One Way to Tell if We Are in a Bear Market

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Bull markets usually go up the first four trading days of the month. After giving a strong negative signal in May, investors should be watching this indicator in the early days of June. A second negative signal would be a confirmation that a new bear market has begun.

Money tends to get reallocated at the beginning of the month. The behavior is more pronounced at the beginning of the quarter and most pronounced at the beginning of the year. In bull markets, much of this money gets allocated on the buy side for stocks. In bears markets, a higher percentage of investing money will go to safe haven assets. So in a bull market the first four trading days (not five as many sources claim) of the month tend to see a nice rise in stock prices. The first couple of days are almost always positive.

Even in strong bull markets, not every month has to have an up move in the beginning days. Every so many months, investors are likely to grow cautious and take some profits. The bulls should regain control for the next several months however before profits get high enough again so that investors want to take some money off the table. So far, the rally that began in March 2009 has managed to just hold together.

The first negative signal for the rally was given in July 2009 for the Dow Jones Industrial Average. The next month was positive though and then another negative signal was given in early September. This was followed by a number of months that when stocks were up in the first four days. Then February 2010 gave another negative signal. March and April were once again OK and then came May.  The flash crash happened on the fourth trading day of May and the market was already down before it occurred. May was an ugly month.

Four negative signals on the first four trading days of the month indicator are a lot in just over a year. It indicates a rally that has weak underpinnings (as does the falling volume on the Dow during most of the rally). We still have not as of yet seen negative signals two months in a row. Maybe we will by June 4th.  If we do, it would be strong evidence that a new bear market has begun.

Disclosure: None.

Daryl Montgomery Organizer,
New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

A Problem With Volume for the New Rally

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


One of the most talked about aspects of the stock market rally that began in March 2009 was the lack of volume support. As the market continued to go up, buying continued to dry up. The rally that began on Monday is exhibiting this behavior to an extreme. Lack of volume support now makes stocks vulnerable to another sudden downturn.

The problem with volume is most evident on the Dow Jones Industrial Average. Around the low last March, the index was trading over 600 million shares a day. Within the last two months, there were many days when volume was frequently below 200 million shares. During 2010, there have been a few volume spikes around 400 million shares, but almost all of these took place on options expiration days. Rising volume on those days doesn't indicate increased investor interest in the market.  Volume finally did perk up considerably at the end of last week though - on big selling.  Over 400 million shares were traded on the Dow on both Thursday and Friday.

Buyers have not been as enthusiastic on the upside however. The volume on the big rally on Monday was around 300 million shares, much less than volume on the two preceding down days. The Dow dropped slightly on Tuesday and volume was somewhat over 200 million shares. In and of itself this was OK since you want to see lower volume on down days.  When the market goes up afterwards though, the volume must also rise.  This didn't happen on Wednesday, despite the 150 point rally. Volume was well below 200 million shares until the close when around 30 million shares traded at the end of the day. Despite all of those shares changing hands, stock prices barely budged. This would indicate equal amounts of buying and selling (also known as stalling or churning). Final volume on Wednesday came in at 195 million shares. So there was a big rally on pathetic volume.

Not only is the rally lacking proper volume support, but the Dow, S&P 500 and Nasdaq all bounced off their 200-day moving averages on Thursday (they actually pierced them for a short period) and they have now traded back up to their 50-day moving averages. This is now a key resistance level. So far, this is a normal bear-trading pattern.  For it to turn into a bull pattern, the stock indices must get above and stay above the 50-day moving averages. We should soon find out if this can happen.

Disclosure: None relevant

Daryl Montgomery Organizer,
New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Why the Stock Market May Be Topping

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Markets hit tops or bottoms when almost everyone shares the same opinion. Current conditions in the U.S. stock market are reaching an excess of bullishness and this indicates a top could be forming. Investors should proceed with caution.

When it comes to market opinion, the majority is usually right and investors should generally move with predominant view in the short term. However, when majority opinion starts to become overwhelming - say less than 20% of investors are bullish or bearish - then herd behavior has taken over and its time to think about stepping aside. At extremes there is no one left to buy or sell, so there is no more fuel left to propel the market in the direction that it has been going. The U.S. stock market has probably already reached that state.

News media coverage is one of the best gauges of whether or not a market has overreached. When it starts to become too positive or negative, the end of the trend is usually near. News coverage for the recent market rally has indeed become extremely positive. When the Dow Jones Industrial Average closed above 11,000 yesterday (April 12th), it got a lot of glowing press reports. This new high for the rally was hit on volume that was below average - an indication of a lack of enthusiasm from market participants. Declining volume has been a serious problem for the rally for a long time now and will eventually do it in.

