A muted investor response to the new all-time high

Investors remain curiously reticent in the face of a new all-time high in the S&P 500 Index (SPX).  The latest AAII investor sentiment poll showed a slight drop in the percentage of bulls to 38% from last week’s 39%.  Meanwhile the percentage of bears fell from last week’s 33% to 29%.

While bearish sentiment is admittedly low, bullish enthusiasm is also relatively muted given the extent of the market rally in the first quarter of 2013.  Bull/bear sentiment readings are similar to what they were in August 2013 after the market rallied for 10 weeks before settling into a lateral consolidation pattern for a few weeks.  This was followed by yet another rally in September.

Bottom line: Until we see a notable increase in bullish sentiment the interim market uptrend will most likely remain intact.

Will Europe sink stocks and boost gold?

Wall Street expressed relieved that Europe’s central bank agreed to release 10 billion euros ($13 billion) of emergency rescue funds for Cyprus.  In exchange, Cyprus agreed to shrink its banking industry, cut its budget, implement economic reforms and privatize some state assets.  Although the measures are expected to result in heavy losses for Cyprus’ bondholders and large depositors, Wall Street was just glad to dodge another bullet.

 

Optimism over the lack of panic in Cyprus pushed the S&P 500 (SPX) to a record closing high.  The new high in the SPX was preceded two days earlier by a new high in the NYSE Advance-Decline (A-D) line, a sure sign that higher prices were ahead.  Internal momentum on the NYSE is also still rising, which helps dictate the path of least resistance for stocks in the near term.

 

The big question on investors’ minds is how much longer the U.S. stock market can continue to avoid Europe’s increasing troubles?  It has been 130 days since the market has seen a pull back of at least 5-10%.  Many investors wonder if we’ll ever see such a pullback again as long as the Federal Reserve has the proverbial “pedal to the metal” with its loose money program.  The answer to this question is more than likely “yes” considering that the market has always had such corrections in previous quantitative easing (QE) periods. 

 

Witness the declines in the stock markets of several major European nations as well the continued weakness in the euro currency.  European bourses were considerably weaker for the week, led by a fresh new quarterly low in the euro ETF (FXE).  Spain’s IBEX 35 stock index was down by as much as 6%, testing its quarterly low while the Italy ETF (EWI) dropped 5% in a 2-day period..  The country that got the euro zone avalanche started back in 2010 – Greece – saw its stock market decline to yet another new low today via the Greek ETF (GREK) shown below. 

 

 

As Sharps Pixley pointed out, “Although the Finance Ministers highlighted that Cyprus is a special situation, the European banking crises and contagious effects are very real.”  Italy meanwhile still doesn’t have a government.  Each of the stock markets and country ETFs mentioned above present a picture of a weakened continent vulnerable to even the slightest bad news. 

 

Speaking of financial contagions, Randall Forsyth, writing in this week’s Barron’s, pointed out the history of overseas financial crises and how they all have a history of eventually making their way to the U.S.  Sixteen years ago the Thai baht became the first major currency to fall in the Asian currency crisis.  That crisis eventually spread beyond the region and made its presence felt in the U.S. and around the world.  The collapse of Long Term Capital Management hedge fund in 1998 and near meltdown of the global financial system was a result of that contagion. 

 

“In 2008,” wrote Forsyth, “Iceland was the improbable site of a credit bubble and bust.  Money flooded into the island nation’s burgeoning banks in pursuit of high returns.  Eventually, the amount at issue grew to about 10 times the size of Iceland’s economy.  But the bubble’s collapse led to defaults to foreign creditors, notably those in the U.K. and the Netherlands, and a massive devaluation of Iceland’s currency, the krona.”

 

Then there was the crisis with Greek government bonds in 2010 which required a massive bailout.  The crisis in Greece spread to banks in Ireland, Spain, and Portugal, with spillover effects on U.S. equities. 

