‘Investors make bottoms and traders make tops’

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Knowledge is treasure but the real treasure for wise man is in his judgement. For the trade secrets of the wise men and women of Wall Street, Ramesh Damani , CNBC-TV18 spoke to Phillip J. Roth , technical market analyst for New York based Miller Tabak & Company who believes that the most important technical precept is that 'investors make bottoms and traders make tops'. He feels that an investor is somebody that's motivated by price and value.

 

On Se nsex movements, he said, "We are in a normal cyclical bear in most of the world markets. We have got financial concerns in the US more than in other areas. So, it seems to me that we have got to get through the problems in the banking and financial service industries in the US. Once that is behind us, the rest of the US market will be in a better position to move ahead and we can start to look at the global markets again. But, they need to be tested by the rest of the bear in the US."

 

Excerpts from CNBC-TV18's exclusive interview with Phillip J. Roth:

 

Q: When you buy a stock through technical analysis you said four things can happen to it what are they?

 

A: It was a colleague of mine who said that when you buy a stock four things can happen; it can go up a lot, which is what everybody is reading for; it can go up or down a little and those sort of wash out and cancel out each other and it can go down a lot. If you eliminate the downer lots, you will make money and do well in the markets.

 

Q: That is how a technical analysis comes in?

 

A: Technical analysis is very good at risk control. It is what fundamental analysis has a difficult time dealing with. If a fundamental analyst likes a stock at 30 because he thinks that it is going to 40, he gives no thought to the fact that it could go 20 or 10. A technician looks at where am I going to sell that if it goes against me? That is the most important thing.

 

Q: How do you judge the primary trend? What is the tool to judge the primary trend of the market bullish or bearish?

 

A: First of all we look at the cycle that is associated with the economic cycle that is three-four-five year trend. About every 50-54 months the cycle makes a bottom, so we are looking for that. The last one was '02; from '02 to '03 it built the bottom. I am expecting it to sustain strength for a few years. So, a period of basing can be six-nine months or so to set up the stages.

 

Q: Will there be a breakout then?

 

A: There will be a breakout, a move to a new high over that period and once it looks like it has broken out into new high ground going back six-twelve months or more. I am going to be looking at trend following techniques, moving averages. If we are looking at a weekly chart, a forty-week moving average, it represents that longer-term trend do fairly well. On a daily chart a 200-day moving average (DMA) represents the trend fairly well. So, if a stock is in an uptrend, I expect it to be moving above its longer-term moving average.

 

Q: Typically would you start on a top-down approach; first take a broader view of market or a sector before you go to stocks?

 

A: I analyze the market every week and I always do a top-down versus bottom-up analysis. My top-down indicators tell me do stocks make sense at all relative to other forms of investments.

 

Q: Like bonds, commodities, and currencies?

 

A: I am going to be comparing them. A judgement about how stocks compared to other investments is made. Then top-down indicators also tell me what kinds of stocks make sense. For example, if oil prices are rising and interest rates are rising, I want to buy energy stocks and sell utility stocks.

 

So, the macro gives me confidence in the equity market as a whole and it points in certain directions. Then I look at as many individual chart patterns as often as I can, to see if I am getting the same message or a different message. Sometimes my market opinion is going to change top-down, sometime it might change bottom-up but I am always comparing the two to have confidence in that trend.

 

My love is the top-down; I am interested in the markets and market indicators. So, I follow many of them more than 100.

 

Q: I have been told that you have indicated junky?

 

A: Nobody follows more indicators than I do. I have been following indicators for forty years sometimes they do not even work well for a while. But, I cannot throw them away and keep following it.

 

So, I start with that and that is important for my confidence. If my macro indicators tell me, it is early in a bull or in the middle of a bull then when I look at individual chart patterns, I am going to be prejudiced by that long-term view. I want to be prejudiced if my long-term macro indicators are positive. I want to find more stocks to buy and fewer stocks to sell.

 

Q: Between volume and price what would you pick?

 

A: If I could only choose one, price is obviously the most important thing because if you buy stock and it goes up you make money; you don't care about anything else. However most of the time stocks and the market have to be pushed up, it takes increasing volume to sustain an uptrend.

