Note in the lower graph the New Highs minus New Lows index is just now getting into the territory typical for a reversal.
June 27 Blog Post Two factors, already evident, will control our future:
The shift in consumer spending from discretionary items -- cars, electronics, cosmetic surgery, vacation travel -- to non-discretionary items -- food, fuel and shelter are the classic necessities.
The shrinkage in debt levels and credit availability. This will raise a painful question -- how big and grand a house is actually needed in an era of tight credit?
Debt & the Privatization of Everything
Debt has played a critical part in the growth of our Gross Domestic Product since the late 1990s, as the following graph shows. At the same time, the growth in payroll employment has fallen.
(The left axis is Dollars of Credit Market Debt for Each Dollar of GDP Growth and the right axis is the decade percentage growth in Payroll Employment Expansion. Data for both graphs provided by Contraryinvestor.com.)
Compounding this problem has been a steadily declining percentage in the increase in average hourly earnings for the service sector:
As credit availability declines, what will happen to all those businesses that depended on credit for their creation as well as their continuing survival? And if credit tightens, how will we achieve economic growth from the continued creation of new businesses based on debt?
This just may mean that the privatization-"self-employment nation" fantasy is kaput. Privatization may in fact be the old model. The excesses it created will force us to adopt a new model.
What will replace it? My guess is the old-old model: Some kind of public spending. The word "public" has pretty much disappeared since Reaganomics took hold in the '80's. America has been like a third world country, enriching an executive-aristocratic class through the privatization of what had been public goods and services. The most recent, and egregious, example of this is the privatization of the US military through for-profit organizations such as Blackwater USA.
Now that the executive-aristocrats -- those Bubble Masters who had ruled the empires of Bear Stearns and Citigroup, Countrywide and WaMu -- have demonstrated the incompetence of their greedy vision (though they successfully enriched themselves as individuals) -- what are we left with? An economy dependent on spending by consumers facing higher costs for basic necessities. Not a prescription for growth.
I rather doubt that American citizens are going to want to trust the Bubble-Masters of our busted economy with its revitalization. But who knows? We are a nation hypnotized by modern, marketing-driven media. So maybe we will see even greater privatizations in the future. It will probably depend on just how painful the immediate transition we face turns out to be.
But rather than a continuation of the recent past, I think the job of creating a new model for the economy is going to go to Government. Sounds impossible, I know. It's human nature to project the recent past into the future but the pendulum swings from one cycle extreme to another. We've definitely passed the extreme of this cycle. A new twist on something that we haven't seen in quite a while awaits us.
Cost-Push Inflation
Cost-push inflation is a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade. (Source: Wikipedia)
When costs for necessities go up, employers have no choice but to increase wages or to substitute technology-mechanization for employees. (As a department manager during the big inflation of the late '70s-early '80's, I remember this dilemma very well.) Eliminating employees has been going on for some time and is likely to accelerate. That means very slow or no employment growth.
Rising costs for necessities, rising unemployment -- how are you going to keep government out of that game? (I guess now that every home can be an armory, wholesale killing of each other is an option -- will we have real food fights?)
But there is a good alternative: create jobs in brand new industries or redirect existing industries into brand new ventures. That is where the stock market is supposed to take us but, unfortunately, with its focus on quarter-to-quarter earnings it will not easily accommodate a genuinely secular change, the kind of change that's needed in the way we do business as a society and a nation. Charts for June 20
The dotted line is the price of the 20-year Treasury Bond. The red line is the S&P 500 Index. The green line is the yield on the 20-year US Treasury Bond. The circle denotes shows bond yields right on their support line; if there's no bounce, look for higher bond prices and, probably, lower stock prices.
The relative strength of small caps surpassed big cap stocks until 2006. Now it appears a decisive change in that relationship has occurred.
It seems likely we'll see 1276 again and a drop to the next retracement level at 1082 doesn't seem unlikely.
A final piece of bad news: the "fear index" closed above its 200-day moving average on Friday.
Charts for May 30
Updates of charts shown earlier -- First, the put/call ratio remains at a low level; the danger sign is when short moving averages (blue line) turns up and approaches the 25-day moving average (red line). Next, price is still above the moving average for two breadth indicators for the NYSE composite.
This is a correlation only, not a cause-effect, but the Japanese Yen appears set to continue its downturn and that has, thus far, been a positive for US stocks:
Charts for May 23 The Put/Call Ratio -- puts anticipate lower prices in the future -- has held an uptrend since 2004. The green circles indicate the peak in the ratio, which correlates with rising stock prices. The red dashed vertical lines indicate where puts begin to outnumber calls and the fall in stock prices.
The Japanese Yen continues its uptrend which so far has correlated with lower prices for US stocks. One warning note -- sharply declining volume since the last big run-up in this exchange-traded fund that tracks the Yen.
Americans who still think Emerging Markets are risky have sure missed the boat.
In the charts for May 16 (following), I pointed out the impending difference between the NYSE Up/Down Volume ratio in 2006, when the market recovered, and 2008. Regrettably, I was right:
Charts for May 16 Peaks in the VIX or fear index generally coincide with stock price lows, and vice versa. But we may be seeing a significant change in trend to lower levels in the VIX. The last time that happened, in 2006, the market rose dramatically in the following four months.
The following two charts seem similar until you look at the heavy green line which shows a distinctly rising trend in 2006 and a sideways trend in 2008.
While this chart is bullish, we need to see at least the 20-week moving average (top chart) turn up -- and preferably the 50-week MA do the same -- before we can say we're looking at an actual change in trend.
It's interesting to see how immune the regional banks (second chart) were to the impact of the dot-com bubble. But today both bank trends appear negative.
Quite a turn-around for lumber prices. Bond buyers demand higher yields when facing the prospect of inflation.
Gold is still in a bull market.
Charts for May 4
Charts for April 18
Skip down to the March 14 charts for a comparison. The only negative on this chart is the lower volume (the histogram at the bottom of the top chart).
The real test for the S&P 500 comes at around 1400 -- the "resistance zone" in the lower chart.
I think this is an interesting chart because it shows so clearly the insanity of the 1999-2000 bull market top. The VIX stayed above 22.5 for most of that time and when it did fall, it shot right back up again, driving stock prices lower. It's also interesting that the fear index never reached the peaks seen in the last blow-off of a bull market despite the damage done to our entire financial system. It may in fact be a sign of complacency. And complacency is a contrary indicator.
I've pointed out a number of times the correlation between a falling Yen and rising US stock prices. On another note, I read an opinion last week predicting a pullback in the Euro at around 1.60. The Europeans can't stand much more pain on export prices. Looking at the chart, the Euro price is far above its moving average, typical of a condition preceding a pullback in price. The dollar has formed a triangle pattern but it's hard to imagine how that could resolve itself to the upside.
Charts for April 11
The light green dotted vertical line shows the momentum (MACD) crossover, a buy signal, but the market was still in a trading range until six months later. The dependable positive change was signaled by the 50-week moving average (blue line, middle chart) turning up. As you can see, that line is still headed down now (red oval).
It may turn into a bullish inverse head and shoulders formation, or not:
It's remarkable how regular the ups and downs of the VIX have been since since the October high in the market, when looking at it on a 10-day moving average (blue line). When the VIX is up, stock prices are down. The hesitation, compared to the preceding two intermediate peaks, is circled.
Charts for April 4 Back on March 14 we wondered if the low at 30 for the percent of stocks showing a bullish chart pattern would turn out to be a higher low and a positive indicator -- so far it has. The market's move, however, has been 'parabolic' and those usually aren't sustainable. But one step at a time.
A positive sign on for the S&P 500 Index is that there were more stocks recording a new high with the index's latest high in price than it's last high earlier this year (the green vertical broken lines). The numbers in purple indicate the "give-back" percentage of profits since the 2003 low.
