October 23rd, 2012

Important Stock Market Supports

I must confess that I’m disappointed by both Romney’s lack of fire in his belly during last night’s debate and in the market’s negative reaction to that performance.  I’m one of the crowd who was looking for a bounce rather than a swoon as we moved on to the election and for several weeks after a Romney victory.  My market optimism was based on the belief that a Republican victory in both the White House and Congress would a big risk factor overhanging the market (whether fairly or not) as far as economic growth and would also reduce the risk associated with the country’s falling over the fiscal cliff at year end.

This morning’s reaction forces me to go reevaluate the game plan.  Perhaps the market will slip over the edge before the economy does.  But then again, there are many potential support levels to stop the fall …. albeit after some major damage to stock prices and portfolios (click on image to enlarge):

 

Those supports are indicated on the chart:

  • The lower boundary of an ascending channel that begin in late-2011.  Perhaps, not coincidentally, that trendline actually stretches back to the 2009 Financial Crisis Crash low (see chart below) and should, therefore, be considered an extremely important and strong one.
  • Three slow moving averages that all happen to currently be ascending
  • A horizontal trendline at approximately the prior 2012 low for the year

Unfortunately, however, my proprietary Market Momentum Meter will turn red suggesting that a move into cash is advisable based on similar situations in the past.  If the decline continues at the current rate, it will be similar to the rapid decline in 2011.  The recovery from that correction was fairly quick and dramatic so many investors, including me, were whipsawed and are still trying to recover.

Some look at the long-term chart a see the market back at the top of its 12-year secular bear market tradition range and, consequently, see the beginning of another major market crash (i.e., decline of 30-50%):

One usually bearish pundit recently wrote the following typical view of an impending market top,

“Cyclical bulls follow cyclical bears, so from those panic ashes a new cyclical bull was indeed born.  And coming from excessive lows, it would more than double the stock markets again.  Over the 3.5-year span running to just last month, the SPX blasted 116.7% higher!  And that brings us to where we are today, what is almost certainly the third major bull-market topping witnessed in this secular bear.”

Rather than the proximity to the top of the secular bear market range, my focus will be on that ascending trendline from the 2011 and 2009 lows, currently at around 1400.  A cross below that line would be a clear indication of more declines to come.

 

October 19th, 2012

Echo of the 1987 Crash

It was twenty-five years ago but it still seems like it was only yesterday.  I didn’t have much money in the market during the ’87 Crash but it was all the money I had saved.  It was a time when it wasn’t as easy as it is now to get up-to-the-minute stock market news and quotes.  It was before the Internet and CNBC so the only way of obtaining that information was either by calling your broker, listening to radio news or waiting for the evening newspapers.

Nevertheless, we some how found out that the market was in free fall.  I somehow got hourly updates and remember running down to my bosses office to update him on what I had learned.  He had much more invested than I and his face was ashen.  By the end of the day, we finally learned that the market had closed down 22.6%, it’s largest ever one-day decline.  All we could do was just pace back and forth in his office, wondering whether we we witnessing the “end of the economy”.

Today is the anniversary of that one-day crash.  And today, we’re experience an echo decline triggered primarily by Google’s announcement about a shortfall from expectations based on disappointing results of their advertising business due to a shift away from desktop to mobile computing and internet access.  In 1987, the focus was on the newly introduced PC’s and what was anticipated to be a revolutionary implication on traditional business.  Twenty-five years later, we see that the world has been markedly been impacted.

As I note in my book, Run with the Herd, the market has suffered through 10 bear markets since WWII and discusses in detail the 4 during the last 40 years.  But one of the best ways of putting the crash into perspective is to read some of the comments of key players in 1987 (these quotes are from my book):