 

Q:  Will stock going up on a poor volume be a negative sign?

 

A: It is something that I would distrust. You don't need volume to go down, stocks can sink unlike volumes. I am looking for increasing volume and volatility on the upside.

 

Q: Moving from short-term to intermediate term, what is intermediate term?

 

A: I have more indicators that work in the intermediate term horizon, there are not that many indicators that one can use for the short-term. When you have a very short-term horizon, you are basically going to be using only the internal dynamics of the market itself. When you get to the medium-term now, I can look at measures of psychology and supply demand and also do market analysis. The most important technical precept to me is that 'investors make bottoms and traders make tops'.

 

Q: Investors make bottoms and traders make tops, explain that?

 

A: An investor is somebody that's motivated by price and value. If you a have long-term view you are not interested in day-to-day wriggles and when stocks go down they get cheaper and the investor gets motivated.

 

Q: Is that bargain hunting?

 

A: You can call it bargain hunting. As stock declines, it's multiple comes down and yield goes up. People with long-term horizons get motivated to buy in that environment. Traders have the opposite point of view; they don't care about value, they care about trend. They get motivated to buy, when the trend is strong.

 

Therefore, if the trend has been moving up at some point in advance, investors who bought them low are going to start to take profits. The trend would continue up for a while and perhaps for a long while because the traders are dominating and very bullish. What's a top?  A top would be that print in an uptrend, when prices stop advancing because investment liquidation begins to offset the buying by traders.

 

Q: We obviously do cyclical and secular trend but let's talk about the trends in global markets. What have been the 2-3 great global tops that you have studied or witnessed?

 

A: In 1999-2000, the Nasdaq market's mark up looked something like the US market. In the late 20s that led to a huge collapse and as you know the Nasdaq market has recouped less than a third of that entire decline. That's normal and if you look at the in the 80s, Nikkei ended 1989 at 40,000. It had a big mark up at the end and we had a series of cyclical bear markets in Japan. The index has recouped a very small portion of that decline. In 1999-2000 it was technology and everybody needs technology. Japan was taking over the world in the1980s.

 

One gets a perception that a real estate and stock boom can go on forever because it never does and you pay for it with a long period of correction.

 

Q: What would be your call for Nasdaq to cross 5,000 or Nikkei to go back to 40,000 technically?

 

A: First of all, maybe never.

 

Q: There is no Santa Clause in the financial market?

 

A: I think that the Nasdaq market could certainly improve again. There would be different stocks driving it. The stocks that drove in 1999-2000 were Cisco , Intel and Microsoft , the much more mature companies now. These will not be stocks that will drive it in the next time, but it is a generational thing. It is not coincidence that there are 20-30 years of speculation because the people that got hurt in the previous bubble just don't come back. It takes a new generation of investors with no memory of that previous decline.

 

Q: Are tops different or some tops that would correct in a cyclical manner and go back to a new high?

 

A: We want to distinguish between the secular trend and the cyclical trend. There is a cyclical trend that is associated with the up and down in the economy and those trends in US has been 4-5 years of period. But, there is also a longer trend or a secular trend that is dominated by something else it could be innovation, commodity prices that will lay us for several cycles. Infact, its an asset based cycle.

 

Q: You can be too early to call a top in the market; there is a huge risk in that?

 

A: Markets can look late in cyclical bulls and go on and on. If we go back to the last cycle again most people thought technology stocks will be repriced in early 1999. The Nasdaq index doubled in the next year from an already overbought price, so it is very hard to pick it up. I don't try to pick it up and let the market do it.

 

Q: What are the most productive looking chart patterns as a technician that you like to see?

 

A: I start by looking for something as spin out of favour for a long time. So, the potential level is a very big base. Normally part of the market is in favour, a part of it is out of favour. So, when we are in a bear or we are beginning in a bull, my first thought is let me look and see what kinds of stocks didn't do well in the last bull market or over the last several bull markets and what do they look like now; are they showing a relative strength, or are they showing a change? So, a stock is spin in a trading range for a couple of market cycles for eight or ten years or more. I am interested in it, but need to see signs of price momentum on the upside in the early stages of an up market. If I see both of those things, big base and momentum then I am interested in the stock.