The last cooling-off period following a parabolic rise in price for both industrial and precious metals resulted in still higher prices. The jury is still out.
The chart for stocks of developed foreign nations shows a great example of panic selling, probably stop-losses being hit, and buying by the pros back in August. Both EFA and EEM are in trading ranges, and that's a positive that may indicate they have shifted from down to neutral. (There are three trends -- Up, Down, and Sideways.)
Chart for March 28 The following chart compares the price for the NYSE composite index with two measures of its "breadth," that is, how many stocks are participating in the market's current direction. The first breadth chart is the percentage of stocks in the index above their 50-week (long-term) moving average; the second is the percentage of stocks in a bullish point-and-figure chart pattern.
Note how price continued to move higher, after the July-August swoon, after the breadth indicators hit their peak in February last year. The first danger sign from breadth was the drop below the 50-week moving average and the slope of the moving average lines turning down. The second danger sign was the failure of both breadth indicators to rise above their moving average lines when the market hit its October all-time high. The point: Even though the index's price didn't fall below its 50-week moving average until December, the time to begin selling into strength began much earlier in the year. This is how long-term charts can make investing a joy.
March 14 Charts
The oscillator in the lower graph simply compares two moving averages of price and is an indicator of momentum. A turn up is positive, but it is starting from a very low level. By comparison, there's no similar sign of life in the S&P 500, no doubt because of it's heavy concentration of financial stocks.
Ironically, this chart is the best looking of the three. Unless this is the end of Western Civilization as we know it, this index is going to stop falling. The question is how long it will bounce around in neutral before reversing up.
Notice how a rally, however brief, follows the spikes in the VIX above 30. This chart is a great example of a bullish wedge. When prices decline in a wedge pattern they typically break higher.
The real issue with the VIX is longer-term. There's a lot to consider in the following chart. One thing it seems to indicate is that a steadily rising market correlates with a VIX below 22.5. When VIX crosses, and its moving average stays above 22.5, it doesn't mean the market has to go down; it does appear to mean more ups and downs, more volatility, until a breaking point is reached, as it was in 2000. What we're experiencing now might just be a repeat of 1998; the market fell dramatically and then picked itself up to reach new highs. If that's the case, though, another 2000 may be awaiting us as well. Keeping an eye on the VIX may help tell us if that's coming to pass.
March 7 Charts
Expect a pullback in commodity prices and precious metals.
A break below 1276 would be bearish indeed. That point gives back 38% of the increase from the 2003 low. Next stop, 50% give-back at 1182.
The 38% give-back point on the Dow is 11621.
Another thing to keep one's eye on is market breadth. Here we see new highs minus new lows. Note how low the price of the index (histogram) is compared to the number of net new highs. We need to see a turnaround in net new highs for this proposed double-bottom to hold.
Finally, weekly down-volume (red line) appears to be reaching a peak. Expect a reversal and rally in stock prices. The theory here is that price follows volume. Note how peaks in the green line (up volume) are followed by falling prices. For a rally we want to see the red line decline from peak and the blue and green lines rise.
February 22 Charts
The commentary for these charts is on the Home Page.
First chart graphs Bullish/Bearish sentiment as reflected in the American Association of Individual Investors survey.
This chart shows how a lower low in the index price but a higher low in the Bullish Percentage provided the set-up for the beginning of our last Bull Market. A higher low in the index price and a much higher low in the Bullish Percentage -- which held above the "buy signal" 30% mark. It was "all in" at that point.
Emerging Market barely fell below the channel and the 50-week moving average. The index appears set for a rally if price decisively penetrates up through the lower channel boundary.
Domestic Large and Small caps look weak by comparison.
BONUS CHART FOR THOSE WHO READ ON TO THIS POINT. The Blue line is a 10-week moving average of NYSE Up Volume (the volume of stocks falling in price). The Red line is a 10-week moving average of NYSE Down Volume. Note how extremes are followed by reversals. The interesting point now is the decline in Down Volume (Bullish) and the increase in Up Volume, also Bullish -- if it can continue. Up Volume has already, but just barely, surpassed the previous high, while the Index price is well below the previous high (the blue oval). If price follows volume, this is a set-up for a rally.
Charts courtesy of StockCharts.com. February 15 Update While there are some signs of stabilization in the market, we appear to be a long way from any sure sign of a reversal to the upside.
In the view of some, since the market hasn't fallen 20% from the October high, we are only in a market correction rather than a Bear Market. It may just be a matter of time.
Consider market breadth. The percentage of stocks above their 200-day moving average is 21.64% for the S&P 500, 22.26% for the NYSE, and 26.00% for the Nasdaq 100. And as the charts show, both the S&P 500 and NYSE are far below their 2006 lows.
Can it get worse? The NYSE and Nasdaq 100 hit 10% and 9% respectively in the last Bear Market.
Looking at these charts, a bounce may be in the cards, but a bounce does not a trend make.
Nor do the Advance-Decline lines give us much reason to hope for any more than a stabilization -- and bottoms typically take many months to complete.
Finally, consider these 60-minute charts. In the first chart, the ETF SPY, representing the S&P 500, note how the volume bars in the histogram at the bottom of the chart decline as the price increases (blue oval) and then how volume increases once the break-out down from the triangle occurs (black oval). A second triangle has now formed, also with declining volume. While the pattern for small caps, IWM, the ETF based on the Russell 2000, is different, the rectangle pattern, like the triangle, is a continuation pattern; so the odds favor another decline rather than a reversal up. This is significant because small caps traditionally lead markets out of a recession. It appears we're just getting started. Charts courtesy of StockCharts.com.
February 8 Update Is the worst over?
It just may be, thanks to the most aggressive Federal Reserve action in history.
A significant divergence popped up last week: We had a low in market index prices without a corresponding number of stocks hitting a new low on the New York Stock Exchange. As you can see on these charts for the Diamonds ETF, the Dow Jones Industrial Average you can buy, and the S&P 500 SPDR the January low corresponded with a peak in the NYSE lows statistic, while the subsequent (higher) low last week did not.
It's also notable that both the DIA and SPY halted their declines at around the 62% mark from the previous low (July 2006) to high (October 2007). A break below that mark would indicate a likely surrender of 100% of the gain -- right back to the July 2006 low.
Looking at the NYSE New Highs minus New Lows, we can see stocks have crawled back to just a hair below zero, a position that has set a base for rallies in the past. We can also see on this chart that the low point for the NYHL was hit back in August -- before the October 9 high in market index prices.
None of the foregoing means we'll actually get the bounce -- the NYSE Advance-Decline Line (stocks advancing minus those declining in price) remains well below its 200-day moving average, which has rolled over, not a good sign.
Another sign of continued uncertainty, are the following charts of the small cap Russell 2000 and large cap Russell 1000. Triangle patterns are considered continuation formations -- which would mean we should expect a breakout to the downside. If we don't get that downside breakout, the worst may indeed be over. We'll just have to wait and see.
January 25 Update There are still Bulls out there.
In addition to the short-term "buy" signal issued by some technicians for the S&P 500 and Nasdaq 100 on Friday, the number of Bulls in the weekly AAII survey remained strong. As last week's update noted, the last Bear market did not reverse until Bullish sentiment had dropped all the way to 12%. This past week, Bullish sentiment was 25.14%, although Bearish sentiment hit 59.02%, a high so far. The all-time high is a 67% reading in 1990. Too many Bulls for us to be contrary yet.
Market breadth indicators do not paint a happy picture. Consider the cumulative New York Stock Exchange Advance-Decline Line. It is further below its long-term moving average than at any time since the last Bear market. Note how the moving average line has flattened out, indicating a change in trend.
We see a similar picture with the NYSE New Highs-New Lows, where the long term moving average (red line) is just starting to flatten out but has crossed both the 50-day and daily price lines. The S&P 500 was at 1200 at the last peak in this indicator in 1998. At that time, New Highs continued to decline as the market hit its peak in 2000 (not shown). At least we're more in sync now.
