The S&P hit the glass ceiling

As expected the S&P was unable to penetrate resistance at the 90 DMA at least on it's first attempt. Now the question is do we get a test of the lows, maybe even a very mild test and then off to the races again or are we seeing a dead cat bounce with more pain to come.

First off let me say the odds are stacked in favor of the bottom being in. No doubt about it. We are entering one of the most seasonally positive times of the year. We just came off some pretty severe breadth and sentiment extremes. We should be set up for a nice rally.

Here's my problem or problems I should say. First off if we were to make new highs then this would move the bull up to the second longest 4 year cycle in history. Second we obviously have the catalyst in place for the 4 year cycle low to happen with the credit crunch and subsequent damage to the financial sector. On top of that we can add the spike in oil that has always preceded or accompanied recession in the past. A bond market that is saying something ugly is coming. Widening credit spreads between T-bills and the 2 trillion dollar commercial paper markets. BTW I have trouble seeing the Fed cutting especially 50 if the market is rallying big into Dec. 11th. And the biggie. Almost everyone thinks the bull market is back. Can it really be that easy? The biggest financial crisis in years and all we get is a meager 10% correction and then it's back to the races with a 5% move in 4 days.

First off I don't know about you but the markets have never been that easy for me. Another thing I don't recall is bull markets moving straight up like a rocket. Don't bull markets climb a wall of worry? I'll tell you what does jump straight up and that is oversold rallies in bear markets. That's how the bear keeps everyone on board for the full trip down. You don't believe me? Just look at the 2000-2002 period. Heck just look at the BKX for that matter. It's obviously in a bear market and we continually see these big rallies that ultimately fail as investors continue to try and pick the bottom. BTW everyone seems to be calling the bottom in the banking sector also.

Some of the biggest one day and one week rallies in history occurred right in the middle of one of the nastiest bear markets.

Now let me state again the odds are highly in favor that we've put in an intermediate bottom. Let's just say I'm still a bit skeptical.

Position size again

This is going to be probably the most important post that I will do this year. I've gone over this before but I'm going to go over it again because I think it's doubly important right now as we possibly head into the 4 year cycle low. Position size!!!

As one might expect I received quite a number of e-mails the last two days from investors freaking out about their short positions.

Now let me reiterate again that I'm not going to be like 99% of the other bloggers and newsletter writers on the Internet. I'm not going to brag about how accurate my calls are and what a great record I've got yada yada yada. Sure it's great for subscriptions but I didn't really start this to sell subscriptions. I started the blog to help novice and intermediate level investors improve their investing skills. (Many are the days I wish I'd never started this. It's become a monster that's eating up way too much of my time.) Sure I've had a few good calls lately. I can tell you unequivocally that it was luck. Pure D luck. I'm going to tell you a secret. No one, not me, not Trade, not F-Trader, not Pattern Guy, not Mr. T, not Richard Russell, not John Hussman, not Dennis Gartman, not Warren Buffett, no one can see the future. I've guaranteed before that I'm going to be wrong on probably 40-50% of my calls. Over the long haul trust me I'm correct in telling you this. It is just senseless to search the newsletter world or Blogosphere looking for someone to confirm your bias.

So how does this relate to position sizing you ask? Well here's what I see happening. From the amount of e-mails I've received quite a few investors are now on the short side. Which by itself is not a problem. Maybe I'm right about the 4 year cycle low and maybe I'm wrong. The problem is that these investors shouldn't be freaking out about a 4% bounce after the market has dropped 10%. At most they shouldn't have more than a 4% drawdown on their account and that's only if they went short at the exact bottom. If you were watching your position size you should only be down 1% or at most maybe 2%. That's nothing to freak out about.

I'm going to say it again. There's going to be huge money to be made in the commodity bull market but you can't make it if you get a case of the stupids and lose everything trying to bet too big on the decline. Big money is never ever made in bear markets, unless you take on leverage, simply because markets can only go down 100% and realistically a bear market is probably going to drop no more than 20-30%. Bull markets can easily go up 1000%.