  • “Technically, the crash of 1987 bears an uncanny resemblance to the crash of 1929. The shape and extent of the decline and even the day-to-day movements of stock prices track very closely.” – George Soros in “The Alchemy of Finance”
  • “The market crash of 1987 caught most economists, scholars, and investment professionals by surprise. Nowhere in the classical, equilibrium-based view of the market so long considered inviolate was there anything that would predict or even describe the events of 1987.” – Robert Hagstrom in “Investing, the Last Liberal Art”
  • “The President [Ronald Reagan] has watched today with concern the continued drop in the stock market….consultations confirm our view that the underlying economy remains sound.  We are in the longest peacetime expansion in history.  Employment is at the highest level ever.  Manufacturing output is up. The trade deficit, when adjusted for changes in currencies, is steadily improving. And, as the chairman of the Federal Reserve has recently stated, there is no evidence of a resurgence of inflation in the United States.” – White House Statement released on October 19, 1987
  • “I have never experienced anything like this, so it is difficult to have clear vision. I don’t understand it in terms of the fundamentals of the economy” – Robert Allen, president of AT&T, October 20, 1987
  • “The borrowing has to stop. The market slide was a shot right between the eyes that had better wake us all up to simple fact that we can’t keep romping forever on borrowed money.”  – Lee Iacocca, Chrysler Corp Chairman, October 20, 1987
  • “It’s the nearest thing to a meltdown that I ever want to see. We were fortunate this occurred when the American economy is very stong.” – John J. Phelan, Chairman of the NYSE, October 20, 1987
  • “They should bar buying and selling by programming. They can’t stop the selling once it gets going, it’s just computers selling to computers. It became a gamble, not an investment anymore. All those guys with 65 credit cards and Porsches who think they are all geniuses at 25 – now see what’s happened.” – Alexander Kopelman, 80 year old Florida man, October 20, 1987
  • “I told my clients that it was a sucker’s market (two days after the crash). A week ago, I would have taken a gamble on anything that looked promising when I was dealing for my own account or for some of my family members. I had been spoiled by the bull market, I never knew anything else. But I became a cynic and a skeptic in a hurry.” – A broker, October 23, 1987
  • “I will tell you that, prior to the opening of the market, Mr. Phelan (Chairman of the NYSE) and I had a conversation where he advised me that there was an inordinate number – “unbelievable” I think was his word – of sell orders coming into their market. That was like an hour before their opening on Monday. So we saw it coming, but who knows who pushed the button to make it happen.  I think that button was pushed a million times by a million people.” – Leo Melamed, chairman of the Chicago Mercantile Exchange, October 28, 1987
  • “Investors had expectations before the 1987 crash that something like a 1929 crash was a possibility, and comparisons with 1929 were an integral part of the phenomenon. It would be wrong to think that the crash could be understood without reference to the expectations engendered by this historical comparison. In a sense many people were playing out an event again that they knew well.” – Economist Robert Shiller
  • ” So improbable is such an event that it would not be anticipated to occur even if the stock market were to last for 20 billion years, the upper end of the currently estimated duration of the universe. Indeed, such an event should not occur even if the stock market were to enjoy a rebirth for 20 billion years in each of 20 billion big bangs.” – Mark Rubinstein, economist in “Comments on the 1987 Stock Market Crash: Eleven Years Later”
  • “Those who thought Black Monday on 1987 was the most frightening day of their lives are forgetting those first few hours of Terrible Tuesday, when the market as we know it simply ceased to exist…. In fact, the dirty little secret of that Tuesday morning is that the screens simply weren’t functioning. It was like the Wild West out there. Anything you tried to buy simply went up ahead of you until you caught it and then it would come down so fast that you could lose hundreds of thousands of dollars in mere seconds. I retreated to the sidelines rather than endure that kind of punishment.” – James J. Cramer, founder of theStreet.com and CNBC personality

Some of these personalities are still around.  It would be interesting to know both their view of the 1987 crash from today’s perspective and their view of today’s sell-off due to what today’s talking heads call the death of desktop computing and click advertising.

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February 14th, 2012

Is the Market Overvalued and Overbought?

I was struck by a post on Slope of Hope entitled “An Ongoing Balloon Ride” the major premise of which was that the the market has risen too far and diverged too far from its 400-dma such that there’s no questions “if this debt-filled balloon will disintegrate, but when“.  The writer’s premise is that the several times in the past when the Index has diverged as far as it has from its 400-dma have all been followed by a drop or correction.

I have my own database and decided to do my own research and gather my own facts to see whether I could replicate those results and come to the same conclusions.  My database goes back to 1963 and the moving average I rely on is the 300- rather than the 400-dma (but what difference does a hundred days make between friends).  The Slope writer visually picked the areas when the index diverged significantly from the moving average and eyeballed the subsequent change.  What I discovered was:

The S&P 500 Index is currently 6.38% above the 300-dma.  In the 12,089 trading days between March 12, 1963 and March 11, 2011, a spread between the index and the 300-dma of 5.00-7.99% occurred on one out of every 6 days, or 16.89% of the time.  One could almost say that this spread is “typical”, not large or overbought or stratospheric.  Actually,  it’s fairly typical.