Concern about recession finds support in the index for industrial metals prices. We are on a long-term support line dating back to 2006 but prices are well below the 200-day moving average, which has already started to slope down. Below industrial metals is precious metals. Given the distance between the price and the moving average, it may be time for a pull back, which would be another buying opportunity based on current conditions.
Finally, for those who want to trade the market short-term, if the S&P500 gets to 1400, it's not a time to be greedy. Charts courtesy of StockCharts.com.
January 18 Update Although the AAII sentiment survey has been Bearish for the last four weeks, there are still too many Bulls out there for the market to be close to a bottom. Compare the percent of Bulls in 1990 to our recent readings. In 1990, Bullish sentiment was in the teens, and fell to a low of 12% just before the market signaled a reversal up, as price crossed up through the 50-week moving average.
The more recent readings show that while the market price is well below the 50-week moving average, the Bullish sentiment has been hovering around 25%. That would indicate lower prices to come.
The S&P 500 ETF (symbol SPY) looks to accomplish its near-term price target of 128 (weekly basis). It closed Friday at 132.13. The Dow Industrial ETF (symbol DIA) closed at 120.57 with a near-term target of 119. The Nasdaq 100 ETF (symbol QQQQ) closed at 45.35 with its next target at 42.35. At the same time as price has been falling volume has been rising, another reason to expect lower prices ahead.
This is a good time to remember one of Dennis Gartman's Rules of Trading -- "In a Bull Market we can only be long or neutral; in a Bear market we can only be bearish or neutral." Looking at the top-performing ETFs for the last week would seem to bear this out: every one of the top 20 ETFs was an inverse fund.
Even a high-flyer like the PowerShares Wilderhill Clean Energy Index (symbol PBW) was down 12.62% for the week with no bottom in sight: Charts courtesy of StockCharts.com. January 11 Update
Will the downward slide continue? While some commentators are calling for an end to this correction -- perhaps encouraged by the briefWednesday-Thursday rally -- the data from the past two Friday's doesn't look promising.
Looking at the close on Friday, January 4 to Friday, January 11, we can see only one of the major index ETFs posting a gain: Emerging Markets (EEM) was up 1.51% (+1.51%). The chart below shows it bouncing right off the support line set by the prior low. Unfortunately, it's not a perfect picture, because volume fell 5.8% (-5.8%), indicative of uncertainty. It would have been nice to see volume rising along with price.
Surprisingly, the next best of the major index ETFs was the S&P 500 (SPY), down only 0.44% (-0.44%) in price but down 14.94% (-14.94%) in volume. Of course, the SPY has already broken the support level going back to late 2006, unlike the other indexes. While declining volume can be a good sign in a correction, there is still too much daily volatility for this to indicate the building of a solid bottom to support higher prices.
For the next three major indexes, this coming week may be decisive.
The Diamonds ETF, representing the Dow Jones Industrials, was down 1.54% (-1.54%) from Friday to Friday but with volume increasing by a dramatic 49.5%(-49.5%), not a good sign. Note the next support (weekly basis) is just 0.51 points away. This coming week may be decisive as the Dow is said to have extra psychological significance for market sentiment.
The developed, foreign markets EAFE index (ETF ticker EFA) was down 1.84% (-1.84%) with volume down 9.46% (-9.46%). Like the DIA, it is less than one point from breaking the next level of support.
Finally, we have Nasdaq, here represented by QQQQ, the Nasdaq 100 index, down 2.79% (-2.79%) in price and off less than a percent in volume. The Nasdaq Composite Index, while down about the same (-2.58%) saw volume fall by 4.51% (-4.51%). Support for QQQQ is also less than one point away.
So there we have it. Uncertainty at best. If the Dow, the S&P500 and the Nasdaq 100 can hold out -- not fall decisively below their nearby support levels -- then our correction may indeed be drawing to a close. But for now, uncertainty reigns. Charts courtesy of StockCharts.com
January 4 Update Here's the story. We're just about back to the beginning of 2007, as far as the Dow Jones Industrials are concerned. The question now is whether our new trend is sideways or down. As the following chart shows, the market tends to flail around for quite long periods of time before making an advance. If this is the start of another Bear Market, we could be looking at a DJIA around 11,500, roughly the 2006 high.
In the above chart, we see how the DJIA advanced better that 17% from early 2003 (the green bar) to just prior to year-end. It then moved in a range between 10,000 and 11,000 for roughly two years before beginning another advance. Now here we are -- is it a sideways action or a new Bear Market? Note the steadily advancing volume from 2003 to 2007 -- volume is the weapon of the Bull.
Market internals aren't favorable as the next two charts show.
The above chart is the Nasdaq Advance-Decline line, on a cumulative basis. Here we see the classic double-decline signaling the end of a bull market (the two red bars).
While the NYSE's A-D line looks a bit better, it is also influenced by many "stocks" that aren't operating companies -- closed-end funds and exchange traded funds holding bonds, commodity contracts, gold bullion, etc. Still, we see the double decline. It looks like a poor time to be buying into broad market indexes. Charts courtesy of StockCharts.com.
January, 2008
Not a lot has happened since the last update as of December 28. The major indexes continue to wobble at their long-term moving average support lines. One thing that did happen was that the weekly AAII sentiment survey went 50% bearish. That has happened only 32 times since the survey began back in mid-1987.
Of those bearish readings, the market was up the following week 18 times and down 14 times. In fact, the market was up 3% or more five times and down 3% or more three times. Well, sentiment is supposed to be a contrary indicator -- when investors are bearish the market it's supposed to be bullish for the market.
For one thing, survey respondents are almost always bullish. In 1,065 weeks, sentiment was 50% or more Bearish only 32 times. The average over all those weeks is 39% Bullish and 28% Bearish. If sentiment were truly a contrary indicator, that would mean the market would almost always be in a slump. Well, to be precise, that contrary-ness of the indicator is only applicable at the change in a trend. When investors are most bullish, most complacent about the market continuing to go up, things inevitably go wrong.
That does not seem to be the case now. Nor was it back before the last real recession we had in 1990. The following two graphs track the S&P 500 index in 1990-1991 and during our last real bear market, 2001-2002. Arrows mark AAII Bullish and Bearish sentiment 50% or higher. Back in 1990, investors were quite skeptical with a bullish reading barely above average. Only the last of the bearish readings can be viewed as a contrary signal, as the market experienced a higher low and was at the point of breaking out above the long-term moving average.
The power of the stock market bubble in 2000 is clearly evident in the following chart. Investors were persistently bullish on the way down. In fact, the first reading of more than 50% bearish sentiment didn't come until July, 2002, long after major damage had been done.
But coming out of that Bear Market, we see the promised contrary indicator:
What about today? It may just turn out that the bullish sentiment at the October high was a dreaded contrary indicator, and the more recent bearish readings are just the prelude to the waterfall, as we saw back in 1990.
December 28 Update There's been a lot of talk about recession, so let's look back to see what the last real recession, July 1990 - March 1991, looked like:
On a weekly basis, that's a decline of 20% from the July high to the October low. A closer look at 1990, eight months before the bear market hit:
And where we stand today:
In both cases there was considerable thrashing over and under the long-term moving average (200-days for daily price data). But we seem to have spent more time under the trend lately than above it. In fact, all of the major indexes are dancing on the trendline. There's no margin of safety.
Whether we're approaching a major sell-off can't be known. But it does appear clear that we've switched gears from a primary trend up to a sideways trend.
Sideways can mean a period of consolidation before the next move up or it can be part of the gradual building of a "top" that precedes a major sell-off and a bear market. Right now, if we look at market internals, there isn't much to make us enthusiastic about a break-out up and out from sideways. For example: The trend in the number of stocks trading above their 50- and 200-day moving average. As shown by the moving averages of this data, the trend in July for the S&P despite the fact that the moving average of price for the index continues to slope upward. Sooner or later, something has to give.
