After yesterday's drubbing, the month to date performance of the major indexes looks like this...
Not very Merry.
Does that mean Santa Clause isn't coming to Wall Street this year? Far from it.
The "Santa Clause Rally," a phenomenon first described by Yale Hirsch in the “Stock Trader’s Almanac, actually refers to the period AFTER Christmas. But because of the catchy name and the media's tendency to promulgate false trading theories, many people expect the "Santa Clause Rally" to encompass all of December. However, the “Santa Claus Rally” only refers to the day after Christmas until the first two days of the New Year. During this period, stock prices typically advance sharply as the thin market offers mutual and hedge funds the opportunity to push stocks higher.
So, as negative as Monday's action was, it probably sets the market up for a true Santa Clause Rally to occur next week...when no one is around or expecting it.
The weekly NASDAQ has broken out of a long triangle pattern. While a retest of the breakout wouldn't be out of the question, the measurement of the triangle (450 points in light blue) indicates a NASDAQ target of about 2680.
In addition, the S&P 500 broke out of a rising wedge pattern. I have found that this rare pattern often leads to quick and outsized gains. That's because many traders see a rising wedge as a bearish pattern. When it breaks up instead of down, it forces short covering which launches the index higher.
The rally remains healthy, as well. The NDX is leading this advance, which is usually a good sign of strength.
And even more impressively, the SOX is leading the NDX. The chart below shows the relationship between the SOX and the Consumer Staples. When investors feel good, they rotate into the higher beta and aggressive semiconductor stocks. When they are scared, the rotate into the defensive consumer staples. Right now, the SOX is leading by a wide margin.
So while many traders might nitpick with the overbought readings and rising optimistic sentiment, the dips will be bought until the character of the market changes.
"Just be the ball, be the ball, be the ball. You're not being the ball Danny."
-Chevy Chase, Caddyshack
I've spoken to several traders who were caught very short and on the wrong side of the market this morning. The odd thing was that the market's strength has made them more stubborn and even more bearish despite the fact that several indexes are breaking to new multi-year highs. If you've been unable to come to grips with the potential for a strong rally, please take a look at the chart of the Dow from 1932 - 1938.
Be aware that the negatives were even more pervasive from 1932 to 1938 than they are today. But during the middle of the worst economic depression in US history the Dow rose from 40 to 190 over four years. So despite the numerous negatives we are facing today - economic "imbalances," rising interest rates, rising inflation, rising energy prices, rising debt levels, popping housing bubbles, etc, etc. - always take into account the market's reaction to the "negative" news. And also be aware of the positives - a global capitalistic boom, strong earnings growth despite rising input costs, the potential for lower energy prices, increases in productivity, and strong corporate balance sheets. Here is an overlay of what the Dow did in the 1930s, and what the NASDAQ is doing now.
I'm not suggesting that the market of today will continue to rise and double, as it did in 1935, 1936 and part of 1937. But it could. Traders need to be prepared for that to occur.
One of the reasons I often highlight both bullish and bearish scenarios for the market on the very same day is that it forces me to "see" the other side of the trade. It's fine to have a belief about what the market could do, but don't become wedded to it. Investing and trading is all about playing the probabilities and managing your losses if you are wrong. At any point in time, the market can decide to focus on the positives, or the negatives, depending on liquidity, psychology, fundamentals, structural issues, and other factors too numerous to mention. That's what makes trading so difficult if you don't "see" the other side of the trade. So if you're bearish as the market rips higher, please keep the charts above in the back of your mind and above all, keep your losses to a minimum.
Tighten your seatbelts and prepare for the greatest boom in history: from 1998 to 2008!
-- Harry S. Dent, The Roaring 2000s
Whenever you get stock picks or investing advice from a guru that has never managed money professionally, make sure to "check your thesis." There's a big difference between writing about stocks and and actually putting peoples money on the line. What "should" work in the markets often doesn't work when actually implemented. This rule goes for the likes of George Gilder, Louis Rukeyser and, especially, Harry S. Dent.
