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Critical Economic and Market Commentary – October 27, 2009

Posted At : October 29, 2009 11:20 AM

Market Update – If it’s obvious…it’s obviously wrong!

There is absolutely no way the market can keep going up, right? In fact there is no way the market could have risen as much as it has done already, right? Right! It’s painfully obvious that the market just has to go down! Well, one thing is for certain in life and especially the market…if it’s obvious, it’s obviously wrong!

Success with just about anything from politics to finance, generally requires stepping back, removing the emotion and looking at the situation objectively. With regards to your personal finances, this is much harder said than done. However, I owe much of my tremendous success over the last few years to being able to do just that. At the moment, The media is filled these days with “expert” opinions on a plethora of potential problems such as inflation, deflation, excessive debt, over-valuations, and a weak economy, to name just a few, that will “undoubtedly” bring the stock market to its knees any day now.

These cumulative opinions comprise the current version of the “Wall of Worry” that the stock market has perpetually climbed during the early stages of every extended market advance since the stock market was formed under the Buttonwood Tree.  Each new major market advance has had its own list of worries which served to keep many investors on the sidelines fretting about problems that rarely materialized.  I do not question that there are serious problems in the world, Nor do I question that some of the current worries will eventually come to pass. It would be very hard to believe that the market can continue its meteoric rise. However, throughout history, whenever investors have collectively believed something, seldom if ever has it become reality. In fact, when they usually are in a very positive frame of mind, such as during the early months of primary market advances, they have usually chosen to ignore the “bad news” and to continue pushing stock prices higher.

Investors remain cautious, still parking money on the sidelines. Today’s decline consumer confidence is another sign of this. The net new money flow into mutual funds remains over 10 to 1 in favor of bonds over equities. The latest numbers from Investors Intelligence now has 49.5% in the bullish camp and 23.1% in the bears. Given the extent of the rally, that is rather surprising. One would have expected the number of bulls to be much higher. Yet, bull markets generally start out climbing a “wall of worry” and this has not been any different.  The rally continues to be fueled by historically low interest rates and no sign that the Fed is ready to change its accommodating mood. Sure we are overdue for a correction. It has been a +20% move since mid-July. But with the Market Environment Indicator still almost at a 90 reading, Leading indicators pointing higher and most importantly, that “wall of worry” keeping most cautious, we would expect the market to have more of a pause than the next major down-leg in this secular bear market.

History also shows that major market declines, such as 1929-32, 1969-70, 1973-74, 2000-2003, or 2007-2009, and the major economic contractions that usually follow, have developed after long periods of rising equity prices, after the “Wall of Worry” has been long forgotten, the news is virtually all positive, and investor enthusiasm for stocks has been fully satiated.

And that gradual exhaustion of buying has always left behind tracks that are visible to those who look for them, such as a four to six month negative divergence between the Advance-Decline Lines and the major price indexes, a six to twelve month negative divergence between New 52-week Highs and the major price indexes, and a steady erosion in Buying Power accompanied with many months of sharply rising Selling Pressure.  These signs of a major weakening of Demand and a major expansion of Supply have been present before important market tops with somewhat the same constancy as shorter days, colder nights and the changing of the leaves precedes the onset of winter.  No one can know with accuracy how long the current market advance will last, but, past experience shows that paying attention to the “Wall of Worry” is usually a mistake.  Rather, investors should closely monitor the forces of Supply and Demand, watching for the signs of strength that accompany sustained market advances, and watching for the warning signs of weakness that typically emerge months in advance of important market declines.

Currently, the Selling Pressure Index was at a 12-month low suggesting that the recent pickup in selling is characteristic of a short term correction.  And, as I previously discussed last week, since the Selling Pressure index has not yet increased enough from its Oct 14th low, the market could still very likely be in the First Stage – the Primary Buying Zone. In addition, none of the warning signs discussed above that typically precedes major market tops are currently in evidence.  For example, none of the Adv-Dec Lines are reflecting even a small divergence with the major price indexes. Of course the trend can change quickly.

The current correction is begging the question of whether this advance is over or just a correction and the recent expansion in Selling Pressure and contraction in Buying Power also suggest the potential for a further correction.  We haven’t seen a 10% correction during this entire run, and a major but normal correction could serve to be a strong launching point for the next leg up or scare enough people into selling early causing a meltdown. Emotionally, most think it will be a meltdown. Technically, it appears to be a standard correction.

Regards – Keith Springer

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