January 31st, 2013

Anatomy of the “Bull Market”

imageEveryone right now is trying to figure out how vulnerable the market is to a serious correction as it approaches its previous all-time highs.  For example, CNN recently posted a piece entitled “Bull market winding down. Don’t panic” in which they overlaid onto the 2009-2012 S&P 500 the template of the market’s traditional psychological life cycle.  [FYI, I’ve used that template myself in many earlier postings.  For example, two years ago in Two Views of the Same Image, some had voiced fears that investors were “euphoric” and that meant that the market was approaching a peak followed by a significant downturn.]

In the recent CNN article, Laszlo Birinyi Associates suggested that the bull market “likely entered its final stage last summer. So far, the S&P 500 has climbed almost 8% during this period of ‘exuberance’.”  Birinyi, says this stage of the market’s life cycle is when “fireworks” happen….. when all the people who have been reluctant and hesitant to invest in the stock market start realizing this isn’t the New York City subway system.  There’s not going to be another train coming so they better get on board.”

Four stages of Bull Market

The CNN article concludes that some of the best gains are to be had in the market’s final stages as everyone begins to pile onto stocks.  This year, that run could be even more impressive as the fixed income bull market ends and investors sell those investments in favor of equities.

When I look at the S&P Index over the same period, I don’t see some rather arbitrary demarcations of changes in market psychology.  I see another interesting pattern of market behavior (click on image to enlarge):

S&P 500 - Steps

At the risk of being labelled an Elliottician, that is a practitioner of Fibonacci patterns and Elliott Wave Theory, I see that this bull market looks like a stair-step affair with each successive leg of the bull run lasting only 50-70% of the previous leg and the % change of each leg being only 50-80% of the immediately preceding one.  The intervening steps down were less regular; excluding the 2011 correction that was amplified by the European debt crisis, each correction leg lasted approximately 60 calendar days and each (again, other than 2011) was 50-70% of the prior one.

Call it a stair-step or ever more tightly wound spring …. no matter what the analogy, the trend is unsustainable.  In the next correction down leg down could be the last of the series.  Each of the four previous corrections were between 50-70% of the immediately previous upleg.  If it holds true again, a correction beginning soon could carry the market down to approximately 1410-1415, another pivot at the bottom boundary trendline.

Looking at the psychological terms in the Birinyi chart above, I can’t come to grips with calling today’s market psychology as “exuberant”.  The reason the market saw an unusually large cash inflow in January was because they’ve been nearly non-existent since 2007.  Even though we aren’t hearing much today about the inadequacy of job creation, consumer demand is still weak and businesses still hoard their cash fearing a weak economic future.  Actually, the market rose 225% since March 2009 not because of a growing economy but only because of how far it had fallen from 2007 to March 2009.

Before there can be market “exuberance” there needs to be exuberance concerning the world economy, a condition that may be near but clearly hasn’t arrived yet.  After the coming correction, psychology surrounding the economy might have improved sufficiently to allow the market to quickly maneuver around the tip of that coiled-spring and make a run at and finally, after 14 years, cross above the all-time highs.

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June 12th, 2012

Cramer and One of My Five Lines in the Sand

I informed Members in their June 3, Weekly Recap Report that “the market has been in a 30% trading range (1050-1365) as the economy works its way through the ruins brought on by the 2007-09 Financial Crisis.  While we’ve been glued to news stories about one crisis or another over the past three years, we fail to see that, underneath the surface, the economy and the market have been in a healing process.”

I included in that Report a chart onto which I inserted five critical trendlines, levels at which the Market has pivoted (reversed direction) from 5-7 times over the past two and a half years.  I also suggested that Members “click on the image to enlarge it, print it out and past it over your computer …. we’ll be looking at it throughout the summer watching for the turn.”

On CNBC’s Fast Money show tonight (to see clip, click here), Cramer revealed a bold prediction by Carolyn Boroden, a highly regarded technician on Wall Street.and one of his “favorite” technical analysts in an “Off the Charts” segment.  The analyst predicted that 1265, the point at which the market seemed to have turned up last week, would be a line in the sand.  It might actually turn out to be the low for the year followed by a run to as high as 1465.  That technical analyst based her interpretation of the chart mostly on Fibonacci time and level measurements which were beyond my understanding.  But what I found most interesting is that the levels mirrored almost exactly the trendlines I’d presented to Members two weeks ago.

