Cycles

I have been meaning for some time to write a blog on cycles within the stock market. I think it is extremely important at this point in our current market advance to shine some light on where I think we are going and why.

Firstly, once again I reiterate that stock market technical analysis is not a crystal ball. It is merely a pictorial charted reflection of the "movements of the masses" expressed by way of how they "vote" with their billions of investment dollars each and every day.

In order to be successful in the markets you need to ride on the tails of the masses (the general public investment "sheep") yet keep a firm eye on a well defined exit strategy to avoid following those sheep over the cliff when the canyon edge becomes apparent (as I have shown with the use of the 13 week vs 34 week exponential moving average crossovers previous). Using simple technical analysis techniques such as these keep you on the right side of the trade when the markets are advancing and either in cash or short the market when markets are declining.

One of the areas that is somewhat outside pure technical analysis is the study of cycles. As we all know, cycles are part of everything around us (24 hour time cycle, monthly lunar cycles, 12 month calendar cycle, 4 season cycle, etc). What many do not know is there are cycles in investment as well.

Most people are familiar with the term "business cycle". It is perceived by most to be a period of economic expansion followed by a period of economic retraction (commonly known as a recession). The common perception is these "business cycles" are controlled or can be manipulated by the Federal Reserve and U.S. Treasury (through the setting of interest rates, the control of the money supply and government "stimulus" policies such as the recent "cash for clunkers" fiasco).

What is interesting (and alarming) to me is that this commonly accepted rational that the government can control long term economic cycles is a recent phenomenon (the past 60 years). The key is this acceptance of government omnipotence has occurred during a time of rather benign (bullish) longer term economic cycles. As such, I believe we have become much too complacent in assuming the government can control our economic future and steer (manipulate) a clear path forward. They have had an "easy go" of it over the past 60 years but that is about to change.

There have been numerous studies over the years looking at cycle theory. Three of the most prominent cycle theorists were Edward Dewey (who discovered the 19 year stock market/real estate cycle), Nikolai Kondratieff (who developed the Kondratieff Long Wave Cycle, which I have written about previous) and Ralph Elliott (who was the father of the Elliott Wave Theory). All 3 confirmed the presence of specific economic cycles that reoccur time and again within a Capitalist economic system operating within a Democratic political system.

In addition to the fore mentioned cycle specialists, two authors who have attempted to put some "science" behind the cycle theory are Harry S. Dent Jr and Stephen J. Puetz. While their approaches to the question of cycles is unique, it is interesting to note their conclusions are remarkably similar.

Mr. Dent uses demographic analysis in combination with well established cycle theory to predict future economic forecasting. His predictions over the years have been somewhat "extreme" (direction and timing correct but magnitude incorrect) but the science behind his theories is relevant and cannot be ignored.

Stephen J. Puetz attempts to quantify various cycle theories previously discovered by others and compress them into one neat package he calls the Extra-Universal Wave Series. While I disagree with some of his assumptions, the core thesis he comes to works well in explaining various cycles previously identified by numerous individuals, including the following:

-a 2.12 year stock cycle
-a 6.36 year stock cycle
-a 19.08 year stock and real estate cycle
-a 57.24 year war and commodity price cycle
-a 171.72 year civil war cycle
-a 515.16 year civil war cycle

I will not bore you with the details (for more Google Dewey, Kondratieff, Elliott or buy Puetz's or Dent's books) but suffice it to say there is fairly good indications taken from the work done by all I have quoted above that we have past the "prime" period of economic expansion in the western world (Especially the U.S.). As such, there is a very real chance we are now going to experience an extended period (2020-2023 bottom for Dent, 2026 bottom for Puetz, 2025 bottom for Kondratieff) of severe economic strife, crushing depressions/recessions, extreme levels of unemployment, violent civil unrest (especially in the U.S.) and the chance of a World War conflict.

Within this we need to consider from a Technical Analysis point of view how to view this potentially extreme event and how to prepare for it. Elliott wave theory does a good job of it for us.

In it's most basic form, Elliott Wave theory takes the form of a 5 wave "up" pattern (3 waves up with each up wave countered by a down wave in between) followed by a counter wave "down" pattern of 3 waves (2 down waves with an up wave pattern in between). The "up" pattern is labelled 1-5 and the "down" pattern is labelled an A-B-C correction.