One can look at both tails of the distribution as indications of how extreme the spread defining overbought or oversold situations, times when one needs to sell or has a true opportunity to buy.  In 2008 and 2009, at the depths of the Financial Crisis Crash, the market was over 35% below the 300-dma …. we should have all bought then but few had the nerve.  In August, 1987, the market was 24% above the 300-dma; a few months later, the market suffered it’s largest single daily decline in the October Crash …. we should have sold.

The market was more than 20% above the 300-dma also in 1983 as the market rocketed in celebration of its exit from the secular bear market of the 1970’s.  Rather than crashing, the market went into a horizontal consolidation lasting 15 months (just like the past 15 months?  I’ll leave that determination for you to make.)

So is the market now overbought?  Not if you use the 300-dma as a benchmark.  Did the Slope of Hope contributor select a seldom used 400-dma benchmark to prove his point?  It’s possible.  Where would the market have to be for it be overextended or overbought by these measures?  Somewhere around 1500-1550 …. interestingly, exactly the level of the market’s all-time high as measured by the S&P 500.

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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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October 20th, 2011

A Scary Anologue Seldom Mentioned

According to Dictionary.com, an “analogue” is a noun meaning: something having analogy to something else.

Chartists are prone to mine historical data in search of precedents, patterns that closely resemble the current market believing that by projecting forward from those historical reference points they will come up with the performance that might be mimicked in the current future.

I think I’ve found an analogue that is amazingly close to the present, frighteningly so. Take a look at the following chart (click on image to enlarge):

I intentionally deleted any date references so that you’ll focus on the following:

  1. The market completed an imperfect head-and-shoulder reversal top; the right shoulder was small so the pattern could have easily been considered a double-top
  2. Moving Averages in perfect Bearish Alignment
  3. After crossing below the neckline, the market traded in a narrow, 3-4 month range
  4. However!
    1. the 50-dma reversed and
    2. the Index exited the range and crossed above all but 300-dma
  5. Volume peaked twice as the market declined to form the lower boundary of the channel after which volume appeared to evaporate

Now compare that to a chart of the market today:

The similarities are eerie and uncanny. I’ve notated the similarities on the above chart of today’s market.

Have you guessed what period the first chart covered? Unfortunately it was February 2007 to May 2008, a period that was the precursor of the recent Financial Crisis Crash. Just on the other side of the first chart above, the market crashed over 50% between May 2008 and March 2009!

In no way am I predicting that we’re on the doorstep of another crash. What I am suggesting is that you should take all the uplifting talk by Cramer and the other “talking heads” on the air and in print with a large dose of skepticism. The market may hinge on agreement in a European bailout financing plan and a continuation of favorable earnings reports here. Those point may be preconditions to assume that the market already hit a low for the year and the bull market can resume.

I think I’ll just wait, however, because if we had bought when we heard the same sort of talk as we entered our own bank and financial system emergency then we would have lost more than half and still had not recovered all our money. Rather than trust the professionals, I’m going to let the market tell me when it’s o.k. to put my money back to work.

October 19th, 2011

The October 19, 1987 Market Crash

Twenty-four years ago today, I walked in the front door from work and my wife took one look at me and asked what the matter was. I made my favorite cocktail, a rusty nail, to steel my nerves to tell her that we’d just lost a good portion of our savings … in a single day.

To commemorate that day, I’m excerpting a chapter in my book, Run with the Herd, in which I describe each of the recent stock market crashes. The chapter sets the stage for describing the importance of and my approach to market timing.

——————————————————————————————————-

The stock market crash of 1987 is perhaps more remarkable than the more recent Tech Bubble or Financial Crisis Crashes and singular even today because of the fact that it was and still is the largest one-day change in market history. The Dow Industrial Average lost 22.6% on October 19th 1987, or $500 billion dollars.

An extremely powerful bull market started five years earlier, in the summer of 1982, and continued into early 1987. That bull market had been fueled mostly by hostile takeovers, leveraged buyouts and “merger mania”, a philosophy of the time that companies could grow exponentially simply by purchasing other companies. Consequently, there was a scramble to raise capital to finance those buyouts. In “leveraged buyouts”, a company would sell junk bonds to the public thereby raising massive amounts of capital needed to finance their acquisition. IPOs were another commonplace revenue source.