 

Q: The hypothesis that you came up within 2003 that global growth is what you are looking at. Did it lead you to watch the Sensex too?

 

A:  I started with looking at the kinds of stocks that were out of favour in the US. Most natural resource stocks fit the bill and they were emerging. So, the next step is okay- I see all these resource stocks that have been out of favour for 20-years in some cases.

 

Q: Did you ask why were they out of favour,?

 

A: I asked why were they out of favour and why should they comeback into favour? The next step is what would drive resource stocks? US is a mature economy, we are not the big users but third world economies, which include the South America and Asia, are younger economies. Our emerging economies are wasteful users of natural resource compared to mature economies. Then my next step was to look at the Indexes like China or India. Big bull markets were evolving and that made sense.

 

Q: As a technician you could spot a great bull market without knowing anything about the Indian economy. The sheer chart and sheer logic drove you to that?

 

A: I am more interested in how something goes up, rather than why it goes up. If I have confidence in how it's going up, my customers want to know whether it is going up a lot? So, they look to me to say why does it look good? So, I need to have the background.

 

Q: Looked at it now the Sensex has risen from 3,000 to 21,000 to the peak, what's your call?

 

A: We are in a normal cyclical bear in most of the world markets. I doubt if they are going to begin in new cyclical bull and so the US strains out; the US is a big factor in the markets. We have got financial concerns in the US more than in other areas. So, it seems to me that we have got to get through the problems in the banking and financial service industries in the US. Once that is behind us, the rest of the US market will be in a better position to move ahead and we can start to look at the global markets again. But, they need to be tested by the rest of the bear in the US.

 

Q: There is a maximum that I always ask that you don't fight the Fed on Wall Street , given the amount of liquidity that the Fed is providing would it shock you to see the Dow making a new high in 2008?

 

A: Yes because that liquidity doesn't have to go into the stock market. It's tremendous liquidity and it's going into oil prices, now in gold prices and so. Don't fight the Fed is a little simplistic.

 

Short-term interest rates have come down, the Fed has done that but the markets has been struggling and hasn't gone anywhere since the Fed started taking rates down because corporate loan rates have not gone down. We have the decline in government bond rates but that reflects fear buying or people are moving out of the equities and are looking to park their money. I feel more sanguine about US stocks, if there is a decline in long-term rates under corporate side, jump on rates is still very high.

 

Q: What was the low for the Dow ?

 

A: I have been assuming an average kind of bear market, which would be 20-25%. For 25%, it is 10,700 Dow. Could it be more than that and could be less. So, right now that's my target and I am willing to envisage that up or down depending on how the indicators evolve from here.

 

Q: The low for the Sensex?

 

A: It's down enough. Time is more of a factor to me than price. I want to look for bottom in Asian markets when the US market is bottoming out.

 

Q: How high can oil go?

 

A: Oil was going much higher in the next cycle than it is now. I don't have a number, which I could tell, maybe USD 150-200 per barrel.

 

Q: Who is not going to surprise you?

 

A:  The world doesn't have enough oil. The problem in fact is that oil is too low not too high. The fact that we were using so much oil especially in the US is because it's too cheap not because it's too expensive. If oil was higher, demand would drop. So, oil will keep going up until demand drops.

 

Q: What about gold?

 

A: I have the same view on most commodities that they are going much higher. Gold is going much higher as well. Why gold is easy because gold moves up when you have a great inflation or a great deflation.

 

Q: Is it because it holds value?

 

A: It will hold value. The chances of a greater deflation are fairly small because global central bankers are concerned with growth. If they are more concerned with growth that means they are going to pay less attention to inflation. Inflation is going to gradually keep increasing, it's not a terrible problem by now but it is going to keep increasing. That's good for gold.

 

Q: So gold could go to 2,000?

 

A: It will.

 

Q: To be a trader what's the biggest thing you have to guard yourself against?

 

A: You have to be disciplined to make money in the market, you don't have to be genius and you don't have to find the best stocks. What you have to do is not lose a lot of money under ones that don't work. So, if you can control risk and take a lot of small losses, you will have big ones and make a lot of money.