During 1998 and 1999, Harry Dent's "The Roaring 2000s" was practically required reading at the investment firm where I worked. In it, Dent used a demographic concept he called the spending wave to predict the future of the economy and stock market. Dent's vision was very compelling and was only enhanced by the fact that he had been exactly right about predicting a stock bull market in 1992 with "The Great Boom Ahead". Unfortunately, "The Roaring 2000s" will go down in history as one of the great contrarian signals of all time - the fact that it reached the top of the best seller lists was a classic sign that Dent was going to be wrong. In fact, Harry Dent's own "Demographic Trends Fund" proved how wrong he was - he started the fund in 1999 and by 2003, it had lost over 50%. So, technically, Dent did manage money professionally - he just did it very, very poorly.
Well, Dent is still around and is still talking about the next Great Boom. And he makes the same compelling and deceptively simple arguments to back up his case. He expects a bull market going into 2009 as money rotates out of real estate and back into growth stocks. A recent article from Stocks, Futures and Options Magazine outlines his bullish views:
Many analysts and economists view the recent long trading range as a sign of limited potential for the economy and stocks in the coming years. We believe this view could not be more wrong. True, stocks have not significantly risen in nearly two years, but given the magnitude of the crises of the past year, it is a major sign of strength that they have managed to hold their position.
Furthermore, the solid growth in earnings in a period of flat equity prices clearly builds fundamental strength. In addition, every stock market bubble in the last century – 1915 to 1919, 1925 to 1929, 1935 to 1937, 1985 to 1987, and 1995 to 1999 – was preceded by pattern of a major correction or crash, a strong initial recovery rally, and then a one- to two-year trading range sideways.
The Case for Dramatic Equity Gains Ahead When new technologies first accelerate their market penetration into the mainstream economy, they bring strongly rising productivity rates and new growth industries that generally develop into two bubbles before they peak, not one. We believe the greatest bubble very likely will occur from mid- to late 2005 into mid- to late 2010 on an 81-year lag to the last technology boom and rising demographic cycle of spending into the Roaring ‘20s, pointing to a Dow of around 40,000 into 2010. Our bullish view stems from an understanding of demographics, best illustrated by the spending wave.
Our spending wave, based on consumption data provided by the U.S. government, simply lags domestic births, adjusted for immigration, for the peak age of consumer spending – around age 48 today. That model, heavily skewed by the massive baby boom generation, has continued to point strongly up into around 2010 towards a Dow around 40,000 and explains the broad, unprecedented nature of this boom. Despite the crash of 2000- 2002, we are predicting a Dow of 35,000 to 40,000 around the end of this decade.
The greater insight, however, comes from our long-term technology cycles. Every other generation, approximately every 80 years, we usher in radical new technologies – like electricity, autos, phones and radios – that create long-term growth in productivity. The current radical technology trend centers around personal computers, wireless technologies, the Internet and broadband communications. These new technologies change business models and create accelerating productivity as they move in an S-Curve cycle into our mainstream economy – as occurred from 1914 to 1929 and 1995 to 2010.
In October of 2002 we gave our strongest buy signal in the history of our newsletter (which began in 1989) right at the bottom and demonstrated how the 2000s “tech wreck” was directly comparable to the auto industry and tech crash of the 1920s – the last major technology cycle on an 80- to 81-year lag – and would lead to one more great bubble boom ahead from late 2002 into 2010. We forecast the boom to continue until the technology cycle and demographic-induced spending trends peak between late 2009 and mid-2010. In early October of 2005 we have our last major buy signal ahead of the next strong advance in the stock market.
How could we be forecasting a Dow of 40,000 by 2010 in an era of growing federal deficits, hurricanes, terrorism and seemingly the never-ending war in Iraq? Consider other examples. We faced a similar environment in the early 1990s, and the Dow hit highs that previously were unimaginable – until you consider demographics and technology cycles.