 

The fear among investors is that Cyprus’ move to essentially penalize large bank depositors will feed a larger fear that this will become the norm in troubled European nations.  Rana Foroohar pointed out in the latest issue of Time that the current Cypriot government was voted in because it promised to protect bank deposits.  “Even if small depositors end up safe,” she wrote, “even if Cyprus doesn’t become the economic equivalent of the assassination of Austrian Archduke Ferdinand, which started World War I – the damage to trust has been done.”  As Mohamed El-Erian, CEO of PIMCO, pointed out, “The population is quickly losing confidence in the political order.”

 

All of which is to say that the fatal concoction of European bank troubles and a weakening euro currency along with depositor/investor mistrust of banks could easily result in another financial contagion in the coming months.  And this is just the sort of thing the gold market could use to reverse its fortune.

How the Fed increases the cost of living

Is the Fed’s QE program increasing food and fuel costs for consumers?  Peter Kenny, managing director at Knight Capital Group, thinks so.  In an interview with Breakout.com he stated that the Fed’s QE policy is pushing up the price of fuel, which in turn raises the price for everything else in the economy.  While monthly headline inflation data is below the Fed's 2% target, Kenny and many other market watchers see it showing up elsewhere “in everything we assume is a part of our daily life.” 

According to Kenny, QE is pushing up the price by about 50% instead of the $65 a barrel level where he believes it should be based on current supply and demand.  Since the Fed is actively injecting more money into the economy, he says that has resulted in “more dollars chasing that fuel” leading to higher prices.

Kenny also sees evidence of the Fed’s intervention in the stock market.   “The soft bid we see in equity markets and that we run into every time there’s a sell-off, that soft bid is the direct result of quantitative easing.”

Few investors doubt the effects of the Fed’s stimulus efforts in boosting oil and stock prices.  Without the impact of higher oil prices the effects of the deflationary long-term cycle would be evident in every sector of the economy.  What’s debatable is how it all ends.  Will the Fed succeed in beating the 120-year deflationary cycle scheduled to end in 2014 with its QE policy?  Or will the structural forces of deflation prevail despite the Fed’s strongest efforts as we head closer to the final bottom of the cycle? 

Mr. Kress himself always believed that while stimulus could temporarily soften the blow of the cycle, no amount of central bank/government intervention could ultimately stop the Master Cycle of inflation/deflation.   It’s too early to say with any certainty that Kress was wrong but we’ll at least have a better idea just how power the Fed has over the market once we see the market’s reaction to the upcoming quarterly cycle peak.

Could Cyprus crisis catalyze a return to gold?

The psychological impact of the capital controls in Cyprus – and its potential spread as a “contagion” – won’t be clear until later this week.  But the damage to Europe’s leading financial centers is already conspicuous as the charts demonstrate.

Witness the declines in the stock markets of several major European nations as well the continued weakness in the euro currency.  European bourses were considerably weaker on Monday and Tuesday, led by a fresh new quarterly low in the euro ETF (FXE).  Spain’s stock market was down 2.27% on Monday and down an additional 1.84% on Tuesday. 

Spain’s IBEX 35 stock market index is testing its quarterly low while the Italy ETF (EWI) dropped 4.06% on Monday and a further 1% on Tuesday.  The country that got the euro zone avalanche started back in 2010 – Greece – saw its stock market decline to yet another new low today via the Greek ETF (GREK) shown below. 

As Sharps Pixley pointed out, “Although the Finance Ministers highlighted that Cyprus is a special situation, the European banking crises and contagious effects are very real.”  Italy meanwhile still doesn’t have a government. 

Each of the stock markets and country ETFs mentioned above present a picture of a weakened continent vulnerable to even the slightest bad news.  If Cyprus bank depositors run the banks on Thursday (when the banks in that country are scheduled to re-open) it could send shockwaves through the financial market of Europe.  This in turn would be the catalyst for a return to gold among investors, especially in troubled European nations.

A closer look at consumer spending

“One often talks about ‘the consumer,’ but there’s no such thing. As a rule of thumb, the top 20% of income earners account for about half of personal income and half of consumer spending. Spending for the top 20% of households shouldn’t be affected much by the payroll tax increase, delayed tax refunds, or higher gasoline prices. Moreover, stock market wealth gains will add somewhat to spending.

