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Stock Market Update – 01/25/12 © ™

JEFFREY SAUT

Back in the 70s and 80s, one of my favorite analysts was Robert Farrell of Merrill Lynch.  He was very, very good and widely followed.  He is quoted by Jeffrey Saut in his Monday missive, which immediately follows.

Everybody’s Unhappy!?
January 23, 2012

“Money managers are unhappy because 70% of them are lagging the S&P 500. Economists are unhappy because they do not know what to believe: this month’s forecast of a strong economy or last month’s forecast of a weak economy. Technicians are unhappy because the market refuses to correct and gets more and more extended. Foreigners are unhappy because due to their underinvested status in the U.S. they have missed a big double play: a big currency move plus a big stock market move. The public is unhappy because they just plain missed out on the party after being scared into cash. It almost seems ungrateful for so many to be unhappy about a market that has done so well. Unhappy people would prefer the market to correct to allow them to buy and feel happy, which is just the reason for a further rise? Frustrating the majority is the market’s primary goal.”

… Bob Farrell, Merrill Lynch; September 1989

The bears are unhappy since the Santa rally, which began last Thanksgiving, has given the short-sellers no comfortable place to cover their shorts. Last week the bears suffered even more angst as most of the indices I follow tagged new reaction highs. The upside skein from the December 19th “low” has left the senior index better by ~8.1%, and up an eye-popping 13.3% since Thanksgiving. Counting the trading days from that mid-December “low” shows the rally has now encompassed 21 sessions with no more than a 1 – 3 session pause and/or correction. That makes this a fairly long of tooth “buying stampede.” Recall, buying-stampedes typically last 17 – 25 sessions, with only 1-3 session pauses/corrections along the way, before they exhaust themselves on the upside. It just seems to be the rhythm of the “thing” in that it takes that long to get participants bullish enough to throw in the towel and “buy ‘em” right before the markets peak and have a downside correction. Moreover, during the current stampede just about everything has been “run,” including all the sectors punctuated by the Banks +11.6% performance YTD. Accordingly, the only thing missing for a short-term “top” is a final burst to the upside driven by short-covering. My sense is this will occur into tomorrow night’s State of the Union address, which should be followed by a post address letdown for the stock market.

To be sure, the recent rally has not been accompanied by a noticeable increase in Buying Demand as measured by Lowry’s Buying Power Index. Rather the rally has occurred more from a reduction in Selling, which is reflected in Lowry’s Selling Pressure Index. Then too, the percentage of stocks above their respective 10-day moving averages (DMAs) has failed to confirm the upside and the New High list is not expanding. In fact, 40% of my short-term indicators are now bearish and none are bullish. Meanwhile, the NYSE McClellan Oscillator is overbought, the stock market does not have much internal energy left for a big rally, the S&P 500 (SPX/1315.38) is three standard deviations above its 20-DMA, the Volatility Index (VIX/18.28) is telegraphing too much complacency, and we have negative seasonality for the next few weeks. Nevertheless, I continue to think it is a mistake to get too bearish because I believe any pullback in the various indices will be contained.

My bullishness was reinforced last week during a conversation with Frederick “Shad” Rowe, the sagacious general partner of Dallas-based Greenbrier Partners. Summing the conversation, we decided the world is becoming richer faster than debt is expanding. This is not an unimportant point since everyone seems to be focusing on the “debt bomb,” which likely means it is the wrong question. Clearly, some folks are living above their means, some below, but many are living within their means, which can be seen in the Household Debt Service Ratio chart that is plumbing generational lows. Manifestly, the world is getting more prosperous and is producing more for less driven by technology. Truly, it is “one world” and we should start thinking of the U.S. as a state within that “one world.” This view is plainly stated in Federal Express’ annual report. To wit:

“We’ve reached a tipping point in how the world works. The largest economy in the world is no longer the economy of any one country – it’s the economy of global trade of goods and services. Value: $18.3 trillion in 2010. At FedEx, our job is to facilitate these transactions, the heart of commerce, by providing access – moving goods across the global supply chain.”

