Archive for September, 2011

For What It’s Worth

Friday, September 23rd, 2011

S&P 500 Index Annotated

I wanted to do a postmortem on the stock market action for the past few days and examine the annotated chart we’ve been following here on the blog for the past few weeks.

Fortunately, Mary Lynn Foster from Connect FM 95.3 asked me to do an interview on this topic, so I thought I’d share some of the notes I took during our conversation. If you aren’t listening to Mary Lynn and her broadcast partner Diane Ducey, my recommendation is to turn off Rush Limbaugh and switch over to their FM Talk Radio program for lively discussion on current events impacting your life here in Champaign County.

My notes on Mary Lynn’s question were kind of sparse so they are just shown mostly as discussion topics below and the answers I gave may not follow my notes exactly, but what I’ve reprinted below catches the essence of what we discussed.

Mary Lynn: The stock market numbers were down for a few reasons yesterday…so I thought we could address them.

Disappointment in Bernanke

Mark: Investors had planned on some new version of Quantitative Easing being announced by Bernanke coming out of the Fed’s meetings this week. They got Operation Twist, but it was much smaller than they had imagined it might be ($400 billion seems like a small number these days given the trillions we are in debt).

This was coupled with his statement that the US economy was significantly softer and that the slow pace was due to more than the temporary impact of the Japanese Tsunami scared people into a mass exodus from stocks over a two day period.

From my perspective, Operation Twist won’t really impact things much. At current levels, interest rates do not inhibit growth. What is keeping growth at bay is fear of the unknown – CEO’s are not willing to invest in new people, plants or equipment when the regulatory climate is so anti-business.

Layers and layers of new regulations – from health care to environmental to financing to labor relations – currently have no rules written to guide business. It’s no wonder that CEO’s won’t expand given the uncertainties that surround them.

We are also probably witnessing that we are at the point of diminishing returns relative to monetary policy and a change in other government policies relative to regulation, taxes and spending is needed.

Mary Lynn: Risks of a Global Recession

Mark: The news coming out of government statistics is definitely negative. However, you really need to look at what they are not telling you.

Take China for example, they have purposely been trying to slow their economy to fight inflation. But they want to slow it to 8% economic growth, which is still a very actively growing economy. Brazil and India are much the same position.

If you look at individual companies and what they are saying, things also don’t look so bleak. Nike reported earnings last night and they were blockbuster. They said that they see growth in all areas internationally. The same reports came from Deere and BHP Billiton, the world’s largest mining company.

There is one chart I watch for signs of international economic activity, particularly in Asia, is the Baltic Dry Index. This is a chart of shipping activity, and it has been on an upward trajectory over the past few months. If we were headed into a global recession, there would be a slowing of economic activity that would show up in this indicator first. Companies do not buy and ship raw materials or ship finished goods if they do not have the business to support it.

The same goes for railroad shipments here in the states, and there is no decline in raw materials or finished goods being transported by rail.

Mary Lynn: Frustration with D.C. Gridlock

Mark: The divisiveness in government is not good for the stock market or for economic activity. Gridlock will not fix the regulatory deluge coming out of Washington – in fact, many of the government agencies are going around congress and issuing rules that impact business in a negative way.

There needs to be a reasoned debate on the issue, all the facts weighed, and then sound law written, but that isn’t happening right now.

This leads to uncertainty and a perception of a lack of leadership, neither of which is good for companies making plans for the future, consumers considering large purchases, nor investors committing funds to the market.

Mary Lynn: Worries about Europe

Mark: Last week, Treasury Secretary Geithner stated that there would be no more Lehman Brothers – the bankruptcy event that froze credit worldwide and nearly totaled the world’s financial systems. I believe that what he means is that the United States and the European Union will not allow that to happen again, no matter what.

They will allow other things to happen that can be painful – forced mergers of weak banks into stronger ones, forced austerity on the weaker economies that are so far into debt that they have no choice to cut back services and entitlements.

The real problem here is that you have the French banks who stretched for yield and bought the sovereign debt of the countries who are in trouble because it paid 16 100ths of a percent more than the debt of Germany or the Netherlands. It’s not completely their fault since the banking rules clearly state that sovereign debt is risk free and they don’t have to allocate capital toward it. However, the banks in Germany, the Netherlands, Finland, Austria, and other like-minded countries did not invest to the same extent in the debt of Greece and similar countries.