“Note that the stock market wealth effect on spending is relatively small, but a large enough change in wealth can certainly move the needle on spending. The wealth effect is also asymmetric. A 20% rise in stock market wealth may add about 0.6% to spending, while a 20% decline might reduce spending by about 2.0%.

“For the other 80%, the payroll tax increase and higher gasoline prices matter a lot. Recall that, for a household making $60,000 per year, the payroll tax increase reduced spending by $100 per month. The payroll tax reduction of the last few years was perhaps the most unadvertised tax cut in history. Most people were unaware that the cut had occurred, but the added take-home pay helped support consumer spending growth.

“Many workers were unaware that the payroll tax rose in January. Hence, the impact on consumer spending is likely to show up with a lag. In addition, higher gasoline prices normally have a lagged effect on spending. Gasoline prices may be falling now, but the full impact of the rise in February has yet to be felt.”  [Dr. Scott Brown, Raymond James Financial, 3/22/13]

Cyprus the latest victim of Kress cycle

Just when investors thought it might be over, the drama continues to unfold in the euro zone.

The latest scare out of Europe occurred during this week’s EU Summit.  European finance ministers agreed to extend a bailout for Portugal and Ireland. They also agreed on a 10 billion euros rescue plan for Cyprus, a reduction from the original 17 billion euros.  

The European Central Bank (ECB) had planned on forcing banks in Cyprus to impose a 9.9% levy on deposits compared to the previously announced 6.75% levy on bank deposits up to 100,000 euros.  Cyprus politicians on Mar. 19 voted the levy down in defiance of the ECB, however.  In response the ECB backed down and agreed to proceed with supplying liquidity to Cyprus banks without the tax. 

Had it been implemented, the unprecedented levy could have triggered a widespread panic over similar levies being imposed on other peripheral European banks.  This in turn would have raised additional concerns on the European debt crisis, resulting in capital flight to safer havens.  The mounting problems in Cyprus have increased demand for alternatives such as gold and safer assets such as U.S. Treasuries.  But the move to gold so far has been a slow walk instead of a spirited run.  That could change next week if phase 2 of the ongoing drama in Cyprus doesn’t unfold according to plan.

Banks in Cyprus will remain closed until at least Monday, the same day the country must come up with a plan to rescue its banks or lose the emergency funding that has been keeping them afloat.  In a press release dated Mar. 21, the ECB said it has “decided to maintain the current level of Emergency Liquidity Assistance” until Monday.  “Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF program is in place that would ensure the solvency of the concerned banks.”

The European Union and International Monetary Fund have promised Cyprus 10 billion euros in assistance if the island nation can come up with an additional 5.8 billion euros.  After rejecting the plan to tax insured and uninsured bank deposits, Cyprus is now racing to come up with alternative plans such as borrowing pension-fund assets, selling the island’s two biggest banks and getting a loan or investment from Russia, whose citizens have large deposits in Cyprus banks.  None of these options are very promising, according to experts, and most observers think taxing deposits will be part of any solution.  In Cyprus, bank deposits up to 100,000 euros (about $130,000) are insured.

All of this falls under the category of “the more things change, the more they stay the same.”  It would seem that even after only three years of failed experience, ECB authorities are still trying to impose heavy-handed austerity type measures on the citizens of beleaguered countries.  Italian voters voiced their clear displeasure with austerity in the recent parliamentary elections.  Even some ECB members were forced to concede that the central bank’s insistence on heavy tax measures against member countries isn't working. 

Once again we see Europe’s leaders trying to impose an economy-killing tight money policy on failing nations.  The latest round of turmoil in the euro zone only goes to illustrate that the impact from the falling 120-year deflationary Kress cycle is still being felt and can manifest in myriad ways between now and late 2014 when it’s scheduled to bottom.  Investors in strong countries like the U.S. should remain wary of the potential spillover impacts from the overseas crises, which will likely reach our shores by late 2013/early 2014. 

For now the main trend for the U.S. remains up but this could change if the euro zone and/or China real estate bubble become uncontrollable.  Remember to closely monitor your trading positions and use conservative stops on all trades.