Basic Elliott Wave formation:




Elliott wave is used down to the smallest time frame by some technicians but I find it most useful in identifying larger term patterns to give us something of a "crystal ball" look at what might be coming.

The problem with Elliott Wave is it is difficult to determine the "correct count" until the event has passed. As such, there are various scenarios that fit the current situation we are in.

Using the Oct/2007 top to Mar/2009 bottom, there are 3 possible Elliott wave scenarios:


Elliott Wave Scenario 1:



This is the most widely accepted scenario. It states we experienced a 5 wave advance from the early 1970's with a Wave 3 top in 2000, a Wave 4 down in 2003, and a Wave 5 top in Oct/2007.

From Oct/2007 to Mar/2009 we experienced Wave A down followed by Wave B up (to our current level). Once Wave B ends we can anticipate a Wave C decline to our final stock market low.


Elliott Wave Scenario 2:



Under scenario 2 it is assumed Wave 5 topped in 2000 with Wave A the decline into 2003, Wave B the rise into Oct/2007 and wave C the fall into Mar/2009.

If this is the case we have begun a new bull market and we would never again see a price below that achieved in Mar/2009 and we would begin a new multi-decade price advance in the next bull market.


Elliott Wave Scenario 3:



The 3rd scenario suggests the same as scenario 2 but instead of a 3 wave A-B-C decline we are in the midst of a 5 wave pattern within an expanding triangle.

In order for this to be valid we would need to exceed the Oct/2007 top followed by a massive decline slightly below the Mar/2009 low, followed by another climb ultimately out of the pattern through the top to commence the new bull market.

Unto themselves, each pattern is possible and plausible. However, given the cycle patterns I mentioned previous, it it highly unlikely the most bullish outcome (scenario 2) would be correct. It would have been the best case scenario 15 year's ago but not now given our current economic climate and this point in the longer term economic cycles (IMHO).

Given this, I think scenario 1 or 3 is in play. I favor scenario 1 (the most pessimistic outcome unfortunately) but cannot rule out scenario 3. The price action over the next 6-12 months will tell us which is correct.

In order to examine these in more detail, I have used the Dow Jones Industrial Average in the following charts to illustrate where I think we are going (click all charts to enlarge):


Elliott Wave Scenario 1:



This scenario is the most bearish yet most closely fits with the pattern of cycles we are currently in. I have yet to see anything on a fundamental level (debt levels, house foreclosures, unemployment rates, realistic stock valuations, etc) that indicates this is not the correct road map forward.

In this scenario we are currently in Wave B of an A-B-C correction. As indicated, wave B normally extends to either the 50% or 61.8% Fibonacci retracement level before beginning it's next decline. NOTE WE HAVE MET THE REQUIREMENTS OF HAVING REACHED THE 50% FIB LEVEL AND HAVE STARTED A DECLINE FROM THIS LEVEL.

From this point (or up to the 61.8% level at 11242 should prices reverse and commence a new upswing) prices should rapidly decline in wave C.

Normally in an A-B-C correction, the length of wave A equals the length of wave C. Should this be the case I have put some estimated price targets on the chart.

Irrespective of how you look at it, this scenario will result in a top to bottom decline of 75-82% from the late 2007 highs. This will be in line with the 1929-1932 "Great Depression" in terms of magnitude. However, during that time the U.S. was the worlds most powerful "Creditor Nation" with huge excess capacity and industrial production. Debt (either at the government or the individual level) was almost non existent. Today is not the case and the U.S. is NOT prepared for what is to come this time around should scenario 1 unfold. With this will come massive unemployment, unprecedented civil unrest and a Teutonic shift in power from the U.S. to the more affluent and developing nations (ie. China).


Elliott Wave Scenario 3:



Under scenario 3 (I've labeled it scenario 2 on the chart; disregard that typo) we go through a period of boom and bust over the next several years with a stock market that exceeds it's 2007 high (slightly) followed by a bust that exceeds it's 2009 low (slightly) followed by the 1st leg of a new bull market.


