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I Wonder…

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Well, its been an ugly period in the market. You can see that from the chart above, we broke through the 89 day moving average in decisive fashion. This is technically an ominous sign. We have had several stop losses hit over the past seven days and if the selling continues, we will have some more. One thing that concerns me is that the selling is happening on rising volume and our trend indicator (the ADX indicator) is showing that the downturn is picking up steam (that rising black line with the big gap between the red and green lines).

But, there is some good news: our short-term directional indicators shows that we are oversold in a big way and that we are due for a bounce. The RSI below 30, the Full Stochastics below 20, and the Oscillator (NYMO) significantly below the 0 line. I’d look for the market to move back up, probably on low volume, and then the selling will likely resume.

What you can’t see from just looking at the broad S&P 500 average is what is happening with the rest of the market. On the chart above, the Advance Decline line is showing that there is a lot of damage being done to individual companies that is being blended by the broader market to look better than it really is. On the chart below, you can see the year-to-date performance of the S&P 500 compared to the Russell 2000 Small Cap Index and the NASDAQ 100 Index, Gold, Gold Miners, Oil Service Companies, and Emerging Markets. I’ve chosen these because they are the favorite areas for institutional investors.

What’s pretty clear is that the institutional favorites that are the most widely held and that have had good earnings and great prospects as the economy recovers – are getting killed by the selling.

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But, the question is who is doing the selling. Given that the selling is predominantly in the institutional favorites, and that if you look at individual companies within these groups you see what looks like a flat out assault on them by someone, it looks suspicious.

I wonder why, when these companies were reporting strong earnings, the GDP numbers reported this week were better than expected, and the unemployment numbers were improved, the selling picks up steam. Its almost like the traders in NY are trying to make a statement.

So are they upset by the proposed regulatory changes designed to deal with “too big to fail” institutions ending proprietary trading and limiting the size of deposit-taking institutions? That we have a new $90 billion tax intended to curtail bonuses? The a new world-wide fund is being proposed that they will have to pay into which would act to deal with future financial messes like the current one?

Who knows – it just seems irrational to me – like something designed to prove a show of force, like a push back against the proposals. I’m not a conspiracy theory person, but something just doesn’t seem right. The selling seems to be happening in the face of improving fundamentals.

Or maybe, its not irrational at all. Maybe the traders have taken the view that if these changes are imposed, corporate earnings will suffer. Maybe they have decided that these regulations and taxes will impede future economic growth because the assumption of risk by the institutions that provide the capital for it will be decreased. Maybe the improving fundamentals are not likely to continue improving:

>the improved GDP numbers came mostly from an inventory rebuilding process in corporate America that will not show up in future quarters;

>the improvement in the unemployment statistics could be temporary since people that stop looking for jobs are no longer considered unemployed in the calculations; and

>corporate earnings estimates for coming fiscal years could be overly optimistic if the GDP and unemployment assumptions are faulty.

All of this is speculation, but I have to develop some theory that we can invest with – in the short term we will keep the remaining stop losses in place and institute new ones with the likely bounce we’ll see (based on the short-term directional indicators discussed above). Unfortunately, we didn’t have stops set on several companies with the best fundamentals and prospects – and some of those have been hit hard. But they will also be the ones that bounce the best.

Yes, the market went up very fast with no real correction in the up move. Yes, we have had stop losses in place to protect many positions against a down move. Yes, valuations were stretched as prices moved up prior to earnings – but that happens in every recovery as stocks discount the recovery in advance.

The real question is this: will the second half of the year see continued economic improvement or a move back toward a double dip recession. The odds are still with continued slow improvement given the vast monetary stimulus in place and likely to continue. If this scenario is the one that comes to be, then we should see the stock market reflect that and continue its move higher. If the speculation about the traders above is right and the new regulations and taxes cause the economic recovery to falter or stagnate – or if the monetary stimulus is removed and we head into a double dip recession – then you will see significantly lower stock prices.

Right now, we are going with the first scenario and will be using the anticipated bounce to add additional stop losses, and if we see a move back above the 89-day moving average in the broader market we’ll probably add to positions that have the best prospects to prosper in an economic recovery. That’s the plan for now.

Your trivia for today relates to a movie about the 60’s set in Modesto Calif in which the above song played a part. Many future stars played teenagers that you followed over the course of one night. Name the movie and also the actress in the Thunderbird that proved to be an obsession for one of the main characters. Then, go rent the movie and watch it again – I plan to since I haven’t seen it in years.

Mark