Or, how about this from Google’s annual report:

“Google is a global technology leader focused on improving the ways people connect with information. We aspire to build products that improve the lives of billions of people globally. Our Mission is to organize the world’s information and make it universally accessible and useful.”

One world indeed and there are actually a lot of good things happening. While the world is still a violent place, it is becoming less so as the wars we have been fighting come to an end. Additionally, the U.S. finally appears to be heading down the road of energy self-sufficiency, which should increase employment, and the U.S. dollar is currently the least unattractive currency in the world. Furthermore, as scribed in previous reports, there is a huge hidden layer of the U.S. economy that is becoming the engine of growth and wealth creation; and, this hidden layer is misrepresented in corporate financial reports. Surprisingly, the equity markets appear to value this hidden layer at approximately zero suggesting huge opportunity for investors to profit. The hidden layer referenced is Organizational Capital and Knowledge Capital, both of which reside under the macro moniker – Intangible Capital – so often mentioned in these missives. As the astute GaveKal organization writes:

“When we account for intangibles the picture of the U.S. economy changes. It is revealed that we are saving more and investing more than we thought. This means our economy is much more dynamic than we thought. This result is relevant in view of the perception of a low rate of saving in the U.S. economy, particularly because existing measures exclude much of the investment in knowledge capital that is a defining feature of the modern U.S. economy. … Validating intangibles is the key to eliminating the guesswork in valuing a company correctly. Indeed, this ‘new view’ of intangibles suggests they are the missing link between financial accounting and financial valuation.”

These observations, taken in concert amid the backdrop of a world that is profoundly underinvested in U.S. equities, continues to leave me walking on the “sunny side” of Wall Street even though in the very short term I am looking for a trading peak.

The call for this week: Last Thanksgiving I suggested the Santa rally was beginning. I stuck with that “call” into the new year. On January 3, 2012 I stated that session felt like an “emotional peak” and that January 10, 2012 felt like the “price peak.” Subsequently I wrote, “The only question in my mind is if the markets are going to have a pullback into the 1230 – 1240 support zone, or go sideways to correct their overbought condition and allow the internal energy to be rebuilt.” So far, it has been a sideways consolidation until last week’s upside breakout causing one old Wall Street wag to exclaim, “Breakout or fake-out?!” On a short-term basis I think it is a fake-out believing a trading top is due this week .

WHAT’S HAPPENING?

January 23rd shows signs that a top of some type was made.  We’ll wait and see if that top holds and the January correction is underway.

As we continue to draw nearer to the May 2011 highs, it appears possible that we have entered large step 3 up.

  • From the bottom in  March 2009
  • Large step one up ended in May 2010
  • Large step two up ended in May 2011.

If we penetrate the May 2011 highs by a significant amount, we can safely say that large step 3 is underway.  Whether we make new all-time highs is only a gleam in my eye.  All-time highs are not a requirement for the megaphone formation (see very long term comment below) but it seems likely that we would get into the area of prior highs.  With today’s economic problems that would certainly require the market to climb the “wall of worry” and that’s the way it’s always done.

No cycles have been posted in this update because nothing has changed.  If we continue through January without a correction of consequence, it makes one wonder if the large data-set from 1950 might have the correct bottom, which was indicated in February (see update dated 01/18/11).

I remain in an “overall” uptrend theme as per previous updates.

THE UPDATE SCHEDULE, ET CETERA

At dinner the other night with a good friend, he pointed out to me that I don’t have much to say in my blog.  That’s very true and it’s something that I had noticed already.

