Stockmarket Man i As

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TO VIEW THE ARCHI VES, CLI NK ON ANY LI NK ABOVE

Due to popular demand, we present the archives for Pictures of a StockMarket Mania. Since we commenced the mania updates on January 15, 19the response was immediate and has grown rapidly. Visits to the entireCrosscurrents site now number more than 1700 per day (620,000 annuallyfrom all around the world. While our site is clearly not as heavily traffickedsome, the many emails we receive each week illustrate that the work we ar

doing is important to many investors.

WHO CALLED THE NASDAQCRASH? WE DID! CLI CK HERE FOR THE PROOF

All reports on this site are prepared from data obtained from sources believed reliable, but not guaranteed by us, and are

considered to be all inclusive. Reports are not to be considered as an offer to buy or sell or a solicitation of an offer to bu

sell the securities or options mentioned herein or any other securities, options or commodities. HD Brous & Co., Inc. its

officers, directors, employees, related accounts and/or discretionary accounts, may, from time to time, maintain a long or

short position or buy and/or sell the securities or related options or other derivative securities mentioned herein. In additi

HD Brous & Co., Inc. may, from time to time, act as a market maker in the issuer's securities and may, from time to time,perform investment banking or other services for or solicit investment banking or other services from the issuer. Opinion

expressed are our present opinions only and are subject to change without notice. HD Brous & Co., Inc. does not assum

any responsibility or liability for the information contained in this report.

| HOME | HD BROUS | MANIA UPDATE | CHART OF THE WEEK| S/T OUTLOOK| COMMENTARY| LINKS |

CONTACT US |ARCHIVES |

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I s I t a B e a r Ma rk e t Y e t ???!!!MOST CHART DATA THROUGH FEBRUARY 23, 2001

A SP ECIAL REPORT BY ALAN M. NEWMAN, EDI TOR HD BROUS & CO. , In c . ' s CROSSCURRENTS

In our last look at the mania, we said the "free 'Greenspan Put' cannot work magicforever." Despite what Wall Street strategists are still saying, the "Put" is looking mighsick. There has to be a limit upon what participants are prepared to pay for stocks, nomatter how optimistic they are. And so, some two-and-a-half years AFTER breadth annew highs peaked, we are finally at a point where the bear market cannot be denied b

any reasonable analysis. By the "official" definition, the bear arrives (way after the facwhen prices are already down 20% from their highs. The S&P 500 represents 85% oftotal stock market capitalization and peaked on a closing basis on March 24, 2000 at1527.46. With the close of Friday, February 23rd at 1245.86. the S&P 500 are now doonly 18.4% from the peak close and are still not "officially" in a bear market. Never mthat on a print basis, the S&P have fallen 21.7% from the March 2000 highs. The realimportant question is whether Wall Street will finally wake up to what has occurred? WWall Street finally admit error? Will the superstar strategists who have hogged the CNplatform for so long finally be cast in the lesser light they have so richly deserved sincelast year's highs?

Ca p it u l a t io n o n ly c o m e s w it h p u b lic re c o g n it io n o f a b e a r m a rk e t !

Normally, we do not quote ourselves, but the following words from the February 20thissue of Crosscurrents accentuate the phenomenon so well.

"On W edne sday, February 7 th , Cisco S yste m s reacted to the prior eve ning 's release o f d isappoin t ing

earnings by t rading 281 ,300,0 00 s hares , an unbe liev able 1 2 ,000 shares for eve ry second th e t rading

m arkets w ere ope n. Total dollar volum e of shares traded was app roxim ate ly $8. 75 billion, the oretica

eq uating to 31 .5% of all GDP ge ne rated th at day . Give n th at retail sales are a s ignificant portion of G

and th at one -th ird of the se sales tak e place in the Christm as sh opping period, Cisco's DTV com pared the actu al percen tage of GDP was probably m uch highe r. Again, the s tock m arket of fered solid proof

that no th ing is m ore im portant than the m arke t it se lf and that the s tock m arke t IS the econom y. Ala

Gree nsp an has confirm ed t his notion by ag gress ive ly cutt ing inte rest rates and continuing to act in th

role of m es siah for all things f inancial. Howev er, we be liev e i t is far m ore im portant to point out th at

actions of the Fed eral Res erve Board got u s to t his place v ia a se ries of decisions that t otally ignored

reality and h is tory, no t on ly a l lowing but encouraging the env ironm ent for a s tock m arke t m ania . Th

repercussions are l ikely to be worse than already experienced to date and could unfold over a period

se ve ral ye ars to com e. In the w ords o f Barton Biggs, ' I t s t ill boggles m y im aginat ion tha t e ve rybody

th inks we can com e th rough th e b iggest bu bble in the h is tory o f the w orld and certa in ly th e longest

boom that the U.S . has ev er had and get ou t o f it wi th a very, ve ry m ild recess ion . '"

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presence of a new bull market. Both charts still illustrate a declining long term trend.

Bre ad th cle arly re m ain s in a lon g te rm d ow n w ard s s lop ing ch an n e l. Cu m u lat iv e h igh s

low s rem ain be low t he ir long t erm de clining trend l ine . Eve n if the se line s fail to hold a

sp ringt im e adv ance , the re is no pos sibility w e are in for a ride b ack to the old highs . T

19 99 h igh s for both charts sh ould rem ain inv iolable. Incredibly, du ring th e last tw o ye

of de te riorat ing te chnical and fund am ent al indicat ions ,w e h ave ye t to s ee any adm iss io

by W all S tree t ' s b ig shot s tra tegis ts o f a be ar m arke t in progres s . For Abby Joseph

Cohe n, Joe Bat t ipaglia , Je f frey Applegate and o th ers , the re h as be en no be ar m arke t , ocontinue d projections for higher prices . W all S tree t 's m arket let te r write rs hav e also

rem ained cons is ten t ly upb ea t , ave rag ing ove r 50% bu lls m on th a f te r m on th . and e ve n

recen t ly av eraged m ore than 60 % bu lls fo r one four we ek s t re tch !

O u r s im p le lit t l e q u e s t io n : is i t a b e a r m a r k e t y e t ? ?? !!!

Every step of the way down, buying appears for Nasdaq's tarnished superstars. Therallies are impressive, up 4% or 5% in a day, up 10% in a week, but truth be told, 50%down followed by 50% up still leaves the overall index in the red by 25%. Repeat theexercise twice in succession and the overall index is back down by 58%, despite thepunctuation of the impressive rallies! Nasdaq still trades at incredibly high P/E multiplfar higher than any recorded in any prior era. Using seven of Nasdaq's most popularissues as a guide, two of which are in the Dow Jones Industrials, we hope to afford aperspective on just how far Nasdaq can fall in price. Interestingly, we are using theperiod of 1995-2000 as a yardstick, during which a veritable mania was in place. Thelowest average multiples suffered by our group of seven was 15.4, a resounding 65.5%

under the current average of 44.7 P/E. It would be somewhat coincidental to see allseven trade at their lowest multiples all at the same time, so the 65.5% probablyrepresents more than the maximum decline we should expect at any point in time.However, 35% or even 50% down from current levels would still represent average P/well above the lows of the mania and ought to present achievable price levels for thegroup. Price levels this low would equate to Nasdaq well under 2000, pos s ib ly w e ll u n d1 5 0 0 . Do we really think price levels this low are achievable? Yes.

We believe the odds strongly favor a bottom now and a tradable rally into the IRAseason. Part of our expectation is based on the historically dominant period of Novem



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to April to provide investors with literally 100% of all stock market gains over the last century. You will read more on that score in our April or May update. As we see here,the period of November to April has been positive for 16 consecutive years, pretty mucin line with the secular bull market that commenced in 1982. However, If the secular has concluded as we believe it has, even the historically strong season for stocks mayfinally give way to a loss. Given that the Dow ended October at 10971, even a 5% ralin the next two months will break the string!