Sectors to Watch In the last several years, bonds, real estate investment trusts, homebuilding stocks and energy stocks have led the market in a lackluster period overall. We see a dramatic reversal in trends with small-cap and large-cap growth taking over leadership from value, and with the strongest performance in technology, biotech, health care, financials, Asia, durable goods and consumer discretionary. We are predicting that the Dow will rise from 14,000 to 15,000 by August of 2006, similar to the strong advance we predicted in March of 2003, with much greater gains in technology and small caps. The next year and next five years should be very exciting and profitable for stocks and the growth sectors! But leading sectors of the past like bonds, energy, commodities, REITs and homebuilders will lag. Energy and commodity sectors may see a final bubble and resurgence from 2007 into 2010.
The problem I have with Dent's view isn't that it's completely off base - the problem is that I actually agree with it. And since one of my cardinal rules is to 'check my thesis' when I agree with a bad stock picking guru, I'll have to go back and question my outlook. However, until I find compelling evidence that Dent is wrong, I'll have to admit that I believe in what Dent is pushing - a productivity-lead bull market.
When bad news is viewed as good news AND good news is interpreted as good news, this is typically associated with a more durable advance and is characteristic of a bull market
-- Doug Kass
If you're wondering how the market could rally in the face of a Dell earnings pre-announcement, a Toll Brothers sales slowdown, a General Motors earnings restatement, continued accounting issues at Fannie Mae, and a new round of Al-Queda terrorist attacks then please re-read Doug Kass' quote above.
Despite the endless string of bad news, two things matter most to this market right now - the Fed and commodity prices. Both are inextricably linked since the Fed has made a point to fight commodity related inflation.
And commodity prices, namely oil, have stopped going up. In fact, the CRB commodity index hit a DeMark Sequential (TM) Monthly 13 sell signal as well as a DeMark Sequential (TM) Weekly 9 sell signal (not shown).
The CRB is still in a strong up trend on the long term charts so it's too early to declare the end of the commodity bull market. But after a three year run, it's highly likely that commodities have to consolidate their gains. That consolidation would give the stock market enough breathing room to move higher.
Even this relatively small decline in the CRB has allowed the NDX to make a four year high on good volume yesterday. This is an important development because when the NDX is leading, the market is generally healthy.
So despite the seemingly endless bad news, keep your eyes on what matters the most to the market right now - commodities.
Both the NASDAQ and NYSE Summation Indexes have turned higher from deeply oversold levels. I believe all the components are in place for a strong rally - price has turned higher, fundamentals are ok, valuation is attractive and sentiment is negative. If the Fed would get out of the way and commodities stopped rising, this market would rip higher.
Indeed, selling dry-up or selling-climax?! Interestingly, Lowry’s Buying Power Index dropped to its lowest level in 10 years (June 1995) last week, prompting Lowry’s to note, “Such decisively negative patterns are not typical of those found during normal correction in bull markets.”
-- Jeffery Saut, Raymond James
The market has either carved out a long term bottom or it has started a new bear market cycle. All signs - sentiment, valuation and price momentum - point to the market putting in a sustainable bottom at these levels.
However, bear markets typically ignore these oversold factors and continue downward. If the market rolls back over and breaks the recent lows, it should be regarded as a sign the bear is back.
But the positives are too numerous to ignore. First, the NASDAQ is moving higher ahead of the S&P 500 and NYSE which is a sign of strength.
The NASDAQ reached extreme oversold conditions. The 10 moving average has turned higher from low levels.
The NYSE Summation index has started turning higher from the -500 level. This level hasn't been seen since April 2005, May 2004 and before that, in October 2002.
NASDAQ vs NYSE volume, at almost 1 to 1, has reached levels that usually indicate major bottoms. The last time the 10 and 21 moving averages of NASDAQ/NYSE volume were at these levels was in October 2002 and March 2003.
Sentiment has also reached a negative extreme. The 21 day total CBOE put/call ratio has reached 1.0x which only occurs at or close to major market bottoms.
And as I discussed in an earlier column, stocks are relatively inexpensive given the strong earnings over the past three years.
The main negatives are that several important trend lines were breached during the last decline. A rally that doesn't recapture these lines will turn the trendlines into resistance.
Also, several other areas of long term support are being tested currently. If these levels break, the market will most likely re-test the bottom end of the channels.
Let's just say it: Right now the stock market is baking in a depression.
