Sunday, March 11, 2007

Stock Update 11 March 2007

Since the market correction on Feb 27, the worlds markets have settled into a "wait and see" situation.

Fundamentally there are many opposing forces currently at work in the market. In my opinion the 2 most important forces that will determine the future direction of the markets are:

1) The future direction of the Japanese Yen (and hence the world carry trade), and

2) The outcome of the US sub-prime mortgage lending fiasco (and the possibility of a meltdown in the financial industry and a recession in the U.S.).

I will watch the Yen closely over the next few weeks as any further strengthening in the Yen will further reduce the carry trade which in turn will result in dumping of stocks and gold in favour of bonds. Ironically should this occur it may be US dollar positive as investors flee to the "safety" of the USD. Kind of ironic given the terrible fiscal position the U.S. is currently in.

The second major event is the sub-prime lending market in the US. In short, the US housing bubble was fuelled by billions of dollars being lent to individuals who in no way could have qualified for those mortgages under "standard lending practises". Instead they were offered zero money down mortgages, adjustable rate mortgages (ARM's), etc to keep the market rising. The industry was comfortable with this arrangement as long as house prices were rising and there was little risk of default. Now house prices are falling, those who have these homes are defaulting on their loans, and the mortgage companies who provided them with these unbelievably loose mortgages are going bankrupt.

Why is this a problem? Simply put, most of these risky mortgages were "bundled" and sold to mutual funds, hedge funds, brokerage houses, etc over the past several years therefore the risk is not just in the mortgage industry but throughout the entire investment community (kind of like a local virus that has been allowed to spread). Also the exact dollar amounts of these sub-prime "time bombs" out there is unknown therefore the expected fallout should this slide in the sub-prime market continue is also unknown. Markets hate "unknowns".

Alas, I turn to the charts for guidance.

First chart is the PNF 1 box chart I use to identify trend changes (click on charts to enlarge):

The chart technically issued a sell signal on a break through 274. I was fully prepared to go to cash on this move BUT the following morning the Yen showed signs of weakness. As such, I delayed my decision to sell to see what the market response would be to the move in the Yen (I was expecting some market strength to develop).

In fact the worlds markets did stabilize that day and they have currently recovered somewhat. This could be the end of the correction or this could be a "dead-cat bounce" and the start of a further (and much uglier) decline.

Next chart is the 1 year daily chart I use to judge trend:

As can be seen, the uptrend line from June/July bottom has been broken. In addition, the "sell pivot" that would indicate a trend change (the dotted red line @ 274) was also broken to the downside as can be seen (which correlates with the PNF chart previous). HOWEVER, the MSCI World Index chart at the bottom bounced right on it's pivot @ 2000. Should both charts have broken below their pivots I would have not hesitate to go to cash. But the bounce on the MSCI chart has kept me unchanged.

Very important to note the red "bearish" vertical line I have drawn. Essentially what has produced this line is that the ADX (14) red indicator has passing through 60 combined with the MACD crossing below zero. I have used this method in the past to indicate important trend changes (bullish trends when the green line has passed through 60, bearish trends when the red line has passed through 60 along with associated MACD crosses). This indication is now bearish and will remain so until the green indicator again passes above 60 and the MACD goes above zero. Until then the market is in bearish mode and subject to decline.

Last chart is the 3 year weekly chart.

This chart has also turned bearish as the StochRSI (25) has crossed below 0.5 and the MACD Historigram has gone negative (blue blocks below zero). In the past this chart has indicated some good trend changes and is especially good when both indicators change at the same time. This has occurred so the odds of the market going down further are real.

Trend line support is at 268 and there is a nice support level @ 264.50. A break below these 2 values will be very negative and needs to be watched closely.

Bottom line: still 50% equities and 50% cash (euros) and watching daily. Which way I go from here will be led by what the market tells me. When I move you'll be the first to know.


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