Markets Will Lead Tomorrow’s Headlines

SPX – 1066.94

DJIA – 9867

October 27, 2009

“One of the favorite games on Wall Street is the big, dramatic call. Predictions that the trend is about to change garner lots of attention and allow market pundits to pontificate over weighty matters that they have been contemplating. The problem is that getting the timing right is most often a matter of luck. Market players are usually better off just sticking with the trend and using good money-management discipline to move them in and out of the market.”

-James “Rev Shark” DePorre

Markets Will Lead Tomorrow’s Headlines

Major excesses are invariably corrected in three stages according to studies by Robert Farrell who used to be the head technical research at Merrill Lynch. The first stage takes the form of a sharp, extensive decline, sometimes lasting one to two years.

The second stage is a snap back, partial recovery; it could last a year or longer as well. After the recovery, the third stage is drawn out and often the longest until it ends in disinterest, neglect and undervaluation. We had capitulation into the March low but I suspect disinterest lies somewhere ahead.

Following the housing bubble and derivatives excess, the government threw a lot at the wall to avert the second Great Depression and subsequent stock market actions tells us enough stuck. It’s the successful exit that could prove tricky, perhaps setting the stage for what Hyman Minksky would call the next phase of instability.

“We are now at the point where we can begin to wind down the programs that really defined TARP in its initial stages,” said Treasury Secretary Tim Geithner. My mischievous take was to lump the three “cash for trash” programs under the acronym for Bank Asset Relief Funding, BARF.

Financial Times associate editor Wolfgang Munchaup explains, “Successful monetary policy would be like walking along a perilous ridge, on either side of which lies a precipice of instability.” Look to one side as the Fed and other central banks begin to implement exit strategies in 2010 and it seems another price decline for risky assets could lie ahead. On the other side, there’s the risk of currency debasement and a bond market crash if central banks keep cranking out paper money at full speed.

The financial markets will sniff out developments first and months in advance so stay tuned. Today’s technical analysis will lead tomorrow’s headlines. All you can buy in the stock market is an uncertain future. The past is not for sale. It’s this uncertainty that presents the opportunity to capture the swing between perception and reality.

Near-term, the S&P 500 (SPX) rallied to a slight new recovery high last Wednesday (1101.36) and reversed, closing lower on higher volume. A series of daily reversals over the past two weeks calls for caution as does the SPX closing just under its 20-day moving average.

S&P 500 - Daily (Source: StockCharts.com

NYSE net volume has not been in synch with the rally since the September 23 high. After it overbalanced with a  (56.8) peak reading, it followed with +47.5. The peak reading on the latest short-term decline is (33.3) as of yesterday, and it wouldn’t take much selling today to reconfirm downtrend or much buying for NYSE net volume to overbalance in favor of uptrend if the market were to rally from this point.

NASDAQ net volume hasn’t overbalanced yet but its +42.5 peak on the last rally didn’t overcome a (43.4) hurdle rate. To overbalance and signal downtrend requires a reading higher than the last peak but it’s only (20.2) so far. There hasn’t been much selling on either NASDAQ or the NYSE but buyers disappeared.

Intermediate-term, the Market Trend Indicator (MTI) remains in an Uptrend because each key index is above its respective 18% weekly exponential average. The SPX’s 18% average is 1045.25 and the DJIA’s is 9972. The New York Advance/Decline line is 3,614 advances above its 18% average.

The MTI reading remains in an uptrend until at least one index closes below its 18% average. The indication shifts to neutral if one or two closes below its 18% average; the MTI changes to downtrend if all three indexes close below their 18% average.

I track two other trend-following indicators to identify and follow swings lasting weeks to months. The 21-day rule and 3-day swing charts are also indicating uptrend. A SPX trade below 1019.75 would signal a change in trend by both.

I prefer to trade intermediate-term trends lasting weeks to months, planning ahead and using exchange traded funds (ETFs) to capture market and sector moves. I believe this sort of planned, deliberate speculation produces the most dependable form of trading. ETFs allow speculators to side step the risk of dramatic plunges suffered by individual stocks if earnings miss or fundamental disappointments unfold.