Now, those countries are being forced to rescue their less fiscally irresponsible cousins. The voters in Bavaria and Lapland that worked hard and saved their pennies are not happy to see them go to pay for Greek salaries for people that worked a fraction as hard as themselves.

It will take years for countries like Greece and Ireland to recover – but Ireland faced up to their problems last year, raised taxes, cut services, recapitalized their banks, forced bank debt holders to realize some losses, and they are in better shape now than before. Eventually, they will see economic activity begin to pick up, followed by employment and they will be able to reduce tax rates as a consequence of it.


As far as the graph goes, you can see that we clearly broke through the bottom of the uptrend defined by the two green lines based upon investors disenchantment with the results of the Fed’s recent meeting.

The good news is that you can see our pink support line definitely held strong. This makes a third retest of the August lows, known as a triple bottom. The chart pattern we are looking for here is called a Triple Bottom Reversal and we won’t know for sure its in place until the market moves higher again and breaks through the resistance at 1205 on the index (you can see that coincides with the blue horizontal line that marked as the 50% retracement of the move from the May highs to the August lows). If we get this, in technical terms this is very positive for the market.

For what its worth, what we have going for us is that we are about three weeks away from earnings season – and I believe you will see a positive earnings season with many surprises to the upside (maybe not of the magnitude of the past two quarters, but still nicely positive). This could be the catalyst to move the market higher and into the target zone defined by the pink box and complete the Triple Bottom Reversal pattern.

Given the estimates for worldwide economic growth being reduced I have lowered our target level just a bit for the market between now and year-end. I think there are still enough positives out there based upon the statements from Nike and other corporations seeing growing business worldwide that we will see positive GDP growth in the US and the developing world, which should be enough to keep things moving forward.

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The Trend is Your Friend

Tuesday, September 13th, 2011

S&P 500 Annotated

I wanted to give you an update on the graph we are watching to see how the upward trend channel is fairing after the turbulence at the end of last week.

You can see that the the market action is still trending upward within the green channel lines I’ve drawn. The pink line at the bottom still denotes what I believe to be the low for the year, with the double bottom clearly visible on that line.

Nothing new from a technical standpoint to discuss. We are sticking with the trend

However, I thought it might be instructive to look at a pattern that we’ve seen in the past that we seem to be following with this current market.

Below is a chart of the 1987 stock market crash:

1987 Stock Market Crash

You can see that I’ve drawn a box around the choppy action in the market as a bottom was formed, tested and then the subsequent move higher in coming years.

Below is a chart of the current market formatted in the same manner:

2011 Market Action

You can see that the post-drop movement in the market looks remarkably similar. The only thing we are missing is the several-year move higher from the lows.

To me, the question is whether we will see that sort of move higher as we are recovering or will a new pattern develop that represents the realities of 2011 and beyond.

There were lots of economic issues in 1987 on both the good and bad sides of the tally, much like today. It seems to me that there are more on the bad side of the tally today but maybe that is because I am living through these as a market-weary 50-year-old but in 1987 I was an idealistic twenty-something just finished with my Masters program and putting my thesis into practice, so everything looked like an opportunity.

In any event, we are taking the 50-year-old’s cautious view and keeping a near-term target for the market through year-end as denoted by the pink box on the graph at the top. There will be resistance to overcome in the form of the blue Fibonacci retracement levels and the falling 50-day moving average, but we will cross those bridges when the come. But, our plan continues to be to raise cash when we approach that pink box [ maybe before, depending upon how we deal with the overhead resistance ] and then make an assessment on whether 2012 will give us a recession or not.

At this point the typical signs of an impending recession just are not there, so we are sticking with the market in the belief that earnings season will provide some positive catalyst for the market to move higher, through resistance and find a home in the area of our target.