The Nasdaq 100 looks a bit better than the S&P, thanks to an absence of financial stocks, but the trend is still down.
Looking at the New Highs minus the New Lows for stocks on the New York Stock Exchange, we see Friday's close at -167, below the 10-week moving average of -97.8 and far below the 30-week moving average of -27.30. The market has been advancing despite the fact that there are more stocks making new lows in price than new highs. Stock-picking is a necessity. Performance from broad indexes is in doubt.
Finally, the fear index, the volatility index VIX, while showing a decline since November, has only reached a level equal to that of the sharp downturn experienced at the end of this past February. The VIX has much further to fall before we're going to experience a market where enthusiasm trumps caution. Charts courtesy of StockCharts.com. December 14 Update Everyone wants to be first. First to know. First to get there. First and foremost. It means the best.
The essence of trend following is not to be first. It is to follow. Take your profits from the middle of the trend, don't try to be first -- that's where "whipsaws" rob you of your anticipated profits.
In my book, "Joy of Stock Market Investing," I recommend that approach for beginner investors. Frankly, many long-experienced investors use the same trend-following approach. In recommending a quick and easy way to track the market. I suggest using a 12-month simple moving average of price. This happens to be the same approach recommended by Suze Orman, though I'm certain we arrived at this conclusion independently.
Using that yardstick, the Russell 2000 is in a bear market. And the S&P 500, which has been flirting with a bear market breakdown for weeks, moved further toward the bear last week. Two indexes down, five to go.
We're at the middle of the month, 10 trading left in 2007. Where do those other five indexes stand? Based on a comparison of monthly and weekly simple moving averages and a quicker, "front-loaded" exponential moving average, they're standing down.
The following chart shows the spread in percent between Friday's closing price and each index's respective moving average. It's evident that the spread is narrowing in every case (getting closer to crossing below the moving average except for the small company stock index, the Russell 2000 which is more than 5% below all three time frames.
What's happened to small company stocks is typical of what happens as a bear market approaches. Investors move from small to large company stocks. A comparison of the Nasdaq Composite, predominantly small companies, to the Nasdaq 100, all large companies, would seem to forecast a bear market is approaching now.
What's decidedly different in our current scenario is Emerging Markets. Yes, the emerging market index closed Friday at a price closer to its weekly EMA than before, but it remains the strongest of the indexes. And a look at its position in its long-term channel shows how far it has to fall before the trend is decisively reversed.
As I said several weeks ago, if we do get a December "Santa Claus" rally, it may be a good time to anticipate and sell into strength. And for pure trend-followers, they may not have too much longer to wait. Channel charts follow. All charts are courtesy of StockCharts.com. December 7 Update First the good news -- all three major indexes have crossed above their 200-day moving average, so we're back out of "bear" territory, although the small cap index still lags. Now the bad news, volume did not confirm last week's rally.
We have traveled a bumpy road since July. On each of the following charts, I've circled the volume histogram -- note how it has been declining since the November low -- in the case of the Nasdaq 100, quite dramatically. Since volume is the weapon of the Bull, this leads us to conclude that the rally is more speculative than substantial, at least so far. IWO and IWN are small cap growth and value, respectively. As with the larger capitalizations, growth is outdistancing value this year.
The dramatic run-up in bond prices -- flight to safety in the face of credit market uncertainties -- appears to have finally reversed, which means higher yields. Typically, this is good for gold (indicating inflation concerns) and not so good for stocks (raising borrowing costs); however, yields have fallen so low, as the second chart shows, that we have quite a way to go before interest rates would deflate a stock market rally.
As the above chart of the 10-year Treasury yield shows, the market reacts negatively to a yeild above 5%, but we have quite a way to go before that happens. Helping along our stock rally has been the decline in the Japanese Yen, which began just as the Dollar began its own, belated, rally from deep in oversold territory, as this graph of year-to-date performance shows.
Looking at market breadth, as measured by the percent of stocks over their 200-day moving average, the jury is still out. Slowing the action down with weekly moving averages, we can see far fewer stocks above their 200-day moving average now than at the 2006 market low for both the S&P 500 (the NYSE composite is almost identical). We may be at a reversal point up, but it's tentative at best. Both volume and breadth need to strengthen for this rally to continue. While the Nasdaq 100 has not fallen below its 2006 low in its percent of stocks over the 200-day moving average it also appears to be further from a reversal upward than the other two indexes. But at least we do have a very short-term uptrend. And short term trends that persist become intermediate trends and then long-term trends. We'll see if this one can get there.
The Primary Trend - December 2007 We are on the line this week. The question is whether we advance or decline. Consider the S&P 500 in 2007 and then in 2000, in both cases just below the long-term support line. Do we advance? Or do we make like 2000? There are arguments on both sides.
For the bulls:
The first of the month is usually bullish.
December is one of the strongest months of the year, even when November was a down month.
This is the third year of a presidential cycle, usually bullish.
None of the major indexes has broken below its long-term bullish channel.
My proprietary signal based on volume is bullish as of Friday's close.
On the Bearish side of the argument:
Last week's rally turned as the market hit a 10% correction. In the last 6 such corrections, the market sustained a rally only twice; four times it fell further over the next two months.
Years ending in seven have been generally bearish.
The cumulative Advance-Decline Line has fallen well below its long-term moving average support line in a series of declining peaks.
The percent of stocks over their 200-day moving average, for each of the major indexes, is below the 50% mark. The bearish trend is shown in these moving average indicators:
On the other hand, this may be a great place to buy low, at least for the short-term, because all the averages are still within their long-term bullish price channels:
November 23 Update The rally we've been looking for occurred -- in a manner of speaking -- on Friday but the real test is the follow-through on Monday (11/26). Strong "up-volume" on Monday will make a December rally a lot more probable than it looks right now.
One factor in favor of a December rally is sentiment, which is universally bearish. And yet another bullish factor is the rest of the world, which is holding up quite well compared to where things stood at the advent of our last bear market. Emerging markets had only briefly emerged from a years-long slump only to collapse again. And developed markets began their decline ahead of the US, as the following two charts show.
Compare that to the situation today. Emerging market continue to look strong, and the developed world, while the developed world markets remain above long-term support.
On the other hand, all our market internals are quite negative, as we discussed last week. So maybe the bears are right. Let's look more closely at the Dow Jones Industrial Average. First, the run-up to the last bear market.
Quite a run-up, eh? Now, where we've been these last ten years.
Elliott Wave practitioners conclude that the last secular bull market ended in 2000 and that we're in a cyclical bull market (a "B" wave) that will precede a much longer, sustained bear market. If they're right, we want to be very careful about that hoped-for December rally. On the other hand, Elliott Wave Theory was created at a time when the rest of the world's markets didn't count for much and the theory is notorious for its lack of precision as a predictor. (Hindsight is 20-20.)
Nevertheless, looking a little more closely, we can see a similarity on the weekly charts between where the market stood in the first months of 2000, preceded by a peak, a dip and a higher peak, and where we stand today, following our all-time high in July.
So a rally this week that keeps us above the 65-week moving average looks to be very important. We'll look at more history at the month-end report next week. Charts courtesy of StockCharts.com.
November 16 Update
The end is near -- the question is, which end is it? The end of the correction or the end of the bull market?
According to Bespoke Investment Group, the recent correction has now pulled back about the same distance as other corrections (-8.0% versus 8.4% average) but the length of the correction is shorter (38 days versus 56 days).
Looking at the weakest of the indexes, the S&P 500, we see that it has bounced off its downside target. Yes, that's a higher low ... will it last? We'll see this week. (This is an update of the chart I posted as a blog entry last week.)
