This year is challenging indeed, and in the last two weeks I had to change the "forecast" few times (g). here it is:
The turnips apologize for a bad call of a good late December market (it is becoming a tradition to apologize for misreading December…).
In the following, they are going to try and layout their thoughts on the market for the first half of 2003. There are a number of parameters going into building the "scenario" including the political environment, international markets, were is the economy going and what will be the perception of where the economy is going, liquidity and market psychology (TA) as well as valuation metrics. In the following, I will try and muse about these and then "design" what I believe might be a likely scenario for the market this year
Politics
There are no major political events slated for this year, except the fight within the Democratic party for the nomination, and "managing" the economy for a republican victory the coming election in 2004. This year like last, international politics will probably have a greater impact.
We have (currently) three major hot spots that could have an impact on the US economy, the War on Terror, the Mideast conflicts (including Iraq) and political instabilities in South America. The Mideast conflict when it gets "hot" has a secondary impact rooted in the fear of oil embargoes, however, with OPEC operating at less than 75% of capacity and Russia still increasing output, I do not see an oil embargo as either likely or feasible. Yet, a "war premium" on crude can persist as long as the Iraqi situation is brewing. Since crude is already at a two years high, I think this impact is partially priced in.
The War on Terror, will, however, continue, and eventually ends up with an actual conflagration on Iraq's soil, right now it seems that everything is "ready" for a start of hostilities by the middle to late February. The model assumes that by April 1st, major hostilities will be over, and visibility of a "victory" should be there before March 15th. Take into account that predicting the results of hostilities like that are fraught with dangers, but for the purpose of the "model" I'll use late March as a major bottom coinciding with that "visibility". By late April the market may start and ponder "what did those hundreds (hopefully not thousands) of American young lives really buy us". Unfortunately, I fear that Saddam will not seek assylum, nor will Bush want to let him go without taking the "pound of flesh".
There are Israeli elections 1/28/03, but that will probably not bring any change there, so apart of a very slow movement (years) toward a settlement, I don't see this hot spot to have any surprises.
As for South America, it really cannot get much worse, solution of the Venezuela problem will have positive impact on oil markets and Argentina and Brazil problems are in a slow process of stabilization. The down side is spreading of the problems there both west and north, that will have a long term effect on the generally weak world economy and indirectly on US exports, more a part of the multi year secular bear that directly impacting next year.
Economy
We still have not had a "consumer led" recession, and paradoxically, the efforts by the administration to avoid such a retrenchment in 2003, may lead to a recession during 2004, if they stimulate even more, it could be delayed to 2005. One of the major issues may very well be how long crude is going to stay above $30. Not only such a high price is a major drain (just like a tax hike) on the US and other economies, but it might revive fears of inflation (and thus a rise in long term interest rates). I think that by April, crude will be back under $30/barrel.
Short term though, we must take into account that the stimulus spigots are fully open and will have a positive impact on GDP at least during the first half of 2003. I am pretty sure that the GDP numbers for the last quarter of 2002 will come in surprisingly higher than the expected 1.5% by the street. (note that in December the national debt has not increased at all, and I hear that Massachusetts actually run a surplus of $30 MM, so somehow, despite the less robust than expected Christmas season, the economy is not going into a tail spin).
Liquidity
Right now there are no real liquidity constraints, if at all both the Feds and the government are working very hard to stimulate the economy and even directly, the market (the "dividend" exemption is nothing but a ploy to support equity markets, it has no economic justification as I have harped about for quite some time). The signal that the liquidity environment chages will b a rise in short term rates (due to feds' action).
Valuation/technical analysis
It is quite clear that valuation models on the Naz are going to keep a ceiling on that market over the next 12 months. However, if one looks at the DOW with an earnings estimate of $504 for the current fiscal year, the PE is only 16.5, in an environment where the 10 years treasuries are yielding under 4% (3.818% as of the close of the year, which could command on equivalence a PE of 26).
Yet, within this constraints, we must keep in mind few factors that are more technical in nature.
While the late July lows were accompanied by major capitulative signals, a retest in early October failed to hold and did not bring with it major repeat of capitulative signals, thus I don't think that the July/October period was a major accumulation phase justifying the start of a cyclical bull move. The poor quality of the run to 1521.44 (9076 on the Dow) early this month did not have sufficient volume to serve as a major top either. Therefore I expect the first half to be a "muddling through period" with few sharp sell off (particularly in view of the fact that sentiment indicators stink here) possibly with a marginal new low on the Naz, but barely so on the Dow. The second half of the year, I just cannot "see" right now, too many imponderable.
Road Map:
We have already had our first top (from the July/October lows) at about 1520 (and 9076 on the Dow) earlier this month. I still expect a possible second high more than 200 Naz points from were we closed the year, maybe as high as 1550 (maybe as late as the fourth week in January, nominal high is now 1537, nominal high on Dow here just around 9100). Such a double top, but on the surface, a breach of the December highs, should bring bullish sentiments to an extreme even worse than it is now and technically should satisfy the formation of a distributive double top. That should set us up for a grand two, maybe three steps, Nassacre lasting possibly till late June, interrupted by a major upleg, after the first six weeks or so of the first decline (about mid March, coinciding with "visibility" of "victory" in Iraq). Nominally, I have the first leg down as a decline from 1537 to 1263 by 3/19. The model for the Dow does not have such a sharp decline, only to around 8500/8650. That is followed by a sharp "victory" bounce (also dictated by other parameters, though) to just under 1400 (nominal 1391 and around 9300 for the Dow) ending around 4/15-22 (the timing of this bounce was tough for the model and some versions have it only 2 weeks long some 5 weeks long). The next leg down is about 300 Naz points, to around 1100 (nominal new low), but it is not clear now if we breach harshly or not, it really depends on the late April behavior. If the bounce does not even get close to 1400, we may drop much below 1100 (possibly to 950). The second "imponderable" is whether we have a late May bounce into memorial day (5/26). No dates for that low right now. If 1100 holds for the Naz, I doubt the Dow goes much lower than 7900.
If by the end of next week we did not have at least one Dow day up 300 and one Naz day up 40, I may have to scrap this model and go back to the drawing board. Note that for the time being the 950 for the Naz and the 6000 for the Dow are delayed "indefinitely", this secular bear has more legs to it in the next few years.
I am not ready to even try a road map for the second half.
As usual, the turnips absolutely reserve the right to be wrong, change their mind and change it often.
Zeev
