Tuesday, September 7, 2010



With the elections just around the corner it’s time for the Illinois politicians in Washington to shine at their best. The Democrats are behind in the polls and there is a good chance they lose their majority in the house thus bringing a relapse of the mid-1990’s stalemate. Back then President Clinton moved toward the center and things got done in Washington. Currently the surprise in the markets won’t be a Republican victory. Their victory is already priced in the markets.

There is one thing which is highly probable – The stock market will establish a trend in the next month or so that could last for years. The question will be which direction? Is the rally off the March 2009 low a bear market rally or the beginning of a bull market which recent action being a small correction from the April highs?

The odds for a continuation of the cyclical bear market are higher than just a correction in a bull phase. The next month or so will give a better clue and IF the market can get above 10750 that tune would change. Conversely a drop below 9625 would bring out the bear in full force.

Historically September is a bad month for the markets although the last 4 of 5 years have been positive. August was a terrible month for stocks with some recovery this past week. Usually a long holiday weekend has a counter trend push followed by a resumption of the trend after the Holiday. If this is the case this week should mark the current rally top and the market should turn down from here.

Recent activity in August namely the death cross (50day MA crossing the 200day MA) and the Hindenburg omen point to an upcoming decline. The Hindenburg omen’s theory takes a few different variables namely percentages of new high/lows, McClellan Oscillator and 10 week MA. One problem with the omen indicator is with all the new ETF’s and interest rate related issues trading on the NYSE that are making new highs as our quantitative easing policy has dropped the 10 yr. back to 2.5%. Instead of looking at preferred stocks, trusts and ETF’s one should look at REAL stocks. The theory behind the omen shows instability in the market when there are a lot of new highs and lows at the same time. Currently there are signs of this unstable activity over the past month.

Another warning that has been occurring over the past 3-4 months is the way the S&P 500 stocks have moved in a high correlation to each other. Currently the ratio is over 80% with 44% being the long term average. This 80% reading is rare and very bearish. Its highest reading was just before the 1987 crash at the 88 level.

There are a lot of cycles namely the midterm presidential cycle. This year the cycle is not different as market weakness is expected during the 2nd and 3rd quarter of a mid-term election. The market usually bottoms in the 3rd quarter and moves higher for the following 2 years. When the market doesn’t follow this tune the decline is ugly.

Another cycle is the 8 year cycle. It’s more of a trend indicator that can last for years. It doesn’t show a trend reversal but rather shows the period when either an old or new trend will be established. If it’s a low it could last for 10-20 years (some lows still haven’t been touched) or if it’s a top it could last for years. The 1930 top took 24 years to break. This indicator is a long term trend and it occurred this past week however as with all long term indicators there is a month or so margin for error on both ends.

The DJIA has resistance at 10,490, then 10,590 then 10750. Support at 10,307 then 10,250 and 10,150. A move above 10,750 will take us back to 11,120 while a push through 10,150 would result in retesting 9660.

The May 6th “flash crash” was the beginning of the instability of our market. It was a warning shot which the average Joe has responded with mutual fund outflows of $50 billion. They are happy getting a return of their investment instead of a return on investment.

Getting back to the upcoming election there will be an increase in promises and more extent and pretend. All those tax increases slated for next year will be on the fence giving the voter a false sense of reality. In reality our government owns over 50% of ALL mortgages through Fannie and Freddie. The mortgage crisis is far from over with 23% of mortgages UNDER their current house value. Our FED is printing money like crazy while our deficits are out of control. How can our government expect to raise money in auctions to pay off the interest and principle (although very little going to the latter) while creating a weaker dollar? Foreigners will stay away from these auctions because of currency risk.

The current bond bubble will end in a crash but that could be years away. Just look at Japan. People thought in the 1990’s they were in a bubble. Their rates remain near zero.

The bottom line is our country is spiraling downward. What will get us out is fiscal responsibility and tighter money. It will be painful for a year or so but the outcome longer term will be worth it. Current policies now in place only drag out the process only making things worse. It will feel like depression but won’t statistically be considered one. The government wants the consumer to spend but the consumer is either paying off debt or saving. Maybe the other shoe should be on the government’s foot?