A b re a k o f a t re n d t h is p ro n o u n c e d w ill lik e ly s ig n if y a s e a c h a n g e in p ro g re s

The recent PPI & CPI inflation reports highlight the threat we outlined on this site montago. This threat is also the subject of an article we wrote for BARRON'S on November 1996. Your local library may very well have this copy of BARRON'S on file for yourperusal. The article is entitled, "A New Law? Call it the conservation of inflation." W e

urge y ou to read it . In short, the theory is that stock prices are responsible for inflatio(or lack thereof), not the other other way around as the conventional thinking has it. the chart at left, we see clearly how the cycle for prices ends when the cycle for inflatiobegins and vice versa. Basic economic fact: prices rise when there is an excess ofdemand and fall when there is an excess of supply. Note the two circled areas, wherestocks briefly plunged and inflation rose. At this particular point in time, stocks drive teconomy like never before, so the rising demand for stocks has meant lower inflation.Now, with lessened demand, money is coming out of stocks and going back into theeconomy and driving other prices higher. Given that our 15-year rate of inflation willsoon be dropping very favorable monthly CPI numbers recorded from April 1986, theaverage rate of inflation is about to rise and signal a further and far more substantial d

in stock prices adjusted for inflation. Note how the line for inflation has already carvedout a pan shaped bottom while stocks adjusted for inflation appear to have topped!

Yet another secular reversal appears to be at hand. After more than a decade of readiin the very lowest portion of our chart, M2 as a percentage of total stock marketcapitalization has finally - albeit imperceptibly - turned up from the record low of 26.7%on March 31, 2000 to 33.4%. Any reversal in this long term downwards trend could bthe precursor to a secular turn. If a secular reversal achieves only half the historicalaverage, stocks will fall by more than 50% from where they now trade. Again, the chaclearly illustrate that stocks have been more important than the economy and in this



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case, more important than money itself.

We showed a different perspective of our next chart in Crosscurrents a couple of montago and it was immediately picked up by Alan Abelson for his column in BARRON'S.

Insiders have long had the reputation of leading the market and clearly, they should kbest if the shares of their companies provide good value or not. Typically, since their"inside" holdings are huge by comparison to their other investments, insiders sell morestock of their companies than they buy. A lot more. But as the 90s progressed,particularly as the mania expanded into 1996 and beyond, insider sales took off andabsolutely blew off the roof. As the final year of the millennium wound down, insiderssold an incredible $21.56 of stock for every dollar of stock they bought. We consider tconclusive proof that the shares of their companies were the worst possible investmen

We usually end our report with a guess or estimate on how far the bear market can go

terms of price. Today's analysis is designed to afford a look at a possible major suppolevel to be broached later this year or possibly next year. Further out, the targets wehave previously presented for lower prices are all possibilities that we will continue toreview from time to time. What stands out most on today's chart of the Dow Industriais that despite the many continued proclamations of a bull market and even more deniof a bear market, the Dow has literally gone nowhere for close to two years! The red lrepresents the bull trend from the October 1998 Fed induced bottom, finally broken in autumn of 2000. The parallel blue trend lines have outlined a new trend in place, actucommencing late in the move of the prior bull trend and continuing to date. The lightbrown support line represents the bulls last and best hope for containment and reversaAny break that lasts longer than a day should eventually lead to another test of the low

declining blue trend line, but fair warning, that test may be months away! Last year'sprint low was 9654 and a test of that level seems remote at this juncture, considering tvery oversold nature of today's market. Ho w e v e r, w e e x pe ct th at ov e ra ll, p rice s w ill t rlowe r for m any m onths to com e, as a lways , p unctuate d by ra llies to o f fer bulls cont inu

hope . We se e a protracted de cline as in 197 3-1 974 as a m ost like ly scen ario , hopefu l l

e n d in g t h e b e a r m a rk e t a t t h e z o n e we h a v e p e g g e d a t m a jo r s u p p o rt b e twe e n 7 5 0 0 -

8 2 0 0 .



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As prices for S&P 500 plunged last Friday to their lowest reading since February 2, 199Wall Street's big shot strategists were still in the mood to only admit to an "earningsrecession," as voiced by Jeffrey Applegate on CNBC that afternoon. Bear market? Nosuch animal! Business is business, and the business of Wall Street is to lure investors

into the arena, not to keep them away. Nowhere do we see the kind of attitude thatpresents us with the evidence that investors, both public and professional, recognize whas transpired. Instead, what we see is the continued reliance and faith upon the "lonterm" to correct all errors in judgment and to alleviate all poor investment decisions. Iorder for a bear market to end, the players must act as if a bear market is in place. Ware still far from that juncture.

A s lo n g a s W a ll S t re e t p ro s c a n n o t a d m it t o m is s in g t h e a w f

d e t e rio r a t io n in p la c e f o r t w o y e a rs , u n t il CN B C' s r e p o r t e r s

a p p r o a c h t h e e n d o f t h e m a n ia w it h t r e p id a t io n , u n t i l

n e w s le t t e r w rit e rs s h o w t h e ir re a d e rs r e a l f e a r , a n d u n t il t h

p u b lic p a lp a b ly re c o g n iz e s t h e b e a r , a n e w b u ll m a rk e t c a n n

c o m m e n c e .

Our dow nside target s for the 200 1 are:

Do w In du s t ria ls 9 2 0 0 - S PX 1 0 8 5 - Nas daq Co m pos ite 1 7 0 0 +

Our upside target pot en t ia ls for the rem ainde r o f 2001 are as fo llows :

Do w In du s t ria ls 1 1 2 0 0 - S PX 1 3 7 3 - Nas daq Co m pos it e 2 9 6 0

Alan M. Newman, February 24, 2001



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WHO CALLED THE NASDAQ CRASH? WE DID! CLI CK HERE FOR THE PROOF.

All reports on this site are prepared from data obtained from sources believed reliable, but not guaranteed by us, and are not considered to

inclusive. Reports are not to be considered as an offer to buy or sell or a solicitation of an offer to buy or sell the securities or options ment

herein or any other securities, options or commodities. HD Brous & Co., Inc. its officers, directors, employees, related accounts and/or

discretionary accounts, may, from time to time, maintain a long or short position or buy and/or sell the securities or related options or other

derivative securities mentioned herein. In addition, HD Brous & Co., Inc. may, from time to time, act as a market maker in the issuer's secu

and may, from time to time, perform investment banking or other services for or solicit investment banking or other services from the issuer

Opinions expressed are our present opinions only and are subject to change without notice. HD Brous & Co., Inc. does not assume any

responsibility or liability for the information contained in this report.

| HOME | HD BROUS | MANIA UPDATE | CHART OF THE WEEK| S/T OUTLOOK| COMMENTARY| LINKS | CONTACT US

RESEARCH |

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found out that the market is not just a one-way street. What's an eleven year old to d

Sell.

Rather than focus as we have before on the lunacy that took transactional volume tolevels suggesting nothing was more important than stocks, we will now focus on wheretransactional volume may r e t u r n to if an entire generation of investors swears offstocks. For starters, there is every reason to believe that at the very least, transaction

volume may return to the levels from which the mania commenced. If we are correctthat the stock market will be anathema for several years to come, DTV for Nasdaq coudecline by more than 9 2 % and DTV for the NYSE could decline by nearly 7 8 % .However, if even a small fraction of the disillusionment we see as probable does indeedoccur, both our indicators must trade to levels that imply far lower prices to come.

A s w e ll, a re t u rn t o h is t o r ic a l n o rm s w ill t a k e y e a rs t o u n f o ld .