The stock of “microcomputer” manufacturers, considered by many to be the top growth industry at the time, was another promising investment area. People viewed the personal computer as revolutionary, something that would not only change our way of life but also create outstanding profit opportunities. Investors were caught up in a contagious euphoria, animal spirits that made them believe, once again, that the market could continue to always move in only one direction – up.

The government began to take action. Seeing a growing inflationary concern, the Fed began raising short-term interest rates to temper the economy and, at the same time, cool the hot IPO-driven stock market. Coincidentally, since the SEC was unable to prevent shady IPOs and conglomerates from proliferating, it begun conducting numerous investigations of illegal insider trading in early 1987.

While the SEC could offer the proper information about the risk in these IPO’s to investors but it couldn’t cause them to change their behavior. Even though the SEC required companies to state explicitly that they had no revenue or profits and didn’t even have a fighting chance at getting any, investors still believed the potential was limitless. Ultimately, the barrage of SEC investigations began to rattle investors who decided by October to exit what they now believed to be a rigged game and move instead into the more stable environment offered by fixed income securities and, even in some cases, junk bonds.

At the same time, many institutional trading firms began increasing their dependence on program trading and to use futures contracts as insurance to protect against the potential of stock dips. But when the selling finally began, all stockholders seemed to want to dump their shares simultaneously and the market systems and procedures couldn’t handle the flood of orders. As the mass exodus began, the computer programs kicked in. The programs had created open stop loss orders and, as the influx of sellers began, the computers sent these stop loss sell orders to the NYSE computer system pushing prices down. The instantaneous transmission of so many sell orders overwhelmed the system and caused the whole market system to lag and leave investors at every level, whether institutional or individual, effectively blind. At the peak of the selling, there weren’t ANY buyers and some shares couldn’t be sold at all! (click on image to enlarge)

Herd-like panic set in and people started dumping stock in the dark without knowing or caring what their losses might ultimately be or whether their orders would execute fast enough to keep up with plummeting prices. The Dow plummeted 508.32 points (22.6%) and $500 billion vaporized. Markets in every country around the world collapsed in a similar fashion.

When they heard that a massive stock market crash was unfolding, individual investors scrambled, albeit unsuccessfully, to communicate with their brokers since each broker had hundreds or thousands of clients. Some investors lost thousands and millions instantly. Some unstable individuals who lost fortunes went to their broker’s office and started shooting and several brokers were killed despite the fact that they had no control over the market’s action. The majority of investors who were selling didn’t even know why they were selling except that they “saw everyone else selling”.

Remarkably, the markets recovered quickly from the worst one day stock market crash. Some modest refinements including “circuit breakers”, or the short circuiting of trading programs when markets slid by set amounts, were instituted. Unlike the stock market crash of 1929 from which recovery took years, this time the market regained its footing and quickly resumed its bull run. The post-crash recovery was reinforced by companies buying back their own stocks at then greatly discounted prices. Additionally, the Japanese Nikkei Index embarked on a massive bull market run contributing its own tremendous momentum to help carry the US stock market to new heights.

The comments of notables of the day are instructive for putting the confusion and crash into some context. The statements are important also because they offer some insight into what different people in similar positions might have said after each of the later market crashes. While each situation is different, people never learn and their responses are always the same. Many of the comments resonate as we are hopefully exiting from the effects of Financial Crisis Crash, the 2010 Flash Crash and the 2011 Deficit and Budget Congressional Debates:

  • “Technically, the crash of 1987 bears an uncanny resemblance to the crash of 1929. The shape and extent of the decline and even the day-to-day movements of stock prices track very closely.” – George Soros in “The Alchemy of Finance”
  • The market crash of 1987 caught most economists, scholars, and investment professionals by surprise. Nowhere in the classical, equilibrium-based view of the market so long considered inviolate was there anything that would predict or even describe the events of 1987.” – Robert Hagstrom in “Investing, the Last Liberal Art”
  • The President [Ronald Reagan] has watched today with concern the continued drop in the stock market….consultations confirm our view that the underlying economy remains sound. We are in the longest peacetime expansion in history. Employment is at the highest level ever. Manufacturing output is up. The trade deficit, when adjusted for changes in currencies, is steadily improving. And, as the chairman of the Federal Reserve has recently stated, there is no evidence of a resurgence of inflation in the United States.” – White House Statement released on October 19, 1987
  • I have never experienced anything like this, so it is difficult to have clear vision. I don’t understand it in terms of the fundamentals of the economy” – Robert Allen, president of AT&T, October 20, 1987
  • “The borrowing has to stop. The market slide was a shot right between the eyes that had better wake us all up to simple fact that we can’t keep romping forever on borrowed money.” – Lee Iacocca, Chrysler Corp Chairman, October 20, 1987
  • The market is sending an unequivocal message to the President and the Congress to stop the political games and agree on a Federal deficit-reduction plan.” – Representative Dan Rostenkowski, Democrat, October 20, 1987
  • “It’s the nearest thing to a meltdown that I ever want to see. We were fortunate this occurred when the American economy is very stong.” – John J. Phelan, Chairman of the NYSE, October 20, 1987
  • “They should bar buying and selling by programming. They can’t stop the selling once it gets going, it’s just computers selling to computers. It became a gamble, not an investment anymore. All those guys with 65 credit cards and Porsches who think they are all geniuses at 25 – now see what’s happened.” – Alexander Kopelman, 80 year old Florida man, October 20, 1987
  • “I told my clients that it was a sucker’s market (two days after the crash). A week ago, I would have taken a gamble on anything that looked promising when I was dealing for my own account or for some of my family members. I had been spoiled by the bull market, I never knew anything else. But I became a cynic and a skeptic in a hurry.” – A broker, October 23, 1987
  • “I will tell you that, prior to the opening of the market, Mr. Phelan (Chairman of the NYSE) and I had a conversation where he advised me that there was an inordinate number – “unbelievable” I think was his word – of sell orders coming into their market. That was like an hour before their opening on Monday. So we saw it coming, but who knows who pushed the button to make it happen. I think that button was pushed a million times by a million people.” – Leo Melamed, chairman of the Chicago Mercantile Exchange, October 28, 1987
  • “Brokers hurling themselves from high windows. Men selling apples on street corners. Silent, shuffling breadlines and shouting crowds outside banks. Even for many of us who did not endure the Great Crash, images of the Depression still flicker across the years. Is that why so many people panicked?” – Susan Toth, author, October 25, 1987
  • “Investors had expectations before the 1987 crash that something like a 1929 crash was a possibility, and comparisons with 1929 were an integral part of the phenomenon. It would be wrong to think that the crash could be understood without reference to the expectations engendered by this historical comparison. In a sense many people were playing out an event again that they knew well.” – Economist Robert Shiller
  • “So improbable is such an event that it would not be anticipated to occur even if the stock market were to last for 20 billion years, the upper end of the currently estimated duration of the universe. Indeed, such an event should not occur even if the stock market were to enjoy a rebirth for 20 billion years in each of 20 billion big bangs.” – Mark Rubinstein, economist in “Comments on the 1987 Stock Market Crash: Eleven Years Later”
  • “Those who thought Black Monday on 1987 was the most frightening day of their lives are forgetting those first few hours of Terrible Tuesday, when the market as we know it simply ceased to exist…. In fact, the dirty little secret of that Tuesday morning is that the screens simply weren’t functioning. It was like the Wild West out there. Anything you tried to buy simply went up ahead of you until you caught it and then it would come down so fast that you could lose hundreds of thousands of dollars in mere seconds. I retreated to the sidelines rather than endure that kind of punishment.” – James J. Cramer, founder of theStreet.com and CNBC personality

November 5th, 2010

Avoiding the Next Bubble

Although everyone is ebullient about the market’s success in making a new 52-week high, I’m adopting an unusual and somewhat uncomfortable stance. I’m going to assume the role of “contrarian” and throw out some caution.

I was as ecstatic as anyone yesterday watching all those green numbers flashing on my computer screen. But have you ever taken a look at the longer-term charts of some of the leading stocks many of which are also on the IBD 100 list? As you scroll through a stack of them, you’ll feel like you’re watching fireworks going off on the Fourth of July. The prices of many leading stocks have doubled, tripled and some have even gone up five-fold since Labor Day 2009. Here are a few examples (click on image to enlarge):

  • APKT (stock has run up over five-fold since Sept 1, 2009 when it was in the midst of forming its previous consolidation pattern. It’s to early to say what the recent movement is carving out, whether consolidation or reversal with the market’s future course probably being the deciding factor).
  • IGTE (has run up without any significant consolidation since its March 2009 low under $2; one is definitely overdue.)