Investor psychology remains muted

For the eighth consecutive week the percentage of bullish investors remains below the historical "danger zone" of 50%.  Bearish investors remain low but not abnormally so.

According to this week's American Association of Individual Investors (AAII) survey, 39% of respondents were bullish on the stock market's interim outlook while 33% were bearish.  This compares to last week's response of 45% bulls against 32% bears.

I would characterize the latest AAII sentiment poll as being relatively benign.  Although the bears aren't numerous, neither are the bulls numerous considering the major indices are hovering near all-time highs.  I can't remember the last time such elevated equity price levels elicited such a muted response among retail investors, can you?  From a contrarian standpoint this is considered supportive of the interim upward trend for stocks.

Needed: a gas price momentum reversal

Continuing our discussion of the U.S. retail economic outlook, gasoline prices have been a double-edged sword for the retail economy.  While higher gas prices boosted retail sales numbers last month, the higher prices have also begun to weigh on consumer spending other areas such as dining and discretionary purchases.  

Lower pump prices are needed to keep the forward momentum in overall consumer spending intact.  The recent pullback in the gasoline futures price is a start, but a decisive break below the technically significant 60-day moving average (see chart below) could pave the way for an even bigger (and economically constructive) decline.  A violation of the 60-day MA would tell us that the interim forward momentum for gas prices has reversed.

Is the retail economy getting weaker?

The New Economy Index chart shown below has recently made lower peaks.  Whenever this has happened it has historically been followed by a temporary decline of the NEI, though not always threatening to the main interim uptrend.  

An NEI “sell” signal means the U.S. retail economy is weakening with results being felt mainly in terms of softer sales of consumer discretionary purchases, but also declining sales volumes for small and mid-size business shippers like FedEx and UPS.  If the NEI declines long enough, it can also signal the onset of an outright economic recession. 

A “sell” signal in the NEI is made whenever the 12-week moving average (red line) crosses under the 20-week MA (black line) and the NEI itself declines below its nearest pivotal low.  As mentioned previously, this hasn’t happened since May 2010 – and at that time the sell signal only lasted a month or two as the retail economy weakened a bit in the wake of the stock market’s “flash crash.”  Otherwise the NEI has been in a confirmed uptrend for most of the last four years.  It will be important then to keep a close eye on the NEI in the coming days and weeks for a potential short-term trend change.

Investor sentiment pulse

Thursday’s release of the AAII investor sentiment survey showed an increase of bullish investors to 45% from last week’s 31%.  Bearish sentiment decreased to 32% from 39% the previous week.  While both the increase in bulls and decrease in bears were fairly pronounced, the real threat to the bull market will occur once the bulls exceed 50%.  At the current rate of 45%, bullish sentiment is still fairly contained and signs of “irrational exuberance” are not yet evident. 

Yet the 14% jump in bullish sentiment and 7% drop in bearish sentiment tell us that investors’ animal spirits are rising.  The market has rallied for three weeks without a meaningful pullback and the latest investor sentiment numbers tell us that the market is getting closer to a correction.  Accordingly, this would be a good time to do some pruning of investment portfolios and raising stop loss levels.

Have cycles been killed by the Fed?

Have cycles have been overpowered by central bank intervention?  This is a question that many investors have been asking in view of the stock market's relentless strength since November.

Some of the short- and intermediate-term cycles that have been historically reliable for predicting periods of strength or weakness in equity markets have undoubtedly been muted – or in some cases cancelled out completely – by the Fed’s ultra-loose money policy of the last couple of years.  Are we therefore to assume that the longer-term yearly cycles will also be annulled by the Fed?

One of the first things I learned when I began studying financial markets was that “liquidity is everything.”  Liquidity is in fact the single most important factor in determining the health of a market and it can trump all other considerations, be it fundamental, technical or cyclical. 