The question that must be asked is "how do we know what we are going to face"? In my mind, the key to watch is the Fibonacci levels of 38.2% (9416) and 61.8% (11242). A significant rise above the 61.8% level and it is safe to assume scenario 1 is off the table (and a rise above the previous top at 14198 would confirm it without a doubt and set up either scenario 3 or scenario 1).

Alternately a price break below 9416 and it is safe to assume scenario 1 is unfolding (confirmed by a price break below the Mar/2009 low at 6469). Should that occur I expect the worst.

How to play this from an investment viewpoint is difficult as there is no clear direction. For now the best is to time the market and wait. If scenario 1 confirms it would result in a severe deflationary collapse. During these conditions "cash is king" and, believe it or not, the best place to hide would be in currencies (the USD as long as it can maintain it's reserve status; otherwise whatever currency replaces it as the world's reserve currency). Interesting enough, gold tends to do well at both extremes of deflation and inflation (it is the "run to" currency when no one knows what to expect in the future) but not when things are going well. As such, I think it is a currency (as opposed to a commodity) that everyone should consider.

Under scenario 3, I would have to assume unlimited fiscal stimulus worldwide would have altered the "correct path". Given this, I would expect very high to hyperinflation in most developed markets. Once again, gold would do well, as would the stock market, real estate, commodities, etc. The dollar (and other currencies) would be trash and would be held for as short of time as possible; only as long as it takes to take them and convert them into "something else".


Conclusion


It is my opinion we have transitioned into a "new normal". The common thought process is that we are in for "more of the same" with respect to the type of economic progress and stock market advances that we have experienced for the past 60 years. I do not agree.

Those who have their eyes open will see it coming and react accordingly; unfortunately the masses will be blind and the coming economic blight will decimate the balance sheets of most of the majority.

Fortunately out of a firestorm comes new growth. Those that can preserve their capital and survive the coming blaze will face prospects unheard of over the past 40 years. Stock valuations will be at obscenely cheap levels, homes will be again affordable, and people will have learned to live within their means for the 1st time in 40 years.

As much as it will hurt, I don't think that is necessarily a bad thing. This reset is long overdue.

Keep your head up and your eyes open. Protect yourselves and your families. I'll see you on the other side.

There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.

Donald Rumsfeld

Dwayne Malone


Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility. The author is not licensed as an investment advisor in the UAE and therefore cannot provide individual account advice to individuals and/or institutions.

dwaynemalone1@gmail.com

Stock Market Update 31 Oct 2009

A very interesting week in the markets the past week. We are at a very important crossroads and next week should give us guidance as to whether we continue up from here or we collapse into the next phase of this bear market.

Click on all charts to enlarge.


SPX 6 month daily:



My daily trading chart gave a short term sell signal on Tuesday as per the annotations on the chart. As of Friday's close, we are still bearish in the short term.

Of note is price has now broken below the 50 day moving average and looks set to challenge the previous support level of 1019.95. This price action is very similar to last significant correction back in the June/July period (more on that with the next chart).


SPX 1 year daily:



During June/July price had set up what looked like a bearish ascending wedge. A breakdown occurred in mid-June and price fell to test the previous support level at 878.94. Note that price violated that support level on an inter-day basis but was not able to achieve a daily close below that level. When this failed to materialize prices again started their advance.

We are in a similar position today. Price has broken below what appears to be another bearish ascending wedge. However, as of Friday's close price has not violated the previous low at 1019.95. Until it does so, it is too early to say that the bull run off the March, 2009 bottom is completed.

Should price close on a daily closing basis below this level (1019.95), it must be assumed we have potentially switched into the next down phase of this long term bear market. Should that occur I would immediately close out my 50% long equity position in the Provident Fund.


SPX PNF traditional:



The Point and Figure chart confirms my analysis previous. The last signal was a bullish buy signal on a price close above 935 and a projected target of 1295. It would take a closing price at or below 1010 to switch this chart to bearish.


SPX 2 year weekly:



A reminder once again of the current forces acting on price:

-the bottom trend line and the 13 week EMA pushing prices up,
-the 50% Fibonacci retracement level at 1121 holding prices down,
-the fairly strong volumetric resistance line at 1120 holding prices down, and
-the trend line from the market top in Oct, 2007 holding prices down (currently sitting at 1125).