As the mania matured, we pointed out the expanding P/E for Nasdaq on numerousoccasions, even comparing the expansion to a financial pyramid wherein there was alwone more sucker available to bid prices up to another high. But all pyramids eventuallfail and Nasdaq was no exception. At the peak, the stocks that comprise Nasdaq'sComposite index traded at an average of nearly 250 times earnings, a phenomenon this not likely to be repeated in the century to come, possibly never. In the final analysistocks can only be worth what the businesses they represent can generate in profit. Fdecades, analysts have studied "earnings yields" and how they relate to dividend yieldsTreasury bills, corporate bonds and even bank CD's, in determining individual stock

valuations. Somehow, tradition and reason went out the window in favor of the beliefthat certain companies were capable of such rapid growth that literally any price was fSince many of these companies had no earnings, value was determined by the growthrate of sales. Incredibly, despite not one iota of evidence that profits would ever beturned, valuations via sales became de rigeur. The pyramid was encouraged by corpomanagements, who saw the excitement of rapidly increasing prices translated into morshares sold to the willing public, in turn generating even more excitement about the neIPO. As we showed in our last report, insiders unloaded enmasse and finally enabled tslippery slope of the pyramid, a/k/a the other side! If you pay $1,000,000 for a businand make $100,000 a year in profits, that's pretty decent. How much would you pay f

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a business that yields $4048? At the P/E peak, Nasdaq investors paid the same$1,000,000!

Incredibly, even as Nasdaq has crashed, so have earnings, taking Nasdaq's P/E again tludicrous extremes!

You can do just so much with money and it doesn't matter how much you invest. It's economic fact that when prices climb too high, demand slackens and supply increases.

Dollar Efficiency has been a strong theme in our work for many years, in individual stoanalysis and in measuring overall market potential. Dollar Efficiency exploded into theearly part of 1995, enabling prices to rise rapidly and efficiency remained positive fornearly the entire mania, with only a very brief trip into negative territory as the the LoTerm Capital Management fiasco led the financial markets to the precipice in 1998. ThFed induced rate-cut bottom led to another rapid expansion in efficiency into the finalphase of the mania, when prices became unsustainable. As our pictures vividly illustraefficiency has fallen off a cliff and is more deeply negative than at any time in the pastdecade. What does negative efficiency actually mean? Addtional dollars invested brinlower prices! At present, no amount of money can support stocks.

Ev e n t o d a y , p r ic e s a re s t ill t o o h ig h !

There is no greater killer of bull markets than volatility. The theory is simple. Wheninvestors and speculators make their decisions, they expect and depend upon a modicof price stability. Without stability, the decision to buy or sell short can be proved wroin a heartbeat and this circumstance tends to lower confidence. Less confidence mean

some traders will pull back from making decisions. This in turn, impacts liquidity.Although some would argue that traders do not account for a sufficient share of overaltransactional volume, the impact on the margin is sufficient to alter liquidity. And asliquidity suffers, volatility increases even more. In 1987, this was one of the factors thled to the crash, but that particular event was influenced far more by so-called portfoli"insurance." It is worthwhile noting and incredibly ironic that the mania has thus far,l e s s e n e d the odds for a crash. How so? In 1987, the portfolio insurance game requirthat some funds take money off the table as prices declined. As sophisticated formula"stop out" and unwind holdings were triggered, they in turn blindly triggered the "stopof other funds. In essence, the snowball rolled downhill until it developed into an



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avalanche. Today, the rationale has turned 180 degrees and funds believe they have afranchise to be fuilly invested. Thus, less stock has been sold and less stock continuesbe sold on a relative basis to 1987, even as volatility increases. This "supportive" irondoes not necessarily have to continue. At some point, the same hysteria that applied tthe upside may apply to the downside. Investors could conceivably look for the exits emasse.

The picture of Nasdaq volatility shows a solid wall of rapid movement, sufficient to take

the boldest players out of the equation. Liquidity on Nasdaq is nil. Volatility on the NYhas increased substantially, but still presents a haven of stability relative to Nasdaq. Tis the principle reason that prices have declined more slowly.

S h o u ld v o la t ilit y e x p a n d o n t h e N Y S E t h e w a y it h a s o n N a s d a q ,

t h e o d d s f o r a c ra s h w o u l d ris e d r a m a t ic a lly .

How does the recognition phase begin? With each new brokerage or mutual statemenopened by investors, the odds increase that patience is about to become a habit of thepast. As our left hand chart shows, Nasdaq has plunged precipitously below its averagprice over the last two years. Nasdaq has been the index of dreams and fantasy and whailed even by the "pros" as a one way ticket to riches. So much so, that in April of layear, Tom Galvin, the chief equity analyst for Donaldson, Lufkin & Jennrette was quoteas saying that "Over the next 12 months, we believe the Nasdaq has 200 points ofdownside risk and 2000 points of upside potential, creating a ten-to-one ratio of rewarrisk which makes this an opportune time to be aggressively buying stocks." Below, wehave placed a tan arrow at the time of Galvin's forecast, a green arrow to show the

potential he afforded price and a red arrow to show the risk parameter Mr. Galvinaccorded Nasdaq. Quite obviously, Mr. Galvin was as wrong as one could possibly be. of last Tuesday's close, Nasdaq is 48.5% below its two-year average price! But WallStreet strategists stuck together throughout the decline, upping their allocations to stoas time progressed and as prices declined, keeping clients in the hunt. By last week, 1top strategists were recommending that 69.5% of client portfolios be in stocks, thehighest stock allocation in history. Wrong all the way down! But bad advice cannotchange the numbers on the statements. The action of the major indexes in the month

just ended will open many eyes. W i d e .



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Our right hand picture shows that even S&P 500 index investors with a three-year timeframe are now underwater for the first time since the mania commenced. In fact, theyare under water by 17.8% as of the Tuesday, April 3rd close. Three years is a long timWhen accompanied by the recognition that the time has been for nought, three years cfeel like forever. The financial industry is doing everything to assuage investor fears bpushing the long term thesis and are attempting to identify positive results for all longterm timeframes.

B u t w h a t if in v e s t o rs a b a n d o n t h e lo n g t e rm t h e s is ?

In our last update, we pegged the Dow 9200 level as our target and this level wasachieved in less than one month. On March 22nd, the Dow Industrials traded as low a9106 print basis. In truth, we had not expected prices to decline so dramatically in sushort span of time and this has influenced our annual target, which is now lowered to

somewhere between 7500-8200. We hope to "fine tune" as time goes on. Our analysof the S&P 500 concurs, affording a target low of about 920 at some point later this yeNote the green trendlines highlight the final bull phase of the mania, then the tantrendlines highlight the topping phase and finally the red trendlines highlight the intialbear market plunge. Incredibly, the SPX has even broken below the rapidly declininglower red trendline. We had previously predicted a test of the circled consolidation zonfrom early 1999 at just under 1210. The line we have drawn below that area was supand did indeed hold again at 1214 print basis on March 2nd, before finally falling on Ma12th. In our analysis, old support levels become new resistance levels and we believe1205-1210 area will now represent substantial resistance for any future rallies. Althouwe can make allowances for a penetration as high as 1275-1285, these higher levels

should be catalyzed by short covering and not the brave new world of a new bull phaseWe look for our target area, from 890 to 950 to be achieved later this year.

The parade of guest "professionals" on CNBC, all proclaiming the long term mantra, habecome obnoxious and offensive to our sensibilities. Conscience dictates reason andreality dictates that we alert you to what history has shown is achievable. Today weheard one money manager interviewed on CNBC claiming that "If you have a 15 yeartime horizon, blah, blah, blah......you would be well advised to START buying stocksnow." This idiotic advice assumes you have not previously listened to the same mantrbefore and have never purchased stocks before. If you had, of course, your nest egg



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would already be deep into the red. But for the moment, let's assume you are a brandnew investor. From what we see, given the recent prolonged period in which returnswere far greater than the historical average, the next decade might easily produce gaiwell under the historical norm. For all 15-year periods since 1912, the annualized retufor the Dow Industrials ex-dividends has been about 4.8%, represented by the blue boline drawn across our chart. How low does the Dow have to go for returns to approachthe historical norm? Rather than answer in terms of price, let's answer in terms of timUsing the Dow's recent print low of 9106 achieved on March 22nd, the historical norm 15-year annualized gains of 4.8% will be "hit" in January of 2010 if the Dow trades at same level. So, someone who buys today and holds until then would achieve a perfectnormal rate of return for the Dow with the Dow trading at l o w e r prices than today.

