What a Week: Losses Bring Out the Bottom Callers

There was more pain on Wall Street this week but no gain for those long stocks.

For the week, the Dow Jones Industrial Average lost 3.4%, the S&P 500 shed 3.7%, and the Nasdaq Composite declined by 5%. The weekly declines left the Dow down 4.3% year to date and at its lowest close since Nov. 12. The S&P is now down 10.5% for 2002 and at its lowest level since Sept. 27, while the Comp is off 21.3% year to date and at its lowest close since Oct. 2.

Still, a recurring theme this week was market participants proclaiming a trading bottom had arrived. Such claims were made amid Thursday's big losses and grew louder Friday after major averages overcame sharp early losses.

After trading as low as 9472.54 early Friday, the Dow closed down 0.4% at 9589.67, while the S&P 500 ended off 0.2% to 1027.53 vs. its earlier low of 1012.49. The Comp ended down 1.2% to 1535.48 vs. its nadir of 1495.81. The Russell 2000 ended Friday up 1.1% to 470.51 after trading as low as 459.76; still the Russell lost 3.4% for the week.

In contrast to the bottom pickers, Jeffrey Saut, chief equity strategist at Raymond James, suggested that investors should "put blinders on to today's session. "We won't have a bottom until CNBC quits calling for a bottom."

Saut referred to comments made early today by CNBC correspondent David Faber, who recalled that the market reversed in September 2000 on the day after Intel (INTC Quote) warned. Thursday night, Intel lowered revenue guidance, and its stock fell 18.5% Friday, triggering much of the early selloff. (Other catalysts included warnings by Biogen (BGEN Quote) and RF Micro Devices (RFMD Quote), plus weaker-than-expected payroll growth in the May unemployment report.)

"If it bottom[ed] today, it's without me," Saut continued, suggesting the market rarely if ever bottoms on a Friday. "If we show up Monday or Tuesday and get a 'I think I'm going to be sick'-type hour, I would buy that for a trade."

The strategist, who has "erred on the side of caution" for more than two years, stressed he'd be buying such a decline for a trade only and forecast that "it's going to be years, not quarters" before the market finally, ultimately bottoms.

Saut also recalled an admonition that the animal that market players should focus on is the boar, not a bull or bear. He continues to recommend investors hold conservative, dividend-yielding assets and buy more aggressive names only when they get "beaten up," but with tight stops, and be quick to sell if they rally.

Still, many other market participants expressed eagerness to get long, given the market's recent thrashing and Friday's comeback. For all the talk of fear in the market, the biggest fear among many participants still seems to be that of missing out on the next great buying opportunity. Though the CBOE Market Volatility Index rose 8% this week and peaked intraday at 29.94 on Friday, it never climbed above 30 and never reached anywhere near the levels seen last September, when it peaked at 57.31.

Building Blocks for a Rally

In addition to the stock market's impressive recovery, some traders were cheered that gold and related shares reversed earlier gains while the dollar closed off its intraday lows.

After approaching $330 an ounce earlier in the session, the price of gold closed down 0.1% to $325.40. Similarly, the Philadelphia Stock Exchange Gold and Silver Index fell 5.9% to 78.75 after trading as high as 85.11 intraday; for the week, the XAU fell 3.5%. The dollar rebounded as well, with the euro finishing the week at 94.38 cents after trading at a 17-month high of 94.85 earlier in the session. The greenback also managed to rally vs. the yen Friday, ending the session at 124.44 yen vs. 124.38 yen the prior day.

"I think [the dollar] has found a floor," said Lara Rhame, an economist and currency analyst at Brown Brothers Harriman. "We're in a phase of dollar erosion, [but] over the next couple of weeks we could see a period of consolidation."

As with Saut and equities, Rhame does not believe the dollar's downturn has ended, but may abate short term. She forecast the euro will be at 97 cents by year-end and the dollar at 120 yen. "Not a massive decline, more a broad-based downtrend," the analyst said, noting -- as many did many others -- that recent economic data suggest the U.S. economy is improving.

While traders focused on the lackluster growth in nonfarm payrolls, the Labor Department said Friday that the unemployment rate fell to 5.8% in May vs. expectations for a rise to 6.1%. Also, the Economic Cycle Research Institute reported that its weekly leading index rose to 124.2 for the week ended May 31, its highest level since October 2000. Earlier in the week, the Institute for Supply Management reported stronger-than-expected results for its manufacturing and services indices, although May's retail and auto sales were weaker than expected.

Foreigners continue to believe the U.S. is again going to be the world's standout, most productive economy. But with the European Central Bank likely to raise rates before the Fed and weakness in U.S. stocks, which is "driving the dollar much more than vice versa," Rhame said "there's less incentive for foreigners to buy U.S. assets in this atmosphere of risk aversion."

The Thin Reeds

Rhame's near-term call on the dollar dovetails nicely with a report Friday by Bianco Research that found that several "measures of market-based inflation are near price peaks, momentum extremes and/or in overbought territory." These inflation measures include the spread between yields on Treasury inflation protected securities and the 10-year note, the Bridge/CRB Index, inflation-sensitive equities, the dollar vs. the euro, crude oil and spot gold.

"These extreme readings often coincide with a short-term correction within the larger long-term trend," the report continued. "If our technical view is correct, the 'inflation play' will continue to profitable after a brief near-term pullback."

Such a pullback should alleviate some pressure on long-dated Treasuries, which have been "[held] back from rallying on terrorism and sinking stocks" due to inflation fears, Bianco suggested. On Friday the 10-year Treasury note fell 19/32 to 98 18/32, its yield rising to 5.07% vs. its low of 4.10% last fall and 4.85% in February.

If inflation fears recede, the 10-year yield could fall below 5%, and that seems consistent with an improving dollar, weakening gold prices and, yes, a rebound in the stock market in the days and weeks ahead.

But the overwhelming evidence also suggests that such a development, should it occur, would represents a countertrend move within a longer-term bear market for U.S. stocks, bonds and the dollar, and bull markets for gold and inflation.