William Gibson, CFA (415)515-8074
3450 Sacramento Street #337 wtgcfa@yahoo.com
San Francisco, CA 94118 October 6, 2009

(SPX – 1040.46)
(DJIA – 9599)

Wall Street started a new month and quarter with a 90%-down day; it didn’t take much disappointing economic news to instill doubts about the recovery. The financial press abruptly latched onto predictions that the top is in and new lows await the unwary.

My technical work doesn’t support that view and fundamentally, any backsliding keeps the Federal Reserve from entering rehab to kick its Treasury and asset-backed purchasing habit. Liquidity is driving this market and those proceeds have few places to go besides the stock and commodity markets.

Steve Leuthold explains, “The stock market turned up before the economy did. Now, the economy is improving. It might be a little better than most think. It ain’t wonderful, but it’s a lot better than it was.”

The freeze may over, but I don’t buy JP Morgan strategist Tom Lee’s assertion yesterday on the Bloomberg channel that the “old normal” is back. Without job growth, a home equity ATM machine and liar loans, people are forced to live within their means like it or not. Leuthold’s S&P 500 (SPX) price targets are higher than Lee’s, 1200 by year-end and 1350 next year, but no one really knows.

The Market Trend Indicator (MTI) reading remains Uptrend. The SPX, DJIA and New York Advance/Decline line are all above their respective 18% weekly exponential averages. The SPX’s 18% average is 1017.42 and the Dow’s is 9415. The A/D line is 6,464 net advances above its 18% average.

There’s no change in net volume readings. The NYSE peak on this decline, (56.8), was greater than the +56.2 figure into the September 23 high (1080.15) and it continues to warn further weakness lies ahead. NASDAQ net volume is in synch with the MTI’s uptrend as its peak reading on this decline is only (43.1) so far compared to a +61.3 peak into the September high.

A lower high and lower low and break of the 20-day moving average for the SPX turned the short-term trend down. Note how the VIX (volatility index which trades inversely to the market) looks like it’s building a base (bottom), so intermediate-term stock market weakness may not be over.

I thought the rapid advance from the March panic low through June was a bear market rally because the bear market pattern looked incomplete and technical signals to indicate bull market (price & time overbalance) were missing.

When the second section of the advance started in July, time (more important than price) overbalanced, indicating a change in the primary trend. There was also a Dow Theory buy signal and moving average cross over (18% exponential average moving above the 5% average and both trending higher) as well as a NASDQ weekly net volume reading that exceeded any negative figure during the bear market.

I switched my bias to the cyclical bull market camp and subsequent market action seems to be bearing out that view. Although the stock market may have completed a two section advance, the rule is to count three sections and expect a fourth, so any weakness from here would likely be a correction in an ongoing cyclical bull market. It would be positive if any decline holds above 944.74, the halfway point of the second section advance.

As for group action, leading groups haven’t pulled away from the pack and a contrary investment style has been the way to go. “The main event featured rebounding laggards, and relatively strong groups were a side show,” wrote Gary Anderson (www.equityPM.com).

Charles Kirk (www.kirkreport.com) runs all sorts of screens for various fundamental factors and during the second quarter, the screens that performed the best were those that looked for recent relative underperformance. In essence, today’s momentum leaders were yesterday’s losers and vice versa.

From a broader perspective, the following table shows the performance of important indexes and a ranking of S&P sector performance. Financials led by a wide margin, followed by Materials and Industrials, both beneficiaries of recovery and a weaker dollar.