S o m u c h f o r t h e l o n g t e r m m a n t ra .

Truthfully, we hadn't considered updating this page so early in the month, but with ourvacation looking on the horizon, we felt our readers and visitors deserved our initial vieon the "official" bear market and deserved to see our price targets updated. We urge to stay tuned for our next update, which is targeted to appear on May 26th. In thisupdate, as we have done twice a year in HD Brous & Co, Inc.'s Crosscurrents, we willpresent our proof that the stock market can be timed. Wall Street does not want you know this dirty little secret. Wall Street believes your assets belong in the hands of"professionals" year round, quite probably the same professionals that were high on thInternet stocks at the top, that believed that "new economy" stocks were cheap, and thave been increasingly bullish as stocks have declined.

Fro m t h e ir c lo s in g h i g h s :

T h e Do w I n d u s t r ia ls a re n o w d o w n 1 9 .1 %

Th e S &P 5 0 0 a re n o w d o w n 2 7 .6 %

T h e N a s d a q Co m p o s it e is n o w d o w n 6 6 .9 %

S t r a t e g is t s h a v e in c re a s e d a llo c a t io n s e v e r y s t e p o n t h e w a y

d o w n , e x p o s in g t h e ir f irm ' s c lie n t s t o la rg e r a n d la rg e r lo s s e

S h o u ld w e b e l ie v e t h e m n o w ?



16/85


Our down side t arget s for 2001 are:

Do w In du s t ria ls 7 5 0 0 -8 2 0 0 - S PX 8 5 0 - 9 5 0 - Nas d aq Co m pos ite 1 3 0 0 - 1 4 0 0

We ble ive the odds o f a t ta in ing th es e targets are h igh .

Our "bes t case " upside target pote nt ials for the rem ainde r o f 2001 are as fo llows :

Do w In du s t ria ls 1 1 0 0 0 - S PX 1 2 7 5 -1 2 8 5 - Nas daq Co m p os ite 2 6 0 0 -2 7 0 0

We be lieve the odds o f a t ta in ing th s e ta rge t s a re rem ote !

Alan M. Newman, April 3, 2001











RESEARCH |

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17/85

Crosscurrents

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B lin d Fa it h o r R e - ig n it io n ?MOST CHART DATA THROUGH MAY 24 , 2 0 0 1


The dream lives on.

The "re-ignition" since the March bottom proves only that most particpants are still buon the stock market, despite the apparent continuing weakness in the U.S. economy. the same manner that the decline in the economy from last year's highs was not

foreseen, it is very likely that continued weakness from this point is not now foreseen.And despite the good intentions of the Federal Reserve, we do not believe the businesscycle has been nor can be repealed. Most importantly, we cannot see how one can repthe secular cycles of stock ownership. From 1974 to 1982, most Americans swore offstocks and were content with conservative investments that could not lose their value(yet still did in inflation-adjusted terms, only more slowly than stocks). The secular bumarket drew 50% of U.S. households in before the top, the largest participation inhistory. Bu t in v e s tors in re ce n t y e ars are los in g m on e y . The longer they remain loserthe more likely the bear is to resume in earnest. Given the relative full exposure by WStreet Stragegists to stocks and still low mutual fund cash levels, the bear market shoresume soon.

W e e x p e c t s t o ck s t o c o n t in u e t o u n d e rp e r fo rm

o t h e r in v e s t m e n t s f o r s e v e r a l y e a r s t o co m e .

The more we look at Dollar Trading Volume, the more we are convinced the mania of1995-2001 has been the greatest stock market mania of all time, surpassing even themanic activity of the South Sea Bubble and the Roaring Twenties. From literally everyaspect we explore, we find that past benchmarks have been exceeded, in many cases

a wide margin. DTV itself is one such benchmark, proof in our eyes that the stock mahas very much become the U.S. economy. Given the actions and written comments ofthe Federal Reserve since the interest rate cuts commenced in January, there can be ndoubt that the Fed sees a threat too large to ignore (" . . . . the possible effects of earlierreduc t ions in equ ity we a lth on consum pt ion . . . . . con t inues to w e igh on the econom y") .

Clearly, the chart of DTV shows that the Roaring Twenties were no comparison to the"traffic" generated in the current mania. Given that the "traffic" itself is now a multiplethe entire gross domestic product of the economy, it is easy to infer that the stock mahas truly become the linchpin of the economy.

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This month, we have decided to replace our traditional view of DTV vs. total marketcapitalization with a new view, equally incredible. To better measure the annual increain speculative fervor, we have divided the annual increase in total DTV by GDP. In thismanner, we believe the annual changes in overall speculative activity are betterrepresented. As seen below, the annual increases in activity measured nearly half of tGDP a lifetime ago. In the current mania, the increase in activity in 1999 and 2000 wefar beyond the Roaring Twenties. In 2000, the annual increase in Dollar Trading Volumactually exceeded total GDP by 21%! What is of particular note is that most of our cha

appears quite empty, showing only the few years of the Roaring Twenties and the currmania as "filled" and "abnormal" space. Wh at pass ed for norm al was a cont inuous pe rof 62 y ears , f rom 193 3 to 1 994 , in w hich ac t iv ity w as only a s m all frac t ion o f m anic

t im e s . That so long a period could elapse without the spikes present during the RoarinTwenties or the present, speaks volumes about the abnormality of the present mania.But is anyone listening?

T h e e v id e n c e p r e s e n t e d b y t h e m a n ia is b o t h s t r ik i n g a n d O BV I O US .

We are presenting a portion of our article in the May 7th issue of HD Brous & Co., Inc.'s Crosscurrentdealing with market timing. The original concept was discovered years ago and is the result of reseaby Yale Hirsch and Sy Harding. For the last 51 years, the stock market could have been timed!

The timing "system" is effective with only two simple investment decisions each year. more than 50 years, the methodology has produced superior and virtually unmatchablgains, further proof that any spin devised by Wall Street pros is utterly useless in the lrun. As our chart at bottom left clearly illustrates, an initial investment of $10,000 in

1950 has grown to $426,227 in the months of November to April. The methodology sethe Dow Industrials at the close of trading every April and buys the Dow at the end ofeach October. Conversely, the same $10,000 invested in only the months of May throOctober has grown to a paltry $11,750! Hardly worth the effort or risk, no? The sixmonth gains from November through April average 15.5%, so far in excess of themarket's own historical record that one wonders why Wall Street strategists are as widfollowed as they are!

Incredibly, returns for the May to October "Dead Zone" (chart below right) actuallypeaked 36 years ago in October of 1965 and an investor exposed solely to this six mon



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period since that time would have lost 16.6% of his original investment. It is with sommeasure of disdain for Wall Street's spinmeisters that we reveal the absolute bestconsecutive ten year stretch for the months May through October (1988 to 1998) hasaveraged less than 4.6% annually! Seems one have needed only to consult a calendarand make a grand total of two investment decisions each year since 1950 to outperforWall Street's pros by a very wide margin.

Of course, there are no guarantees that the methodology will work forever. Despite th

obvious caveat that this methodology may not even work this year, we believe the stais set for another stock market decline into the end of October. Even in the last fouryears of the greatest stock market mania of all time, the May to October "Dead Zone" produced total annualized gains of a mere 2.3%, less than half the historical norm andway, way below investor's expectations. Only 21 days into May 2001, the Dow hasproduced a gain of 5.6%, already well in excess of what we might expect on averageduring the "Dead Zone." Since history has shown May to October to be a bummer, thiparticular May to October - at the tail end of the greatest stock market mania of all timshould find the bear market alive and well.

Ev e n w h e n m e a s u re d f ro m t h e 1 9 8 2 b o t t o m ,

t h e " D e a d Z o n e " h a s o n ly r e t u rn e d 3 . 4 % o n a v e r a g e ( a n n u a lly ) .

