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Home » Smart Money Indicators » Interview with market pro Don Hays in Barron's (April 2nd, 2001)

Interview with market pro Don Hays in Barron's (April 2nd, 2001)

Barometer Readings! APRIL 2, 2001

A onetime "perma-bull" pores over a host of indicators and turns bullish again. An Interview With Don Hays - If you think only a rocket scientist could figure out the centrifugal forces of this market, then this is the guy for you. A former engineer working with the team that developed the Saturn rocket for NASA some 35 years ago, Hays long ago found that Wall Street could supply him with the same thrill of going to the moon and coming back to earth, with a bigger, and definitely more essential, payload attached. His skills in detecting market patterns by using a battery of barometers, then drawing historical correlations from those patterns, have led to an enormously successful run of correctly gauging the market's flight path. Notably, he warned his clients early on that the movement in the Nasdaq showed a remarkable resemblance to Japan's Nikkei index in the late 'Eighties and would likely return to its pre-Internet-madness level of 1800 before all was said and done. Coming from a self-appointed "perma-bull" who turned bullish in 1981 with the sage prediction that disinflation would lead to an unprecedented period of prosperity, this was sacrilege, indeed. Still, he was right. He was in Florida when we caught up with him by phone the other day. Listen in to learn where Hays, who has run the Hays Advisory Group (www.haysmarketfocus.com) since leaving First Union and its Wheat First Securities unit in the fall of 1999, sees the market headed next.

 

Sandra Ward Barron's: I hope the weather is better in Naples than on Wall Street.

Hays: It was a little cool yesterday, but back up to 80 today, the sun is shining and there are no clouds on the horizon.

Q: No wonder you turned bullish.

A: Well, it's been that way for the past three months and I've only just turned bullish.

Q: Why does the world look rosier to you? You've cited the Arms Index as one reason. Why don't you tell us about that?

A: It has got all kinds of names. It was known as the MKDS and sometimes it's referred to as the "Trin." It was developed by Richard Arms. I like it because it has worked so well. To me it is like the fuel gauge on your car. It's as if you have a dragster and you want to go from zero to 120 in four seconds, and you have a carburetor that just sucks gas and it takes a huge amount of fuel to push the car down the strip.It's the same way with the Arms Index. It measures the amount of upside volume to downside volume in relation to the number of stocks. So think of it as a measure of energy being required to push a market up or down. Anytime it goes above 1.3, and that's the 10-day average now, it's a sign that you have got to stop and refuel before you go down some more. But when it goes above 1.5 it's a sign you are virtually out of gas and running on fumes and there isn't much more energy to push it down, based on historical examples, of which there have been 12.

Q: So we've hit bottom? Or do you need some other signal to confirm that?

A: You are not kidding we need more evidence. We got the signal one day before the October 19 crash in 1987, but you lost your shirt -- 22% -- if you bought into the market the day it gave a signal. In almost every one of the instances where the Arms Index moved above 1.5, there was always some more vicious decline after it. So there is more to go on the downside and you don't want to pull the trigger yet. But you have got to be ready in the next couple of weeks.

Q: Can you be more specific?

A: I have no idea when it will be, but I know in the past the longest wait was 20 days from the signal. I don't think it will be 20 days. For the past 15 years, it has always been in the four days following. That's the reason I think yesterday's [March 22] intraday low probably will be the low. I will be dollar-cost-averaging into the market in the next two weeks. The signal to watch for -- a rally of 1% in the S&P on increasing volume from the previous day -- should come after the first three days, between the fourth and the 10th day. That says the odds are high for a move on the upside. If I see that happening, I may jump ahead a little bit. But I always like to go back to history and find other examples that I think are similar in background and similar in action. I find March 24 of 1980 to be the most equivalent. In 1979-80-81 we were going into a period in which the new theme was disinflation. It was setting the framework for the next bull market. Every time inflation came back, the Fed fought it a little harder and there were very definite signs in 1978, '79, and '80 that inflation had been defeated. That became more evident in 1981. This time, the new theme will be deflation and the spread of democracy. If this is similar, we have three or four weeks here of ebbing and flowing before we take off. "I think [March 22's] intraday low probably will be the low."

Q: All this comes to you via the Arms Index? A: Oh, no. But it is a great indicator to tell you that there is something very significant happening. Until this point, I thought the capitulation phase of the bear market would not come into effect until sometime in the April-June period. About three or four weeks ago I changed my mind. The Arms Index gave the signal, and you could just feel how everything felt so much like March of 1980, when everybody was thinking the end of the world was here. I realized we were going out of the interlude and into the capitulation phase, and so I upped my cash and decreased my equity position. Q: What charts other than the Arms do you rely on? A: I'll give you the most pertinent ones that are sending me a message now. A valuation gauge that is very important is one developed by I/B/E/S measuring the earnings yield of the Standard & Poor's 500 based on 12-months forward earnings. That earnings yield is then compared to the yield of a 10-year-note and from that you can glean whether the market is overvalued or undervalued. At yesterday's close [March 22] it was 8.7% undervalued. It is the first time it has been in the undervalued category since the panic selloff in 1999 and before that in 1997-98. It had been 70% overvalued at March 10 of last year. That's one, but psychology is my favorite indicator because, I think, psychology determines what the Federal Reserve does.

Q: Isn't that the hardest one to get right?

A: Not if you have the right indicators. I use the equity put/call ratio, and that has the best record of measuring real bullishness or bearishness.

Q: That gives you a read on the mood of individuals, not professionals?

A: It is more focused on the individual investor and individual stock. It excludes indexes. The three-week average is 12% above the 39-week average. Like the Arms Index it doesn't tell you it is going to turn around the next day. It tells you that the "wall of worry" has been rebuilt. A fairly recent addition to my psychology composite is the Smart Money Flow indicator. It is fantastic, and I like the philosophy behind it.

 

Q: Explain. A: It confirms other signals. If the Dow makes a new high, the Smart Money Index has to confirm the action. It called 1987 perfectly. One of my subscribers brought it to my attention about three years ago. He had been keeping it all these years and in 1998 before the August debacle, it started plunging and called that one perfectly. Again, in the fall of 1999 it started plunging. Every time the Dow tried to rally after the January-February high, this kept on plunging. It has not had any higher highs until the last two months and it has really been acting good.

 

Q: What exactly is the Smart Money guage?

 

A: You calculate it by taking the action of the Dow in two time periods, the first 30 minutes and the last hour. The first 30 minutes represents emotional buying based on good news or Maria doing handstands. It is dumb money. So the keeper of the index, Lynn Elgert, subtracts the dumb-money action on the Dow that occurs in the first 30 minutes and he adds the last hour, which represents the smart money because the action in the last half of the day tends to be based more on logic and reason. For the very first time that index has been making higher highs. Yesterday [March 22] the real snap-back was in that last hour. I think that is more evidence that psychology is good.

 

Q: So these indicators are still viable even though there's increased access to information and news flow leading to lightning fast changes in the markets?

 

A: I don't think that makes a bit of difference because people are still driven emotionally and I don't think that fear and greed have changed. No matter how quick you get information, it still takes about the same length of time for fear or greed to build up. So I don't see any difference in the volatility of the market. Depending on where you are in the cycle, in the super cycle, not just the three-year cycle or four-year cycle, but if you are in one of the 18-year super-cycle markets, or in an evolutionary stage, I think the indicators are still very accurate.

 

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