Consider that the present bull market has continued despite numerous metrics which suggest the rally should have ended long ago.  For instance, corporate earnings growth was lower in the fourth quarter of 2012 than in the previous year.  Yet equities ignored this and continue to rally in the first quarter of 2013.  Fundamental analysts have tried to rationalize this but probably the best explanation I’ve heard was summarized by David Kotok of Cumberland Advisors.  He writes, “We continue to argue that classic and typical methods have to be set aside in an era in which the short-term interest rate is near zero; hence, the equity risk premium determined on the short-term interest rate is near infinity.”  Kotok expressed concern over the eventual unwinding of the Fed’s policy, but for now is committed to being fully invested – a sensible response to unlimited central bank support.

Another respected analyst, Bert Dohmen of Dohmen Capital Research, points out the technical flaws that have emerged in the stock market in the last few months.  Yet despite these flaws, the market continues to rally.  “The massive monetary creation by the Fed is producing the fuel for the rally,” he writes.  “Unless you think that will stop, the market should rise until Bernanke leaves, though with periodic market corrections.  We all know that this cannot end well.  But the day of reckoning may still be a long time in the future.  The pessimists have given too much credence to the reality of the unsustainable debt globally and not enough importance to the power of infinite money creation by the central banks.”

Foreign inflows into U.S. equities have also been driven more recently by euro zone and China weakness.  This has been an overlooked aspect of equity market strength at home as other nations experience the effects of weak economies and are looking for a perceived “safe haven” from domestic woes.  The U.S. aptly fits the description as one of the strongest financial centers at the present time.

To further answer the question of whether central bank policy can overpower cycles, let’s look at some past analogues.  Perhaps the biggest instance of a yearly cycle “failure” was in 1954.  According to the cycle account of the Kress 60-year cycle, 1954 should have been a big down year for equities.  Yet the stock market boomed in ’54, achieving a 25-year high and finally overcoming the 1929 all-time high.  The 60-year cycle is admittedly a key long-term cycle; in fact it forms the basis of the Kress 120-year Mega Cycle.  1954 was also the year that the current 120-year cycle (the one that began in the mid 1890s) peaked.  Not only was there the counter-balancing peak of the 120-year cycle in 1954, but as Mr. Kress himself also pointed out the Depression years had done much to unwind the excessive debt which contributed to the Great Depression. 

More pertinently, money supply growth had greatly expanded in the 1940s and in leading up to 1954.  The Fed was young and inexperienced and barely had the policy tools to cope with the Great Crash of ’29.  It was heedless of the fact that by contracting money supply in the year leading up until 1929 it actually helped facilitate the crash and subsequent depression.  After the hard Depression years, however, the Fed learned some valuable lessons and realized that “easy money” was the way to go as far as inflating the country to prosperity. 

In defense of the Kress cycles I will point out that while the stock market may have ignored the 60-year cycle bottom of 1954, there has never been an instance of the 40-year cycle being ignored by the market.  The last 40-year bottom was in 1974 and it produced a major bear market and economic recession, as did the previous one in 1934.  The upcoming 120-year cycle bottom scheduled for late 2014 includes the latest 40-year cycle.

It’s still debatable whether the recovery bull market can continue much past 2013.  With some analysts believing that Fed Chairman Bernanke’s successor next year won’t continue his ultra-loose money policy, there is certainly a possibility that 2014 will vindicate the long-term cycles.  But the stock market game isn’t about next year; rather it’s about the hear-and-now.  And for now investors should be focused on the opportunities that Bernanke’s policy has presented them. 

Don Hays is fond of saying, “Bull markets don’t end until the Fed takes away the punch bowl.”  Another way of expressing this is in the Wall Street maxim, “Don’t fight the Fed.”  As long as the Fed is committed to “QE infinity” there’s no reason to expect a premature end to this bull market.  I’m sure Mr. Kress himself would agree – let’s take advantage of the opportunity while it lasts.

Why no cycle bottom?

Client question:  “I do very much appreciate, enjoy, and utilize your system and all the information that goes with it.  In the 2+ years I have been reading MSR, I don’t think there has been a cycle bottom as conspicuous as this last one has been.  The market showed so little sign of breakdown in this last week of what should have been the winding up of the hard down phase.  I thought that was noteworthy, and will be excited to hear why you think that was the case, and whether that will have an effect on the next important cycle low (maybe making it stronger due to the failure this time?).”