Nasdaq has only released information through March, so we have estimated P/E's for tmonths of April and May, based on the same levels of income registered in March andincreased share prices. Given the pattern of declining net income in the first threemonths of the year (down an astounding 50%), we believe our estimates are probably

too far off the mark.

The Nasdaq pyramid we have drawn on several occasions simply shows how investors speculators get sucked in on the way up only to suffer as prices subsequently collapseIncredibly, the pyramid appears to be forming once more but at vastly higher levels thbefore. At today's high, we estimate the overall P/E for Nasdaq was 361, 47% higherthan last year's February high of 245! Nasdaq represents a leap of immense faith forinvestors and speculators at this juncture. If one were buying for an expected annualprice gain of 20% predicated on a DOUBLING of Nasdaq earnings, one would STILL befacing an overall P/E of 217 next May.



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It is commonly believed that a bull market thrives on an expansion of volume (the thebeing that increased volume represents increased demand). However, at its essence,volume simply represents turnover and not necessarily accumulation. Below, we see hsteadily increased volume on the NYSE over a two year period has had absolutely noinfluence on price. In our view, if anything, the higher volume may represent supply adistribution instead of demand and accumulation! Volume increased by two-thirds whithe Dow has traded sideways to lower. Wh at k ind o f vo lum e increase s w ill be n ee ded t

p u s h th e Do w in to u n ch art e re d t e rritory w e ll abov e las t y e ar's h igh s ? Given the alread

huge exposure of Americans to stocks and the overwhelming bullishness of strategistscan a substantial increase in volume even occur?

T h e s e p ic t u r e s r e p r e s e n t b lin d f a it h , n o t a " r e - ig n i t io n " o f t h e b u l l m a rk e t .

Since our previous update, these two pictures have actually deteriorated. The cost of

average dollar invested in the S&P 500 has risen to 1407, still 7% higher than lastTuesday's print highs. Given how a mania works, most of the money that is drawn intthe game is drawn late in the game, when prices are at their highs and the lure isirresistible. More than $520 BILLION in net inflows entered the stock market in the ye1999 to 2000, yet before the year 2000 had ended, investors that had entered the main that period of time were still behind! How does that work?! The biggest net inflowshistory (by far) cannot support prices? Truly, truly amazing.

As we see next, money goes so far and can go no further. When prices are too high, namount of money can buy price improvement. Even after a stunning 21.6% rally off t

March 2001 lows, annual Dollar Efficiency for the S&P 500 remains negative. [EDNOTE: CHARTS ASSUME A $10 BILLION INFLOW FOR APRIL AND A $15 BILLION INFLOW FOR MAY WITH MACLOSING AT SPX 1315). The belief that a re-ignition phase is taking place runs counter tothe evidence that shows investors are likely to be growing very impatient with losses athe inability of invested monies to buy sufficient price improvement to bring them backa level consistent with profits.

W h a t w ill h a p p e n if in v e s t o r p a t ie n c e f in a lly ru n s o u t ?



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Crosscurrents

Thus far, our Dow "potential" target was exceeded by 3% and our SPX target waspenetrated by 2.1%. Our Nasdaq potential target was not exceeded. However, we weclearly wrong about last month's action and have had to update our views on the chartbottom left and are offering new projections (further below). The rally was far stronge

than we envisioned, but we certainly do not see the nascent bull market or "re-ignitionmuch of Wall Street would have you believe is now in force. We do se e b lind fa ith .Typically, prices rise as sentiment turns bullish and this time has been no exception.From continued increases in strategist's allocations to stocks, to investment advisersreturning to a 50% bullish position, to the return of positive mutual find inflows (albeitbelow record setting pace), to large speculators again accumulating larger positions in S&P futures, we see sentiment as having turned extremely bullish in recent days. Thisshould result in a correction soon and perhaps a test of the March lows. In fact , asuccess fu l t e s t o f these lows m igh t e ven tu rn us bu llish fo r the sum m er .

The odds favor strong resistance short term at SPX 1317 (50% between last year's higprint of 1553 and this year's low print of 1071). However, even if that resistance ispenetrated, we can still easily make the long term bear case and do not expect to turnmore than short term bullish at any point. Bear in mind, our CROSSCURRENTSnewsletter is almost always both long and short and attempts to be as market neutral the circumstances permit. However, with respect to momentum, it is probably correctalter our forecasts. Our worst case scenario for the remainder of the year would see atest of the 1998 lows, down around SPX 923. More likely, a viable target residessomewhere between our worst case and the nominal test of the March lows of 1081 prbasis. This "likely" target would take the SPX to approximately 1002.

Over the long term, despite the protestations of those who espouse the new economy,should be evident that the 70% crash in Nasdaq prices has told us a far different storyThe good times were discounted as much as a decade away at last year's highs and arstill likely discounted years out. Businesses cannot be worth more when earnings decland the current environment will probably produce far lower expectations at some poinWe have already experienced the longest peacetime expansion in our history and theboom times have driven both personal and corporate debt levels to extremes that cannbe sustained. Simply put, a contraction in economic activity at this point is logical.

The savings rate for Americans has turned negative as speculation has increased and



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23/85

Crosscurrents

I n t h e f in a l a n a ly s is , s t o c k s c a n o n ly b e v a lu e d o n t h e e a rn in g s

e a c h b u s in e s s c a n g e n e ra t e a n d o n t h e v a lu e o f t h e u n d e r ly in g a s s e t s .

Our down side t arget s for the rem ainde r o f 2001 are:

Do w In du s t ria ls 8 8 0 0 -9 2 0 0 - S PX 9 7 0 -1 0 3 0 - Nas daq Co m pos ite 1 3 0 0 -1 5 0 0

We bel iev e th e odds o f a t ta in ing the se t arget s are a t leas t two- in- th ree .


Do w In du s t ria ls 1 1 5 0 0 - 1 1 6 0 0 - S PX 1 3 3 5 -1 3 4 0 - Nas daq Co m pos ite 2 6 0 0 -2 7 0 0 We be lieve the odds o f a t ta in ing the se ta rge t s a re a t bes t one - in - three .

Alan M. Newman, May 25, 2001










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24/85

Crosscurrents

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T h e Cy c le En d s . T h e Cy c le B e g in sCHART DATA THROUGH J ULY 1 , 2 0 0 1


Our new article focuses on the turn of the cycles. Like the wheel of time, one cycle enand another begins. The secular bull market, capped by the greatest stock market maof all time, concludes. A secular bear market commences. How can we be so sure?

The evidence from history precedes our own analysis and illustrates how the folly of a

great imagination belies those who would be visionaries to an impossible future. Simpput, optimism has its place. The internet, even if it was going to re-shape our lives in 21st century, was bound to displace segments of the economy and result in a few yearreaction to the sea changes in progress. It has happened before as the advent of the of radio and autos can attest. In fact, it has happened again.

De s p it e t h e p h e n o m e n a l a d v a n c e s in t e c h n o lo g y in t h e la s t d e c a d e , t h e a d v a n

t h a t s t a n d s w it h o u t p e e r is t h e p r o g r e s s i o n o f t h e " s c ie n c e " o f f in a n c ia l

e n g i n e e r i n g .

The impact of ESOPs (read tax benefits to Cisco Systems), the growth accorded by nonoperating earnings (read Intel's investment portfolio) and the benefits provided byderivative manipulations (read Microsoft's Put selling program) have all conspired to shthe corporate world not as it truly is, but as it would like you to believe it is.

A s W a ll S t re e t ' s a n a ly s t s b e g in t o s u f f e r t h e re c o g n it io n t h e y r ig h t ly d e s e rv e

s o s h o u l d t h e o p e ra t io n s o f co r p o ra t io n s n o w c o m e u n d e r c lo s e r s c ru t i n y .

We always begin our presentation with a view of Dollar Trading Volume, the mostimportant indicator we can show and perfect proof of the stock market mania that haspervaded the environment since 1995. Despite falling nominally since our last update,DTV is still 283% of total gross domestic product. Wall Street has maintained its swayover investors, who continue to trade $2.83 of stock for every $1 spent on the purchasof goods or services.