You can also enter long-term stop orders with ETFs to limit losses and lock in profits, so you’re not necessarily glued to the tape. A speculative strategy doesn’t work without this component.

I realize readers are all over the map, ranging from short-term traders jumping in and out of set ups in individual stocks to long-term investors with a buy-and-hold strategy. Hopefully, you’ll find my insights of value whichever strategy you employ, just make sure you have one so you’ll know how to react when conditions change.

My sense is that despite the pain to date, a lot of short-term traders are picking at the top. Of course, even if they catch it, they’ll pocket little with time horizons that stretch from minutes to days. Longer-term, there’s no shortage of “technical” bears, mostly out of the Elliott Wave camp even though their counts are all over the map.

As for group action, the commodity-based sector and financials have been as good as any. If the dollar manages to mount what I believe is a counter-trend rally, it may be time for a pullback in commodity-oriented stocks. I’m not as constructive for continued leadership by financials as the Fed begins to struggle with an exit strategy.

In general, it’s been a “buy low, sell high” traders market, as opposed to continued momentum by the leaders as typically found in healthy markets. Group leadership continues to shift in a ranking of 100 groups I track.

For example, as late as the week ended October 9, the top ten group list as measured by relative strength included Aluminum (now #24) and Gambling (now #28). Airlines were in the top ten group on the week ended October 16 and now rank #54, leading the Transportation index lower. Home Construction was in the top ten group list September 4 and it’s now in the bottom ten (#97).

Home prices never fell to levels consistent with long-term price-to-income and price-to-rent ratios, helped in part by Treasury purchases of mortgage-backed securities and a tax credit for first-time home buyers. The Treasury Department determined that the government reimbursed about $139 million to more than 19,000 filers for possibly fraudulent first-time home buyer tax credits.

The government’s track record and the big bank bailout may be behind why so many people are worried about government-sponsored healthcare despite recognition the current system doesn’t work very well. Peggy Noonan explained in an editorial in The Wall Street Journal, “People who oppose a health-care overhaul are not in love with insurance companies. They’re not even in love with the status quo. Everyone knows the jerry-built system of the past half-century has weak points. They just don’t think the current plan will shore them up. They think the plan would create new weak points and widen old ones. They think this because they have brains.”

Back to other financial markets, long-term government bond prices fell enough to confirm downtrend when using TLT as a proxy, it traded below its September 9 low of 93.52. The easiest way to be short this market is to be long TBF (ProShares Short Barclay’s 20-year+ Treasury ETF) or for double leverage, TBT (ProShares UltraShort Barclay’s 20-year+ Treasuries). I prefer a relatively tight stop point if wrong, just above the TLT’s October 20 high of 97.25.

TLT - Daily (source: StockCharts.com

TLT (Barclays 20-yr+ Treasury ETF (Source: StockCharts.com)

The dollar popped yesterday after trading on the side for two days. It would take a U.S. Dollar index trade above 77.47 from here to indicate to me that an intermediate-term swing is underway. Perhaps it can return to “best horse in a glue factory” status if stock prices correct.

U.S. Dollar Index - Weekly (Source: StockCharts.com)

With regards to gold, I plan to key in how it reacts if the dollar rallies. It remains in strong positions as long as it holds above the trendline connecting the March 2008 and February 2009 highs. I recommend keeping trailing stops loose for now (just beneath the August 17 low, $932.75 2^nd fix) to accommodate any possible correction. The plan would be to tighten up trailing stops if gold fever engulfs the public. “Gold still represents the ultimate form of payment in the world,” said Alan Greenspan in May 1999. “Fiat money in extremis is accepted by nobody. Gold is always accepted.”

GLD (Gold ETF) - Weekly (Source: StockCharts.com)

The lead front page article in last Sunday’s San Francisco Chronicle told of more people panning for gold in the Sierra’s to take advantage of higher gold prices. It doesn’t quite qualify, in my mind, as evidence of a top in the making given the human interest angle, and the Sierra’s are a nice place to hang out. If and when gold makes the front page of daily newspapers in large headlines tied to easy money, it will be time to look for the exit.

