"Only Commit Cash to a Rising Market"

S&P's Paul Cherney doesn't think the markets have much further to sink, but he isn't predicting a major return of the bulls, either

Investors are likely to see the stock market moving sideways for a while -- but Thanksgiving could bring investors something to be thankful for. So says Paul Cherney, market analyst (and online columnist) for Standard & Poor's. Cherney applies both fundamental and technical analysis to his interpretation of the market.

With the consumer and business both on the spending sidelines, he doesn't see any immediate upturn in stocks. But he thinks the market is close to a bottom, and that the last five or six weeks of the year could see better prices -- but nothing like the bull market of recent memory. It will take a return of the big money to a buying mode to produce a genuine upturn, Cherney believes.

He has studied the behavior of the market in the nine previous times since 1918 that it fell 10% or more in a week and finds that in only two of those nine did stocks climb in the following week, as they did after the recent 14% drop. That gives him hope for the future. And, in any case, he suggests a strategy of dollar-cost averaging even now -- putting a regular amount into the market at weekly or monthly intervals.

Cherney made these comments in a chat presented Sept. 27 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Edited excerpts from this chat follow, and a full transcript is available on AOL at keyword: BW Talk.

Q: Paul, the market has been trying to comfort us a bit, but the bottom-line question remains: Are we anywhere near a bottom?


I think that the S&P will be unable to close below 926 [the close for the S&P 500 on Sept. 28 was 1,040.94]. Yes, I think we're close to a bottom. However, I do not think that we will revisit the rocketlike upside that so many people became used to in the last bull market.

Q: [That figure of] 926 on the S&P still sounds like there's further to go. Do you think the market will hit that low?


No. But I cannot rule out a close which undercuts last Friday's close, which was 965.8.

Q: Do you think we're in a U curve as opposed to a V?


In terms of the economy or the stock market? In the economy, the consumer looks to be out of the equation in the short run. That would mean a flat economy, possibly a recession. For the stock market, [it would mean] a similar sideways move, without much to the upside, for the next two months, because we're still in the upper edge of the envelope in valuations.

Q: With consumer spending hit and no sign of an upturn in corporate earnings, what could trigger a revival in stocks?


Unfortunately, you've hit two nails on the head. Those two reasons are exactly why I do not think the markets can trend higher in a significant fashion. The possibility is real that we will move sideways in a trading range bounded by the lows we set over the next five trade days, and highs above that of 6% to 8% for the S&P 500 and 15% to 18% for the Nasdaq.

Q: Paul, when there's a horrible, unpredictable shock to the financial system as we had on Sept. 11, how do you adjust for it as a technical analyst? I would think charts might not have much to tell us in that situation.


Chart support and resistance are always evident on the charts. However, you're right. When an exogenous headline or event is injected into market-participant sentiment, it can force prices to move erratically. However, so far, the longer-term support evident from June through September of 1997 [I think] is still in place.

Q: Isn't it true that historically, disasters have proved to be a launching board for stock market rallies?


Yes, quite often they represent the final shock to a declining market, which first forces sellers off the fence.... And's easy for stocks to trend higher, because the only buyers are believers that the long term will show gains. And they will be reluctant to sell out on a short-term dip because they truly have made the commitment for the longer haul.

Q: What do you think about the Nasdaq 100 (QQQ )? When would be a good time to buy?


I don't look at the chart action of it, but just today I ran a quarterly review to see which stocks had done the best and the worst. As of yesterday's close, I showed only one stock in the Nasdaq 100 that had a gain so far in the quarter: That was BGEN (Biogen). When things get this bad, you tend to think that they can't get worse. But I'm of the school that you only commit cash to a rising market because the odds are with you then. So far, this market has not shown the ability to trend higher yet.

Q: For my next buy I'm looking for a bargain with long-term growth -- what sector is best?


At this time, I think it's most important to wait for the market to reverse the bearish trend it's in first. Then, start to look for the sectors that are outperforming. The Street is littered with people who have bloody hands from trying to catch this falling knife. My attitude is, let it hit the ground, then wait to see who leads on the way up. Any other method or speculation is purely a guess.

Q: When the stock market recovers, what stock sectors do you foresee recovering first?


Only because they have suffered so tremendously, there should be a spell of rapid increase in prices for the former bellwether techs. However, I repeat, and I mean this sincerely, the time to choose those sectors and stocks which look to be the market leaders is after the trend has reversed.

Q: Isn't the market a bargain hunter's dream?


It depends on your time horizon. I think yes. However, as I've stated before, the reluctance of big money to commit to a market that does not fit many valuation models will probably prevent the markets from putting in a consistent uptrend for the next couple of months.

Q: Do you see any sign of the big money returning to a buying mode?


I would expect the bigger money to support an uptrend once it becomes more evident that the Fed's policy is reaping rewards -- i.e., that capital investment is increasing and that the general cycle of investment is expanding. That probably won't occur until after the market has been stumbling higher for three to six months. Big money defines the trend. Right now, the trend remains down because big money is on the sidelines, waiting for more conclusive evidence of an improvement in earnings and the economy.

Q: Paul, do you think we can learn anything about what might happen to the markets by looking at how they responded to past shocks to the financial markets?


Yes, I think so. I just did a study that looked at price performance in the week after a week that showed a closing loss of 10% or greater in the DJIA. Interestingly, of the nine previous times since 1918 that the DJIA has lost 10% or more in a week, there have only been two occasions when the market has risen on the first trade day following the 10% decline. We did that this week. Monday was a day of good gains. The only two times out of the nine that the Dow managed to put on good gains in the first day after a weekly loss of 10% occurred on 7/22/33 and 6/21/30. In both of those cases, the low from the previous week was not undercut (except for one day in 1930 -- no days in 1933 undercut the previous week's close), and stocks managed to stumble higher for at least 18 trade days. So that historical scenario has the potential to unfold right now.

Q: As the holidays near, should we write off the last quarter and shift focus to the first quarter [of 2002]?


I don't think so. There's a very strong seasonal pattern which comes in around mid- to late November. There's the potential that most people who want to sell will have done it, or will do it, between now and the middle of October. We have to look at the price action, and we have to stay aware of the international situation [that America is dealing with in combatting terrorism]. I think there's a good chance that the last five or six weeks of this year could see prices move higher.

Q: The last time you were with us, someone asked if you had looked at the Dow of 1929 compared with the Nasdaq of 2000. What have you found?


The patterns are very similar. However, if we were to continue on the track timewise that the Dow exhibited, it would be a little bit over a year before the Nasdaq would hit bottom. I don't think it will take that long, because the markets these days react more quickly than in the past. So, something at the latest like the springtime would probably mark a two-year bear market, and the end. That's probably a worst-case scenario. I still like the notion of the seasonal strength starting around Thanksgiving.

Q: Do we continue to buy in these times if our time frames are five years or more, or wait for some kind of bottom?


I think, right now, if you don't do it already, dollar-cost averaging makes the greatest sense in the world -- just consistently, monthly or weekly, putting money into the market.

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