This perspective has been our focus for longer than the two-and-a-half years our web has been in existence. The charts have been shown in our newsletter for close to fouryears. Why this indicator has received so little attention beyond our coverage is beyonour ability to discern. The charts have appeared with our permission on only one othe

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website and in only one other financial publication despite our constant reminder that ware willing to grant permission as long as attribution is granted. You can't have a manunless the public is involved to such an extent that the economy itself winds up playingsecondary role to the upwards march of stock prices. As the current mania progressedfrom its early stages, the velocity of funds thrown at stocks increased rapidly. Then, athe internet craze became full blown, velocity increased geometrically. What you see othe chart is partially explained by the old adage that "in a bull market, everyone is agenius." But in a mania, participants presume perfection, both for circumstances andtheir ability to predict what is yet to come.

At one point in late 1999, it really did not matter what internet or technology stock onemight have chosen. Almost all were equally regarded as having near limitless potentiaand had to trade higher, whatever the current price. Aided by the price projections ofinvestment bankers who had a vested interest in maintaining the illusions of a perfectfuture, participants bought Amazon, Priceline and Qualcomm at their highs, truly believthe shares would double or triple in short order. As we see below, Nasdaq's share of tpie grew from nominal at the beginning of the secular bull market in 1982, tooverwhelming in 2000. What we see in this picture is the public's growing acceptance risk as a legitimate cost for making money in the bull market. Of course, as prices ros

the attendant risks rose, so the chart is also implying the acceptance of HIGHER risks atime progressed!

W it h b o t h c h a r t s f in a l ly t u r n in g d o w n , t h e i m p lic a t io n i s t h a t t h e c y c le i s a t a

e n d .

We are presenting a portion of our article in the May 21st issue of HD Brous & Co., Inc.'s Crosscurrendealing with inflation and tying stock returns directly to rising or falling long term rates of inflation. Tis another view of a cycle at an end and a cycle just beginning.

Question: is inflation a factor in the performance of stocks or is it the other way aroundWe wrote a somewhat controversial article for BARRON'S in November of 1996, claiminthe latter. Our theory posits that inflation is always present somewhere in the economyWhen stocks are in a long term phase of accumulation, a sufficient amount of money isdiverted from the purchase of goods and services and inflation occurs in the price ofstocks. When stocks are in a long term phase of distribution, money flows back into thpurchase of goods and services, driving up the rate of inflation. As proof, we matched



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Crosscurrents

inflation adjusted Dow Industrial averages up against the 15-year rate of inflation. Whythe 15-year rate and not another period? The 15-year rate showed precisely what weintended to illustrate. As it turned out a slighter more rapid rate also worked andapproximated a one-quarter cycle of the long term 56+ year Kondratiev wave. Since thKondratiev cycle is predicated on four seasons, a one-quarter length period to measureinflation seemed appropos. Judging by how well the theory works in our picture, this isexplanation that is too elegant to ignore. An eye opener. The cycles dating back to theinflation adjusted Dow highs of 1966 match almost exactly, certainly precise enough toassume there is a mutual force at work. As our chart clearly illustrates, the 1966 and1999 inflation adjusted highs in stocks are neatly matched by a long term low in the raof inflation and the 1982 inflation adjusted low in stocks is very closely matched by a loterm high in the rate of inflation. As further proof, the circled areas show shorter termdivergences in stocks that are also neatly matched by divergences in the rate of inflatiThe big news here is that the cycle once again appears to be reversing as the inflationadjusted Dow is now in decline and the long term rate of inflation is beginning to rise.Given that the inflation numbers being dropped are the very friendly numbers of 1986the long term rate of inflation appears poised for a solid advance. For the sake ofcomparison. the annual rate of inflation averaged only 1.5% from April 1986 throughJanuary 1987. How bad can it get? The prior down cycle for stocks lasted from 1966 to

1982. a period in which losses were far greater than those perceived. The inflationadjusted Dow traded at 3092.80 in January of 1966 and at 829.33 in July of 1982. a loof 73%! This is an excellent picture of the damage a secular bear market is capable of

Of course, as we imply with our first chart, inflation on one hand is offset by deflation othe other hand. The cycle that has now appeared for Nasdaq is one in which earningshave entirely disppeared. The prior expansion witnessed only modest growth of 1.6% the best period of earnings from March 1999 to September 2000. Despite the public'swillingness to buy Nasdaq stocks at 150 times the index net earnings in September 20the type of growth that might have justified such a stance was never visible. This pictis additional evidence that the cycle for stocks has concluded.

Cy c le s e x i s t . A ll b u ll m a r k e t s e n d . M a n ia s e n d v e r y p o o r ly .

The first step in the concluding act of a mania requires that participants simply notcomprehend the end process. Thus, despite a collapse in Nasdaq prices, down 70% in



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Crosscurrents

one year - and a fair sized bear market for the S&P 500, down 28% - the public andprofessionals have retained their bullish stances. The public still believes returns inexcess of 10% per year will continue and Wall Street strategists have raised theirallocations to stocks to all time highs. Even we are somewhat chastened by theappearance of the recent rising peaks and rising valleys of our cumulative high/low chaUntil, of course, we dig a bit deeper into our interpretation of the chart. First off,cumulative high/lows are still only a measure of what has transpired over the course oprecisely one year. This chart is actually a compilation of one-year rolling periods,measured day by day. Given the enormous draw down by stocks suffered in the lastyear, a bottom of some significance had to occur. At one point, the U.S. stock markethad surrendered close to 40% of its entire capitalization. If history has shown us anylesson, we have been taught that all declines are followed by rallies, regardless of thestrength of the dominant trend. In this case, we believe the recent divergences havebeen brought about by the humongously oversold nature of the initial Nasdaq collapse

Judging by our second chart, there is still no reason to believe that a bullish sea changat hand. In the earlier phase, 91% of the time, 10-day new highs predominated overnew lows. In the latter phase, despite the recent day-to-day appearance of very positnumbers, new lows STILL predominate over new highs 52% of the time. Should we be

paying more attention to the modestly positive readings for all of the last several weekWe tend towards the view that the current rally has peaked so far from the peakssustained in earlier years of the mania, that the second and weaker phase is still quiteevident.

T h e e x t e n t o f t h e b u l lis h d y n a m ic s p re v a le n t d u r in g t h e m a n ia a re n o lo n g e

v i s i b l e .

Could the time since the late March bottom actually be a nascent bull market as so manow believe? Could it be the worst is finally behind us? Perhaps if what had precededtop was a typical bull market, the answer would be yes and even we would be bullish.But never before in history has a mania ended without fear and panic taking hold and ensuing phase where investors just gave up hope and talk of the stock market wasaccompanied almost universally by despair. In the case of the current mania, there armany, many signs that the principal presumption is "business as usual." Wall St.strategists maintain a near 70% allocation to equities, the highest in history. Mutual



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after the election. Although we are only showing the results back to 1950, results bac1832 bear us out. Our view shows pre-election years up every time and they have beeup 74% of the time going back in time. As well, our view shows the current cycle dowseven of 14 years, whereas it has been positive only 46% of the time back to 1832.Thus, another influence is at work against stocks for 2001.

T h e t w o s e c u la r b e a r m a rk e t s o f t h e 2 0 t h Ce n t u ry b e g a n i n 1 9 2 9 a n d 1 9 7 3

T h o s e w e r e a ls o p o s t - e le c t io n y e a rs !

