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Critical Economic and Market Commentary – October 22, 2009

Posted At : October 23, 2009 10:18 AM

Market Update – The party is getting crowded

The stock market has looked pretty good of late, hovering near the recovery highs and fast approaching my original target of Dow 10,300. That would make a near perfect 50% Fibonacci retracement of the run, while the high end of my forecast channel would be about 11,300, and a 61% retracement. However, it’s never that simple as it will run a bit past that or end here, but not stop on the dime. The recent technical strength does look good enough to propel that the current (bear market or echo boom) rally even further, but the increasing bullish investor sentiment is serious cause for concern.

This morning’s announcement of a stronger Leading Economic Indicators report suggests the market may stay strong for a few more months. Remember though that the stock market is a forward looking barometer, and it will begin to turn down well in advance of any actual economic decline. In fact, it will probably look pretty darn good about the time it starts to get ugly again, just like it has been looking quite bad these last few months as the market has risen.

One of the biggest concerns continues to increased complacency. This recent advance has pushed most of the major price indexes to new rally highs in the primary uptrend dating from the March’09 market low.  But, perhaps an even more important indication of the internal strength of the market from a longer term standpoint is that, despite occasional corrections, investors have become increasingly convinced that prices are headed higher in the months ahead. This increased bullishness a.k.a. complacency can be a very strong warning. Thus, the party is getting very crowded.

There’s no doubt that the market looks good, especially from a technical standpoint. The problem is that people are labeling stocks as being in a new bull market, which suggest that stocks will continue to advance for a sustained period of time. When people say that the recession has ended and we’re now in a “recovery,” the tendency is to look at how the market has performed in previous recoveries, which has almost always been “V” shaped, without noting the profound differences between those instances and the current environment, and assume it will be the same. This is simply not the case as the drivers of economic growth that exist in typical economic recoveries, particularly debt origination and consumption growth, are not there.

There are basically three stages of every market advance. The buy zone, the hold zone and the sell zone. For the last 6 months we have been in the buy zone, which has kept us positive but on high alert for evidence of a change. Although not giving up yet, evidence of a short term correction has been building that could end the Primary Buying Zone.

In addition to the increased investor bullishness, technical strength seems is beginning to wane as well.

Buying power has been softening while Selling Pressure has been on the rise. A continued rise in selling pressure will confirm that the market is converting from the first stage of the uptrend from the March’09 market low with the Primary Buying Zone coming to an end ushering in the Second Stage – the Holding and Upgrading Zone.

The first stage of the primary uptrend will come to an end and the second stage will begin when the Selling Pressure Index rises 2 to 6 more points. During the Holding/Upgrading Zone, the emphasis should shift from buying stocks to managing the existing portfolio for maximum returns, culling out weak stocks at the time of short term sell-signals, and focusing attention on the strongest portfolio components. Investors must recognize that the risk to reward ratio has begun to change. It doesn’t necessarily mean it has to be drastic, but it could! This loss of strength seems to coincide well with our expected loss of momentum in the economy which will usher in the next down leg in this bear market.

What is keeping this rally going?

This “Echo Boom” is a temporary bear market rally that is stronger than most because it is being financed by zero % interest rates and government handouts. Once the subsidiaries stop, the consumer has to make up the difference in spending to drive the economy. The government is hoping that it can spend long enough to bring back the consumer.

Unfortunately, it is simply not possible. The demographics of our aging population point to increased saving and less spending. Add in the emotional devastation of two huge losses in one decade, and the people cannot and/or will not be able to spend. This whole discussion of a jobless recovery is hogwash! It’s not possible. It can be masked by government tricks, but it’s only temporary. We were led to believe that the last recovery, 2003-2006 was a jobless recovery, but it was nothing more than a mirage, and look what happened next…the economy fell right back and is actually worse. You must fix the root of the problem. The government can only mask it for so long with cheap money, and each time they attempt it the time frame gets shorter.

Regards -Keith Springer

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