We can see the struggle at the top clearly in the MS World index and the Nasdaq, with the S&P right on the line (the 50-week moving average) and the New York Stock Exchange composite heading that way. It should be interesting.
One area of concern is the Put/Call ratio. I showed this chart in last week's update and the shorter 10-day moving average (the blue line) had not yet cross the longer 65-day moving average (the red line). It has now done so. If it falls back now -- if options buyers return to calls (betting future prices will be higher) rather than puts (betting future prices will be lower), it will be a positive sign for this market. But as you can see in the lower part of the chart, the S&P has fallen below its short-term support line. It's done it before and pulled back. We'll see if it can do it again ... or if it's all over.
It seems to me that this correction -- if that's what it is -- has a bit longer to run. After all, its below-average (in terms of time) so far.
November 9 Update We badly need a bounce on Wall Street in the coming week, although the odds don't appear to favor it. All three major indexes are right on the line:
And the trend in breadth, as measured by the stocks making new highs versus new lows in price doesn't look positive. We're back to the negative levels we saw in 2002 for the Nasdaq (second chart) and for the New York Stock Exchange, 2004.
On the international front, developed nation stocks seem in the same "on the line" situation as US stocks, but emerging markets continue to look the strongest of the markets.
The Primary Trend - November 2007 It looks as though the rest of the world is leaving America in the dust. Our currency is devalued -- the Canadian dollar is now worth more than the buck -- and foreign exchanges enjoyed positive returns last week compared to our barely mixed results. Inflation is clearly a factor -- the best performers were gold and commodities (as well as foreign currencies). The only positive sectors in the US were Technology and Utilities. What a combination!
Gold broke $800 an ounce and interest rates fell -- another odd combination. If gold and commodity prices are harbingers of inflation, the bond market should be demanding higher interest rates. Instead, the bond market's dropping yields seem to be signaling an economic slow-down.
While one can argue that the trend is still up for all our major indexes -- and up well above the 50-week moving average, which can represent a positive trend indicator, both the New York Stock Exchange Composite and the S&P 500 are below their previous highs.
And, while the World index and Nasdaq are above their old highs and pointing higher, the question is whether they can overcome what may be a substantial drag from our financial services sector, led down by Merrill Lynch and Citigroup. Apparently for the financials, the worst may be yet to come.
And Nasdaq may not be as strong as it seems. Looking at market breadth -- the number of stocks participating in the move up -- we see a negative trend: the 26- and 50-week moving averages of stocks above their 200-day moving average are both heading down, while the price of the index has risen sharply. A momentum oscillator at the bottom of the chart shows a similar decline, calling into question the strength of the price move up.
And of course Nasdaq's breadth looks good compared to the S&P 500:
On the other hand, the volume of stocks moving up in price compared to total volume on Nasdaq looks good:
Especially compared to the NYSE, where volume has been heading down. The issue here is simple: new highs aren't made on lower volume. Buyer enthusiasm -- signified by volume -- is necessary for higher prices.
Another indicator of market "riskiness" is the Put/Call ratio. When traders expect prices to be lower in the future, they buy puts. The blue line on the following chart is a 10-day moving average of the ratio between Puts and Calls. The red line is a 65-day moving average. When both lines rise, there are more puts being purchased than calls. But where the blue line has crossed up above the red line, the market has sold off, as indicated by the broken red lines and the S&P500 at the bottom of the chart. The blue line is heading up toward the red line now, but will they cross? It's something to keep our eye on.
Finally, as promised, here is a closer look at Merrill Lynch. The weekly chart shows all the negative price patterns and "sell" signals: (1) the double top; (2) price crosses below the 50-week moving average; (3) price breaks down from the triangle, a consolidation pattern, instead of up; (4) price crosses below the $63.73 price target from the double top. So there were sell signals at $85, $80, $75, and $63.73. Next stop, $54.30. Just an example of how trailing stops could be set to protect your capital in this kind of a risky market.
Update - October 26 Two weeks ago we pointed out the likelihood of a correction in the stock market. This week it appears that the correction is over and the market is poised to advance once again based on short-term indicators and using a weekly or intermediate-term chart. Given the volatility of the market this year, any longer-term forecast seems foolish.
First, let's look at the relationship of stocks to bonds since the July 2006 rebound. The chart below shows the uncanny correlation between bond market bottoms and stock market tops. The red broken lines show the bond market (in this case, the Lehman Brothers Aggregte Bond Index iShares ETF) lows. Tracing up to the iShares Russell 1000 Index ETF, we can see each bond low precedes a stock top and drop. Conversely, looking at bond tops, the green broken lines, we can see that they precede stock market advances.
Where are we now? A bond market top and the stock market coming out of a low. If old relationships hold, that should be bullish. Another inter-market relationship -- the Japanese Yen to US stocks -- may be favorable as well. After a strong showing mid-week, the Yen closed in an uncertain posture on Friday, having failed to break through an old high, closing lower.
The weakest part of the US market is financial stocks. Below is the iShares Financial Services Sector ETF. Investors created a double-top earlier this year -- the two highs with the intervening low (the heavy blue line). That pattern would give a price target of $116.41, which was hit several times during the formation of the triangle pattern. Prices broke up from the triangle and then fell back in the correction two weeks ago. Last week, on higher volume, prices rose, giving us a short-term bullish signal. A longer-term indicator, the 50-week moving average, has peaked and turned down and that looks bearish. Financial services stocks are not out of the woods yet.
But large cap growth stocks, led by technology, are forging ahead.
To review that bearish signal we saw two weeks ago in the following charts, note the red arrows. The tick mark to the right is the closing price, to the left is the opening price. You see two bars, the second being equal to or longer than the preceding one, with the right tick mark lower than the preceding bar's close. That's bearish. But last week, we see the reverse. A long bar -- the range of price movement during the week -- and a higher close than the preceding week. That's bullish.
Technology, the top chart (PowerShares QQQ Trust, representing the Nasdaq 100) looks very strong (a higher closing rice on higher volume) and the Russell Large Cap Growth Index (iShares Russell 1000 growth ETF), which has a heavy helping of technology companies, looks strong as well. The bottom chart is the Russell 1000 Value, with a heavy helping of those weak financial stocks. They still have something to prove, but even there, the short-term indication is favorable. Think of these long bars as representing the battle between traders/investors who are bullish betting against those who are bearish. If prices had closed lower, the bears would have won. They didn't, for now.
International stocks also show the same favorable weekly indicators, with emerging markets continuing to be stronger than developed nations. Charts courtesy of StockCharts.com. Update - October 19 In last week's update we noted the high probability for a correction in the market and we got it. It's notable that the action last week hurt small capitalization stocks the most. The Dow Jones Industrial Average and the S&P 500 Index were also, relatively speaking, hit hard, while the Nasdaq 100, and developed nation foreign stocks were down only modestly.
One of the more recent changes in the market has been the re-emergence of large capitalization growth stocks. The first chart shows the the relative strength of the Russell 1000 Growth exchange traded fund IWF to the overall market, represented by the iShares Total Market exchange traded fund IYY.
Note the "congestion area" between the two horizontal lines from mid-2006 to mid-2007 and the reversal up, indicated by the 10-week moving average crossing through and above the 65-week moving average. At this point, large cap growth stocks began outperforming the total market.
The relative strength of small cap stocks (iShares Russell 2000 exchange traded fund IWM) presents quite a different picture. Small caps relative strength to the total market began falling back in 2006, even as the price of the shares rose. But aht kind of divergence eventually catches up with the price. Now the share price of IWM is below its 50-week moving average, the only one of the major indexes to have broken this long-term trend indicator.
Gold was unaffected by last week's correction in the market (top graph, below) and it's relative strength is well ahead of the overall stock market. However, note the wide spread between its current price of 75.70 and the 50-week moving average price at 66.03. If you believe in "reversion to the mean," chances are gold has a correction ahead as well.