All this leasds us to the inflection point we are currently at. I feel a resolution in either direction will be swift and violent so we need to be very vigilant here.


SPX weekly vs 89 wSMA:



A troubling signal is price closing this week below the 89 week Simple Moving Average (currently at 1060.37). A previous close above was one of the confiming signals I used to shift funds into equities due to it's very accurate long term track record.

This level is critical if this market is to continue to rise and must be watched closely.


SPX monthly vs 20 mEMA:



Lending credence to a possible downward thrust is the refusal of price to close above the 20 week Exponential Moving Average on a monthly closing basis. We were over it mid-month but by the last trading day in Oct (Friday's close), price was unable to close above the 20 mEMA.



Bottom Line:

I said this in my previous blog post:

I will continue to monitor the markets over the next few weeks but will not be
comfortable "all is well" until we can get above the 61.8% Fibonacci level of
the decline (approximately 1230). Until that level is surpassed, I am of the
opinion that this is still a rally into a long term bear market. As such, I
still think that we will see lower prices (below the March/2009 bottom) some
time in the future. My work with cycles indicates we will not be in a
"comfortable" position until at least 2015.

My opinion has not changed. This market is dangerous and over-valued. There are 100's of "fundamental" reasons why we should not be any where near this price level. However, for whatever reason we are where we are.

The thing about Technical Analysis that is so amazing is what the charts reveal is the collective thought process of millions of investors who are "expressing their opinion" with the only thing that really counts; MONEY. No matter what "X" or "Y" advisor or analyst thinks about the markets, the only thing that really matters is price.

As of today, the technicals are telling us the "collective" believes prices have gotten a bit too high in the short term. Is it possible that this could turn into the next severe bear market leg down? Absolutely. However, technically that information has not been presented "yet?".

Should price close below approx 1019 on the SPX, that would violate the previous support level and be a technical trend change to the downside. As I discussed previous using 5 x the ATR, my calculated stop was 1027.72. I am prepared to allow a slight amount of "leash" to the 1019 level to give the market a chance to prove itself. However, should price close on a daily closing basis below 1019 I think there is a very real chance we will have begun Wave "C" down in this bear market.

I will blog another post on the longer term cycles and potential (I don't want to scare the hell out of everyone just yet!) but it is important to know where my "line in the sand" is with these markets.


As of today my strategic position remains unchanged at a 50% Equity/50% USD cash position.**

**Strategic allocated percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).


Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility. The author is not licensed as an investment advisor in the UAE and therefore cannot provide individual account advice to individuals and/or institutions.

dwaynemalone1@gmail.com

Stock Market Update 20 October 2009

Further to my blog of 18 October, I have included a few charts outlining my reasons for switching to a 50% equity/50% cash position in my provident fund account.

Click on all charts to enlarge:


SPX 10 year monthly:



The first of my "long term" charts turned bullish at the end of July when the closing price was above the 12 month simple moving average (blue line). Since that signal the markets have advanced approximately 10%.

I have indicated on the chart the market action the last time we had a bullish buy signal on the 12 sma cross (March, 2003). During that price advance, it can be seen that price ran up into 2004 until it hit the 50% Fibonacci retracement level. At that point, price stagnated in a narrow range between the 50% Fib and the 38.2% Fib until the 12 month sma was able to catch up. At that point price was pushed above the 50% Fib by the 12 month sma and the bull market continued in earnest.

Should the same occur again, I would expect prices to stagnate near current levels (the 50% Fib @ 1122 on the SPX cash index) followed by a period of consolidation between the 50% Fib (1122) and the 38.2% Fib (1014). Once the 12 month sma has had a chance to catch up, that is when I think the next up leg in the market will begin.


SPX 2 year weekly:

The second of my long term charts. A possible bull market was indicated in late March when the Stochastic midpoint crossed 50 in combination with the FORCE Index moving into positive territory (green). It was these signals that I used in my personal accounts (non Emirates) to move into long positions.

Unfortunately these signals are somewhat volatile and cannot be used for longer term holding accounts such as the Provident Fund. As such, I waited for a further signal to signal all is clear.

This signal was given in late July when the 13 week exponential moving average (blue line) crossed above the 34 week exponential moving average (red line).