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Higher Highs and Higher Lows

Wednesday, September 7th, 2011

S&P 500 Annotated

I thought I’d show you an update of the graph of the S&P 500 I’m watching for clues as to how the market recovery is developing. If you didn’t read the original blog post with this graph describing the various indicators, you can find it here:

Click here for the original post

As you can see, I’ve added two additional green horizontal lines showing that we are developing a clearly defined pattern of higher highs and higher lows. This is a very healthy pattern for a recovering stock market and one that I am happy to see – granted the down days like yesterday are no fun, but if they are part of the recovery pattern, then they are a necessary evil.

The reason we like to look for patterns is that they tend to identify broader trends. In the case of a market making a pattern of higher highs and higher lows, you can see an uptrend develop. It is in reality just a depiction of investor psychology – one of the two elements of a stock market (earnings and sentiment) – in the case of this pattern, you can see that a more positive sentiment is developing and that buyers are beginning to outweigh sellers.

I see no reason to change my view that we will continue to rally into year-end, with the green box on the chart representing our target for the market at which point we will begin to raise cash in client accounts. However, many things can change between now and then, so if something happens to cause us to adjust our strategy or view on the market we will advise you here on the blog.

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All Right Now

Friday, September 2nd, 2011

S&P 500 Index Annotated

I wanted to show you what’s been happening in the market since the last post, and as you can see, the slow grind higher is still in place.

We will have an accomodative Federal Reserve that will keep monetary stimulus flowing, we are approaching earnings season which should again be solid, and consumer spending continues to be strong even in the face of a consumer sentiment report that says they have significant fears of the future. This leads me to believe that the stock market will move higher into year-end.

Looking at the graph above, as we approach the green box which is our target for the market, our plan will be to reduce stock market exposure in client accounts. You can see from the red circle on the left that there is little overhead resistance from potential sellers to a move higher until you get to the green box area. You can also see from the pink line I drew that today’s selloff is being curtailed by the volume at that level which represents previous buyers.

We had several up days that pushed us toward our goal of reaching the green box, but the news out of Europe again has people perplexed. Will a rescue effort for the banks be implemented – will the FLEAS (Finland, Luxemburg, Estonia, and Austria – sorry I can’t take credit for the acronym but also can’t recall who coined it) prevent a bailout of Greece by the European Union – will the banks acquiesce to the IMF and raise capital? No one knows the answer to these questions, but everyone is certain that Europe is in dire straights.

Ted Spread

You can see from the chart of the Ted Spread above that the troubles in Europe are not causing it to forecast a crash in world’s financial systems. However, we continue to monitor it – it is starting to edge up a bit – but nothing like when we experienced the sub-prime crisis and the bankruptcy of Lehman Brothers.

The European news combined with the jobs news today showing that no net new jobs were created last month (public sector layoffs negated private sector hirings) has people perplexed whether a new round of quantitative easing will be instituted by the Federal Reserve when it meets in a couple of weeks. Will that be good or bad for the economy and the markets? Again, everyone is perplexed – QE1 and QE2 were good for the markets (QE1 led to an almost 80% recovery in stock prices and QE2 added somewhere under 20%) but when the programs ended, the markets sold off as we are currently painfully aware of from the chart above. Will QE3 cause a similar rise in the markets? Will it finally stimulate the economy? Will that somehow generate some economic momentum that will lead to increased employment?

You can see that there are more questions than answers. At this time, I am going to stick with my plan for the investment markets..

10-Year Treasury Yields

As for the bond market, you can see from the chart above of the yield on the 10-year treasury note, we are historic lows (this chart is for the past 20 years), so the big risk to bond portfolios is to the upside. Yes, if the Fed employs a strategy of targeting the 10-year note to bring yields down to 1.5% from 2.25%, that will obviously be more profitable for longer duration portfolios than shorter duration portfolios. But, that small upside potential gain is dwarfed by the huge downside risk that the market will go against the Fed and drive bond rates higher as it perceives more risk in treasuries due to our levels of debt.

our plan is to continue to shorten durations in client portfolios that have a fixed income allocation and to add to the variable rate fixed income investments that increase in value as rates move up plus also increase their yields as the general level of bond yields increase.

In summary, today’s selloff does not seem to me to be another leg down in a cascading stock market crash. I think the stock market will be all right and move higher into year-end – but expect some volatility, significant at times. I think the bond market will be flat within a range, but eventually rates will move up and surprise a lot of people that have not prepared for it.

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Enjoy your holiday weekend!