The Crisis Is Not Over, but the Bullish Interlude Can Last a Few More Quarters

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http://www.moneyandmarkets.com/the-crisis-is-not-over-but-the-bullish-interlude-can-last-a-few-more-quarters-3-34895   The Crisis Is Not Over, but the Bullish Interlude Can Last a Few More Quartersby Claus Vogt   07-29-09

You might be familiar with this common example of probability theory: The exercise of drawing colored marbles from a container.

Half of the marbles are white, the other half are black. You remove one marble, write down the color, and put the marble back in the container. Then repeat the process, again and again.

In the short run you may experience streaks of drawing one black marble after another. It might happen three times in a row, five times in a row, even ten times in a row.

However, these short-term results do not change your long-term outcome — the fact that you’ll draw black marbles half of the time and white marbles half of the time.

When investing, this same law holds true. Some decisions will turn out to be losers. In the long run, though, you’ll earn money if your methodology has an edge.

Let me explain …

A Disciplined Approach
Is My Edge …

Is Buffett just a lucky guy, or does he hold an edge when investing?

The “random walk” approach to markets supposes that 50 percent of the marbles in the bucket are white and 50 percent are black. Accordingly, nobody can achieve more than the market’s average performance, and Warren Buffett was just an incredibly lucky guy.

I don’t think that premise is true. And I believe that Buffett’s long-term success proves this point.

In my opinion, the world of investing does not always deal with 50:50 chances … sometimes there are buckets with more black marbles than white ones by a wide margin and vice versa.

My indicators are geared to inform me when this is the case. And they tell me when the buckets hold special opportunities or unexpected risks.

I may still encounter a streak of losers in the short run. But in the long run, I’ll make money because my winners will outweigh my losers by sticking to my disciplined approach.

How My Approach Works …

When there are more white marbles than black ones, I run with the bulls.

If black marbles represent falling stock prices and white marbles represent rising prices, it becomes clear what to do: Whenever black marbles are a majority I implement a bearish strategy; whenever white marbles dominate I run with the bulls.

For example, when the yield curve is inverted, and the year-over-year percent change in the Index of Leading Economic Indicators (LEI) is negative three months in a row, chances are extremely high that a recession will follow soon.

In this case let’s say, that 90 percent of the marbles in the bucket are black. Whenever this rare condition is given I’ll get out of stocks and buy inverse ETFs and long-term Treasury bonds. The last time this condition prevailed was in 2007.

Technical analysis is just one part of my approach. Longer term, fundamentals and macroeconomics are the financial markets’ driving forces. But markets can stay irrational much longer than you might think. That’s why it pays to take technical analysis seriously … at least when compelling signals are generated.

And that’s precisely the case right now. Take a look at the chart below …

Source: Tradestation

Last Thursday, the S&P 500 index rose above its June high. In doing so, it’s showing an important bottoming formation: A huge head and shoulders bottom. Rising volume and strong market breadth confirmed the buy signal. Additional proof came from foreign markets showing more or less the same bullish pattern. And from the 200-day moving averages, which are in the process of turning around as well.

I take these signals seriously. They’re telling me to expect a continuation of the bear market rally off of the March lows.

I deem it probable now that this rally will have legs. And I expect the markets to keep rising and not come under serious pressure again until the second quarter of 2010.

I use the LEI to back up this view. It moved up from minus 4.0 percent year-over-year in May to minus 1.2 percent in June. This clear improvement points to some kind of an economic rebound.

No, the crisis is not yet over. Longer-term fundamentals are strongly against a more optimistic outcome. But a few quarters of a shallow economic recovery, caused by the huge stimulus programs all over the world, is the most probable outcome now.

In other words, all my indicators are telling me the jar now has more white marbles in it than it did just a month ago.

Best wishes,
Claus

apollochil

Investors Just Witnessed the Perfect Bear Trapby Claus Vogt   07-22-09


The stock market is said to be a vicious beast, trying to hurt as many investors as possible. And last week it hurt the bears by luring them into the perfect bear trap.

On July 7, everything seemed to be clear. Most European and some U.S. indexes had just broken below what looked like head and shoulder formations. This seemed to be the logical conclusion of the stock market’s advance off of the March lows, which was a very doubtful move with low volume and horrible fundamentals.
By now, though, we know that this breakdown was not the start of a new bear move … but clearly a bear trap. Instead of the expected follow through to the downside, the stock market turned on a dime. And in a short five days the S&P 500 gained a notable 8 percent!

In just five days, the S&P shot up 8 percent, sending the bears into hibernation.

Bear Traps Are Warning
Signs Nevertheless

In having risen above the breakdown line, the sell signal was aborted. Technicians disagree about the meaning of this aborted signal. Some say it was a sign of special strength that prices did not fulfill the technical forecast of this formation.

But others, including Edwards and Magee, the authors of the first comprehensive book on technical analysis, come to a totally different conclusion …

They argue that the market signaled weakness by showing a topping formation in the first place. And the reality of this weakness should be treated with respect — as a harbinger of more weakness to come relatively soon.
I tend to stick with Edwards’ and Magee’s explanation. Especially because …


Stocks Are Richly Valued and
Macroeconomic Fundamentals Are Dicey!

If you want to know how dicey the economic picture really is, you don’t have to go any further than the minutes from the Fed’s FOMC meeting on June 23-24. Here’s what you’ll read there:

Nonetheless, most participants saw the economy as still quite weak and vulnerable to further adverse shocks.

(B)anks could face substantial losses in their loan portfolios in coming quarters.

(O)btaining financing for commercial real estate projects remained extremely difficult amid worsening fundamentals in the sector.

Most participants judged that consumer spending would continue to be subdued for some time.

The Fed has admitted that the bleak housing situation could get even worse.

Most participants viewed the (housing) sector as still vulnerable to further weakness.

(L)abor market conditions were of particular concerns to meeting participants. ( … ) Labor market conditions were even more difficult than indicated by the unemployment rate.

This sounds like there are a lot of major, unsolved problems out there.

I fully agree with the Fed’s dire insights. And I want to add that the Fed is famous for being overly optimistic about the economy. They tend to be cheerleaders, always trying to upgrade the psychology of the economy. So if they’re saying that the situation is lousy, it’s probably even worse!


What’s Next for Stocks, Then?

The stock market is back to where it was in October of last year, after the crash. In the bigger picture, however, it has traded sideways since then — including a huge decline to the March lows. And this trading range has become quite narrow since May.

The way I see it then, nothing special has really happened. But somehow this kind of “nothing” has obviously been very nerve-wracking for bulls and bears alike.

If the market was indeed the vicious beast that I described in the beginning of this column, having hurt the bears so much, it now seems likely to go after the bulls …

The trap is set. A lack of follow through, a turn on a dime and a decline in line with fundamentals is all that remains.

The best way to accomplish that is for the S&P 500 index to rise above the June high of 956 and set up an even bigger bull trap!

In doing so, the charts would show an accomplished bottom formation signaling the rally to endure. Bulls would feel vindicated and start buying. And many of the remaining bears would be forced to retreat and abandon their short positions.

Thus the trap is set. The only thing remaining now is a lack of follow through, a turn on a dime and a decline in line with fundamentals.


Best wishes,
Claus


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