markets. In Ring One we have those old mainstays of service and manufacturing known as the New York Stock Exchange and Dow guys. Ring Two contains the drama of the large cap NASDAQ darlings and tightly packed into Ring Three, is the rest of corporate America. Orchestrating our circus is our ringmaster, dressed in his trademark green, “the man” Alan Greenspan, standing on a three step ladder, overlooking the show of shows. His task is to blend the performers in the three rings into a balanced show, not allowing any one ring to overpower another.

This circus has been out of control for over two years. As the red line, in chart number one shows, the players in Ring One, those very large cap giants such as General Electric, Exxon-Mobil, Wal Mart, Citigroup, SBC Communications, America Online, Hewlett-Packard and a few others, led the Dow Jones Industrial and the New York Composite averages to record levels over the last two years. These few companies are the stars that propelled the indexes to the heavens and have danced away from their brothers and sisters. The majority of listed companies, represented by the black line, have been relegated to Ring Three. This divergence began in April of 1998 and has continued to date. But we must remember that the majority of companies in Ring One are the producers. They are the ones that make money and pay dividends and although they are big and heavy, they have been standout market performers.


NYSE Advance-Decline Line

Chart 1

Intel, Cisco, Microsoft, Sun Micro, MCI World Com, Qualcomm, Dell Computer and a few more high tech companies have charged ahead in Ring Two and become the glory boys of the new economy, that is until March 10th of this year. These tech and net stocks drove the NASDAQ Composite up 172% over the past twenty-six months (see chart two). A close look at this chart tells an interesting story. The divergence between the Composite index and the majority of stocks listed on the NASDAQ is even more striking. Here the divergence began in December of 1997, two and one half years ago. This was four months before the separation on the NYSE as shown in Chart 1. This may be the reason that the NASDAQ took such a sharp plunge downward of 1,884 points, or over 37%, this spring.


NASDAQ Advance-Decline Line

Chart 2

Now here is what our Ringmaster is looking at. In Ring One he has a few stars that are large companies, the majority of which are making money and paying dividends. The investing public and money managers love them and they have performed well. In Ring Two, he has a few lean, mean tech and net guys that are fast growing but are not at the point of showing much of a profit. In Ring Three he has relegated all of the “also ran” companies, represented by the black line in Charts 1 and 2. Many of these companies are making money but just are not noticed by the investing public. Many are excellent companies that have real values, but no one wants them because their market performance has not been great.

Ring One could be likened to the elephants. Ring Two houses the slick cheetah that will race to the front killing anything in its path. Ring Three contains the vast majority of corporate America, both listed and NASDAQ. The listed companies are the chariots drawn by horses and the NASDAQ ones are the monkeys springing up and down on the backs of the horses. Around and around go these horse drawn chariots at a steady pace, just marking time. Not one investor’s eye is looking at this ring; all of their attention is focused on Rings One and Two.

Our Ringmaster has many tricks in this tool bag. Most important is his interest rate whip and next is his loud voice, which can travel across media wires in a microsecond. Early in the circus performance he uses this voice calling out, “irrational exuberance” hoping to calm those participants in Rings One and Two. Just the opposite takes place as those assigned to these rings begin to thunder ahead. The elephants begin their run and raise their trunks high in the air. In Ring Two the cheetahs begin their dash to the heavens. When our Ringmaster sees that his voice is ignored, he cracks his whip over these exuberant rings. Again and again, the whip flashes out, six times in all.

This is where we are today. The markets are off their record highs but they are acting in a neurotic way. Mr. Greenspan has raised short-term interest rates on six occasions, trying to cool the economy, yet the jury is still out on the effectiveness of his moves. Herein lies his dilemma. If he raises rates too high the economy will go into a tailspin and the U. S. will find itself in a recession. Worse, the bubble that is supporting the equity markets would burst and we could witness a market correction of all corrections. On the other hand, if he stops raising rates the equity market will continue to roar ahead and all semblance of value will be lost and the bubble will just become larger and larger.

Now let us look at Mr. Greenspan’s balancing act. As he has raised interest rates, he has also provided the liquidity necessary to support equity prices at these lofty levels. The latest report from the St. Louis Fed shows that MZM (money of zero maturity – cash) is rising at about a 6% annualized rate, which provides adequate funds to support the market. But this is tricky. Too much money chasing too few goods causes inflation, which is what he is trying to avoid or; too little could cause a liquidity squeeze, and put pressure on stocks.

In some ways, the markets have co-operated with Chairman Greenspan. All of the market indexes corrected this past spring. The Dow was off about 12% from its high in March, while the NASDAQ was down 37% from its high. The Dow has retraced about one half of its loss and is now trading in a narrow band around this 50% retracement area of Dow 10,759. The NASDAQ will have to better the 4000 level to retrace 50% of its loss which it has not done at this writing, but may do so if a summer rally develops.

There is no doubt that the Fed Chairman is watching the equity markets for signs of what he should do next. He seems to react rather that act. Although the economic data announced in the last several weeks is supportive of a minimal slowing of the economy, the market soared ahead when this news hit the wires. An example was the employment statistics released on June 2nd. When the number of Americans looking for jobs increases, the sane reaction would be for the markets to go down. Not so. When this news was released, the Dow was up 143 points. We are in a volatile market run by amateurs who are speculators not investors. They are aggressive traders who buy every dip. Their holding period is days, not years. To them, there is no limit to the markets advance. All this goes into Mr. Greenspan’s equation for higher interest rates to cool the economy and to lessen speculation.

So, what should we look for next? One signal that the Dow has given us is the fact that it has rallied four times since April. Unfortunately, each attempt has seen a lower high on the Average. The key is going to be if and when the Dow can rally above the 10,759 mark, mentioned earlier. We would be looking for it to stay there for a while, then attempt a move to a new high.

What this balancing act is producing, however, is a return to those companies that have been mired in Ring Three. Money managers and individual investors are finding out that dividends do count. In a market that is going down or moving sideways in a narrow range, if you do not have income you do not have a return on your investment.


Gordon B. Lamb

June 9, 2000