Note that price has risen to a critical level. It is now at the point where it is challenging the 50% Fibonacci level, the descending trend line from the market top in October, 2007 and the top of what appears to be a bearish rising wedge.

If price can break above these levels, there is a very real chance it could rise to challenge the next level of strong volumetric resistance at around 1200 followed by the 61.8% Fibonacci level at 1228.

The next 2-3 weeks will be critical to watch.


I alluded in my last post to a few charts that persuaded me to enter the market. Here are 2 that I follow:


SPX 20 year weekly vs 89 week sma:



As can be seen, a weekly close above the 89 week simple moving average has an excellent history going back 20 years. Only in 1994 did it oscillate back and forth above and below the 89 week sma before finally settling on a direction.

As of last week, price had closed above the 89 sma.


SPC 20 year monthly vs 20 month ema:



Another chart with an excellent record is a closing price above the 20 month exponential moving average. We need to wait until the end of October to confirm but a close > 1058.60 would be a bullish confirmation.


SPX 6 month daily:



A daily buy signal was generated on Oct 7. On Oct 14 price broke above previous resistance at 1080.15. Based upon this I took a 50% equity position in the Provident Fund account.

A critical thing to consider when entering any position is to have an exit strategy in case the market turns against you. I never enter a position without having a plan to exit. It is critical to limit losses should the trade turn against you.

In this case, if you look at the "nature" of the price advances and declines since the March/2009 bottom, the greatest pullback occurred in the mid June-mid July period. During that time, price fell from 956.23 to 869.32 (86.91 points). However, in hindsight we can see this was not a true sell signal but merely a pause in an ongoing bull market up trending rally.

Using this "fingerprint" from the last decline, we can set a reasonable stop loss in case the market turns against us. If you look at the bottom of the chart, the Average True Range (ATR) is indicated. The ATR is the average price range over the given time from (in this case, 14 days). The 20 day exponential moving average smooths out this data to give us a reasonable figure.

On the day of the short term sell signal (16 June), the 20 day ema of the ATR was at approximately 20. We can see if we had used 4 x the ATR that would have given us a calculated stop loss of 80 points. Given the final decline (86.91 points), we would have been stopped out of what turned out to be not a reversal but a correction of the ongoing price rise. As such, we know that a 4 x ATR stop loss is too tight in this current market.

Based upon this, we can use 5 x the ATR to give a reasonable stop. The 20 day ema of the ATR currently stands at around 14.49. If we calculate a 5 x ATR stop, that would be 5 x 14.49 = 72.45 points. From the top yesterday (1100.17), our stop as of today would be 1027.72 (1100.17 - 72.45). Should prices fall from here that would be the point at which I would sell my position. However, should prices rise I will continue to move that stop up until it is at least break even (1073.19 based upon the SPX price at which I made a decision to purchase my 50% position in the Provident Fund).


Bottom Line:

The markets have had an incredible run off the March/2009 bottom. In fact, it is an unprecedented advance based upon unprecedented liquidity being forced into the market by the U.S. Federal Reserve.

There is an old saying that you do not fight the tape (stock market price direction) and you do not fight the Fed (based upon the direction of interest rates). Both are still saying you need to be long the market.

Having said that, there is no way to tell exactly how this is going to turn out given we are in uncharted waters with the current U.S. government policies. Hence the reason I have been reticent to enter the markets and have done so with only part of my Provident Fund holdings.

I will continue to monitor the markets over the next few weeks but will not be comfortable "all is well" until we can get above the 61.8% Fibonacci level of the decline (approximately 1230). Until that level is surpassed, I am of the opinion that this is still a rally into a long term bear market. As such, I still think that we will see lower prices (below the March/2009 bottom) some time in the future. My work with cycles indicates we will not be in a "comfortable" position until at least 2015.


As of today my strategic position remains unchanged at a 50% Equity/50% USD cash position.**



**Strategic allocated percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).


Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility. The author is not licensed as an investment advisor in the UAE and therefore cannot provide individual account advice to individuals and/or institutions.

dwaynemalone1@gmail.com

Correction to previous post

I am currently in Melbourne (got called out on reserve very early Sat morning) but have received several emails regarding my last ECAM blog.