When I began this blog in July it was obvious that the market was in trouble.  Markets in decline propel me into a hyper mode and I have a lot to say.  During the summer I was constantly looking for signs of a market bottom and pointing out possibilities.  After we bottomed on October 4, 2011 and again in November and December, I have been more relaxed and content to let the market trend higher.  This mode will continue in my blogs until I become worried that an inflection point is near or passed.  I expect at that time I will have a lot to say again.  Until then Alfred E. Newman and I are:

Alfred E. Newman

But as always I’m alert to unexpected market changes.

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CHARTS

  • These are my personal charts and my playground for doodling trend lines, wave counts and other ideas.
  • I draw the trend lines and wave counts on a daily basis (sometimes more often).  You can find these doodles from 1 minute to monthly charts.
  • You will find the best trend lines and wave counts on charts with longer time frames.  This gives perspective to the lines and counts.  Perspective was a favorite of Edson Gould.
  • I usually restrict my trend lines and wave counts to the first three charts on each page, TSX, DJI & COMPQ.  The other charts on the page are usually for confirmation of the trend and wave structure.
  • Page 1 – Buy/Sell Signals
  • Page 2 – Indexes With 1 Minute Bars
  • Page 3 – Indexes With 5 Minute Bars
  • Page 4 – Indexes With 15  Minute Bars
  • Page 5 – Indexes With 30 Minute Bars
  • Page 6 – Indexes With 60 Minute Bars
  • Page 7 – Indexes With Daily Bars
  • Page 8 – Indexes With Weekly Bars (since 1981)
  • Page 9 – Indexes With Monthly Bars (since 1981)
  • Page 10 – Indexes With 60 Minute Bars, Candlestick
  • Page 11 – Indexes With Daily Bars, Candlesticks
  • Page 12 – Indexes With Weekly Bars, Candlestick
  • Pages 13 through 14 are shorter term indicators.  The indicators are used to simply look for some type of leading action before a turn or confirming action of the wave count.  Page 13 is a look-everyday indicator page.  The other indicator pages are less frequently visited.
  • Page 15 – Hurst FLD Projections
  • Page 16 – Indicators, Long Term
  • Page 17 – International Indexes
  • Page 18 through 30 are sector ETFs.  They represent most of the active sector ETFs and are always a good hunting ground when looking for something that is breaking in a new direction.
  • Page 31 through 45 are growth stocks with indicators.  These are stocks that have been in a lengthy uptrend.  One qualification is that they must not be severely damaged in a bear market so they can’t rise to significant new highs in the following bull market.
  • The growth stocks show daily market action for the last 3 years and weekly prices since 1992.  This gives a good perspective of how they have behaved in the immediate past (daily charts) and how they behaved during good and bad times (weekly charts).
  • Page 46 – Misc older charts

WAVE COUNTS SIMPLIFIED

  • My wave counts are not Elliott Wave!  It’s different, simple and functions without a maze of exclusions.
  • There are 3 peaks (or valleys) to a completed wave count. A reversal of trend takes place after a completed wave count.   Often times it’s as simple as counting 3 bumps (or dips) on a chart . . . Other times, not so easy.
  • In a downtrend the same rules apply except you are counting 3 dips instead of 3 bumps.
  • Each group of 3 steps must stay confined to a channel.  Laying a pen or pencil on the chart will help you visualize the channel.
  • As the trend progresses, all of the steps that make up a larger trend will also be confined to a larger channel.  Sometimes the channel is not revealed until the surge phase has ended.
  • When the market breaks a channel (regardless of the perceived wave count), the current step has been terminated.  (Make sure your channel was correctly drawn before calling a termination).
  • The correction following the second step is larger than the correction that followed the first step.  Obviously the correction following the third step is a reversal.
  • A single wave may sub-divide into another 3 waves.  I will call this an extension.  When this happens (1) the trend is still intact, (2) the channel will widened and (3) instead of a total of 3 steps, there will be 5 steps.
  • Sometimes I will use the terms “step” and “wave” interchangeably.
  • Reading the glossary helps in the understanding of this blog.  There are many other important facts in the glossary.
  • Glossary Link

