Lose Your Opinion; Not Your Money

SPX – 1050.47

DJIA – 9,816

June 8, 2010

“We have market forces that are deflationary and policy response that is inflationary…The next bubble – and this is the lesson of what this Greek drama was all about – is sovereign debt…The government’s official stance is that these deficits are just temporary. And the Fed says we have an exit strategy to reduce the liquidity of the U.S.’s balance sheet. If the notion becomes widespread that this is permanent and that they have to do even more in terms of more of this bad medicine, that’s the kind of thing that could lead gold to go up dramatically from here.”

-John Hathaway, Tocqueville Gold Fund, Barron’s June 7, 2010

Based on a wave count and psychological backdrop, I thought last week that the May 25 low (1040.78) may have completed the bear market’s first section down. Following fierce selling last Friday, a test of that low is underway and hanging by a thread with the S&P 500 (SPX), the Dow Jones Industrials (DJIA) and Dow Transports (DJTA) all finishing yesterday on new closing lows for the move.

Technical indicators work best in active markets as opposed to those with appropriate snooze quality like the final cyclical bull market leg from February 5 through the April 26 high. Average daily volume for the first leg down through May 25 increased more than 30%, producing multiple indications of a shift in the primary trend, including price and time overbalance, Dow Theory, trades below the last start of the last intermediate-term advance and falling below 5% exponential and 200-day moving averages.

Meanwhile, mainstream strategists are hanging together at Camp Correction, formerly warm and comfortable place but nerves are beginning to fray around the campfire on dark evenings. A smart group of 13 over-informed experts, their year-end SPX price targets unchanged from the first quarter, ranging from 1175 (Citigroup) to 1375 (Deutsche Bank) and averaging 1268. Targets often change after the fact; that’s how the even smarter stock market works, its collective intelligence encompassing all that can be known about future business conditions, achieving a superior track record and recently revealing the best was discounted and the bear is back. Note how the ECRI (Economic Cycle Research Institute) leading indicators reflects the lowest annual growth rate since last June.

A Florida-based trader just back from New York City wrote me that if you want to understand the U.S economy, drive from Highway 287 NS in New Jersey for 40 miles into Manhattan along Route 22E, the original road the mall concept evolved from and still covered with stores and malls. Sign after sign reads For Rent, For Sale, Closing, Out of Business, Going out of Business Sale, Half Off Sale, For Lease, Stores for Rent and Bankruptcy Sale. These signs weren’t so prevalent in January 2010 and if that’s it for the recovery, we need to prepare for a cold winter.

The Market Trend Indicator remains in a DOWNTREND until one or more of the MTI’s key indices closes above its respective 18% weekly exponential moving average. The SPX’s 18% average this week is 1121.21 and the DJIA’s is 10,438. The New York Advance/Decline line is 4,287 net declines below its 18% average. The MTI is designed to identify and capture most an intermediate-term trend lasting weeks to months, minimizing lag but missing the turning points. Net volume hurdle rates that need to be overcome to signal a reversal are (70.9) for the NYSE and (71.3) for NASDAQ.

Group rotation remains the norm but losers are starting to fall away from the pack, not good sign for those clinging to the bull market faith. Basic Materials was the worst sector, both from the April top and over the past two weeks, but the worst performing group as measured by relative strength is in the Consumer Goods sector. After 14 straight weeks in the top ten group list, most recently the week ended April 6, 2010, Consumer Electronics takes the honor, off the most over the past month and topping the worst list for the past two weeks. Real Estate Development and Home Construction, off the top ten list since the week ended February 19, were among the ten worst performing groups over the past month but haven’t yet reached the bottom ten group list.

In other markets, gold is outperforming virtually all currencies, back near its highs despite strength in the dollar and I plan to stick with long positions until the market proves otherwise. Flight-to-safety buying is propelling long-term government bonds and I still think it makes sense to short that market once stocks confirm an intermediate-term low is in place.

We’ll want to keep our eyes on money supply charts, particularly the relationship between M2 and M3, the broadest measure including Treasury repos and institutional money funds. The Federal Reserve discontinued releasing M3 data in 2006 but other parties keep up the data, including Capital Economics whose chart is shown here. The M3 decline most likely reflects institutional money flowing to Europe on top of the slowdown in lending but it bears watching for insight into deflationary pressures.

Harmonic Preview:

(Higher Probability SPX Turning Point or Acceleration Days)

May 27                 (Thursday)

June 2                    (Wednesday)

Jun 11                    (Friday)

June 14*              (Monday)

June 25                 (Friday)

• An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

Stocks have already peeled off more than $1.6 trillion of market value. What happens to consumer spending if and house home prices follow the bear market down. It’s too late for good policy choices and it’s tough to imagine Helicopter Ben and TurboTax Time jamming through another simulative spending package.

Conclusion:

If the May 25 low (SPX-1040.78) doesn’t hold, I suspect the low isn’t far away in either price or time but that’s bias, educated or not The next support level is around the early November 2009 low (1029.38) and the October 2009 low (1019.75) under that. Once an intermediate-term low is put in place and confirmed, my recommended plan is to initiate long positions (appropriately sized for a counter-trend move) in exchange traded funds tied to the SPX and the relatively better acting Nasdaq 100 (NDX). Once the initial reflex rally runs its course, the plan is to put on new short positions, holding on through secondary rallies until the bear market runs its course.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.