At this point in our updates, we always attempt to answer the question,"How far canstocks fall?" Sometimes we offer a worst case scenario, sometimes a best case scenarSometimes a bit of both. Below, we see three regression lines stemming from the Aug1987 TOP, which was also a mania, driven primarily by institutions but insignificantcompared to the current era. The green line extends to last week's Dow close andrepresents annualized gains of 10.1% (all stated percentages are ex-dividends). The bline connects two important bottoms in the fall of 1997 and 1998 and representsannualized gains of 8.6%. The red line connects the 1987 top to the 1994 top, shortlybefore the bull market began to morph into a full fledged stock mania. This linerepresents annualized gains of just over 5%, consistent with average gains recorded fo

more than a century. The green line grows at better than twice the historical average cannot be sustained. If, for the sake of argument, we could prove that these huge gaicould be sustained, then we must also assume that interest rates have to increaseaccordingly to compete with the permanent superior gains that would be afforded bystocks. If rates rose to compete, their relative riskless attraction would eventually lureinvestors away from stocks, lowering returns from stocks! The new era supposition fothe permanence of higher returns for stocks is impossible.

All three lines are measured from a blowoff top, the most conservative/friendly/bullishview we can present. Measured instead from the 1987 crash bottom, the green linewould represent 13.75%, the blue line 12.25% and the red line 8.51%. The historicalaverage for the Dow Industrials (ex-dividend) going back to 1897 is only 5.02%. Thegreen line is where we now stand. The blue line is where we are likely to stand within years. The red line is a probable support for the very long term, i.e., for the duration the secular bear market.

De s p it e t h e c a ll f o r h ig h e r p r ic e s , lo w e r p r ic e s a re lik e ly ,

b o t h in t h e in t e r m e d ia t e t e r m a n d in t h e v e r y lo n g t e rm .



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We invite you to stay tuned for our next report, in which we intend to precisely illustrathe truth about the long term. We hope to entomb the common wisdom, the mantrarepeated by all of Wall Street's so-called professionals, i.e.,"buy-and-hold."

I n t h e lo n g t e rm , t h e o n ly c o n s e q u e n c e t h a t is g u a ra n t e e d is t h e p a s s a g e o ft im e .

Our shorter term indicators point to an increasing likelihood of a test or break of theMarch lows for the stocks. Given the current prevalent attitude instead expects a rallynew Dow highs, we expect this disappointing decline will add to the consternation ofinvestors and will probably cause money managers to hasten the process of"distribution." Since stocks are always 100% owned, this may simply mean that assetare rotated into those issues that are considered safest in a worst case scenario. Weexpect whatever sponsorship remains will attempt to rotate assets into the Dow stocks

Indeed there is a remote chance that the Dow may yet run again to one more new higbefore the cycle of the mania runs to its completion.

I n t h e la s t f e w m o n t h s o f 2 0 0 1 , t h e 3 0 Do w s t o c k s

m a y y e t r e s e m b le t h e " N if t y -Fif t y " in t h e la s t f e w m o n t h s o f 1 9 7 2 .


Do w In du s t ria ls 8 8 0 0 -9 2 0 0 - S PX 9 8 0 -1 0 2 0 - Nas daq Co m pos ite 1 5 0 0 -1 7 0 0

We bel ieve the odds o f a t ta in ing these targets are about two- in- three .

Our "bes t case " upside target pote nt ials for the rem ainde r o f 2001 are as fo llows : Do w In du s t ria ls 1 1 5 0 0 - 1 1 6 0 0 - S PX 1 3 3 5 -1 3 4 0 - Nas daq Co m pos ite 2 6 0 0 -2 7 0 0

We be lieve the odds o f a t ta in ing the se ta rge t s a re a t bes t one - in - three .

Alan M. Newman, July 3, 2001



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RESEARCH |



32/85

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W a ll S t . R u n s O u t O f W is d o mCHART DATA THROUGH AUGUST 21 , 2 0 0 1


The mania continues to amaze, offering history new chapters in human folly andcircumstances beyond belief. For the latter, we cite the Nasdaq 100 Trust (QQQ), alsoknown as "Cubes." The Cubes are issued by a trust that holds the stocks of the Nasdaq100 index and were first listed on March 10, 1999 by the American Stock Exchange. Athe trust gained in popularity from inception, it needed to buy the shares of the

underlying companies. The demand became a substantial reservoir of buying power thprobably had a lot to do with the upwards explosion of Nasdaq share prices. Growth hsurged from 300 thousand shares at inception to 134 million a year ago and 532 milliotoday. The rapid growth of Cubes has quite obviously provided support for Nasdaq's tocompanies, even as their fundamentals have crumbled and earnings have disappearedAs we suggested in a recent issue of HD Brous & Co., Inc.'s Crosscurrents, dealers whosee the order flow believe institutions, not individuals, are driving the market. With thCubes liquidity now so high, it is believed that mutual fund managers are now substituthem for the cash typically required to meet fund redemptions!

W e h a v e c o m e a lo n g w a y in t h e m a n ia a n d h a v e f in a lly a r riv e d a t a p o in t

w h e r e a d e r iv a t iv e b a s e d o n a n i n d e x w it h c o lla p s in g f u n d a m e n t a ls

is n o w t re a t e d a s a c a s h r e s e r v e .

Of course, there is always an offset and the worst case scenario of a prolonged bearmarket will obviate the need for 532 million Cubes. Despite the wisdom of many WallStreet professionals that technology stocks have declined to attractive levels, the vastmajority of Nasdaq stocks - particularly tech stocks - are still grossly overvalued.

N a s d a q p r ic e s c o u ld re m a in u n d e r p re s s u re f o r a t le a s t s e v e ra l y e a rs t o c o m

After several years of the greatest stock market mania of all time, total Dollar TradingVolume ("DTV") is beginning to rapidly decline. This does not quite mark the culminatof the mania, which can only come when all participants finally realize that the good timare not going to return and the need for capital preservation takes over, triggered byvisible and palpable fear. In the meantime, many players are still hopeful and areclinging to the long term mantra that Wall Street has injudiciously chosen to leadinvestors through the lean times. Although seven years of plenty need not be followedseven years of lean, we believe the signs point to a prolonged period of underperforma

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by stocks as valuations return to levels that were readily accepted as normal before thmania commenced. DTV topped last year at more than 322% of GDP and was still 283of GDP as of our last update on July 3rd. DTV has now declined (estimated for July &August) to about 258% of GDP. As our chart clearly illustrates, if we treat 1998 as thefirst year of mass hysteria (we believe the mania actually began in 1995), this measurstill has quite a ways to go before it drops out of consideration as an ongoing mania!Even now, for every dollar spent on the purchase of goods or service in the overalleconomy, $2.58 is spent in the trading of stocks. It is no wonder that the economy hafinally turned sour and now suffers as stocks maintain their mantle of importance, albesomewhat reduced from the height of the madness.

Versus total stock market capitalization, the recent contraction has also had a sizableimpact. The pink bar (current reading in purple) shows how high this measure travele2000 at the very top, exceeding even the insanity of 1929. The measure subsidedsignificantly before the end of the year and has dropped only nominally since, but is stproof that trading is very much the primary undertaking of market participants,institutional and otherwise. Given the relative size of the stock market, trading continto run close to five times the normal pace, normal being the standard for all the years considered as a mania (1928-1929; 1996-2001). Even when encompassing the mania

years, trading runs nearly four times "normal." One factor not previously discussed habeen the development of derivatives, such as the S&P 500 Spyders, the Dow Diamondand the Nasdaq 1000 QQQ trust. In the case of the QQQ's, turnover is astonishing,averaging about 10% of GDP each day and at current rates, the trust's outstandingshares change hands about every eight days. By comparison, heavily traded CiscoSystems requires more than 100 days to trade its outstanding shares.

We believe the changes set in motion by the price collapse of Nasdaq will inexorably leto a tremendous contraction in trading at some point. Investors will eventually becomdisillusioned as the prospect of the patience required of them jolts them back to realityand both of our indicators will eventually return if not to normal, to levels far below the

levels of today. And if 532 million Cubes are no longer needed, the Trust will eventualhave to unwind some outstanding shares. Selling pressure for the Nasdaq 100 may gofor far longer than imagined.