ABBREVIATIONS

  • DJI = Dow Jones Industrials
  • DJT = Dow Jones Transportations
  • SPX = SP 500
  • ES = SP 500 Futures
  • COMPQ = Nasdaq Composite Index
  • TSX = Toronto Stock Exchange (Canadian blue chips)
  • SOX = Semiconductors
  • TXX = Technology

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  • Long Term – UP
  • Uptrend
  • Mar 2009 To Present
  • Step 2 Up (of 3) Completed
  •  Step 3 Up Has Possibly Begun
  • From the bottom in  March 2009
  • Large step one up ended in May 2010
  • Large step two up ended in May 2011.
  • Significant break above the May 2011 highs should signal that Step 3 up is official

12-28-11 LONG TERM

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  • Very Long Term – DOWN
  • Downtrend
  • Jan 2000 To Present
  •  Step 2 Down (of 3) Completed
  • Currently In Rally Phase From Step 2 Down

12-28-11 VERY LONG TERM

VERY LONG TERM COMMENTS

We have 3 possibilities for the future.

  • We have entered a very wide swinging market (megaphone formation) similar to that of 1966 to 1974. During that era we had three bear markets with two intervening bull market rallies.  Each bear market had a lower low than the previous bear.  The intervening bull market rallies saw new all time highs before the next bear market began.
  • We also have formed a huge head and shoulders formation since 1998.  If this formation is valid, the downside measurement calls for a bottom around Dow Jones Industrials 1,000.
  • We began a long term bull market in March 2009.  Each subsequent min-bear market will result in higher lows than the prior major low.
  • I favor the megaphone formation as the most likely scenario.

Since 2000 we have had two bear markets, 2000 to 2003 and 2007 to 2009. Like 1966 to 1974, the recovery from the first  bear market saw a new all time high (2007 peak). It’s possible that we may experience another all time high during the present recovery period.  This would support the megaphone formation.  A failure to make new highs would support the head and shoulders argument.  In both formations the conclusion of the present recovery would call for a third and final bear market. An estimated time for the conclusion of the final bear market is approximately 2018.

The lesser downside target of both formations is the megaphone formation as it likely calls for a bottom 1,000 to 2,000 points below the 2009 low, which would be around Dow 5,000.

In the head and shoulders formation the measurement calls for a bottom around Dow Jones Industrials 1,000.  This is almost an unimaginable event regarding the possible fundamentals to create this scenario.  If this did happen, everything that could go wrong would have to go wrong.  The reasons range from the absurd to the absurdly absurd.  This scenario is so dark that it doesn’t seem possible but nevertheless, the head and shoulders formation is there and will be waiting until we pierce the all-time highs of October 2007.

Remember these are simply possible scenarios and are not embedded in fact.  Whatever the outcome, it never hurts to be a little cautious with some of your money.  But in the worst case scenario, everything that we take for granted as being safe . . . .  would not be safe.  This is something to never forget in the event things go very badly.

Hopefully we will never have to think about worst case scenarios other than to have a good laugh at them presently.

