SPX – 1042.88
DJIA – 9789
“The time for good choices was ten years ago. Now we face the prospect of painful decisions, no matter what we do. It is not a matter of pain or no pain, of somehow avoiding the consequences of our bad decisions, it is simply deciding how much pain we will take and when or allowing the pain to build to a climactic event.”
-John Mauldin, October 30, 2009
Investors Quick to Jump Ship
The Market Trend Indicator (MTI) is Neutral; it shifted from uptrend last Wednesday when the S&P 500 (SPX) sliced through its rising trendline (connecting the March and July lows) and 50-day moving average, bringing out even more selling.
The SPX remains under its 18% weekly exponential average which stands at 1043.84 this week. The DJIA is still above its 18% average as institutional investors required to stay fully invested seek safety in the largest blue chips; the Dow’s 18% average is 9665.
The New York Advance/Decline (A/D) line is only 150 net advances above its 18% average; A/D strength (including advances leading declines more than 2-to-1 over a ten-trading-day period in September) increases the likelihood that price weakness is only a correction in a cyclical bull market.
NYSE net volume reconfirmed downtrend last Tuesday and it ended the week with a (64.9) peak reading. NASDAQ overbalanced its +42.5 peak Tuesday as well and its peak reading on this decline is (65.9). Net volume typically precedes price and these signals point to the probability of further price weakness in coming weeks.
S&P 500 – Daily (Source: StockCharts.com)
Price and time overbalanced for the Nasdaq 100 (NDX) from the March low but not yet from its November 21, 2008 bear market low but the count is still live. SPX is unlikely to overbalance either price or time from its bear market low on this section down.
Price and time overbalance are important trend indicators revealed by W.D. Gann. Price overbalances when an active market falls further than it has on any decline from the low and vice versa on moves from the high. Time works the same way; it is more consequential than price. I’ve only seen a few analysts adopt this process and none that measure it like I do.
I don’t intend to share the secret but I will reveal the source, the first three chapters of Gann’s commodity course, the most important of his writings (dealing with trend, discipline and money management) written just before he died. You’ll also have to read his books to find the measurement technique I use; I forget which book and I’m not about to tackle these again as I did in the mid-1980s when I dove into the technical analysis deep end.
Gann was a prolific technical analyst and writer, difficult to comprehend but he developed a myriad of esoteric tools tied to sacred (pre-Euclidian) geometry. He has quite a cult following, including authors of multi-book texts devoted to supposedly unrevealed astrological techniques. This is a group, in my opinion, dedicated to predicting future tops and bottoms (generally unsuccessfully). instead of making money in the here and now.
S&P 500 – Monthly (Source: BigCharts.com)
Speaking of Gann’s esoteric concepts, yesterday marked a harmonic from the bear market low, the sort that often calls short-term highs and lows. Could it possibly be the low of the first section down from the SPX’s October 21st recovery high (1101.36)? It didn’t look like much of a reversal.
It’s only been eight trading days from the SPX’s recovery high. From the high through yesterday’s low, the small cap Russell 2000 is off 11.5% compared to a 7.2% decline for NDX, 6.5% for SPX and 4.3% for the DJIA. Within Standard & Poors’ sectors, the strongest during the advance are down the most, including a 12.6% decline for Financials and 11.7% for Materials. Defensive sectors, Consumer Staples and Healthcare, are holding the best, down 3.3% and 5.1% respectively.
The table below updates percentage moves for key indices and sectors as most moved to modestly higher highs in October. Industrials and Materials are the only sectors which didn’t rally higher.
| Index | Cyclical Bull | 1st Section | July Decline | 2nd Section |
| S&P 500 | 65.2% | 43.4% | (10.0%) | 26.7% |
| DJIA | 56.4% | 37.2% | (8.9%) | 25.1% |
| Nasdaq 100 | 74.8% | 48.3% | (7.7%) | 27.7% |
| S&P Mid Cap | 18.8% | 51.8% | (10.8%) | 33.2% |
| S&P Small Cap | 81.8% | 56.2% | (11.0%) | 30.8% |
| Russell 2000 | 82.5% | 56.4% | (11.6%) | 32.1% |
| Sector Ranking | ||||
| Finance | 168.0% | 122.4% | (17.2%) | 45.5% |
| Materials | 83.8% | 60.7% | (16.8%) | 37.4% |
| InfoTech | 83.2% | 52.6% | (7.9%) | 36.3% |
| Industrials | 82.0% | 59.4% | (16.2%) | 30.4% |
| Consumer Discretionary | 78.5% | 53.3% | (12.2%) | 32.6% |
| Technology | 67.7% | 44.0% | (7.9%) | 26.5% |
| Energy | 61.9% | 46.6% | (20.4%) | 38.7% |
| Telecommunications | 50.6% | 48.5% | (12.1%) | 15.6% |
| Consumer Staples | 38.3% | 24.3% | (5.5%) | 17.7% |
| Healthcare | 36.6% | 21.7% | (5.6%) | 18.9% |
| Utilities | 34.4% | 26.2% | (5.9%) | 13.1% |
The Great Liquidity Race: Wall of Money Climbs Wall of Worry was the title of the Paul Tudor Jones letter last month; it sums up the stock market rally to the high. The strong advance was characterized by a “buy low, sell high” mentality for most groups but was not momentum-driven in the second section up. Momentum-driven is typically present in healthy markets.