Index & Sector Performance

Index Mar-Sep 1st Section Jun-Jul Correction 2nd Section

S&P 500 (SPX) 62.0% 43.4% -10.0% 24.3%
DJ Industrials (DJIA) 52.3% 37.2% -8.9% 21.9%
Nasdaq 100 (NDX) 72.2% 48.3% -7.7% 25.8%
S&P Mid Cap (MID) 77.6% 51.8% -10.8% 31.2%
S&P Small Cap (SML) 80.4% 56.2% -11.0% 29.7%
Russell 2000 (RUT) 82.5% 56.4% -11.6% 32.1%

SPX Sector Ranking

Finance 162.6% 122.4% -17.2% 42.6%
Materials 83.8% 60.7% -16.8% 37.4%
Industrials 82.0% 59.4% -16.2% 36.3%
Information Technology 77.7% 52.6% -7.9% 26.5%
Consumer Discretionary 74.3% 53.3% -12.2% 29.4%
Technology 64.1% 44.0% -7.9% 23.8%
Telecommunications 51.0% 48.5% -12.1% 15.6%
Energy 50.5% 46.6% -20.4% 28.9%
Healthcare 34.8% 21.7% -5.6% 17.3%
Utilities 33.9% 26.2% -5.9% 12.8%
Consumer Staples 33.2% 24.3% -5.5% 13.4%

In other markets, a headline in a quarterly review last week in The Wall Street Journal sums up the credit market, “Treasuries Buoy Credit Markets, but Junk Is King.” The intermediate-term trend remains up for long-term government bonds but I’m keeping my eyes peeled for technical confirmation that the move is complete.

The Wall Street Journal also reported that Invesco and TCW qualified for the Treasury program by raising at least $500 million each to buy toxic assets; they raised $1.13 billion, which gives them $4.52 billion of buying power with a dollar-for-dollar government capital match and debt financing.

Further down the food chain, Meredith Whitney wrote, “Access to credit is being denied
at an accelerating pace. Large, well capitalized companies have no problem finding
credit. Small businesses, on the other hand, have never had a harder time getting a
loan…In the U.S., small businesses employ more than 50% of the country’s workforce
and contribute 38% of its GDP.”

The dollar closed out the quarter falling against virtually all currencies, a rare occurrence.
Yet is held above its September 22 low and the falling wedge pattern is the sort that is often followed by a sharp rally. It will be key to watch how gold reacts if that occurs.

The breakout in gold looks better on my chart of the second London fix than it does on the continuous contract. It looks like it could pull back to $975 (2nd London fix). While I expect sharply higher prices in coming weeks and months, my recommended stop sell point for speculators is just under the August 17 low ($932.75 2nd London fix) and for investors, under the July 13, 2009 low ($908.50). I don’t want anything to do with the gold market below these levels.

The International Monetary Fund (IMF) raised its global 2010 growth forecast to 3% from 2.5%. Australia became the first country to raise interest rates since the meltdown began with a quarter-point hike from a 49-year low.

An initial public offering (IPO) for Chinese Resources Cement closed down in Hong Kong, the fifth IPO in a row to do that in that market. Note how Shanghai market turned down ahead of ours.

I attended the ninth annual “Hardly Strictly Bluegrass” festival in Golden Gate Park over the weekend, a free concert with about 80 acts sponsored by Warren Hellman. What a great gift for the city of San Francisco!

Listening to Boz Scaggs and the Blue Velvet Band (James Cotton, Nick Lowe, Austin De Lone, Buddy Miller, Derek O’Brien, Wes Starr, Jimmie Vaughan and Jack ‘Applejack’ Walroth) perform “Big Boss Man” on a sunny afternoon took me back to listening to Jimmy Reed at the Savoy Tivoli in 1976 when I was a rookie analyst with San Francisco Investment. Reed looked the part of a hard drinking, chain smoking Chicago bluesman in a smoke filled night club in North Beach. He died a few weeks later in Oakland just before he turned 51.

Back to stocks, the monthly charts for the SPX and NDX look positive, which fits into the higher prices lie ahead them. I’ll close with the quarterly chart for the SPX from the 1974 low.

My recommended stop sell levels are unchanged, just underneath the September 9 low (991.97) for ETFs tied to the SPX and just below 1585.56 for the NDX. I think the market is setting up a buying opportunity but it’s ok for speculators to initiate appropriately-sized short positions if and as technical tools indicate an intermediate-term downtrend. For shorts, I favor ETFs tied to small cap indices.

For investors, I think it’s best to hold quality merchandise. It’s also time to plan ahead as to what percentage of assets to hold in stocks once my technical tools indicate the cyclical bull market has run its course. We’re not there yet.

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