Oh, if we had only had the foresight …. and the courage ….. to put our money into these stocks and a raft of other momentum stocks rather than watching a stagnant S&P 500 struggling for a year to break free of its consolidation trading range! If we only had hindsight! But we didn’t because no one can predict the future. All we can do is to find indicators that give us some warnings about what the future might hold and then, if the events materialize, we try to react appropriately.

A few days ago, I wrote in “IBD and Market Timing? I Don’t Think So” about the Market Security Meter. The market timing indicator did properly indicate that the best strategy was to exit the market in January 2008 and then reenter in June 2009, however, those calls confirmed, on the one hand, the market’s damaged and weak condition and, on the other hand, its full recovery.

Looking closely at the IBD 100 chart in the posting referenced above, it appears that the IBD 100 index peaked ahead of the general market as measured by the S&P 500. Perhaps if we focused on today’s market leaders and try to discern when they turn weak and roll over, that could serve as an early warning to approaching weakness in the broader market?

Towards that end I created what I call the “Bubble-30 Index”, an index composed of 30 of today’s leading momentum stocks including names like Priceline (PCLN), Netflix (NFLX), Chipolte (CMG). The list crosses many industry groups and includes several international stocks. When demand for these stocks dry up and the money flow reverses direction, this Index should send an alarm of an impending change in market sentiment.

Here’s what the indicator looked like last night (click on image to enlarge):

Greenspan warned on “irrational exuberance” back in 1996 but no one listened to and soon forgot his warning because stocks continued to run. If we had our eyes focused on the Bubble-30 Index of that day, confirmed by the Market Security Meter, perhaps we would have not been devastated in the Tech Bubble Crash.

The Bubble-30 Index, along with current readings of the Market Security Meter, are tools included in the Weekly Recap part of the Instant Alerts subscription.

October 22nd, 2010

IBD and Market Timing? I Don’t Think So

I was an avid subscriber to Investors Business Daily for many years and envied to returns they were able to generate through their top 100 stocks. They said that if I followed their CANSLIM methodology I too could generate comparable returns for my portfolio. But it wasn’t as easy as they claimed. My portfolio just wasn’t matching theirs.

But then the Financial Crises Crash hit towards the end of 2007 and the market imploded with a 57% decline. Fortunately for me, in my attempts to emulate their approach I realized that it was probably more important to time the market well that it was to pick stocks well. The amount of money that you lose during major down turns can almost totally wipe out any profits you made in the bull market leading up to the Bear Market. That’s especially true during the secular bear market we’ve unfortunately had to endure for the past 12 years.

IBD may be excellent at identifying stocks leading the market but they do so in a vacuum without any apparent concern for market timing, without giving any recognition to the fact that there are times when it doesn’t matter how good your stocks are they’re not going to be good enough, that upside momentum can lead to out-sized gains but downside momentum can also lead to out-sided losses:

While the Financial Crisis Crash S&P 500 collapsed the market by about 57%, the IBD 100 stocks were decimated by around 85%! Sure, they’re coming back but how good would their performance had looked had their approach be able to anticipate the coming crash and signaled that an exit was crucial. [No broker, advisory or newsletter service will suggest that probably because of the fear of losing subscription or fee revenue.]

At the end of 2007, I developed a market timing indicator that signaled a major decline was probably immanent. I have since translated the indicator into a simple “Market Security Meter” similar to the Homeland Security’s Terror Alert system:

O.K., so it’s not that original but it works. And what does the MSM indicate now? Yesterday it was indicating Pause (a caution light). But I know for a fact that as of today, if the market closes ends about where it is now (1182.11 at 12:40) the signal will change color and flash a different signal. Every time I send an Alert, subscribers to the service see the current MSM indicator; when it changes or is about to change, I send out a special alert.

Having a successful process for picking good stocks gives you a terrific advantage but avoiding the kind of damage as suffered by the IBD 100 list during the Financial Crisis Crash gives you a true edge for getting far ahead over the long run.

August 18th, 2010

Head and Shoulder Reversal Chart Pattern?

