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What’s Worrying Me

1937-compared-to-today

Many thanks to the StockTock blog for the chart above. He updates it periodically and I check occasionally to see what it looks like.

The chart is a comparison of the Dow Jones Industrial Average during the 1937 Great Depression to the S&P 500 during today’s recession. It follows an uncannily similar path. The rally during the 1937 Dow ended up being a very strong bear market rally. Unfortunately, it ended up bouncing off a longer term downtrend line and ultimately heading lower as the economy did not recover until WW II brought the industrial machine of the USA back to life.

I’ve been posting a chart showing that volume may be signaling an extension of our current rally – our target is 1050 on the S&P 500. However, I have also noted that we have several severe headwinds that could keep any advance contained: continued deleveraging by the consumer, bank failures, deteriorating quality of the Federal Reserve Bank’s balance sheet, record foreclosures and loan delinquency, high levels of unemployment that will likely persist for some time into the future, FDIC special assessments needed to keep it afloat, a projected commercial real estate crisis similar to the housing crisis, weak-to-non-existent corporate top line earnings growth, potential inflation in coming years due to unprecedented monetary stimulus.

In my normal weekend reading to prepare for the coming week, I note that there is a new Merrill Lynch survey of mutual fund managers which shows that cash levels are at near historic lows and bullishness is at near historic highs. This, quite frankly scares me. So, I decided to take a look at an oldie-but-a-goodie indicator, the Bullish Percent Index.

bullish-percent

The Bullish Percent Index is a breadth indicator. When the “Close” is a reading above 50 but below 80, this indicates a bullish market. As you get above 80, this indicates the market is likely over extended and due for a pullback. If you scan the “Close” column, you will note that several of the market sectors are above 80 with technology above 90. My gut feeling is that we are likely in for some consolidation to shake the bullishness out of the market.

If you refer back to yesterday’s post, I noted that we have a short-term consolidation on low volume then four rally days with slightly higher and increasing volume, but not up to the green trend line. Given the readings on the BPI, it seems that we are probably going to be stuck in a consolidation range for a while as we work off the excess bullishness. If we do hit our 1050 target, I’d expect a pullback toward the lower end of that range (975-ish).

Does that mean this rally is over? Not necessarily – much will depend upon coming economic outlooks and prospects for top line revenue growth (remember, even given the headwinds, revenue growth is a comparison to previous quarters and year-over-year, which are fairly easy targets to beat). These two things can keep investor psychology improving and keep volume increasing during rallies – a strong sign of positive things ahead.

Caution is warranted near-term, but as long as volume shows positive psychology, intermediate term is likely good for the market – with maybe a run up to 1250 on the S&P 500 Index (the level of the market before the Lehman Brothers bankruptcy that precipitated last Fall’s crash). However, it is too early to be looking for that level – volume speaks volumes, and the low volume consolidation is our current challenge to be overcome.

Enjoy the rest of your weekend.

Mark