A similar wide spread between the price and the 50-week moving average can be seen in the hottest of the sectors -- energy. It too was unphased by the market's correction last week.
While the Industrials and Technology sectors experienced a bit of a correction, their relative strength and position ahead of their 50-week moving averages also remained strong.
So what's the overall condition of the market? One measure is the NYSE Advance-Decline line, pictured below using a 26-week moving average, along with the S&P 500 below it.
In one respect, the market has better breadth than it did during its rally from mid-2006 to February, 2007 -- note the heavy red lines moving in opposite directions showing that the number of stocks advancing in price declined while the index price rose. On the other hand, the volatility of the current market is quite high -- and volatility is usually an indicator of a change in trend. Unfortunately, given the level of financial derivative activity today, "usually" may not mean what it used to. We'll just have to see what happens next.
Update - October 12 Time for a breather?
On Thursday, most of the major indexes closed on what is known as a Key Reversal day. Here's what it looked like for the S&P 500, using standard bars. The high was higher and the low was lower than the preceding three days and the index closed lower than the preceding day. Another negative sign came from volume, which was the first down day with high volume since the August correction.
The Nasdaq index especially seems to have gotten ahead of itself, here viewed using Japanese Candlestick patterns.
Although the Nasdaq 100 showed a similar Key Reversal day, it's longer-term chart shows a decisive break out of a long-term channel.
The S&P 500 Index and the Dow Jones Industrial Average have not managed the same feat.
On the other hand, the spread between the Nasdaq 100's price and it's 50-week moving average has widened considerably, which indicates a growing probability for a little "reversion to the mean" action. In this case, any pullback would seem to present a good buying opportunity. Update - October 5
Many decisions await investors this week. The stock market has roared ahead, surpassing old all-time highs set earlier this year (in some cases just barely). Looking at the very steep advances all the indexes have enjoyed, it may be time for a rest period. But regardless of a reversal, this bull market seems determined to plunge ever upward. First the Dow Jones Industrial Average. Nothing but blue sky ahead.
The same is now true for the S&P500 (bottom chart). Note how the Reuters-CRB commodity index has turned back from its trendline channel while the S&P500 broke through.
The S&P 500's performance has depended on the recovery of financial stocks. You can see they bounced off their 2006 low price and are headed back up -- but resistance lies dead ahead (the green line, which had been the previous support trendline). Meanwhile, technology stocks, here represented by the Nasdaq100, are heading for a decision point of their own; but regardless, the trend is decidedly up and the index is far above its old all-time high.
Small company stocks, compared to the giants of the S&P 100 index, fell further and have recovered less ground. Interest rates may be the key for the small caps.
And interest rates (bottom chart, represented by the 10-year Treasury bond yield) are at a decision-point of their own, having broken their uptrend support line but now rallied back to it. Will they break up or back down? What happens will impact small company stocks and home builders, but regardless, gold-bugs seem determined to drive the price of gold ever higher. Charts courtesy of StockCharts.com.
The Primary Trend - October, 2007
Decisions. Decisions. Decisions. September has returned the market to a point within reach of its July highs. The Bond market, having fallen recently, is poised to rally up once again. This week investors will make the call ... stocks up, interest rates down? Interest rates up, stocks down? It's decision time, as the following charts, courtesy of StockCharts.com, show.
Below is a chart of the 30-year bond (price) and the S&P 500. Note how the recent lows in bonds occurred around the lows in the S&P 500. Note also that the recent rally in bonds broke above the blue line and then fell back. Keep your eye on bonds breaking above 111.75 or falling back.
A similar picture of being "on the cusp" is the chart of the 10-year bond yield (yields and price move in opposite directions). Note how the yield broke down from an uptrend that began in 2003 but has now rallied back to its old (green) support line, which now serves as resistance. Will it break through? Traditionally, that would not be good for stocks.
The Nasdaq is leading the stock market charge and this is normally a good thing for the overall market, since confidence in the higher priced (price/earnings) and more volatile Nasdaq stocks is confidence indeed. There appears to be no hesitation in the Nasdaq composite now as there was in 2006. But is investor confidence sufficient to break through the psychological barrier of the July highs?
The S&P 500, despite its burden of financial stocks, seems poised to move higher, well above its 200-day moving average (the red line).
And even the financials appear to be heading upward.
I've posted a version of this next charter several times, indicating the ominous looking top that had formed between June and August. But making an adjustment and treating the old low in 2006 as a cyclical low turns the chart bullish, with two more years (from July 2006) of uptrend.
Since 2003, what have the real winners been? As much as I hate to invest in gold, because it is a non-productive asset, there is no question that the gold bugs have been right. Gold has outpaced the broad stock market,. Is it heading for triple digits, as some observers predicted several years ago? It seems on its way at 750.
The other winner has been Emerging Markets, once thought to be oh-so-risky, but this year especially leaving the broad US market, here represented by the exchange traded fund IYY (blue line), in the dust.
For those who have read this far, I think you can see which way the wind is blowing. But nevertheless, I wouldn't be surprised by a setback before prices continue on their way up, at least for a while.
Update - September 21
The bull market rolls on by hook or by crook -- you decide which is Ben Bernanke -- but roll on it does. The question on everyone's mind is -- for how much longer? Gold, Commodities and Interest Rates hold the key.
The warning signs are up -- as they have been since mid-2006. Will the stock market keep laughing them off? We'll soon find out. Regardless of the talk about recession and a deflationary environment created by falling real estate values, the decisive issue, I believe, will be inflation.
Despite the Fed's calculation of low consumer prices, two indicators of inflation are hitting -- or are close to hitting -- all time highs: commodities and gold. And a third -- long interest rates -- has resumed its uptrend, now that the flight from stocks to bonds has reversed. (Panic buying of bonds following last month's panic selling of stocks raised bond prices and consequently made yields fall.)
The first chart shows the Reuters-CRB Index (top) and the S&P 500 Index (bottom). Both have been moving up since mid-2003. Both are approaching the top of their long-term channel -- the parallel lines that price bounces between during a long up trend. If prices don't pull back to within the channel, we'll have a new condition, a new, higher trend in commodity prices. Will stocks be able to match that new trend? I think it's doubtful.
The second chart show the a ratio (top) of Gold divided by the Financial Sector, represented by the exchanged traded fund XLF. When gold outperforms the financials, the line trends up. When the financials outperform gold, the line trends down. The bottom chart is the S&P 500 Index.
As originally pointed out by contraryinvestor.com, when the outperformance of gold relative to financials peaks, the S&P 500 hiccups. As we head for another peak, will we have a hiccup or a new condition -- a breakout to higher highs for the S&P 500? We'll know soon enough.
The last chart shows the price of the 30-year US Treasury bond. When prices fall, yields rise. You can see this occur in April-May 2006 and again in June-July 2007 (each circled on the chart), and to a lesser degree in February 2007. Each time, the S&P 500 has sold off. Note that the bond price's 20-week moving average has just slipped below the 50-week moving average, indicating that lower prices may be coming. That means higher interest rates which is not a positive for the stock market.
As we've shown in the past, the stock market has dependably fallen when the 10-year Treasury rate exceeds 5%. Friday's rate was 4.63%. If it rises above 4.75% we may very well see 5% once again. Charts courtesy of StockCharts.com.
Update - September 14
I certainly don't advocate short-term trading, but a picture came along last week that I can't resist.
The dashed vertical lines follow the spike in volume to the price change at the top. The brown line, OBV, on balance volume, assigns daily volume to a positive or a negative depending on whether the price closed up or down. The bottom charts show the same kind of spike in Accumulation and Money Flow. Pretty dramatic.
