Bouncing around in the 8,700-to-9,000 range, the Dow Jones industrial average is back where it was in March. Four times it pierced the 9,000 barrier and four times it fell back. If you look at a daily chart, it looks as if a broad, flat market top began forming at the beginning of April.
I wouldn’t rule out another assault on the 9,000 mark, but I believe the stock market is acting “toppy.” Corporate profits look soggy. The ratio of stock prices to value measures (earnings, dividends, book value, you name it) is extremely high.
In fact, valuations rival or exceed those of historic tops in 1929, 1962, 1973 and 1987. And if the Federal Reserve Board raises interest rates, that would probably be the finishing blow.
All that is just one man’s opinion, of course. I wanted to check my view against other people’s, so I called a few people who specialize in taking the pulse of the market.
Richard Arms, who sells research to institutions under the name Arms Advisory in Albuquerque, said he has “looked at every bull market this century, and a strange thing happens at the end of each bull market. I call it the ‘terminal burst.’ ”
This burst is a strong price advance that lasts about three months and takes place “after the bull market looks as if it is over,” Arms said. This time, he says, the bull market looked as if it might die when the Asian economic crisis erupted in October. Stocks did decline 10%, but then the bull staggered to its feet and staged a terminal burst from January into April.
There were terminal bursts of 10% or more in seven of this century’s nine major bull markets, Arms says. The average burst carried stocks up 19%. In 1997-1998, the Dow gained 33% from the Oct. 28, 1997, low of 6,971.32 to the May 4, 1998, high of 9,261.91.
Now, Arms believes the terminal burst has spent its energy, and “it certainly looks as if the market has rolled over.” He thinks the Dow industrials will fall at least to 8,300 (their 1997 high) and possibly much further. If they decline in line with the past eight bear markets, he says, the Dow could fall to about 5,500.
Richard Eakle, president of Eakle Associates, a money management firm in Fair Haven, N.J., says he finds it “amusing” that some people think the stock market bottomed out on Tuesday. “A number of events have occurred that suggest a top,” he said.
Eakle rattles off several technical market indicators that he says look ominous. The number of stocks making new 52-week highs peaked last July, he says, on both the New York Stock Exchange and the Nasdaq Stock Market. Historically, he said, the new-highs indicator “has peaked eight to 12 months before the market in general.”
Volume on the NYSE peaked last October, Eakle says. And the advance-decline line--which is a cumulative total of the number of advancing stocks minus the number of declining ones--peaked on April 6.
Eakle also looks at the year-over-year percentage change in market indexes such as the Standard & Poor’s 500. At the end of March, the S&P; 500 had a 12-month gain of 46%. Now, the year-over-year gain has been pared to 25%. “Historically, momentum as measured by the annual rate of change peaks out several months before the market does,” he said. “I think there will be a major correction around the end of the third quarter.”
As Eakle sees it, we are in the third month of what will probably be about a five-month “topping formation.” Then the decline will get seriously underway, pulling the market averages down “well over 10%, conceivably 20% or more going into next year.”
Acting on his bearish view, Eakle is short-selling (betting against) such stocks as Boeing Co., Charles Schwab Corp., United Technologies Corp. and various banking stocks.
A more positive view comes from Gary Anderson of the Eugene, Ore., investment advisory firm Anderson & Loe. “Some of the best people in the world have destroyed themselves by calling tops,” Anderson said. While he is loath to forecast the market’s direction, Anderson said, “If you put a knife to my throat, I’d say the market is probably a better buy than a sell.”
The worst fury of the Asian economic crisis has probably passed, Anderson says. “The technology stocks will probably make another run. And the basic materials stocks that have been pounded so mercilessly may rally.” As a bet contrary to prevailing opinion, he likes energy stocks, particularly Exxon Corp.
“We’re in a tricky market, but we’re not in a bear market,” Anderson said. “When you’ve got a bull market with this pedigree, you have to be careful” about saying it is over.
Anderson is right, of course. But I’m paid to climb out on a limb, so here’s my prediction. I think the market will continue to churn through the summer, with a slight downward bias. By fall, I think it will be headed south with enough speed to alarm the timid and some of the bold. I believe the market’s long winning streak will be snapped at seven years, and that the Dow Jones industrial average will end 1998 below 7908.25, which is where it started.
John Dorfman is a Boston-based money manager with Dreman Value Management who writes regularly for Bloomberg News. His firm or its clients may own or trade investments discussed in this column.