This means that people are not just assuming a slowdown in sales -- they are assuming a complete reversal in sales, perhaps even 10%-20% declines in the sales at these companies, which are some of the largest components of the S&P 500.
I couldn't agree more. Based on a Baseline measurement which calculates the premium or discount of a company's earnings vs the 90 day treasury, the S&P 500 is trading two standard deviations below its historical price premium. In fact, it's basically trading at the "baseline" or the risk free rate. If the S&P simply returns to its median historical valuation vs the risk free rate, it would be trading around 1750, as the following chart shows...
Altucher points out several large cap stocks are now trading at 10 year lows based on price to book, price to earnings and price to sales ratios...
For instance, GE has a price/book ratio of 3.2. The company has increased its book value every year for the past 10 years. Its average price/book for each year in the past 10 years is (starting with 2004 and going back): 3.5, 3.9, 3.8, 7.2, 9.4, 11.9, 8.5, 6.7, 5.2 and 4, respectively.
In other words, the market is valuing GE at a lower level than it has at any time in the past 10 years. Again, the market is giving zero credit for continuing any growth and the market is baking in a huge slowdown in sales and growth. Yeah, GE's price is higher than it's been at the lows, but its cash flows and book value have improved over the past several years as well. The stock price has not reflected that improvement at all, as evidenced by these ratios.
Then there's Intel, which has a P/S of 3.8 and a P/Book of 3.8. Both ratios are near the lowest levels of the past 10 years (except for a brief time in 2001 when it was lower in the middle of the last recession) despite the company steadily increasing its book value each year (except for a small decrease in 2000). I like to see an increasing book value just like I like to see my checking and savings accounts grow each year. It shows that not only are you making more money, but you are saving it or building value with it as well. A steadily increasing book value gives me some comfort that the company has experienced little volatility in its growth.
I would expand the argument and say you can basically throw a dart at the S&P 500 and have a good chance of hitting a high quality stock trading at least one standard deviation below its historical price premium. The following list includes over 160 stocks that have an S&P 500 rating of B or better (a measure of quality based on earnings stability and dividend sustainability), should grow earnings above the avg S&P 500 earnings growth rate of 7%, and are trading at least 1.5 standard deviations below their historical median valuation.
Some of these companies have good reason to be trading at historical low valuations but many are simply out of favor as investors flee to oil and gold stocks. Companies such as Walmart and General Electric have been putting up good numbers and are simply way out of favor because the ugly macro economic environment.
Well, I woke up Sunday morning With no way to hold my head, that didn't hurt
-- Johnny Cash, Sunday Morning Comin' Down
One of the front page Yahoo headlines on Saturday was "October Scares Investors More This Year". The Friday evening news led off with Brian Williams stating "consumer prices soared by the biggest amount in a quarter-century". And the news media have gone from covering Louisiana and Mississippi's hurricane recovery to covering the outbreak of the Avian Flu in Turkey and Romania. The Presidents poll numbers are hitting all time lows despite the fact that 35% of the country would probably support him no matter what he did.
It's clear that investor sentiment is starting to turn truly negative for the first time since 2003 and 2002. The total bulls measure, which adds up the number of bulls from all the major sentiment surveys, is finally under 200 again at 197. It hasn't been there since March and April of last year. From anecdotal sources, I'm presuming that the measure, which lags by about a week, will continue to fall. A reading under 180 would indicate a high probability of a significant bottom.
The 21 day moving average of CBOE total put/call ratio has stayed in "negative sentiment" range for the longest time that I can remember and the average is now over 1.0 which is truly a rare and "extreme" occurrence. The last two times the 21 day average reached 1.0 was October 2002 and June 2004, both at or near major lows.
And even equity only put call ratios on the CBOE and regional options exchanges (a measure I use for a confirming indicator) have rising close to new.
Traders need to remember that in using sentiment analysis one of two things have to happen for it to be a trad-able contrarian signal. Either it needs to reach an extreme level (which it is doing) or it needs to reverse direction and become "unwound". While I believe the market could see more volatility as it gropes for a bottom, sentiment is indicating that it is close to doing so.
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