The dollar has had a significant sell off from around 82 to 80 in the last few days because of the Greek bailout. Money has flowed out of Europe during the crisis and into North America, helping to drive up the U.S. stock market as well as the dollar. A resolution to the crisis will reverse this flow and be bearish for U.S. assets. In reality, the problems in Greece are not over. While a bond auction held yesterday was quite successful in terms of selling the bonds, the interest rates Greece paid were very high - more than double the rates from the January 12th auction for similar debt. Greece's problem wasn't selling its bonds, but the high rate of interest it had to pay on those bonds. So far, the bailout doesn't seem to have fixed the actual problem. While money may no longer be flowing out of Europe, it may not be quite ready to return there just yet. When it does, the U.S. stock market will drop.

Yale professor Robert Shiller has just released an updated version of his historical PE chart for the S&P500. The current level, just below 22, is around the long-term market peak in 1966 and is higher than the PE before the 1987 crash. It is well below the 30 level reached in 1929 and the 44 level reached in 2000 though. Investors should assume that the current 22 number understates the actual PE ratio. Changes in accounting rules during the Credit Crisis have made corporate earnings much higher than they would have been, especially for the financials. The New York State Comptroller's office reported that Wall Street's earnings were three times larger in 2009 than they were in 2007, which itself was an all time record year for earnings. Investors should wonder how earnings could triple from historical highs during the worse economic downturn since the Great Depression. Disneyland accounting along with the federal government transferring money from the U.S. treasury into the coffers of bailout recipients is the answer.

As always, investors should pay close attention to the VIX, the S&P volatility index. A low number indicates investors have become too complacent and the market is likely to start selling off. The VIX fell to 15.23 yesterday and is testing levels last seen in May 2008 and October 2007. The 2003 to 2007 bull market peaked in October 2007 and stocks fell off a cliff in the fall of 2008. Investors were extremely optimistic during the 2007 VIX low, as they always are during a market top.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Unwinding the Fantasy Trade

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Stocks plunged after the open today on the Chicago Purchasing Managers report which indicated contraction in the largest manufacturing region of the U.S. Also this morning, commercial lender CIT, one of the largest sources of loans in the U.S. for small and midsized business, is on the verge of collapse. The company has received $5.3 billion in federal bailout money so far... and even after that, it is still having trouble staying afloat (it will be the fifth biggest bankruptcy in U.S. history if it goes under). Yesterday's September Consumer Confidence number fell instead of going up as economists predicted. Added to all this, the FDIC board voted to ask solvent banks to pre-pay the next three years of their insurance premiums so its deposit insurance fund won't run out of money. Just more evidence of how well the banking system has been 'stabilized' and how well the economic 'recovery' is doing.

The 4th quarter begins tomorrow and the first four trading days should give us a good indication about whether or not the big money will be selling stocks. A net drop in stock prices during this period will be negative going forward. The rally that has taken place since March has a typical bear market pattern to it. In the case of the Dow and S&P 500 it just shot straight up without any basing pattern forming. The rally that followed the 2000 to 2002 sell off, had a ten-month base and this is what allowed it to continue for several years. Stocks have also reached historically overbought levels based on the percentage of stocks trading above their 200-day moving average (the definition of a rally). This reached 95% on the NYSE. Previously a number in the low 70's would have been enough to create a top. While stocks have skyrocketed, Nasdaq up 68%, S&P 500 up 57% and the Dow up nearly 50%, volume has not. Volume on the Dow has continually declined during the entire rally - a very bearish pattern. Even worse a handful of junk financials, traded mostly by computer, have accounted for a large percentage of overall NYSE volume.

Stocks, and bonds as well, have had spectacular rallies because the monetary authorities have pumped an unprecedented amount of money (a lot of it newly printed) into the financial system. The U.S. government additionally changed its accounting rules and this magically made the close to worthless subprime debt held by financial companies worth a lot more overnight. The rising prices of stocks and bonds that followed have been used as evidence that the economy is recovering and along with the accounting rule changes allowed banks and brokers to report significant, but illusory, profits last quarter. The IMF has helped perpetuate this financial fantasy in a just released report that estimates that bank's losses from the Credit Crisis will only be $3.4 trillion now instead of a previously estimated $4 trillion. The logic behind their reasoning? Stock and bond prices have gone up! The IMF is still willing to admit however that U.S. banks have yet to recognize 40% of their losses and UK and euro zone banks 60% of their losses from the Credit Crisis. It warned that monetary policy makers had better consider this before deciding to withdraw the massive stimulus programs that are currently in place.

Government stimulus can only work so long in keeping stock prices up. The Japanese found this out in the 1990s and early 2000s. The Nikkei had more than one spectacular rally, but each time the rally failed because stimulus programs ended or were eventually cut back. New stimulus programs were then created and the cycle began all over again. The one thing the Japanese didn't do was fix the underlying problems with their banking system. The U.S. has not done so either and until this happens, the government can produce all the economic 'recoveries' it wants to, but they won't last. What will last is the inflation caused by all the money printing needed to produce the recoveries.

NEXT: If You Ignore the Facts, Things Are Good

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.