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EDSON GOULD

  • Edson Gould, Premier Stock Market Strategist – Edson Gould had a profound influence on the development of my techniques and  indicators.  Prior to me subscribing to his advisory service, I was just one of the crowd.
  • After 40 years I still have many of the publications from his advisory service, “Findings & Forecasts”.  Fearing the loss of these hard copy reports I have recently scanned and created pdf files of these reports.  Now I have hard copies and computerized versions of the reports.
  • I have used a technique of his that I found in an obscure reference in one of his reports.  It was only mentioned once and never again.  I believe that he used this tool extensively and never told the world it’s importance.  Prior to my finding this tool, I had been trying unsuccessfully to find a different way to chart the market.  When I read about his technique I knew instantly that this was exactly what I had been seeking.  I have charted this method back to 1939 and found it to be very useful.  There is no mention of it in the reports that I posted below as I have deleted any reference to it.  It’s a super secret indicator and I’d have to kill you if I told you about it.
  • Edson Gould was truly a legend in his own time.  It’s too bad that today most people have forgotten or never heard of him or his discoveries.  Below you will find only the first page of these reports.  A teaser is what you might call it.  The rest of the reports are available upon request.  This is a man that deserves to be remembered throughout technical analysis market history.
  • The following are links to Edson Gould reports.
  • My Most Important Discovery by Edson Gould
  • It was also my most important discovery, for it explained the irrational volatility of markets that had mystified me in my early years.  During those early years I found nothing worked in predicting these irrational market swings.  But the fog lifted after reading this report and I began to understand how to begin predicting the market.
  • Edson Gould’s 1974 Forecast
  • Gould’s 1974 forecast kept me bearish and short throughout 1974 until the week before Christmas 1974, during which I began making long term purchases.  After that it was ride the bull phases that transpired from 1975 to 1982.  1982 to 2000 was the greatest bull market of all time.
  • Edson Gould’s 1975 Forecast
  • Edson Gould’s 1976 Forecast
  • Edson Gould’s 1977 Forecast
  • Edson Gould’s Five Year Forecast 1977 to 1982
  • This was a remarkable forecast in 1977, where the Dow Industrials had never been higher than 1,000. NO ONE predicted a rise of this magnitude in 1977.  Most were waiting for a resumption of the bear market.
  • As part of the 1977 to 1982 forecast: On Wednesday August 4, 1982 I went long the market for the first time in months.  By Friday, August 6 I was worried that I had made a mistake as I was deep in the red (I was long the Kansas City Stock Market Contracts).  The Kansas City Stock Market Contract was the first of the stock index contracts (February 1982).  It was based on the Value Line Arithmetic Index, margin requirement were quite low, and it had a multiplier of 100 times the Value Line Arithmetic Index, which meant the leverage was very high.  On Friday (Aug 6), my wife and I went to dinner and I told her my tale of woe and whether I should sell my long positions.  I explained that my key indicator had reversed and continued higher on Thursday and Friday but the market had continued lower.  Since the key indicator was usually correct, we decided to stick it out for a few days more (I was crazy in those days).  My key indicator was mentioned by Gould only once in his market letters.  If you didn’t catch its importance, too bad, because he only gave you a peek.  Prior to Gould writing about this indicator I had been looking for one that had similar characteristics without success.  Thus when Gould wrote about it, I recognized instantly that I had struck gold.  I have modified this indicator slightly and researched it back to 1939.  This was a lot of work as it was before computers and online data (remember when Barrons was available only on paper, still is for the distant past).  Meanwhile on Monday August 9, 1982 the market took off like a rocket and never looked back.  I skyrocketed out of the red and had a big profit.   In August 1982 the only people that were bullish were Edson Gould, Robert Prechter and myself (probably a couple of others but I didn’t know them).  Everyone else was extremely bearish.  It was a perfect example of crowd behavior.

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TRANSACTION SIGNALS

  • All actionable signals are only for short term time frames.  These signals are not designed for intermediate or long term time frames BUT . . . . .
  • After a short term buy signal, long term tax status  can be achieved by a continuation of the upward trend, which causes short term actions to morph into long term holdings. 
  • See more details in the glossary under “Taxes, Futures Contracts” and “Money Management”.

TRANSACTION RECORD

  • In this blog a warning of an impending bottom (or top) is often issued well in advance of the formal buy or sell date.  This allows thoughtful consideration prior to a formal action signal.  To get a sense of how this works, you should read a few days prior to a formal buy/sell signal.  I often buy/sell in my personal account based on the early warnings.
  • The transaction record near stock market bottoms will show that I am very skittish and usually remain so until the new direction is well underway.

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MISCELLANEOUS

  • There are useful items throughout this blog.  For instance, the “Wall Street Quotes” can be very instructive.  So make sure and look all through the blog.

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