Fed Action, Contrarian Indicators Signal Investor Opportunities

GuruVision: The Opportunity Is Nigh

SAN FRANCISCO -- Instead of biding their time, chewing their nails and nervously waiting for the Federal Reserve Open Market Committee's meeting tomorrow, as many expected, investors chose to buy stocks today in anticipation of the Fed's presumptive ease. The Dow Jones Industrial Average rose 1.4%, the S&P 500 climbed 1.8% and the Nasdaq Composite gained 3.2%.

Thomas McManus, equity portfolio strategist at Banc of America Securities, also didn't wait for the Fed to take action. Today, he raised his recommended equity exposure to 65% from 60% and reduced bonds to 30% from 35%, leaving cash at 5%. McManus left his 12-month price target for the S&P 500 unchanged at 1475, as well as earnings-per-share estimates for the S&P 500 at $54 for 2001 and $62 for 2002.

"While our [earnings] forecasts remain lower than consensus expectations, we believe stocks are finally beginning to wake up to the magnitude of the earnings degradation we envision," McManus wrote.

Note McManus' allocation and targets remain below the average of his fellow Wall Street strategists, and that 65% in equities is still far from bullish. He's expecting "an avalanche of negative guidance" when first-quarter earnings are reported and possible liquidity problems for the market as the April 16 income tax deadline approaches.

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"But our aim is to be overweight in equities at -- or near -- the bottom for this challenging period," he said, calling today's move a "first step up" in that process.

The 5% increase in equities reverses the downgrade McManus made in September, when he completed a process that took his recommended equity allocation from 80% at the beginning of 2000 to its nadir of 60%. Such decisions and a series of prescient calls last fall refuting the popular notion a bottom was at hand led McManus to be named our Guru of the Year for 2000.

Notably, today's call isn't predicated on whether the Fed eases by 50 basis points or 75 (or even 100) tomorrow. "I don't see any near-term change in the fundamental outlook that would make you be more aggressive," McManus said in a follow-up interview today. "I'm not convinced we've got a bottom, but I am convinced the time is right to start looking for opportunity to put money back in the market."

The Fed will ease by 50 basis points tomorrow, he predicted, suggesting Alan Greenspan "will continue to show the market less appeasement than the bulls have been counting on." Such a move is prudent, McManus said, arguing the economy is certainly weak, but not in recession as evidenced by continued strength in retail sales, and the auto and housing markets.

However, last week's losses suggest there's "less room for disappointment" if the Fed doesn't cut by a more aggressive 75 basis points, he said, adding Fed easing is clearly an "intermediate-term positive we have to give weight to." Additionally, by definition, the Fed is now closer to the end of its easing cycle, which McManus has long argued is more significant than the beginning because it suggests the economy should be closer to its nadir.

What has McManus feeling more positive is a sense that everyone else has gotten too negative.

First, he noted the abrupt sentiment change that has occurred regarding the Fed. When the Fed started easing in early January, people thought it would be a panacea for the stock market, regardless of the economy's state, he recalled. Today, there are worries the Fed is powerless to prevent recession or significantly aid stocks.

Second (and less anecdotally), the daily bullish consensus survey done by Market Vane fell under 20% late last week. "Readings under 20% have been extremely rare since this indicator was created in 1982," McManus observed, recalling past instances in June 1982 (twice) and May 1984. "Both of these instances were great opportunities to buy, although the market didn't really take off until August, in each case."

Additionally, the spike in the Chicago Options Exchange Volatility Index and heavy put buying in recent weeks suggest both professional and retail investors have "tempered their enthusiasm for the market," he said.

Third, and finally, margin debt has fallen on a year-over-year basis for three consecutive months. In February, it was $211.4 billion vs. $265.2 billion in February 2000, the New York Stock Exchange reported last week.

"Clearly, people are financing lower amounts than a year ago," McManus said. "Typically, by the time people get themselves into a mode where they have to de-leverage, you're not that far from a good buying opportunity.

McManus didn't offer specifics about what to buy, but recommended increased exposure to firms with "cyclically dependent earnings streams," such as discretionary consumer and technology stocks, while reducing exposure to defensive areas such as energy and utilities.

However, while tech "could be ready for a bounce," there's still the negative overhang in the group that should keep it from reasserting long-term leadership for several months, he said. "The air is still leaking out of the [tech] tire, but that doesn't mean you can't pump it up quickly and drive on it for a bit."

The Opportunity Is Nigh, Part II

A so-called Fibonacci turn window set to begin tomorrow, and a host of other indicators, "suggest a stock market bottom is imminent," according to Steve Hochberg, co-editor of The Elliott Wave Financial Forecast.

Those "other indicators" include Elliott Wave Financial's own sentiment indicator, which is showing oversold readings on par with those registered at past major low points, including October 1987, October 1998, July 1996 and December 1994, he said. Additionally, when mass market magazines such as Newsweek have cover stories about stocks, the market changes its trend within one to three weeks, Hochberg reported. "It will be almost immediate [this time] because the turn window is here."

The turn windows are designed to identify when short-term changes will occur, not which direction the market will go. The theory is that whichever direction the market is going heading into the turn date, it will reverse course thereafter. Given that there's a one-day grace period on either side of a turn window (meaning today could have been its onset), it's pretty evident which way stocks were heading going into the new widow.

I've been remiss in following up, but faithful readers will recall Hochberg has made some well-timed calls here. On Feb. 2, for example, he forecast the Comp could "retest its Jan. 2 lows and the Dow could break 10,000" in the weeks before the next major turn window, which is now upon us.

The newsletter editor foresees two likely scenarios: That the market continues to rally through the next major turn window beginning April 24, or that it rallies into a smaller window April 2-3, suffers a brief pullback and then rallies again into late April.

Either way, he is confident the rally will be "very strong" and last "at least two weeks."

Confidence in stocks was not in short supply today. As mentioned in RealMoney.com's Columnist Conversation, Don Hays of Hays Advisory also issued a bullish comment today. Watch this space for a detailed update, coming shortly.

(For a GuruVision primer, check out this story.)