Mr. Market’s Message

SPX – 1165.81

DJIA – 10,785

“If you want to lose in the market, buy what’s popular when it’s popular and don’t bother to understand the underlying businesses involved.”

-Marty Whitman

The stock market is one tricky devil, made up of lots of bright people battling to outsmart one another. The results generally unfold in a manner that confounds many, often contradictory and contrary in nature. For investors, I like the concept envisioned by Ben Graham to view the stock market an emotional and sometimes irrational business partner named Mr. Market. Mr. Market stands ready to buy or sell your share of publicly-traded businesses five days a week.

At times, Mr. Market is optimistic and will to pay a high price for your share of the business. Sometimes, Mr. Market is worried and willing to sell you his share of the business at a low price. Transactions are strictly at your option; you only deal with Mr. Market when you choose to and it’s OK to ignore him most of the time. Mr. Market is there to serve you, not guide you, so don’t fall under his spell. You’re after his money, not his wisdom. The key is to know the business, its outlook and value better than your partner.

It’s a little different for speculation because Mr. Market is more than a willing business partner, encompassing everything known by anyone who could possibly affect corporate profits. As reflected in leading indexes such as the S&P 500, the stock market embodies all investor knowledge, hopes and fears regarding future business conditions. Mr. Market acts as a discounting mechanism adjusting prices to business conditions in the foreseeable future, typically months ahead. There is little the stock market as a whole does not know in advance. By the time the fundamental data is published, the market’s price action is history.

Technical analysis studies of the stock market’s action, providing a leg up on tomorrow’s news. Day-to-day action is often random but trends exist and trends tend to persist. Three levels of trend interact- primary, intermediate and minor. The primary trend is governed by the business cycle and fundamental conditions. It typically lasts for years and is labeled a bull or bear market. The primary trend swings between discounting the best that could occur (bull markets) and the worst that might happen (bear markets). Valuations typically overshoot in either direction, no surprise given the anxiety, anger, caution, confidence, enthusiasm, jealousy, greed and fear that players bring to the table.

Remember, we started with the idea Mr. Market is a tricky devil. Part of his job description in bull markets includes going up with as few people on board as possible, a role performed splendidly over the past year. Mr. Market’s role in a bear market includes sinking with as many people on board as possible, then inducing fear to abandon ship as close to the lows as possible. I’ll let you rate the performance in the last bear market?

For trading purposes, I prefer intermediate-term trends, the sort generally lasting weeks to months, moving in the same direction as the primary trend or as a secondary reaction against it. This letter is focused on capturing most of the middle of intermediate-term moves through planned, deliberate speculation utilizing exchange traded funds (ETFs). Minor trends are the least important, day-to-day movements reversing quickly in either direction and too precarious to trade for my emotional makeup. Still, short-term swings make up the building block for longer-term moves and for the SPX and I maintain hourly chart and 3-hour swing chart (now in its 13^th swing, late in the move) as well as daily charts.

What’s Mr. Market saying? When the Dow Industrials confirmed the Transports by closing on new recovery highs last Wednesday, yet another fly in the technical ointment was rectified. A feeble S&P 500 (SPX) breakout three days before the Dow Theory reconfirmation remains tenuous, momentum indicators are in ‘overbought’ territory and volume is still light but prices are trending higher. Overbought conditions typically last longer in a bull market while an ‘oversold’ condition ends quickly, like the February 5 low.

The Market Trend Indicator (MTI) UPTREND reading persists, an indication that stays in effect until or more of the MTI’s key indexes closes below its respective 18% weekly exponential moving average. The SPX’s 18% average is 1120.85 and the DJIA’s is 10,439. The New York Advance/Decline line is 9,382 net advances above its 18% average. Peak net volume readings are in synch with the uptrend, +42.6 for the NYSE and +44.5 for NASDAQ.

As for groups, 99 of the 100 Dow Jones groups I monitor are in positive territory. Life Insurance and Full Line Insurance have climbed back into the top ten list as measured by relative strength. Full Line Insurance was in the bottom ten as recently as the week ended January 8, 2010. Seven of the top ten groups (Automobiles, Consumer Electronics, Recreational Products, Airlines, Recreational Services, Retail Apparel and Footwear) are in the Consumer Discretionary sector. Note the strength above in XLY, the SPDR Consumer Discretionary ETF.

Other key markets have stalled over the past three weeks, at resistance for long-term government bonds and the dollar and at support for gold. I’m expecting gold to hold and rally while the dollar reverses but have no intention of fighting if the markets don’t follow my script at this juncture. My recommend stop buy points on TLT shorts (a proxy for long-term government bonds) is a few ticks above the February 5 highs (TLT-92.42). For gold, I advise stop sell orders under the February 5 low for recent purchases while keeping much looser stops (under the September lows, $989.50 2^nd London fix) for longer-held positions. The plan is to raise this point if gold starts to rally from this area. Whether using trailing stops to lock in profits while holding out for more or limiting losses on new positions, I like Doug Kass’s guidance, “Taking small losses is part of the game; taking large losses can take you out of the game.”

Harmonic Preview:

(High Probability SPX Turning Point or Acceleration Days)

March 24         (Wednesday)

March 29         (Monday)

April 5             (Monday}

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

As for price, harmonic SPX resistance levels above last Wednesday’s high are 1182.07 and 1197.31 and while I wouldn’t count on a set up, stranger things have been known to happen.

Conclusion:

The burden of proof is back on the bears. The rally may not be powerful but it’s persistent. I think it makes to raise stop levels a little tighter than would be the case in a breakaway move. For ETFs tied to the SPX, I recommend  raising stop sell levels from a point just under the February 25 low (SPX-1086.02) to a point just under its 18% exponential average, 1120.85. For ETFs tied to the Nasdaq 100 (NDX), I favor a stop point just under its 50-day moving average, 1838.43. When the trend reverses, I think the best short candidates will be ETFs tied to small cap indexes.

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.