If you bought on the day of the first volume spike, at the average price of the high and low, you would have earned 1.7% by selling 5 days later (red arrow) at the average price that day. Note that if you had held on, you would have sustained losses. In the second example, the holding period was 4 days for a 1.2% gain. Seems paltry, but here's how it works:
If 40% of your trades made 1.2% and 60% of your trades lost only .5%, then your annual net gain would be 37.9%. (I have not included transaction costs.) The point is that investing is not about getting the biggest gains but rather keeping losses to a minimum.
It's also interesting that the above chart is the Consumer Discretionary Index, not a sector you would expect to see shoot up in the face of all the recession talk. Are the speculators trying to lure in the suckers? We'll see how it works out.
As far as the total market is concerned, the Bull seems to be regaining its strength. Barring a stingy move by the Federal Reserve Board on Tuesday, the market should take off. It is certainly poised for a take off, as the following charts show, although only the Nasdaq 100 (the third chart) is within striking distance of its old high.
Unfortunately, what the charts don't show, and what a Fed move to cut interest rates will only exacerbate, is the devaluation of the dollar. The following chart shows how low the dollar has fallen (green line), how much the total market has risen, in dollar terms (red line), and how little that has amounted to in terms of the price of gold (blue line, the stock index divided by the price of gold). That's inflation. The Consumer Price Index is an irrelevancy. A final note on the Dow Industrials. Last week's update pointed out the negative-looking top formation. Here's the difference a week made. Again, barring unexpected bad news, the Dow seems poised for a break-out. All charts courtesy of StockCharts.com. Update - September 7
The psychological strain among investors started to show this week. Two primarily psychological bellwethers reacted strongly, in opposite directions. After Friday's action, the Dow Jones Industrial Average (INDU) fell dangerously close to its support level at 13000, looking more and more like a massive top head of a Bear Market.
While the technology-heavy Nasdaq 100 (lower chart) has a second level of support to ride, if the Dow breaks through 13000, we're looking at 12200 or lower.
On the other hand, Gold, the most purely psychological "investment" in the market and here represented by the exchange traded fund GLD, rallied strongly and broke through a long period of indecision among investors. Gold typically rallies along with rising interest rates -- both in reaction to inflation expectations. This time around it would seem that gold bugs are ahead of the curve as long rates, here represented by the 10-year Treasury Bond index TNX, look to have topped out and are now heading down. Investors seem to be expecting the Federal Reserve to inflate the economy to ward off a housing-led recession. Lower short-term rates now will lead to higher long-term rates as the bond market recognizes the inflation threat. Or so the scenario goes.
Looking at the markets with a longer term view, however, we can see that the statistical picture is still bullish. The following two charts show the Dow Jones Industrial Average and the Nasdaq 100, the 100 largest companies in the Nasdaq, and use monthly data -- each data point represents an entire month of price changes. We can see that the price of each index has not fallen too far below the top of its 12-month channel line. When the price crosses the midpoint, it can definitely warn of a change in the Primary Trend. We're not there yet. Charts courtesy of StockCharts.com. The Primary Trend - September To answer the question from my blog post first -- yes, investors are feeling a bit better, as revealed in this 2-year picture of the same data. The High-Low index is about back to the level we saw coming out of the 2006 sell-off. Now, if it can hold that line.
It is interesting to observe that, barring financials, the strongest trends that preceded the July-August waterfall have returned to post the strongest performance: Emerging Markets, Technology and the Dow Industrials.
As you can see, unless you bought at the peak in the QQQQ's price (the fund you can buy representing the Nasdaq 100 index), a buy and hold strategy through the sell-off was the thing to do.
On the weak side of the ledger, the previously market-leading capitalization index -- small caps -- which broke down before the July-August selloff, continues to struggle compared to the mega-caps, here represented by the S&P 100 index.
As the chart shows, the Russell 2000 has fallen further and has further to fall if it breaks the support from its old 2006 lows. By contrast, the S&P 100 is still well above its 2006 low.
Finally, all attention is on the bond market, the mortgage-related credit crunch, the risk of insolvency facing some housing-related businesses and consumers as well. The bond market has rallied as a result of a flight to safety -- money left stocks and went to bonds, driving down the yield. Now the question is, can the bond market keep rallying? The Federal Reserve as signaled it will lower the Fed Fund's rate. Will lower short-term rates lead to a steepening yield curve and higher long-term rates? That would not be good for stocks. Something we'll have to pay attention to.
So the question before us is simply this: Was the July-August sell-off simply a corrective one -- reducing the extremely steep slope of the advance -- or is it the beginning of a sustained down market. September, historically not a kind month to stocks, will probably answer that question. Update - August 24
This newsletter is about the Primary Trend. The three components of trend are price, volume and breadth. Despite the rally in prices last week, the condition of the market remains uncertain, as the breadth indicators reveal.
Breadth measures the number of individual stocks that are participating in the trend. Typical measures are the Advance-Decline Line, which measures those stocks advancing in price versus those declining, and the percentage of stocks whose price is above their 50-day (or 200-day) moving average. Let's look at the 50-day moving average.
The following chart has three moving average lines -- 10-day, 20-day, 30-day; when the faster line, the 10-day, crosses over the others, that indicates more stocks are moving above their 50-day moving average in price; when it crosses below, it's the reverse.
If we look at the circles marked "1" on the chart, we see that the number of stocks above their 50-day moving average declined from October, 2006 through January, 2007 as the price (the lower chart) steadily advanced. This is a negative divergence -- an indicator moving in the opposite direction of the price. That's a sign of weakness as fewer stocks are carrying the average, in this case the S&P 500 Index.
Then in February there was a sharp rally in both breadth and price, followed by a sharp drop at the end of February and into early March. The green arrow indicates that a higher low developed quickly and the green 10-day moving average line crossed through the 20-day line indicating that both rising prices and rising breadth were "in gear." A rally was in process.
What happened next was a bit more ominous. As you can see, breadth dropped from "2" to "3" while prices see-sawed and then rose to an all-time-high but on breadth that was only modestly higher than the February low, a major divergence. The red arrow indicates that the subsequent low was much lower than the first. An even sharper divergence -- last Friday's close was about the same as the February high, but look at the difference in the number of stocks still below their 50-day moving average price. The rebound doesn't have it's legs yet.
For the Nasdaq 100, we see a similar but stronger picture (as there are no financial stocks in the Nasdaq 100). The negative divergence ("2") is less pronounced while the negative divergence ("3" to "4") is a bit more pronounced. But compare the moving average lines: For the Nasdaq 100, the fastest moving average (green line) stays above 30% while the S&P 500's dips below 20%, well below the level of the 2006 low. Also notice how the Nasdaq 100's price is well above the February high while the breadth indicators are at about the same level -- a positive divergence.
Another positive sign was the breaking of the head-and-shoulders patterns I mentioned last week. These were imperfect patterns, since volume did not confirm them, and last Friday's price action is a good harbinger of higher prices. We'll have to see what this week brings.
Another somewhat ironic positive is another measure of breadth, the New York Stock Exchange Advance-Decline Line. One of the historical observations about market breadth is that it peaks out well in advance of price. The peak on this chart is obvious. So is the fact that there are lower lows in the A-D Line (red circles) compared to higher lows in price, another divergence. The dramatically higher peak may indicate that the market will recover over the short term but then fall into a genuine bear trend. Continuing to observe the breadth indicators will give us a clue about whether that is in the process of happening. Update - August 17
Two weeks ago I started this update feature with the following. Updates are in italics.
* Fear stalks the Street -- and it still does. * Small cap stocks weaken further -- and they're still weak. * Home builders are back to 2003 stock prices -- and they're even weaker. * The purging of excess in financial stocks begins in earnest -- but the Fed's rescue efforts softened the blow. * Is it the decoupling of the US from the rest of the world? -- the answer appears to be 'no.' * Can a change in leadership keep this bull market going? -- no new leader has yet appeared.