Here is my motto and has been for several years. "If the market is going to take away any of my money it's going to have to fight me tooth and nail to get it and you better believe it's not going to get very much at any one time."

BKX

I think this is the key to whether the market recovers and goes higher or whether the rally yesterday and today was just a pressure release of extreme bearish sentiment. So far the piggies are still making lower lows and lower highs. I suspect they still have many skeletons in the closet that haven't popped out yet. If the BKX rolls over again and heads down I have a feeling we're going to see more downside for the markets. As we all know I think we are heading into the 4 year cycle low. It is possible that the 4 year cycle low was put in with a 10% decline. It would be the smallest cycle low in history if so. It would also be the shortest peak to trough cycle low. It is possible the Fed has done away with 4 year cycles aka the business cycle. It's also possible the Fed has now done away with ever having another recession. Let's just say I'm a skeptic.

weekly chart

So far I just don't see any reason to get rid of my short position or to doubt the Dow Theory primary sell signal. Notice also that the S&P still isn't even oversold on the weekly charts yet.

A great start to the holiday shopping season

The media would like us to believe that the holiday shopping season started out with a bang. For some reason the retail stocks don't believe the spin. But then of course there's no inflation either. Jeez It makes you wonder how long it takes before people realize the king has no clothes.

"You find out who's been swimming naked when the tide goes out." - Warren Buffett

Cycles

I've posted two long term charts of the Nikkei and the S&P showing the 3 year cycles in the Nikkei and the four year cycle in the US markets.

In the first chart we see the secular bear in the Japanese market. It started with a 2 1/2 year decline from the late 89 peak to the 92 bottom and an initial loss of over 60%. What followed was a series of right and left translated cycles until the bottom in 03. That's a 13 year bear market. Notice the right translated cycles end very quickly and the left translated ones tend to just grind lower. Also notice the first counter trend rally ended in a right translated cycle and a vicious waterfall decline. The remaining cycles were all left translated and each successive 3 year low ended lower than the preceding one. The current cycle looks to be a left translated cycle or possibly a very shortened right translated cycle. It's also entirely possible the secular bear market in Japan isn't over yet. The slowing US economy has the potential to drag down the rest of the global economies. The action in the Nikkei is becoming rather ominous.

Now let's look at the US market. Here we see the same series of cycles only the US cycle is a 4 year cycle. We also see that right translated cycles have ended in violent moves downward even in a secular bull market. We see the cycle that topped in 2000 was a left translated cycle that ended the great secular bull market that started in 74. The normal 2- 2 1/2 year decline that followed is typical for first legs down in secular bear markets. During this decline the S&P lost almost 50% of it's value. We now have the third longest 4 year cycle in history. This cycle is now coming to an end and it's doing it in the overall context of a secular bear market. It's probably discounting a recession. Maybe even one that's already started. By the action in the Nikkei and China it may very well be discounting a global recession. This has the potential to be a very wicked bear move if it ends like other right translated cycles have ended and if it is in fact discounting a global recession.

Bonds have spoken

The bond market dwarfs the stock market. It's also generally considered that bond traders are a more savvy lot that stock traders. You don't really find Joe Sixpack trading bonds. These markets are the dwelling place of institutional investors aka the smart money. When the bond market starts talking it's usually a good idea to listen. Well the bond market lately has been doing more than talking it's screaming at the top of it's lungs. Notice how the bond market rolled over in early 2000 just prior to the market topping out. This is usually the case about 90% of the time. Bond traders will spot problems on the horizon before stock traders and start allocating capital to "safe" investments. Now take a look at the 3 month T-Bills. What we see happening in the last few months is an unprecedented flight to safety. This move even makes 98 look tame. Remember the upheaval in 98 produced a 20% correction in the market. What does the current state of the bond market say about the future I wonder?

