For those who read this piece regularly you know we have recently made some pretty good calls regarding the stock market. On Halloween in 2007 our piece tilled “Welcome to My World” we shared some technical indicators that we felt were not overwhelming jargonish (yes we made the word up) and could be understood by non-professionals. We shared why these indicators were telling us that the market was running out of steam. The stock market has not seen those levels since. Last September 2nd we wrote a missive titled “September Up To Its Old Tricks, Wake Me Up In November” and what happened subsequently made stock market history.
We don’t write this to boast, hubris is usually an invitation to the market’s guillotine, but to impress upon you that we sense storm clouds brewing again. Let us be clear we do not enjoy being a prognosticator of bad things to come, but if the evidence is stacking up we think you would want to know our thoughts. We believe this is no time to play ostrich, and that is actually one of our data points of concern. We have met many investors of late who are convinced the market is as low as it can go. Also we watch CNBC everyday and the number of talking heads saying a bottom is in makes me nervous. Especially since these are the guys who never saw the drop coming. We don’t understand how they can say this is the time to get in, because if we had listened to them we would have very little money left. It is this type of complacency that often precedes corrections.
What unnerves me the most right now is the manic movements the market has made the last three weeks. As we moved into the New Year we thought the collective technical look of the stock market appeared constructive. So much so that we thought there was a chance the Dow could get to 10,000 in the first quarter. By the end of the second week of January the constructive look was all but gone. This past Wednesday a 200 point up day on the Fed meeting looked like maybe some repair was upon us, but we gave it all back and more the next day and continued down another 148 points on Friday. The action reminds me of October/November and we view it as extremely untrustworthy.
In our initial letter of the year we noted that if the Dow Jones Industrials takes out the low made in December during the first quarter it is a significant red flag. According to the Stock Traders Almanac, this has occurred thirty one times since 1952 and twenty nine times the market has continued lower. The average retreat was 9.8%. The low in December was 8141 and in the last couple of weeks we closed below that number. The average drawdown would take the index to 7343, a new low for this Bear Market.
A week and a half ago the Financial Services Index was the first sector/index to take out last years lows. Every other major sector/index has been able to keep above that point so far. Friday saw the Transports come within a hair of their November lows. Two of this index’s most important components, Federal Express and UPS (see chart below), broke down below last years lows and have an ominous look to them. Our sense is that they may drag the sector down, which may in turn drag the market down. The Transports are a pretty important component of the stock market and have often led the market up or down. (Note that this represents the Chart Spotlight section for this edition).
One more set of charts to highlight my nervousness: The volatility indices, VIX for the S&P 500 and VXN for the NASDAQ 100, tend to be reasonably accurate contrary indicators for stocks. They are also known as the fear indices and when they are moving higher the market moves lower and vice versa. Our work shows both these indicators flashing positive divergence signals. What that means is as the index has moved back to the lows of earlier this month, the internal indicator MACD on both have not confirmed the move down (red arrow). Often this means the index has good probability of moving higher in the coming weeks, and that is not good for stocks.
Again we don’t like to get to technical here with industry jargon, but the evidence is piling up and we believe it is more impactful if we share specifics with you. We have a difficult time projecting magnitude and term of corrections and advances. We usually will wait till we see a bottom or top to form before We change my take. We give much credence to our targets of about 6,000 on the Dow. Ouch!
We would have to give our odds of stocks dropping precipitously in the coming weeks about a 70-30 probability. We actually hope to be wrong. There is one caveat that could take stocks higher and we thought it would have happened last year. Twice the SEC put in rules that curbed short selling last year and both times the market rallied. If the new administration/regulators reinstall the uptick rule (you can only short stocks after they trade higher) and put in severe penalties for those that abuse the short selling rules, we think that could spark a significant rally. Our sense is that they will not do that until the market has made new lows in order to stop the correction.
We have mentioned that one of the premises of our work is “It is okay to be wrong, it is not okay to stay wrong’ and if the market holds here and decides to move higher we will change our minds (a technicians as well as a woman’s right) and redeploy funds. We think flexibility is the biggest key in making money in the stock market for the next decade and right now caution and vigilance is important.
Did You Know…
The House of Representatives voted on Wednesday 1/14/09 to raise the federal excise tax on cigarettes by 61 cents a pack (from 39 cents to $1) and to earmark the additional tax revenue (estimated to be $20 million a day from the additional tax on 33 million cigarettes smoked daily) to expand the State Children’s Health Insurance Program. The Senate will take up this legislation in the future (source: Tax Foundation).
Final Thought
“Even if you're on the right track, you'll get run over if you just sit there” -- Will Rogers
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