Let's start with the two questions. Has the rest of the world decoupled from the US markets? Not so far. The developed world index continued to fall on Friday, as did emerging markets. There appears to be no refuge in international stocks generally.
Is there a change in leadership in US stocks that can keep the bull market going? Nothing has appeared so far. In fact, the major indexes all closed down for the week, despite Friday's rally.
Friday's rally did nothing to soothe fears, as indicated by the Volatility Index, far higher than at the 2006 lows:
Comparing the small cap index, Russell 2000, to the S&P 100 Index (the 100 largest companies in the S&P 500), it is clear that large caps have fallen less and are further above support levels than small caps.
The slump in housing worsened, with the Dow Jones Home Construction Index down more than 10% for the week.
But Friday's rally did snap the Financials Index up 2.5% for the week although still below the bull market trend line.
What fueled the rally was the precipitous drop in short-term interest rates, as shown in the two bottom charts in the following group. The 10-year Treasury Bond yield broke a short-term support line while the 30-year Treasury Bond yield continued upward. As reported earlier, a drop in short-term rates fuels inflation worries and causes long-term rates to rise -- we'll have to see if that trend continues. There is talk once again of deflation in Japan and commodity prices are falling. The picture is cloudy for now.
Update - August 10
The mainstream media is full of advice for the "long-term investor" -- hang on, the market is self-correcting, blah blah blah. But what you do today depends on what you did yesterday. That's something none of these experts ever mention. It's the point I make in today's blog post. Nothing is more powerful -- to gain on the upside or avoid loss on the downside -- than catching the change in the Primary Trend.
So where are we? The jury is still out. But I'm beginning to think that our best days in this bull market are behind us. Let's start with a direct quote from President Bush at his news conference last week.
“In other words, is there enough liquidity to enable markets to be able to correct? And I am told there is enough liquidity in the system to enable markets to correct.”
The key phrase, of course, is "to enable markets to correct," which means there will be an effort made to prevent an outright crash but not a correction. So, without looking at a chart, I would expect a sideways-to-down market for the next several weeks or months. I would not rule out a rally at some point. The question is whether a rally can be sustainable.
The big institutional traders are as uncertain about all this as the rest of us. Both institutional buying and selling spiked last week. Although net selling won out the worst of the intensive selling appears to be behind us, at least for the immediate future. Traders have given a signal, though, through the Volatility Index, where a definite change in trend seems to have occurred.
Another major change may be developing -- strength in the Japanese Yen. This could spell more trouble ahead for the already-troubled financial sector, not to mention leveraged hedge funds. Here is the Yen compared to the Euro. A break to the upside appears to have developed.
The strength of the Yen may be offset somewhat by a rally in the dollar, admittedly off its very devalued position on a long-term low. So a pending liquidity crunch hasn't moved the price of gold so far. But interest rates are signaling another major change -- a return of the normal yield curve, with yields on longer-maturity bonds higher than shorter-term notes and bills. It hasn't been that way for some time, it will further tighten liquidity needed as fuel for the stock market.
Adding up these three changes spells more volatility (typical of downtrends) and shrinking liquidity compared to the conditions prevalent during the last leg of our bull market. Reasons to believe our best days may be behind us.
Several weeks ago I suggested avoiding financials and small caps. Here is the position of the closing price Friday of each index above or below its 200-day moving average price. This basically lists, in descending order, the strength of each index against its own past performance. The negative trends are obvious.
MSCI Emerging Markets +13.1% Nasdaq 100 + 4.5% MSCI World ex-US + 3.3% Dow Jones Industrials + 3.2% S&P 500 0.0 Russell 2000 (small cap) - 2.1% DJ Financials Index - 8.7%
Clearly, its time to be selective. Watch out for those S&P 500 funds and dividend-oriented funds, which tend to be weighted to financial stocks.
Update - August 3
In capsule form, here is the weekly update to The Primary Trend:
Fear stalks the Street.
Small cap stocks weaken further.
Home builders are back to 2003 stock prices.
The purging of excess in financial stocks begins in earnest.
Is it the decoupling of the US from the rest of the world?
Can a change in leadership keep this bull market going?
Last week I recommended avoiding small company stocks and financial stocks. This week underscored that recommendation with a blunt red pencil. I also suggested sticking with the Dow Jones Industrials and the Nasdaq 100. No change on either of those. The percentage of stocks in the S&P 500 -- with more than 20% financials -- trading over their 50-day moving average fell to 12.8% on Friday, compared to the Nasdaq 100's 42%.
As investors bailed out of small caps and financials, fear stalked the Street. A look at the VIX, the volatility or so-called "fear index" and the Put/Call ratio both indicate that we may just avoid the end of the world right now with a rebound next week based on past patterns. Time will tell.
Commentators have been commenting on the decreasing importance of the US stock market to those in the rest of the world. The major foreign stock indexes are both sitting right on their respective support lines but far above their long-term moving average, indicating they have room to fall further without endangering their positive trends.
The fate of the market will depend on investors' willingness to shift their assets to other equities -- such as, for example, health sector and technology stocks -- versus just sitting in cash. Time will tell. For now, with the specific exceptions noted above, the Primary Trend remains positive. All charts, courtesy of StockCharts.com, follow:
Fear can be a contrary indicator. If next week proves that the highs next week are indeed "lower highs," then stocks may rebound.
A similar pattern can be found in the Put/Call ratio, which shows the level of those anticipating lower-prices in the future.
Small company stocks are decisively weaker.
The Dow Jones Home Construction index is now back at prices last seen in 2003. The "head and shoulders" pattern, which describes investors "giving up" on a stock, or in this case a sector, repeats itself several times on this long-term chart.
For the financial stocks, it is truly ugly. First the index, then market bellwether Merrill Lynch, and finally the poster-child for subprime mortgage-hedge fund fiascos, Bear Stearns. The first chart shows the weak condition of the financial sector compared to the relatively stronger position of the Nasdaq 100.
Volume confirms the bad news for these big Wall Street names. The horizontal bar in both graphs represents the previous high set in the spring of 2006.
It's way too early to declare the end of the Primary Trend for the rest of the world's stocks. The first chart is the emerging markets and the second the developed world, ex-US.
Large technology stocks -- as represented by the Nasdaq 100 (which excludes financials) -- and health care medical devices are two areas which are showing good relative strength compared to the rest of the market. The first chart shows the percentage of the 3,000 stocks in the Nasdaq index on a technical "buy signal," compared to those in the Nasdaq 100. Big caps rule.
The Health Care Medical Devices exchange traded fund IHI shows clear superiority to the Wilshire 5000, representing the total market.
The Primary Trend - August 2007
July has boldly illuminated the warning signs that we've been pointing to in prior weekly updates. The bottom line:
Avoid small cap stocks and financial sector stocks of any size
Continue to hold foreign stocks, both developed and emerging markets
Continue to hold the Dow Jones Industrial Average and the Nasdaq 100
For an asset allocation (longer than 7 years' time horizon):
25% Domestic Large Cap stocks (with emphasis on growth stocks)
35% Foreign stocks (25% developed/10% emerging)
20% Domestic Treasury Bonds
10% Foreign/Sovereign bonds (with emphasis on Asian countries)
10% Cash
Market breadth has weakened considerably, with both the New York Stock Exchange and Nasdaq Advance/Decline Lines falling below the level of last summer's big sell-off.
Up Volume for both exchanges also appears less than robust.
Of the major domestic indexes, the Russell 2000 small cap index is the weakest, followed by the S&P 500. Representing the small cap index is the exchange traded fund IWM. A clear negative trend is indicated when the shorter (quicker-moving) moving average crosses below the longer (slower-moving) moving average, as it has here with IWM.
The number of stocks trading above their 50-day moving average -- which means the number of companies enjoying rising stock prices -- has dropped sharply after a persistent decline, even as the inde
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