S&P has now broken the 65 WMA

The S&P has now broken through the 65 week moving average. This has contained all corrections so far in the cyclical bull market. Notice that -2.88% in the top right hand corner of the chart? The period from Friday's close to the Wed. close before Thanksgiving is historically one of the most bullish times of the year. Well this year we just got the second biggest decline during this period in the last 27 years. The only year that exceeded 07 was the period in 2000 as the market was rolling over into the first leg down of the secular bear market. I also see a lot of discussion leaning towards another rally to let the big money out at higher prices. Unfortunately I think investors are probably going to be disappointed in this hope. We already had that rally out of the summer bottom. I mentioned during this time in the dailies that Lowry's buying pressure was not increasing and that selling pressure was spiking as the market rallied. This is not what we should have been seeing as the market moved higher. In hindsight it seems pretty obvious that the smart money was unloading stock to the little guy all the way up. I also mentioned the extreme ROBO (retail only, buy to open) levels of call buying and the extreme ratio of volume on the Nasdaq compared to the S&P. Both of these were signs of extreme speculation by the little guy at the same time the big money was jumping ship. At the present time the Nasdaq volume is still way to high. The smart money and media are now in an all out campaign to convince the retail investor that tech stocks are the place to be as protection against subprime fallout. Low and behold the sheep are falling for it all over again. They haven't learned a damn thing since 2000. First off this recession isn't being caused by subprime problems. Granted it's not helping matters. It's being caused by inflation. The same thing that was the Achilles heel of the 70's markets. We are currently in the exact same investing climate as the 70's and the Fed is trying to use the exact same methods to solve the problems. Namely printing money. Predictably we are now getting the same results. Spiking energy costs are the noose around the global economies necks not subprime loans. Tech is not going to be any protection against a contracting economy. As a matter of fact it will most likely be the worst area to be in. Everyone should read the quote on the home page by Edwin Lefevre and decide if they wish to avoid a similar fate. By the way he is talking about the 29-32 bear market.

BTW If you are reading this on Thur. then you are obviously a fanatic about the markets. Get out of here and go enjoy Thankgiving with your family :)

Point and Figure charts: not a rosy picture

Despite today's little rally attempt the markets are not on solid footing. Looking at the point and figure charts we see a descending triple bottom breakdown, another descending triple bottom breakdown and another descending triple bottom breakdown. The test of the Aug. close might have failed today but I doubt that will be the last test and I'm not so sure the next time it's going to hold. All three charts are now in down trends until otherwise notified.

65 week moving averages violated

The S&P has now dropped below the 65 week moving average. Other than one week during the summer 06 correction this average has contained every other decline. If this is just a correction we need to see this level recovered soon. The Wilshire has also violated the 65 WMA . The Russell is in considerably worse shape than the broader market. Finally the transports look like it's going to take a miracle to revive this chart.

Troubled sectors

I've included a few charts today of specific sectors that are already in a bear market or are dangerously close. Of course we all know the financials are in trouble. The thing that's troubling here is that they make up 20% of the S&P. Unless they can all of a sudden find new life and start rallying strongly I don't see how the general market is going to make a lot of headway. The other obvious one is housing. No need to elaborate there. Third on the list is retail. This one is concerning since we're in a time of year when retail should be moving up strong as it has every other year since 03. Instead it's dropping like a stone. Since the consumer is 70% of totally GDP this just doesn't bode well. The transports are also flirting with bear market status. I could have also included the semi's here. The SOX rolling over right before Christmas isn't a particularly bullish development either.


The last one is a chart of the Nikkei which is now down 18%. The third largest economy in the world is heading into a bear market. If all this talk of the global economy still being strong is correct then why is Japan heading south?

Secular Bear markets

Looking at the first chart and keep in mind the effects of inflation does this really look like a new secular bull market sprang out of the ashes of the bubble bursting in 2000-02.

Now take a look at the second chart of the late 60's to early 80's. This is what a secular bear market looks like and I think this is what we're in store for in the coming years.