Now that Cramer has pulled the covers off a market timing analysis that closely correspondents to one that I distributed to Members a couple of weeks ago, I wouldn’t be committing any breach with Members’ by now including that chart here:

Interestingly, Cramer and I aren’t the only ones having focused on the importance of the 1265 level.  Yesterday, in the Minyanville post The Single Most Important S&P 500 Level, Kevin A. Tuttle wrote that over the last dozen years, the SPX has crossed, retested, and breached this level 12 times.  According to Tuttle,

“When adding the melodrama and sensationalism, Wall Street scandals, global tensions, political finger-pointing, misappropriation of funds, struggling economics, quantitative easing, and the US’ skyrocketing debt load, it can become somewhat overwhelming to ascertain potential direction.  It’s the whole “forest for the trees” idiom. My firm believes that no single individual or institution has the mental capacity, intellect, or quantitative ability to comprehend the amalgamation of all global fundamental factors to derive a meaningful conclusion about the general direction of the market without employing the demand factor, or better said, the law of supply and demand.”

I, said as much to Members in my Report of two weeks ago.  I confessed that I
“…. don’t have enough time for that and throw my hands up when it comes to trying to evaluate and assess the potential impact of the news flow from around the world.  I find it overwhelming and I just don’t feel up to the task.  But I can look at the above chart and identify important levels where the supply and demand for stocks came into balance and created turning points in the past (even if temporarily) and may, with a high degree of probability, do so at the same levels again in the future.”
The low of last week may have been one of those critical turning points.  If it was, then it behooves investors to begin putting some more cash to work because the summer break may be short and the run to higher ground may begin sooner than most anticipated just a month or so ago.

March 28th, 2012

Just 10% to previous all-time high

Conversation on CNBC the other morning centered on why so many financial managers, hedge funds, institutional and individual investors are skeptical about the sustainability of the market’s strength.  The debate revolved around whether the skepticism results from the global situation, strength of the domestic economy, Federal budget deficit and its fix, the outcome of the upcoming Presidential election or any of a half dozen more reasons?

I wish, however, there had been a “none of the above” choice because I think the answer may actually lie in basic investor psychology.  The answer is as fundamental as the difference in perception, the mind’s eye, between a recovery move higher and a move higher into all-time new high territory.  When an individual stock or the market as a whole descends the far side of a valley in a crash or correction it leaves pivot point markers which serve as resistance levels on the near side as it ascends from the valley’s bottom [and for those doubters let me say there always is a bottom except for tulip bulbs and perhaps the Japanese stock market].  Those pivot point markers were the failed attempts to find and create the bottom.

After actually making a bottom and reversing, those earlier failed attempts often mark the approximate levels where fear takes hold that the recovery will fail again fueled by those who rationalize or explain why the recovery will fail and the market or stock will will turn lower again.  Remember all the talk back in 2009 about the S&P’s “double-top” that would lead to a final Wave 3 descent to below 600?  In August 2009, I wrote:

there are the Elliott Wavers led by Prechter who claim that a “Primary Wave 3″ down will soon get underway because “the DJIA has now retraced a Fibonacci 38.2% of the 2007-2009 plunge in stock prices, meeting a minimum threshold for the completion of the Primary Wave 2 rebound”. One Elliottician blogger also believes that

“the next wave down will likely entail the collapse of Western Civilization. Given the precipice of history at which the world stands, I’m hurrying to complete my thesis regarding the creative insanity of man. There’s a possibility of global nuclear war by mid-October according to my analysis.”

It was pure malarkey then and it is today.

But when the market or a stock ascends ever higher into all-time high high territory there are no benchmarks on the facing wall, no earlier pivot points where optimism slowed the fall which could now turn into skepticism and hesitation about the ascent.  Once the ceiling is penetrated, fears and reservations don’t stop the ascent but overconfidence, irrational exuberance and mania will.

Consider the S&P 500 in two alternative periods; the current secular bear market and the other the 1982-2000 bull market (click on images to enlarge):

But what does 10 or 15 years of stock market history have to do with investment decisions today?  What does it have to do with the explanations for investor skepticism given by those CNBC talking heads the other morning?  The relevance comes from the omission of one important fact not mentioned in the whole discussion:  the approach of one of the most significant pivot point benchmarks of the last 12 years …. the previous all time high, a mere 10% away from the market’s current level.  (To be technically correct, there is one other lessor precursor pivot point at around 1450 emanating from the other side of the Financial Crisis Crash valley that has to be crossed before the market can break into the clear, blue, cloudless skies of all-time new highs territory at around 1565.)

While the market is still 10% below its previous all-time high made in 2007, close to 40% of stocks are now trading higher than their highs of 2007 including such well-known leaders as QCOR, PCLN, GMCR, REGN, HSTM, SHOO and PRGO.

The secular bear market won’t die easily and it may yet survive forcing us to live through another major decline (that’s from where all that skepticism originates).  But then again, those talking heads haven’t yet had sufficient reason to think up the explanations and rationalizations for why the market will break through the resistance into blue skies.  But my guess is that they’ll have to start looking for them towards the end of this year.