As the week began, everyone was talking about the Hindenburg Omen. Granted, it’s a clever choice of name but probably indicates little else. Anyone creative enough can come up with a bunch of disparate, unrelated and rather arbitrary metrics and by way of testing its efficacy over some time period in some contrived combination and prove that they work, they signal a subsequent market decline and unspecified time in the future.

In my opinion, the back-testing results of the HO (it’s now well enough known so that it has its own acronym, akin to MACD, OBV, BOP and RSI …. let’s see how long that lasts) is about as meaningful as the Lunar Cycle indicator. If the Lunar stats I’ve present here effectively represent a 14 month back-test with a 71% accuracy (much better than the HO, by the way) then why don’t more people give it any credence? Because if the Lunar Cycle indicator were tested over 30 or 40 year (i.e., 400-500 lunar cycles) its level of accuracy would probably drop to a 50/50% proposition.

On the other hand, there’s momentum investing. I came across an interesting article entitled Momentum Investing, Finally Accessible for Individual Investors written by Tobias Moskowitz (link obtained from the Dorsey Wright Money Management site). Moskowitz is the Fama Family Professor of Finance at the University of Chicago Booth School of Business which, coincidentally and ironically, is named after Eugene Fama, the professor who popularized the Efficient Market Theory and compared technical analysis to astrology.

Granted, the paper focused on the fact that Powershares has now introduced three ETFs ostensibly constructed around stocks with momentum, PIE, PDP and PIZ [I overlaid the these ETFs onto a graph of the S&P 500 and didn’t find a significant divergence in performance]. For me, however, the key point is that an academic paper concluded that “Momentum is a powerful investment style, nearly unmatched in its predictive strength and robustness.”

For there to be momentum stocks, however, there needs to be some momentum …. somewhere …. and it turns out that the supply/demand situation is in such perfect balance. There are as many buyers as there are sellers …. everyone is equally uncertain about the future …. and many, if not most, stocks, industry ETFs, commodities, currencies are close to where they were 10 months ago. It’s tough trying to make money in this market. A common question on Fast Money of guests and panelists is “how are you trying to make money in this market?” and you get all sorts of answers like selling covered calls, buying high dividend stocks, jumping on the current bubble, fixed income securities.

I wrote about this struggle in Top or Consolidation, That Is the Question” last week; I hope we’re coming closer to a resolution. Just when it looked like our hopes were dashed, the market found its footing and bounced off the rising 300-dma.

Slowly, ever so slowly, the market is attempting to put in the right shoulder of a small but important head-and-shoulder reversal pattern. The pattern isn’t large enough to generate any sort of substantial upside move if and when completed. But every momentum move has to begin somewhere. An even more significant accomplishment would be if the market were able to cross above the upper boundary of that Consolidation Channel because that descending resistance trendline stretches all the way back to the market peak in 2007.

While you wait, what are you doing to make some money?

July 1st, 2010

A Stealth Market Crash

Market momentum is turning from bullish to bearish through a process that most technicians now concede is an emerging asymmetrical head-and-shoulder top chart pattern. However, conventional technical indicators like the Black Cross failed to warn us of the speed and severity early enough to become adequately defensive. What is hidden within that formation has been a stealth crash, a 16% decline over the mere 50 trading days since the April 23 peak of 1217.28.

But how common is a correction of that magnitude in such short of time? I scanned all the 50-day changes over the past nearly 50 years (since 1/1/62 exactly), or 12,212 total trading days, and discovered that the past 50 days ranks 188th worst period, or among the worst 1.6%! So if you have suffered since April, you can understand that the period we’ve been through is nearly unprecedented; there haven’t been very many 50-day stretches that have been this bad.

The past 10 weeks are comparable with which other periods? The worst was November 2008 when the market fell 40% in 50 trading days. The next worst was the crash of 1987 when the market convulsed 26.3% in three days. The rest were:

So if you’re feeling awful, hurt, violated and damaged then rest assured …. you have a right to feel that way. You have lived through 50 days that were just about as bad as any comparable period. In fact, the past 5 weeks was as bad as any of the Bear Markets and Crashes over the last 50 years. And we thought all that was happening was the formation of a head-and-shoulder chart pattern.

Is it over? Will it now rebound from an “oversold” position? Most of the previous declines continued over several trading days and this one in all likelihood won’t be any different.