By Rupert Hargreaves. Originally published at ValueWalk.
Continued from part one….
The interview then moved on to discuss other market indicators. The divergence between the Dow Transports and Industrials, for example, as well as bullish sentiment in financial publications and the strength of the IPO market. Joe Feshbach drew parallels between the oil market and new issue market:
“…no different than oil at $48 everybody thought it was going to $70. The whole world wanted to get into the market, and all we saw was drilling, drilling, drilling, creating supplies, supplies, supplies — thus leading to a top. The exact reverse took place at the bottom. Everybody wants to get out…The same applies in the stock market when prices are high in a certain area, the new issue market starts to heat up.”
Nevertheless, despite the indications that the new issue market was heating up, Joe was hesitant to bet on further declines. The reason given was the fact that the market had changed, and was now being controlled by mutual funds, which were holding a high percentage of cash as assets. With this much cash sloshing around and mutual fund demand for stocks high, a sort of ‘mutual fund put’ was in place.
Joe Feshbach: Market rally
The conversation then moved on to the factors that would drive a rally in the market. While Joe Feshbach believed the markets downside was limited, until a catalyst came along, upside was limited as well. However, Joe thought bonds were set to rally during the fourth quarter of 1986, he concluded that this would drive funds into equities and start a rally:
“B: You’re saying that, come the fall, both the bond and the stock markets are going to take off?
F: Yes. After we get temporary hiccup, let’s say, in August-September of 8% — 10%, in the equity market, we will see an explosion in the stock market in the fourth quarter.
B: How big an explosion?
F: It will be 500 points, maybe more. If I am wrong, I am too low.”
Joe Feshbach was quite correct. The Dow dropped 7.5% in early September 1986 before rallying around 1,000 points to 2,709 in August 1987.
“B: If you’re right, what will be hot?
F: The only group that hasn’t been exploited yet to its fullest excess potential: all the big-capitalization stocks. All the quality names, from GE to MMM — all the stocks that are going to lead the market….
“F: All these big-cap stocks are really bond surrogates. That’s it. The bond market did nothing for about 10 years, until 1981–1982, and so did all those big-cap quality names. The retailers did nothing. The consumer growth stocks did nothing. The drugs did nothing. Financial stocks obviously did nothing. They were all bond plays.”
“B: When you say bond play, what do you mean? That you’re buying them for a yield?
F: Right. In the 1970s, who cared about Bristol-Myers growing at 15%; you could buy Alcoa Inc (NYSE:AA) or Atlantic Richfield, which had pricing leverage in a period of hyperinflation and were growing at 40%. So nobody wanted these boring PGs and GEs that had the usual 12%–15% growth. Now that has totally changed. There is no inflation, so is no pricing leverage, and so who cares about all cyclical companies or commodities-oriented stocks but give me Bristol-Myers, which grows at 12%–15%–18% every year, and you get the predictability. And, as long as rates come down, you get the benefit of the multiple. So it is a valuation-driven market and not an earnings driven market; and it is going to remain that…as long as rates continue to come down, the bond market does well and the big caps will continue to do well.”
A brief discussion about what Joe Feshbach was advising clients to do ahead of the fourth quarter rally (buy) followed. Then, the interview moved on to the implications of tax selling and then Joe’s outlook for the market for the next year.
Joe Feshbach
Joe Feshbach: Bear market ahead
After around 12 months of market strength, during which time Feshbach believed the market would rally in excess of 500 points (it rallied 1000 between the fourth quarter of 1986 and the ‘87 peak) Joe foresaw what he described as a “wicked bear market sometime later in the 1980s — an outlook that turned out to spot on the money, quite literally.
“F: The guys coming in sometime in May — June of next year at 2500 — 2600 or whatever, on the Dow are the ones who will have a real problem.
B: After 2500 — 2600, look out?
F: It is too tough to make a forecast like that. But if everything works out the way I think it will…At some point the market will be over owned, and we are going to be in for some extremely rough times…all these derivative products like futures on options, and options on futures, and futures on horse manure will have led to the great speculation. There will be a wicked bear market sometime later in the 1980s.”
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