When I made the last ECAM post it was done in a hurry (due to other commitments I had to attend to at the time). In do so I made an error in the specific description of the switch.

The description was "generically" correct (ie. a 50% repositioning of the account from USD cash into equities) but it appears many are following my moves to the letter. As such, I have discovered I need to be more specific.

Specifically, I switched out of Blackrock/MLIM US cash into the Fidelity International fund. This has rebalanced the account to a 50% equity/50% USD cash position.

As of today, here is my positional balance:

Fidelity International Fund: 33%

BlackRock/MLIM Equity Fund: 7%

Russell Global 90 Fund: 10%

BlackRock/MLIM USD Cash: 50%

The reason I chose the Fidelity International fund over the other 2 equity funds we have access to (Blackrock/MLIM Equity or Russell Global 90) is it's relative outperformance over the other 2 since the bottom in March and also since the bottom in July. The difference is only a few percent and, over time, will make little difference (as any one of the 3 funds tends to outperform the others for short periods; there is no clear "outperformance" winner in this group) so the choice of which specific equity fund to purchase is irrelevant.

When I return to DXB I will put up a few charts on why I have made this move. I will also go over my investment strategy in detail for those who are new to the site and are a little confused as to how I go about making my investments. I will also discuss how I manage my own personal "C" account through outside brokers.

Note I am NOT bullish on the long term and in no way do I expect this to be a long term holding position. I am still of the opinion we will see much lower prices in our future (when only time will tell) but there is still the potential for considerable further upside in the markets before this rolls over.

For those who are shadowing my moves, please assess your own financial position and risk tolerances before deciding this is what you want to do.

Stocks and Dollar cross key levels

The stock market and dollar on Tuesday crossed key levels.

The dollar is on the verge of a breakdown and the stock market on the verge of a breakout.

Click all charts to enlarge:


SPX 6 month daily:



The SPX has been on a short term buy signal since Oct 07. Price has held up well and held a key support level I have been following when trading my personal account (1071.66).

All short term indicators are on a buy signal.


SPX 2 year weekly:



This market refuses to die. Price last week regained the 1050 support level. The weekly chart remains on a buy signal.


USD 2 year daily:



The dollar is in trouble. It has begun a free fall and there has been little-to-no attempt by the US government to intervene.

Key support at 75.89 was broken yesterday. Minor support now is at 74.48 followed by 70.70.


UUP 2 year daily:



UUP is the bullish USD ETF. Note it is well established in the down trending channel and looks to want to test it's previous low @22.00.


UUP 2 year weekly:



The UUP weekly chart reflects the same as the USD charts. All the indicators on the chart are bearish and, with the exception of the bullish wedge, there is very little to like about the USD.

The only thing that gives me pause on the USD:

1) the percentage of investors who are now bearish is 96%. This this is the highest on record.

2) in the options and futures market, the "commercials" (ie. the big boys) are heavily long the USD. These guys are the "smart money". The small traders are heavily short the USD.....these guys are the "dumb money".


Bottom Line:

Given the above, I repositioned my Provident Fund account as follows:

50% Fidelity Equity
50% Fidelity USD cash

I will watch the USD for the next several days before deciding what to do with my USD cash position.



Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility. The author is not licensed as an investment advisor in the UAE and therefore cannot provide individual account advice to individuals and/or institutions.

dwaynemalone1@gmail.com

Stock Market Update 03 Oct 2009

Many of you have been wondering where the ECAM blog had gone over the past 7 weeks (last post 10 August, 2009). I have received numerous emails over the past few weeks enquiring as to the status of the blog. Rest assured nothing of significance has changed.

I was fortunate to be able to take 5 weeks vacation (leave + days off) and was at our home in Mexico finishing construction on our future retirement abode. Unfortunately the house has yet to receive either telephone or Internet connection services so I was basically isolated from the world for the duration of our stay (which is not necessarily a bad thing).

Having returned to Dubai (to attend to ground school, 6 month refresher, etc), I have now been able to fully analyze the market action over the past month. I look back at my remarks in my last blog and ironically have very little to add:

Bottom Line:

The weekly chart issued a bullish signal based upon the 13/34 exponential moving average cross. Now both the monthly and weekly charts are on a long term bullish signal.