Hopefully, newspapers last that long. I’ll miss them when they’re gone. The Audit Bureau of Circulations reported that the decline in average daily circulation is accelerating. It dropped 10.6% in the six month period between April and September, following  7.1% decline in the preceding period between October 2008 and March 2009, and a 4.6% shrinkage in the year-earlier April through September 2008 period.

I’ll close with a fascinating statistic from Stephanie Pomboy at MacroMavens via Alan Abelson’s column in this week’s Barron’s. She figured public companies cut labor costs $327 billion over the past year while corporate earnings declined $177 million over the same period. According to her calculations, consumer spending would have to climb over 3% for revenue to match the cost savings.

Conclusion:

My recommend stop sell level under the SPX’s 3-day swing low of 1019.75 on October 2 remains unchanged. The equivalent figure for the Nasdaq 100 (NDX) is just below 1656.57, up from 1585.56 previously. I plan to initiate short positions when the MTI signals downtrend and add to those positions (if it follows in this order) when the 21-day rule and 3-day swing charts confirm. For weakness, I prefer ETFs tied to small cap indices cyclical issues in weak stock groups

For investors, internal technical dynamics such as the A/D line and new highs point to higher prices following any correction, but it’s time to plan ahead as to what percentage of assets to hold in stocks once longer-term technical tools indicate that the cyclical bull market has run its course. If you’re strictly bottoms up, Warren Buffett advises, “The stock market is there only as a reference point to see if anybody is offering to do anything foolish. When we invest in stocks, we invest in businesses. You simply have to behave according to what is rational rather than according to what is fashionable.”

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Technical Dichotomy

SPX – 1097.91

DJIA – 10,092

October 20, 2009

“It’s the little details that are vital. Little things make the big things happen.”

-John Wooden

Technical Dichotomy

Trend indicators remain positive. Price momentum and robust breadth suggest higher prices lie ahead, but net volume warns this rally could mark the final run to a tradable top. There’s a dichotomy in the stock market’s technical dynamics.

The Market Trend Indicator (MTI) is signaling Uptrend as each key index continues remains above its respective 18% weekly exponential average. The 18% average is 1038.05 for the S&P 500 (SPX) this week and 9586 for the DJIA. The New York Advance/Decline (A/D) line is 8,866 net advances above its 18% average.

The A/D line represents the degree of participation by all stocks on the NYSE, generally referred to as “market breadth.” The A/D line has a long history, generally leading the SPX at tops but lagging at bottoms. The lead time varies considerably. When the A/D line is stronger than the SPX, one can expect good market conditions to continue. The current strength (nearly back to its all-time high) increases that likelihood (but doesn’t insure) that the next intermediate-term downtrend is followed by higher prices next year.

I’ve always tracked the A/D line without adjusting for the number of issues traded, a process which gives it an upward bias. Of course my time horizons in using it in the MTI are much shorter. An 18% weekly exponential average is roughly the equivalent of a slightly-weighed 10-week moving average.

Despite new recovery highs by the SPX, net volume is not in synch with the rally. Specifically, NYSE net volume overbalanced with a (56.8) peak reading following the rally into the September 23 high (1080.15); its peak reading on the rally since is only +47.5.

NASDAQ net volume hasn’t overbalanced yet but its +42.5 peak on the last rally hasn’t overcome a (43.4) hurdle rate. Perhaps the Apple results could have a positive impact today; you’ve got to be impressed with a company whose sales increase 25% (more than 3 million computers, 7.4 million iPhones and 10.2 million iPods) in a consumer-challenged economy.

Net Volume Explained

Net volume helps resolve which way the market is likely to go; it is one of my most important technical tools. It acts as a forecasting barometer, important for its bearing on the future, but not necessarily immediate price changes.