Answer:  The failure of the interim weekly cycle to bottom with emphasis was certainly rare, but it has happened before.  I’ve seen it happen in strong bull market moves, like the one we saw in the second half of 2006.  Basically the cycle was overpowered by a combination of loose Fed money and crowd psychology.  This can happen with the weekly cycles on occasion.  

I don’t think we can make any inferences from this, however.  Bud Kress, the namesake of the Kress cycles, had a tendency to react to cycle failures by often stating that the market would have to make up for the failure to bottom (or peak, as the case may be) by doing so before the next scheduled cycle.  I don’t agree with this.  If a market is being driven by an unusually strong force – in this case QE money – I think we have to follow the market itself for turning point clues, as we’ve been doing this year.  

To repeat my personal trading/investing philosophy: market (i.e. technical) analysis must always take precedence over the cycles. 

The return of Dow 36,000

Some of you may remember the unforgettable title of the 1999 financial best-seller, Dow 36,000.  It made a lot of waves back during the heyday of the internet stocks and day trading, but unfortunately for the authors, the timing of the book’s release was less than ideal.  The market topped out in late ’99 and the infamous “tech wreck” followed in 2000.  To this day, Dow 36,000 is considered as the ultimately example of a contrarian indicator – that is, when a book cover announces an extremely bullish forecast, the end is usually near for the bull.

I was surprised to discover recently that the Dow 36,000 forecast has been resurrected.  A Bloomberg article last week penned by the co-author of the book, James Glassman, tried to make the case that his mis-timed forecast still has validity in the foreseeable future. Glassman argued that Dow 36,000 is within reach in view of current levels of market momentum, corporate earnings valuations, etc.  Given that the first release of Dow 36,000 was a contrarian harbinger of doom, should we be concerned by its reappearance in the media?

To answer that question I recently paid a visit to my local Barnes & Noble bookseller.  I’ve derived a great deal of useful data over the years, from a contrarian perspective, from perusing the shelves of mainstream booksellers.  When the financial section of book stores like B&N are brim-full with bearish titles, like they were for much of 2009-2012, you’re generally safe in assuming that the market is probably not going to crash.  This is based on the principle that when all the scary bearish scenarios make the covers of mainstream books, the negatives have already been fully discounted by the stock market.  What’s more, book authors are notorious for being behind the curve of market trends.  Most of them write about what happened yesterday, not about what’s going to happen tomorrow. 

Bearish book titles have abounded in recent years and a few examples will suffice:  The Warning: The Coming Great Crash in the Stock Market, Conquer the Crash, the The Great Crash Ahead, Patriots: Suriving the Coming Crash, the Coming Collapse of the Dollar and How to Profit From It.  Admittedly the numbers of crash-related books have thinned from bookstore shelves in the last year or so, but I found many more bearish book titles on my latest visit than bullish titles.  I didn’t get the impression, as I did in the late ‘90s, that the collective mindset of financial book writers was overly optimistic – far from it!  There’s still a great deal of caution and conservative that characterizes today’s leading financial book titles and Dow 36,000 is at this point an anomaly. 

If ever Dow 36,000 and its ilk become the rule rather than the exception, we’ll definitely have much to worry about as far as the stock market is concerned.  For now, however, I think we can pretty much discount the super-bullish forecast of Dow 36,000 as being an attention-getting ploy rather than a manifestation of widespread bullish psychology.

The importance of the advance-decline line

“I have conducted several studies asking, ‘If something changes, what and why did the change occur?’ I asked my research students to go back to 1929 and look at every time the Dow made a new high and the advance-decline index failed to confirm. There were roughly 15 times. There are very few absolutes on Wall Street. This is as close as it gets. Every one of those 15 times preceded a measurable sell off.

“When the Dow is making new highs, but fewer and fewer stocks are doing so, we have a recipe for disaster. The stock market can only continue to rally for just so long with stocks getting more and more narrow. So if you were aware of this sequence, you would have been out of the market prior to the 1987 top, the 1990 top, the 1998 severe sell off, and the top in 2000. I started to warn in late 1999 because breadth continued to get more and more narrow. And that continued for a long time.