The shorter term daily chart is still bullish but overbought. I am now "officially" bullish but am waiting for a pullback in the daily chart to initiate long positions in the provident fund.

My initial position will be a 50% equity/50% cash position strictly due to the fact we are on the verge of entering the Sept/Oct period (which is traditionally the 2 weakest months of the year as I've shown previous).

It is sensible to believe price will retrace somewhat during this Sept-Oct period. The nature of any such decline will tell me whether my worries about the economy (as discussed above) are overblown and we are at the beginning of a new bull market or whether we are on the verge of the next collapse. In other words, I will be hedging my bets by only being 50% in equities until the economic road ahead is clearer.

I expect the view ahead will be clearer by November and will allow for a better entry of the remaining 50% of my provident fund portfolio at a lower level if all looks well. Alternately, if we do top out here and head down my exposure is limited and I will look to exit back to cash should my mid to long term charts return to bearish.

We are at a very dangerous point in the markets. This could go either way from here into the late fall.

Risk adverse subscribers who have shadowed my moves would be wise to wait in cash until past the Sept-Oct period to commit funds into equities.

Those who are more risk tolerant may want to move in line with my upcoming positions (50% on a short term pullback and 50% later into the fall when I see how the market behaves in Sept/Oct).

I am still holding current positions as of today (approx 16% equities and 84% USD cash). I will immediately blog any changes I make.

In short, very little has changed from a long term perspective. The markets are still overvalued and overbought (though they have begun a correction; see below) and my position remains unchanged.

The best way to work back into this discussion is to examine the current charts. Click on all charts to enlarge and see comments below each chart.


SPX 6 month daily:



In my August 10 blog I indicated the markets were overbought short term and due for a pullback. The SPX at that time was 1010.

The market did indeed pulled back to 978 and then began its next leg up to 1080. Today the SPX is at 1025; essentially unchanged from where it was when I left.

The market is now again in a short term decline from an overbought condition. All technical indicators on my daily trading chart are bearish.

Price as of Friday was at the 50 day moving average; this is a common area where price reverses to the upside. Should this not happen, we could repeat the price action of the last minor correction where price broke below the 50 dma but then found support at the next important support level (as shown on the chart).

Should this happen again we could expect the market to find support at the 978-991 level before the next up leg.

SPX 3 year weekly:



The weekly chart is still bullish. Price has continued to push the upper Bollinger Band and price has found some resistance at the 100 wMA.

Of significance to note is the SAR (Stop and Reverse) indicator has reversed for the 1st time since the bull market began in March. 2009. This unto itself is not a strong reversal indicator but it does raise the caution flag that this correction could be more than the previous ones we've encountered since the rally began.

As long as price remains above the Bollinger Band midpoint (currently 974.09) and the Force Index remains positive this can be viewed as a correction within an up trending market. Should those indicators reverse it would indicate the start of the next leg down in this multi-year bear market.

Stock Market Seasonality:



Stock Market Seasonality:



A reminder we are still in the "dangerous months".

Ironically we got through September with a 3.6% gain. This is very encouraging and if we can get through October without a significant decline it will be very bullish going into the Nov-Apr bullish period.

Having said that, October has the reputation of being the month with the most violent single day declines so it is important to keep this in mind should you be long the market.


Non-US Indicators

I think it is important to note there are numerous markets and indicators I monitor that give a somewhat different picture to the rather benign and bullish picture presented by the previous charts.

Shanghai Index 6 month daily:



The Shanghai index topped at the beginning of Aug and has been in decline since. It had a minor bullish pop in early Sept but has resumed the downtrend the past week. This is not a particularly encouraging sign (see below).

Shanghai Index 3 year weekly:



Note the Shanghai Index bottomed in Nov, 2008 and led the world out of the stock market meltdown. Bearish readings were recorded 4 weeks ago and the index is now officially in a bearish decline as far as my indicators are concerned.

So far price has held up relatively well but there is very little price support between it's current price and it's Nov, 2008 bottom. It would not take much to send this right back to the bottom (and the rest of the world's stock markets with it).

If the Shanghai Index has indeed become the leading world stock market index, this needs to be watched closely.

Given the above, we need to explore what I feel are the top indicators to monitor China.