Let’s keep it simple. There is a buyer and seller on every trade. If more buyers than sellers show up at any point, prices rise. If sellers out number buyers, prices fall. Economics 101 – demand and supply. Technical analysis attempts to read the battle between these two forces.

Price is charted vertically on most charts. Volume is typically shown in bars along the bottom of the chart time below price. I always had trouble “reading” bar-type volume charts, so I started experimenting in the mid-1980’s.

Advancing volume is the volume of all stocks that advanced for the day and declining volume is all the volume on stocks that close each day. To determine net volume, I subtract declining volume from advancing volume and divide by total volume.

The result is a percentage that falls in either positive or negative territory. For example, if advancing volume was 780 million shares and declining volume was 525 million shares and total volume was 1.4 billion shares (including the volume for unchanged issues), net volume for the day would be +18.2. If declining volume were greater than advancing volume, the result would be a negative percentage.

The idea to chart net volume horizontally came from George Seamans, a technical analyst in the 1930’s and 1040’s who charted total volume horizontally, a technique later popularized by Richard Arms and known as Equivolume in charting programs today. These are interesting charts in their own right. For example, if volume increases at the top of a rally with no improvement in price, the “distribution” is more apparent than with bar-type volume charts.

I experimented with various moving averages to smooth out the daily volatility, settling on three days as the best balance between smoothing results and identifying change early in the cycle. Whether positive or negative, the percentage change in net volume, when charted, moves horizontally to the right. Green represents positive net volume (more buyers than sellers) and red represents negative net volume (more sellers than buyers).

Net volume shows whether buyers or sellers are winning the battle. Over time I learned that net volume holds the key to the intermediate-term trend lasting weeks to months. Specifically, as long as the net volume on each short-term rally stays above the net volume on each short-term decline, the uptrend remains intact. In a typical rally, net volume peaks early or in the middle of a move. The uptrend remains  intact as long as net volume on the rallies exceeds net volume on the declines. Markets sometimes bottom on a peak reading but I’ve never seen a top on peak readings.

Just the opposite is true on a decline when sellers (supply) overpower buyers (demand). Net volume is not a tool to pin point tops and bottoms but rather confirms a reversal early in the move. For example, once the net volume on a short-term rally exceeds the net volume of the preceding short-term decline (not the peak, just the preceding decline), the trend change is confirmed. The net volume signal typically precedes 3-day swing charts (pattern) and moving averages that I use to confirm the change in trend.

A Look at Groups

As for groups, an article in last Friday’s New York Times, The Tech Sector Trumpets Signs of a Real Rebound, highlighted economist Ed Yardini who said, “This will be a technology-led recovery, and the recovery we’re seeing from technology companies suggests the recovery has legs.”

From the “that’s what makes markets file,” Doug Kass’s interpretation was more skeptical, “IBM was bad, AMD was bad, Accenture was weak, Nokia was terrible and Acer delivered weak four-quarter guidance. Intel benefited from inventory restocking, but investors are seeing through that extra ordering. Google was great, though.” The breakouts for IBM, Intel and Advanced Micro Devices didn’t hold but Accenture’s did and Google continued to rally. IBM, Intel and Advanced Micro Devices reversed and didn’t hold their breakouts, Accenture held its breakout and Google continued to rally while Nokia was unable to rally to new recovery highs.

Groups and broader sectors that led the advance to new highs (a sign of strength and speculators want to stick with strength) included Oil, Oil Services, Natural Gas, Energy and commodities in general plus Broker-Dealers, Software, Internet, Networking, Technology, Pharmaceuticals and Retail.

More defensive groups such as Consumer Staples, Food & Beverage, Defense and Gold also led the advance to new recovery high; I think their inclusion of these groups indicates a shift to a more defensive posture at the margin by large institutional investors,

Groups that didn’t follow the rally to new highs (a non-confirmation that indicates weakness) included Airlines (despite being in the top ten group relative strength list), Housing, Basic Industry, Real Estate, Utilities, Biotechnology, Healthcare Insurers (on the opposite side of the coin from drug companies on the impact of government-sponsored healthcare).