How about a peek at the Nikkei in the 90's. Secular bear markets don't end over night. They surely don't end in 2 1/2 years. To think the decline from 2000-2002 was the end of the bear is a little absurd in my opinion.

semi's lagging

The semi's are a very good indicator of economic strength. When demand is high it's a good sign of economic growth. Notice on the first chart how the semi's resisted making new lows in 03 as the market was putting in the final low before the multi year rally. Now look at the recent chart of the semi's. Does this look like strong economic times ahead to you? I think today was just an oversold rally. This is how the bear keeps everyone riding all the way down. As I've said before markets go up different than they go down. The bull does his best to buck you off and the bear (that sneaky bastard) will do anything he can to keep you on board for the full ride down. If you let emotions control your investing decisions then they will both be successful. Remember our objective is to beat the market not let the market beat the crap out of us.

I've added the chart of copper, also a good indicator of global economic strength.

Watershed event????

Keep in mind that what I'm going to show you doesn't mean that we are in for a similar event but then again we could be. I've pointed out before that extremely right translated bull markets tend to end in very quick nasty bear markets. Ones that are extremely long tend to produce even nastier endings or a waterfall decline if you will. The two longest 4 year cycles in history were the 32-37 bull and the 82-87 bull. Look at the charts to see what the outcome of each one of those was. A 42% decline in 37 and a 35% decline in 87. Take special note of how fast this devastating drop occurred. The current 4 year cycle is the third longest in history.

Now I see on CNBC that most everyone thinks we are searching for a bottom. Quite a few are expecting a 10% correction. I even heard one analyst say we were due for a 10% correction. ?????? Didn't we just have one a couple of months ago? Why on earth should we be due again already? I also see may traders on the blogs positioning to catch the "coming powerful bounce".

Let me just point out something. A watershed event if indeed that's what we're in for is the most powerful move in the stock market. Why oh why would you want to stand in front of something like that? Does the phrase "trying to catch a falling piano" mean anything to you? Now take a look at the waterfall decline in the 93 Nikkei. Again we see the 2 1/2 month move with most of the decline occurring over 23 days . There were only 3 days were a trader could have realistically made any money on the long side. How many losing trades would you have had to take to catch those three days and in the meantime you are missing out on the move of a lifetime. In this type of event you don't try and catch a counter trend move. If you get one then great use it to add to shorts but for heavens sake don't stand in front of a train that size.

The Line in the Sand

Here's the line in the sand 12,845. If the Dow closes below that level we will have a primary Dow Theory sell signal. Nuff said!

Transports in trouble

I pointed out to subscribers the other day when the transports closed below the Aug. 16th close that we now had a Dow Theory nonconfirmation. Let's take a look at the weekly chart of the transports shall we. We see the 65 week moving average that has supported every decline since the 02 bottom decisively penetrated this week. We see that moving average ready to roll over unless the transports can mount a powerful rally and quickly. The tranny's are already down 16% from the peak. We are dangerously close to an official bear market in the transports. What's even more disturbing is this index still isn't oversold on a weekly basis yet. True bear markets can not only get severely oversold but they can stay oversold. I'll be watching this closely.

Cash Flow

Tonight I want to talk about cash flow otherwise known as income. From what source do you get your income? What does this have to do with investing you ask? We’ll get around to that in a minute.

First off let me say that if you want me to show you how to put together options strategies I can’t do it. If you want me to tell you what a calendar spread is I have no idea. I have no expertise with complex hedging systems (which BTW are a waste of money unless you are a large hedge fund that can’t sell your positions without moving the market). I have no idea what the Black Scholes model is other than a way to determine option value. I have no expertise in any of these areas and I must confess that I have no desire to acquire any. There is just no need to know this kind of stuff to make money in the markets. This is all just a way for investors to make something that should be simple and boring into something that’s complex and exciting. I get plenty of excitement by hanging off the side of mountains. I want to keep my investing strategies simple.

Now what I am half way decent at is seeing the big picture. I can see the forest and not just the trees :)

Now how does cash flow fit into the big picture you ask? Well first off let’s look at the different types of cash flow.