February 16th, 2012

Parallel trendlines for positioning targets

There are those who follow Bob Prechter, one of the strong proponents of the Elliott Wave principles have their ways of identifying price level targets.  And then there’s the crowd who hide out at Slope of Hope, the place where perma-bears can always find a reason for an impending correction or “much welcomed” bear market crash through targets derived by their overly precise application of arcane Fibonacci mathematics.  But I’ve always found a rather simple approach to projecting out potential targets by applying a resistance trendline parallel to the corresponding supporting trendline and thereby creating a channel.

Take for example XHB, the homebuilders ETF.First, you should note how reversal and consolidation patterns easily morph from one form to another without a general market tailwind.  Until last summer’s meltdown due to the domestic budget and European sovereign debt crises, it looked as if XHB would break out the upside of a symmetrical triangle.  Since last summer’s 30% decline, it now appears that pattern has morphed into an ascending triangle and, with cooperation of a more constructive general market backdrop and expectations for finally an improved housing market, that upside breakout might now be at hand.

If break out does materialize, the next question is what might be a reasonable target for the move higher?  Consider a parallel line as on benchmark:

Parallel lines are simplistic and anything but elegant but they usually work.  They definite position a target for one’s expectations.  They won’t let your dreams run wildly out of control and add a time dimension to a price expectations.

Reality never really works so perfectly but, if the market and XHB dramatically diverges from this trajectory then we can make mid-course adjustments when and to the degree necessary.

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January 10th, 2012

Modern-Day Patent Medicine Salesmen

Bob Prechter and his Elliott Wave newsletters never fail to intrigue me.  Over the years, I’ve tried to understand the basic concepts behind Elliott Waves and Fibonacci wave counting but to no avail.  I just don’t get it.  Even more, I don’t get why there are so many people who fall for what to me sounds like one of the best marketing gimmicks and, dare I say, scams.  To me it’s not any better than snake oil salesmen out west in the 1880’s or circus barkers in the 1930’s.

I signed up for his free emails just to see whether he was selling anything new and find that there’s a veritable unlimited supply of gullible and desperate investors.  For example, a recent letter entitled “The Market is Forming Its ‘Biggest Head and Shoulders Top Ever’: Prechter” includes the following chart:

According to the Prechter email:

“This shows the Dow Industrial Average going back to 1980. It has formed the biggest head and shoulders top that I think has ever existed in any stock market…we’re now heading downward from this formation.”  Since 2000, the stock market has been in a topping process. Eleven years may seem like a long time for a market to “top,” but consider how long the 1980s / ’90s bull market was. It takes time for that market optimism to dissipate.

I’ll say it takes a long time!  Almost two years ago, in a post entitled “S&P Index at 3000 by 2020“, I wrote:

“I don’t know how many of you saw all the exposure Bob Prechter of Elliott Wave fame been recently getting (he even made the Sunday NY Times Business Section front page). Prechter, true to form as a perma-bear, reinstated his call for the next leg of this Crash to resume predicting it will be on a par with the 1929-32 Big One with the Dow-30, currently at 10198, “likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end.” But he’s been calling for a decline on that order of magnitude for what seems like years.”

Well, the Dow Jones closed today at 12462, or 22.2% higher than on July 13, 2010, when Prechter made the front page of the NY Times Business section.  Coincidentally, that NY Times piece appeared almost at the precise launch of the market’s last huge 27.9% run between August 31, 2010 and May 2, 2011.

Rather than joining Prechter’s bear camp then, I went the other direction with the view that we were (and still are) in a period very similar to the end of the last secular bear market in 1977-1982 … a view that’s more widely held and written about today than it was in 2010 when I seemed to be alone with that opinion.  My view then was and today still is:

“I’ve modeled a recovery from a similar low in the current Crash (March 2009) to where the S&P 500 Index might be in 2020 if it were to follow an identical path to the one it followed from 1975 when the Index last touched the lower boundary.  If the market were able to climb out of this secular bear market in a manner similar to the path out of the 1970’s one, then the S&P 500 Index could hit – are you sitting down – 3000 in 2020.”

and included the following chart:

Is Prechter correct in saying that the market is at the end of the topping process that began 10 years ago or is it the beginning of the march to 3000 by 2020?  If anything, Prechter [like Cramer] is often a very reliable contra-indicator.  The time he’s most bearish (if degrees to his perpetual bearishness is possible at all) is the time that the market on the very of a huge bullish move.

I you were smart, you wouldn’t have bought patent medicines or believed the acts in a carnival freakshow.  Let’s hope you don’t fall for this perma-bear sideshow and that Prechter’s new call for a market top turns about to be another contra-indication.

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