“So there were 15 times going back to 1929 when a decline in breadth preceded a major sell off. You want to be aware of this, because its track record is incredibly important.”  [Ralph Bloch, 8/20/2004]

Bears increase despite new Dow high

Investor psychology remains muted despite the new all-time high in the Dow Industrials.  This week’s AAII investor sentiment survey revealed only a slight increase in the percentage of bullish investors, to 31% from last week’s 28%.  That’s still a remarkably low percentage of bulls given the new highs in the major indices.  The percentage of AAII bears rose to 39% compared to last week’s 36%.  I regard a rising bearish percentage and a low bullish percentage in a bull market as healthy.

Investors Intelligence shows a similarly healthy reading of bulls and bears according to its latest survey.  While the major averages rebounded from their sharp drops on Feb. 25 to end that week with small gains, the bulls declined to 44.2%, the fifth week of lower readings.  There was no change for the bears at 21.1%.  The difference between the bulls and bears declined to 23.1%.  As Art Huprich of Raymond James points out, “That difference is well below the dangerous territory around 30%, and higher.”

Jeers but no cheers for Dow's new high

The Dow reached an all-time high of 14,253 on Tuesday and naturally, the financial press drew lots of attention to this fact.  Conspicuously absent from the media attention, however, was a complete lack of enthusiasm.  The perma-bull cheering section was eerily quiet as widespread apathy was evident.  This continues a trend of muted investor psychology which I find refreshing given how far the market has come since November.  

I was rather surprised to see a feature article on the Yahoo.com landing page entitled, “Why the Dow Is Still Rising After Yesterday’s High.”  Instead of cheering the Dow’s accomplishment as mainstream media sources are wont to do, the article by John Maxfield urged investors to tread cautiously and to not “get too excited.”  My how things have changed since 2007! 

Another article appeared on Yahoo’s financial site with the headline:  “With Dow Industrials at Record Highs, When Will Gravity Take Hold?”  So here we have another example of observers waiting for the inevitable pullback instead of focusing on the all-time high.  It’s another clear instance of the seismic shift in investor psychology since the credit crisis.  Investors have been psychologically conditioned to mistrust any rally and to expect it to be followed by a sell-off.  

Bullish enthusiasm is at low ebb, which is not at all consistent with a major market top.  Bottom line: the uptrend continues.

Surprise! Revenue momentum leads the way

One of the criticisms of the post-2008 recovery bull market, especially in its early stages, was that it was driven primarily by cost-cutting measures on the part of corporations.  While there was undoubtedly some truth to that assertion, cutting costs can only take you so far.  Sooner or later the benefits of cost cutting will reach their limits and, if you want to keep the positive trend going, you have to start showing increased sales. 

Indeed, corporate sales figures are in many ways a more important measure than net earnings.  A rising trend in revenues can serve as an excellent “heads up” indication that a company’s undervalued stock is about to turn up.  Aside from internal sector momentum and price momentum, I consider sales momentum to be one of the most important things an equities trader should look at when evaluating a stock. 

As it turns out, corporate revenues have risen appreciably during the last several quarters.  According to Dr. Ed Yardeni (blog.yardeni.com), S&P 500 revenues per share bottomed during Q1-2009 and are up 30.2% through Q4-2012, and 5.9% year over year.  Revenues for the S&P 500 Industrial Composite, which excludes Transportation, Financials, and Utilities, is up 42.4% over this same period, and 4.4% y/y.  “Both measures are at record highs,” writes Yardeni, “and I am predicting that revenues will increase 5% this year and next year.”

Meanwhile forward revenues, the time-weighted average of these two forecasts, rose to a new cyclical high.  The strong revenue trends show that this bull market is built on a solid base.

Lessons from the late Ralph Bloch

I was saddened to learn of the recent passing of Ralph Bloch, former chief technical analyst for Raymond James.  Ralph was an inspiration to me back when I began studying technical analysis, and I always enjoyed reading his weekly stock market commentaries in the Mansfield Chart service. 