Let’s start with earned income. A job! Security, risk free right? Well maybe and maybe not. I think before I’m done we are all going to see that there is no such thing as risk free cash flow. Security… maybe unless we have a recession then unemployment is going to soar. Also technology is now advancing rapidly. Most of the scientific discoveries ever made in the history of the world have occurred in the last 20-30 years. Your job skills could and probably will become obsolete quickly in this changing world. Also as I’ve stated before I think we are in an inflationary environment. During times like this businesses are going to have their profit margins squeezed. At times like this it is hard for business to raise payrolls enough to match rising input prices. Bottom line the employees of the world are going to get hammered by rising prices and stagnant wages. Also if you are in this category the government is going to take their chunk before you ever get your hands on your paycheck. Needless to say as an employee you have no tax advantages.

Now let’s take a look at passive income starting with real estate. First off real estate has great tax advantages. One thing going for it. If you had bought real estate back in the early 90’s you could rent your property, get a positive cash flow and on top of that normally your property would be appreciating as someone else paid for your asset. I think it’s safe to say that that category of cash flow is now kaput. Not only can you not purchase real estate at a price that will let you get a positive cash flow but your property will most likely be depreciating for the next 10 years. I think we can all agree that this category is now too risky to invest in.

How about risk free bonds? I’m going to show you why bonds are about as far away from risk free as you can get at this time. Almost as bad as real estate. Let’s say you bought $10,000 worth of 10 year notes in 2000 yielding 6.75% annually. Now let’s use that gallon of gasoline as a proxy for our inflation gauge since everyone is dependant on it. At roughly $1 a gallon your original $10,000 would buy 10,000 gallons of gasoline. Compounding that return for 7 years we get $16,860. Now let’s take that gallon of gas which is now costing $3 and see how many we can buy $16860 / $3 = 5620 gallons. Son of a B****. The damn government just stole half my purchasing power on a risk free investment. Let’s just say that inflation is just now getting started good. Let’s also agree that we don’t want to make that mistake again.

That leave’s us with two options that I think have a better chance of actual returns.
The first is to start a business. I personally have owned several businesses. There’s nothing better than being your own boss and having other people work for you. On the other hand there’s nothing worse than being the one that has to be there to solve any problems when they happen because your employees are not going to take your problems home with them. It will be up to you to handle life’s little curve balls. This of course isn’t risk free by any means either. Especially in the coming times of high inflation it’s going to be challenging to start and keep a business alive and well. But at least you are in charge not someone else. You also have some tax advantages. You get your hands on your money before the government. If you desire you can use some of those profits to expand your business or as investing capital before the government takes its share.

Now the last category: investing. For our purposes we’ll stick to investing in the stock market. Also I think we all will agree not risk free. As I’ve said many times now I think we are in a secular bear market for paper assets and a secular bull market for commodities. If you had bought stocks in 2000 you have lost a tremendous amount of purchasing power even though the Dow is considerably above the highs of 2000. Even if you bought the Dow at the absolute bottom at say 7000 and are now up 100% you have still lost purchasing power compared to that gallon of gas because that gallon of gas has increased 200%. So even if you are the best market timer in the world you have lost half your purchasing power. However if you had bought oil in 2000 you have not only kept up with inflation but you have vastly outpaced it. Same with almost all commodities. So if we are going to produce cash flow in the markets we either need to be both an excellent market timer and a great stock picker or we need to be invested in commodities because that’s were the real bull market is. On top of this investing has advantageous tax breaks if you are a long term holder. At the moment long term capital gains are taxed at a 15% rate as opposed to as high as 35% for short term gains.

Now I’ve gone over all this because I think we are quickly coming to the end of the “fun” times for this monetary inflation period. The Fed is now in a box. They need to cut rates to keep the economy growing. The last two rate cuts have produced a brief rally in the stock market that has quickly faded away and put the dollar in jeopardy of a waterfall collapse. If this were to transpire inflation would skyrocket. Here’s what I think is going to unfold. The Fed is going to have to hold off on more cuts and the economy is going to stagnate. When this gets serious the Fed is going to have no choice but to cut. The dollar collapses and inflation really starts to take off. Maybe we even see hyperinflation. This puts an even bigger strain on the economy as paychecks can’t keep up with rising prices. Standards of living decline. Multiple recessions take their toll on the economy. At some point we will have to suffer through a bad recession or possibly even a depression to clean out the excess built up during the bubble years. Historically a depression happens about every 75 years. At some point a Fed president will have to be willing to flush out all the excess liquidity like Volker did but this is going to be very painful and I have a feeling the powers that be will put this off as long as possible thus making it infinitely worse than it has to be.