Food Retailers and Wholesalers climbed into the top ten list last week as measured by relative strength; it was in the bottom ten list as late as the week ended October 2. Airlines were in the top ten list as late as the week ended October 16 but are now in the bottom ten list as are Tires, which were top ten as late as September 9.
In other key markets, a headline in the Money & Investing section of yesterday’s Wall Street Journal, Dollar Calls the Tune For Stock, Bonds, Oil, noted the relationship noted how stocks and oil rally and bonds decline when the dollar is weak and vice versa. I think it’s time to be alert for a curve from the markets given how aware most players are of this phenomenon.
Economist Nouriel Roubini is particularly worried about the link, highlighted in a Financial Times column, The mother of all carry trades faces an inevitable bust. The dollar is used by speculators (major bank and brokerage firms) as a “funding currency” (shorting the dollar results in a negative annualized interest rate) and employing high leverage to buy risky assets. What happens when the Federal Reserve begins to implement its exit strategy? Roubini suggests “the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash.”
Returns are over 50% from the low for high-yield bonds as $27.8 billion flowed in; just remember there’s a reason they call these junk bonds. “The Fed is beating investors into buying junk and other risky assets, a hair-of-the-dog strategy if there ever was one” said Jeremy Grantham. The default rate exceeds the spread versus Treasury bonds. Where’s the margin of safety is missing. It brings to mind a line from Robert Frost, “Fools rush in where fools have been before.”
Long-term government bonds seem to be attracting flight-to-safety buying but it’s been minimal. I use TLT (Barclays 20-year+ ETF) as a proxy. The TLT weekly chart points to a possible rally but the monthly chart looks more negative. I previously recommended a short position with a tight stop point just above the TLT’s October 20 high of 97.25.
TLT – Daily (Source: StockCharts.com)
The dollar also appears to be benefiting from “flight-to-safety” buying. A countertrend rally is long overdue. The U.S. Dollar index needs to rally above 77.47 to indicate to me that an intermediate-term swing is underway.
U.S. Dollar Index – Daily (Source: StockCharts.com)
I think gold acts like its raring to. The key is how it reacts if the dollar rallies. It remains in strong positions as long as it holds above the trendline connecting the March 2008 and February highs. My recommendation is to keep trailing stops loose, just below the August 17 low, $932.75 2nd London fix to accommodate any possible correction. The plan is to tighten up trailing stops if gold fever engulfs the public.
Bloomberg announced this morning that the International Monetary Fund (IMF) sold 200 tons of gold (its first sale in nine years) to India at $1,059 an ounce. The sale is about half of what the IMF agreed to sell last November to shore up its finances.
The stock market reflects investor psychology, particularly greed and fear superimposed on the business cycle. It is comprised of divergent interests, including millions of traders and thousands of hedge funds all intent on picking each other’s pocket. Although Wall Street doesn’t operate in harmony with itself, its “collective” intelligence knows more than anyone about future business conditions.
For example, it may be a jobless recovery but the U.S. economy grew 3.5% in the third quarter, a development the stock market began to discount months in advance when it bottomed in March. Consumer spending dropped late in the quarter, down in September after rising five months while the savings rate continued to increase in a paradox of thrift. The public is already dispirited; what happens to consumer spending if the stock prices continue to crack? The answers will surface in the fullness of time but we’ll spot them first on the tape.
Key SPX levels include 985.34 which marks the halfway point of the advance from the July low. It’s positive if prices hold above that level and imperative for the “correction in a cyclical bull market” thesis that prices stay above the halfway point of the advance from the March low (884.04) as well as above the July low of 869.32.
Russell 2000 – Daily (Source: StockCharts.com)
Conclusion:
Bernard Baruch once said, “I’ll give you the bottom 10% and the top 10% of any move if I get to keep the middle 80%.” My plan is built around this precept.
Prices are closing in on my recommend stop sell level just under the SPX’s 3-day swing low of 1019.75 on October 2. The equivalent figure for the Nasdaq 100 (NDX) was 1656.57, and it was violated yesterday. Long positions tied to the NDX should be history.
No one really knows how far the market will fall or how long the decline will last. I sense we’re near the end of the first section down. There’s generally been enough selling when the MTI first signals downtrend that a rally soon follows. I think the best place to initiate short positions is when that rally fades. The logical place for initial stop buys is just above the October highs, to be lowered as soon as possible if and as a second section down unfolds. For shorts, I prefer ETFs tied to small cap indices.
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.