The first charts are the Baltic Dry Index:

Baltic Dry Index 6 month daily:





The Baltic Dry index is basically an index of the cost of shipping bulk non-liquid cargo (i.e. ex- oil, natural gas, etc) worldwide. A high Baltic Dry indicates robust raw material shipping activity (high demand for ships) while a low Baltic Dry indicates low demand for shipping.

Note on the daily chart peak shipping rates occurred in June and have been on decline since. This is a strong indication that the shipping of raw material goods used in manufacturing (mostly China) has peaked and is in decline. This is not a good sign of strong future economic activity.

Baltic Dry Index 3 year weekly:



Note the Baltic Dry bottomed at the end of Nov, 2008 and peaked the 1st week of June, 2009 (as did the Shanghai Index). This is not a sign of robust future economic growth; it is a sign of a future reversal of the bullish growth forecasts currently being put out into the markets.

Copper 6 month daily:



One of the most important raw materials used in building and electrical components is copper. It is a great "lead indicator" of future manufacturing activity.

Does this chart look like a top occurred in late Aug-early Sept? It does to me.

Copper 3 year weekly:



On this 3 year chart it is evident it bottomed in mid December, 2008 and appears to have topped in late Aug, 2009.

Is that a bullish indication?

Lumber 6 month daily:



In addition to copper I like to monitor lumber. The unique thing about lumber is it is harder to stockpile for extended periods of time (which you can do with copper and other base metals). As such, it is more of a "real time" indicator of construction activity.

The daily chart shows a double top with price declining since early August.

Lumber 3 year weekly:



On the weekly chart lumber bottomed slightly later than copper (early March, 2009) but topped in mid June, 2009.

Is it reasonable to assume lumber rose in anticipation of an economic recovery (especially in housing in the US) but now is telling us that view was mistaken.

I believe it is so.


To add to the puzzle, let’s look at the bond market.

First, it is important to understand the bond market is MUCH more important than the stock market.

Size wise, here is the contrast:

Size of Bond vs. Stock Market:



The bond market is the 6000 pound elephant in the room. You ignore it at your peril.

TNX 6 month daily:



The daily chart of the yield on the 10 year treasury has been on decline since the second week of August.

This is telling us the bond market believes:

1) inflation is not a problem; deflation is more likely
2) economic expansion as a result will be slow to non-existent

The 3.265 level had been a floor that had held since July; it broke down on Thursday. This is a very dangerous sign for the stock market.

TNX 3 year weekly:



Note on this chart the last time we had this set up in the bond market. It was August, 2008 and just before the huge plunge in bond market yields (and with it stock prices).

There is some support around the 30.54 level on the weekly chart. If that doesn't hold there is a good chance we revisit the bottom at 20.38.

Should this retest occur it will result in a stock market collapse that will take us below the lows in March, 2009.


USD 6 month daily:



The USD is in a declining channel as indicated on the chart. It is short term bearish but close to turning bullish. A bullish dollar will be bearish for stock markets given the inverse corrolation that has been evident over the past year.

Price needs to break above 77.43 to have any chance of getting a rally going.

There is strong overhead resistance all the way up to 81.47 and the only way it is going to get through those levels is with a significant stock and bond market collapse.

USD 3 year weekly:



Bearish on the weekly chart. Price appears to have found support at the resistance level of 75.89.

It would take a weekly price close > 78.84 (Bollinger Band midpoint and coincident 100 wMA) to switch the weekly chart to bullish. A break of 75.89/74.31 and we go back to test the bottom at 70.70. If we do so, I do not believe it will hold.


Bottom Line:

No change. The markets are in a short term decline. If price finds a nice support level and the bond market cooperates, I will move into a 50% equity position on a buy signal on the daily charts. The other 50% will be moved out of the USD and into the Australian dollar (given the inverse dollar/stock market relationship that currently exists and the Aussie exposure to China which would need to lead any further stock market gains).

Should stocks collapse the USD will be the place to be. Should this occur I will remain in my 100% USD cash position.


As of today my strategic position remains unchanged at a 100% USD cash position.**


(Actual holdings approx 85% cash, 15 % equities due to ongoing monthly equity purchases through the company required provident fund contributions)

**Strategic allocated percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).


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