Cautiously bearish

I have now turned cautiously bearish. I've elaborated my reasons in tonights daily update. I may be wrong and kind of hope that I am as the US is in no shape to withstand a recession at this point.

bull market rallies

As many know by now I like to take a longer term outlook on my investments. To that end I often prefer to look at the weekly charts and also multi year charts. Sometimes we get so caught up in the day to day happenings that we forget to step back and see what's actually going on. Today I'm posting a chart of the XAU but the principles are quite often the same for most stocks or indexes. Typically what happens is we see a strong rally followed by a correction or consolidation. The retail investor trading on emotion usually doesn't trust the move until it's about over and consequently often enters close to or at an intermediate top. If he does get in in the middle of the move he is often so nervous that he can't hold on to his position for more than a couple of points. He then either gets knocked out by the correction or worn out by the consolidation. Notice how each successive consolidation has been longer than the preceding one and each rally has been larger and now they are becoming steeper also. This latest rally is really breaking the mold for parabolic moves so far. I think the reason for this is the market realized that the Fed decided to sacrifice the dollar to try and save the economy by entering a rate cutting cycle. Now this is just my personal observation but it seems like everyone is expecting a rally in the dollar and that of course would mean a crash in gold. Several members of the Fast money crew have been talking down gold for the last $100 or so for that very reason. However taking a look at the size of the consolidation and the extreme hesitancy of investors I've got to wonder if we

don't still have a ways to go yet. So far even though this move has been parabolic in nature it still hasn't even come close to matching the size of the other three uplegs.

The bigger the consolidation the bigger the bull

I've noticed that often the size of a consolidation will give one a clue as to how big the rally will be once that consolidation is complete. Often the length of the rally will approximate the duration on the consolidation. I'm not necessarily talking time wise here since a powerful rally will often cover a lot of distance rather quickly. What I'm suggesting is that the length of the consolidation can give us a target for the magnitude of the following upleg. In the first chart of gold we see a 9.5 month basing period that was followed by a rather large rally that actually exceeded the size of the consolidation by a bit. In the next chart we have every ones favorite bubble, China. However look at the sheer size of the consolidation during the devastating bear market from 01 to 05. That my friends is a 5 1/2 year consolidation from a bear that took away more than half the value of the Chinese market. It looks to me like the upleg is still a bit short of matching the magnitude of the consolidation. Now lets look at my favorite market, Gold. What we are looking at is a 16 month consolidation of the gold market. This would suggest a tremendous move is now underway. As bulls are want to throw off as many riders as possible we are already hearing the cries of gold topping out. Hell, it doesn't even look like it's getting started good yet. My suggestion is to ignore all the naysayers and let the bull make you money. All the doom and gloomers are going to do is cause you to miss one of the greatest bull markets in history.

Nicolas Darvas

Today I'm going to tell you the story of Nicolas Darvas. The short version. Actually the very short version. Darvas was a professional dancer who made over 2 million dollars in the stock market from an original stake of $8,000. Basically he found a system he could stick to (his box theory) and then he followed it. However and this is what I found very interesting, as long as he was overseas and away from the stock market he made money. His broker would send him the tape once a week. That's it! He wasn't distracted be the constant noise of daily news, wall street hype, etc., etc. He just watched the tape once a week.

But then he decided that he could improve his investing if he went to New York where he could be in the middle of the action and get the latest happenings as they unfolded. So what do you think happened? That's right he immediately started to lose money. You want to know why? Because all that worthless noise played on his emotions till he couldn't stick to his system that's why. My suggestion is you turn the damn TV off and ignore all the crap that the media and wall street put out every day. Just look at your positions once a week like Darvas did and I suspect you will have a much better chance of achieving results like he did.

Ever wonder why Buffett lives in Omaha, NE?