Bloch could best be described, in the words of one of his colleagues, as “old school.”  He majored in old-fashioned chart reading the Edwards & Magee way and he eschewed many of today’s commonly used technical indicators.  In an interview for a well known financial magazine he was asked if he ever used the stochastics indicator.  He replied, “Number one, I haven’t a clue what it is, and number two, I’m not even sure I can spell it.”  He believed that most technicians today are over-reliant on computer trading systems and have gotten away from the basics of what he called “Technical Analysis 101.”

Bloch made a point of reading Edwards & Magee’s classic work, Technical Analysis of Stock Trends, along with Jesse Livermore’s pseudonymous Reminiscences of a Stock Operator at least once a year, believing that everything a trader needs to know is contained in these books.  He was also a chartist par excellence. He once defined a stock chart thusly: “All a chart is are people’s perceptions of what they think the fundamentals are when they put their money where their mouth is.”  He added that when investors put their money where their mouth is, “that’s when technical analysis takes place.”  He believed that both disciplines, technical and fundamental, confirm each other.

Ralph also emphasized the limitations of technical analysis, believing that it’s primarily a tool for making short-term forecasts.  He was quoted by Investors Business Daily as saying, “It is a mistake to use it for anything longer” than short-term planning.  In an interview with Chris Wilkinson in the book, Technically Speaking, he added: “People who make long-term calls usually go down with the ship.” 

He believed his job as a technician was to look at the market every day and judge whether or not it was healthy.  To do this he embraced a bottom-up approach by looking at individual stock charts first, followed by the indicators.  He defined a strong market as being one where the Dow Industrials are making new highs, the Transports are confirming, and the Advance-Decline Line is also confirming and making new highs. 

Bloch was a big believer in tape reading and was one of the last pure practitioners of the art on Wall Street.  He challenged anyone to match his record on Wall Street, believing strongly that “Technical Analysis 101” would beat new-fangled computer trading systems and arcane indicators.  He believed that analysts who follow myriad technical indicators are purposely avoiding making a decision.  As Wilkinson wrote of Bloch in 1996, “His simple and basic approach” made him “immune from ‘analysis paralysis,” a condition of mental immobility resulting from too many indicators generating conflicting signals.” 

He was a member of a dying breed on Wall Street whose accuracy in making stock market calls was unsurpassed.  He will be greatly missed.

Stock market update

In the two weeks there have been two days in which the ratio of downside-to-upside volume has been at least 90%.  This is a sign of internal weakness and, when it occurs at or near a rally peak, is usually a signal that the market is poised for some additional weakness. 

Meanwhile there has been quite a bit of sector rotation in the market with a handful of sectors strengthening while others weaken.  The weaker industry groups include the golds, the oils, and the defense stocks.  Consumer discretionary stocks have shown surprising strength as witnessed by the recent higher high in the SPDR Consumer Discretionary ETF (XLY).

The cross-currents within the broad market are best illustrated by two charts: the Dow 30 Industrials and the S&P 400 Midcap Index (MID).  Note the higher series of highs in the Dow…

…against the lower series of highs in the MID.

To get a renewed broad market “buy” signal we should ideally see the MID reversing this series of lower peaks by closing above the mid-February high at 1,125.  We should also see a reversal of the recent NYSE volume trend with at least one day of 80% and preferably 90% upside volume along with an expansion in the number of stocks making new 52-week highs.  We should also see a diminution of new 52-week lows below 40 for a few days to let us know that internal selling pressure has completely dissipated.  

Gold in the balance

According to the CFTC, gold speculators have cut their combined futures and options net-long positions by 40 percent to 42,318 contracts in the week ending Feb. 19, approaching the low reached in September 2008.  Gold-backed ETP holdings also fell to a five-month low on Feb. 25 to 2,536.289 metric tons while large investors such as George Soros and Louis Bacon cut their gold holdings in the last quarter.  Add to this the bearish forecast on gold by Goldman Sachs – whose pronouncements on gold have tended to be accurate – and investors were given yet another reason to fear lower prices ahead for the yellow metal.