A s t ra d in g s u b s id e s t o m o re n o rm a l le v e ls , in t e re s t in s t o c k s m u s t s u b s id e

I n t e re s t m o v e s p r ic e s h ig h e r , d is in t e re s t d o e s n o t .



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The wisdom imparted by Wall Street's pros in recent months insists that new money beplaced into stocks, which will again soon surge north and provide profits for investors.Strategist's allocation to equities remains very close to all-time record highs over 70%Even so, domestic inflows to mutual funds have subsided, but have been replaced to

some extent by foreign inflows. Apparently, inflows from pensions and 401Ks remainstrong, as evidenced by the indicators shown below.

Cumulative money flow for the NYSE has also been greatly aided by a shift of assets oof Nasdaq and recently surged to a new all-time high, even as the Dow and other majoindexes recorded lower peaks and rally failures. The slight downtrend of the Dow sinc1999 is accentuated by a broadening formation in money flow. More money cannot taprices higher?! There is a visible divergence and we believe the broadening formationaugurs quite poorly for even the venerable NYSE.

In a bull market, the 50-day cycle for inflows typically displays peaks that run higher tthe valleys run low, as we see occurred through 1997. Since that time, however, thepeaks are very much mirrored by the valleys that follow - in our view, a sign that massdistribution is underway. Despite the huge hit to the S&P 500, down 30% print high toprint low, fear was non-existent and Wall Street's wisdom coerced many to pile onimmediately, told that "it can't get any worse, so it's got to get better." The result wathe biggest blowoff in NYSE history, as shown below. The blue arrow at right showswhere the indicator currently resides. Given the pattern that has repeated several timalready, we believe the inflow will eventually be met with an equal and opposite reactian outflow to our target, sufficient to take out the March lows.

B y c u t t in g ra t e s a n o t h e r t h re e t im e s in re c e n t m o n t h s , Th e Fe d e ra l R e s e rv e s a y in g " I t ' s n o t g e t t in g b e t t e r . I t c a n g e t w o rs e . "



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The common wisdom imparted by Wall St. pros is that improved NYSE breadth is proofan incipient bull market and that at historically high levels, the TRading INdex (TRIN) iproof a huge bull phase is right around the corner. The trouble is, we have heard thesrefrains since May and the major indexes have gone nowhere. Why? We believe Wall

bulls have been completely taken in by the changing environment. There is now noquestion that the moves by the NYSE to trade in sixteenths and then to trade in decimhave had a significant impact upon traditional indicators, such as the cumulative daily line (not shown). The A/D line has been on a steady incline for awhile and is now alinchpin of Wall Street's bullish wisdom. However, as shown by our Breadth Dynamicsindicator, it is clear that the moves to smaller pricing spreads have reduced thepercentage of unchanged issues significantly. Aided by several factors, such as assetsshifting from the Nasdaq to the NYSE and assets shifting into non-commons on the NYS(48% of total issues on the NYSE), the impact on breadth has favored advancing issueover declining issues by a factor of 5 to 2. Traditionally, the daily A/D has been biasednegatively so an improvement in breadth would look even better to pros, but the indic

has now become POSITIVELY biased as circumstances unfolded and although pros arelooking at the charts and commenting how good they appear, they are actually worsethan they look! Given that the changing environment has also impacted the numeratothe TRIN equation, pros are also mis-reading this important indicator, concluding that historically high numbers must mean a huge rally ahead. As we see it, high numbersindicate ongoing distribution and are bearish.

If Wall St.'s bullish wisdom was to be validated, then certainly CumulativeAdvancing/Declining volume for the combined U.S. markets should have alreadyexperienced a modicum of upwards spin. If we were in an incipient or nascent bull

market, should not the line for A/D volume have traveled along a similar line to the bluline shown below? Higher lows and higher highs would clearly mark a change inenvironment to a more bullish mode, but that has not occurred. Instead, the marketsswooned to new lows after the rate cuts began and staged a rally failure. Wall Street'sbullish wisdom is very much in question as the indicator now threatens to take out theMarch low. Interestingly, the set of green arrows outlines an identical time frame to thmeasured by the red arrows. The first green arrow corresponds to the Fed rate cut ofOctober 1998 during the LTCM fiasco. Clearly, what followed was bull market action.

Cle a r ly , w h a t h a s f o llo w e d t h e r a t e c u t s o f 2 0 0 1 is b e a r m a rk e t a c t io n .



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Several times before, we have shown a picture of 10-year annualized returns, but thistime perhaps a longer perspective is in order. Given the long term mantra espoused bWall Street professionals, perhaps 15 years represents the time horizon we need toexamine the potential for stocks. If so, the picture remains bleak! In this snapshot, th

extent of the mania is startlingly clear. The madness of recent years went well beyondthe Roaring Twenties, well beyond the impact of the bull market catalyzed by the end World War II and well beyond the mid-60's when household participation reached a therecord high. That high occurred in June 1966 (first red arrow) when more than 45% ohouseholds owned stocks. The reversal for our long term annualized average ended foyears later in July 1970 (second red arrow). If participation declines as it did past 196and takes the 15-year annualized average to the same 2.6% of July 1970, the DowIndustrials will be enabled to trade down to 5435, down 47% from now. Amazingly, lethan 48% of all periods shown are in excess of a 4% return and fully 13% show returnzero or less! Granted the depression that followed the Roaring Twenties could haveconceivably have skewed the results, even when we measured from August 1944,

although zero returns occurred only 5.4% of the time, returns of 4% or less occurred32.5% of the time and the average for all 15-year periods from August 1944 was just6.5% annualized! Excising the crash and depression, a return to normal is still very faaway! In fact, if 15-year annualized returns sank to the conservately "adjusted" averaof 6.5% five years from now, the Dow would trade at 7706!

Given the regression line in place since 1897, a forecast of lower prices for the severalyears ahead seems quite reasonable. Again, we can see just how incredible the impacthe stock market mania was. Two earlier secular bull market periods resulted in pricessix-fold, but in the present mania, they were up 15-fold! The regression line now stan

at 6841, down fully one-third from today. If the line were to be met even four years fnow, the Dow would still fall to 8176, down 20% from today.

Wall St. claims history as its guide for the advice to "buy for the long term." But for thwho bought at the top in 1929, the long term measured 24 years. For those who bougat the top in 1972, the long term measured 16 years. For those who bought in Februaof 2000, the long term could still be years away.

H is t o ry s a y s s t o c k re t u rn s a re s t il l e x t re m e ly h ig h .



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We invite you to stay tuned for our next report, in which we hope to further reflect upomore rational view of the financial markets. Clearly, Wall Street's professionals havebeen on the wrong course for at least a year-and-a-half and show no signs of relentingtheir grip on the bull thesis. There is a flip side to the coin.

Our shorter term indicators still point to an increasing likelihood of a test or break of thMarch lows for stocks. More so than at our last update, the current prevalent attitudecontinues to expect not only a rally, but a new bull market! If we are correct about amove to new lows, this could conceivably result in a big swing in sentiment catalyzed bsiappointment and finally, the recognition that circumstances can deteriorate evenfurther. A significant trading bottom might be enabled for the intermediate term, but wstill see very limited odds for the upside before the end of the year.


Do w In du s t ria ls 8 8 0 0 -9 2 0 0 - S PX 9 8 0 -1 0 2 0 - Nas daq Co m pos ite 1 4 6 5 -1 5 6 0 We bel iev e th e odds o f a t ta in ing the se t arget s are a t leas t two- in- th ree .


Do w In du s t ria ls 1 1 0 0 0 - 1 1 3 5 0 - S PX 1 3 0 0 -1 3 2 0 - Nas daq Co m pos ite 2 1 0 0 -2 3 0 0

We be lieve the odds o f a t ta in ing the se ta rge t s a re a t bes t one - in - three .

Alan M. Newman, August 22, 2001





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B a c k To S q u a re O n eCHART DATA AS OF OCTOBER 1 , 2 0 0 1


One sobering view of reality has America in its grip. Another reality cont

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