Key Markets

In other markets, the long-term government bond market looks vulnerable and using TLT as a proxy, was weak enough to initiate a short position when it traded below 94.60. My recommended stop sell point is above the October 8 high of 99.76. I plan to add to the short position on if and as TLT trades below its September 9 low of 93.52. The easiest way to be short this market is to go long TBF (ProShares Short Barclay’s 20-year+ Treasury ETF) or for double leverage, TBT (ProShares UltraShort Barclay’s 20-year+ Treasuries).

Fundamentally, time is closing in on a Fed exit strategy from its Treasury and mortgage-back bond buying program. I don’t picture a smooth exit amid a pork-barrel laden and “tax-credit in every pot” mentality in Congress, but pressure builds with what appears to be an V-shaped recovery. Beyond the initial bounce, my bias leans towards a cycle shaped like a square root sign because less bad is the “new normal” and that’s a euphemism for hard times.

Dealogic figures that most of the $2.3 trillion raised in debt offerings this year went towards balance sheet repair, hoarding or acquisitions, but it won’t do much to stimulate the economy.

There’s a general flight from currencies and the dollar is the weakest of the lot. Dead cat bounces aside, the U.S. Dollar index has yet to show it can reverse despite an overwhelming bearish consensus. It would take a trade above 77.47 from here to indicate to me that an intermediate-term swing is underway.

As for gold, it’s been a bull market since July 1999 ($252 an ounce, 2^nd London fix) and the gold market, is in the psychological phase where gold fever and public participation (already feeling their oats) could take over, much like Internet in mid-1999 and housing in 2005. For speculators, I recommend keeping trailing stops loose for now (just beneath the August 17 low, $932.75 2^nd fix) to accommodate any possible correction. The plan would be to tighten up trailing stops if the rally accelerates.

Major U.S. banks and brokers will pay workers about $140 billion in 2009, up from $117 billion in 2008 and above the record peak of $130 billion in 2007. “I determined that if you want to make money on Wall Street, you work there, you don’t invest there.” said Leon Cooperman in a Barron’s interview in July 2008. “They just pay themselves too well. I would rather look elsewhere for investment opportunities.”

“Bid ‘Em Up Bruce” Wasserstein’s career highlights the issue. His 2008 pay package, $20.4 million and mostly in restricted stock, exceeded the combined pay of the next four officers at Lazard. His early death triggered the vesting of his stock options valued around $188 million. Forbes magazine estimated his wealth at $2.2 billion, self-made from a career at First Boston, Wasserstein Perella (sold to Dresdner Bank in 2000 for $1.4 billion) and Lazard. He understood the key to rainmaking was all about ego, golden parachutes and fees.

In a story involving fewer dollars, I was surprised at how little Business Week sold for, even in an Internet-driven new media world. Terms were undisclosed for what Bloomberg paid McGraw-Hill for Business Week but it was understood to be about $5 million plus the assumption of liabilities, which stood at $31.9 million in April.

John Wooden turned 99 last week. I became a fan after I moved to San Diego in 1969 (UCLA games were rebroadcast late at night). “The main ingredient of stardom,” said coach Wooden, “is the rest of the team.”

He talked little about winning but stressed giving your best each day. During a 27 year tenure at UCLA, coach Wooden won 664 games including 19 conference championships, 10 NCAA titles, a 149-2 record at Pauly Pavilion and four undefeated seasons (statistics courtesy of the Los Angeles Times).

I watched a team led by Sidney Wickes, Curtis Rowe and Steve Patterson win the national title in 1970-71 and 1971-72 seasons. Freshmen didn’t play on the varsity on those days but you knew great basketball was on its way when 1970-71 champions were defeated by the UCLA freshman team with Bill Walton, Keith Wilkes and Dave Meyer. The Walton-led teams put together an 88 game win streak.

Conclusion:

The public appears to be tip toeing back into stocks above Dow 10,000 as prices climb the proverbial “wall of worry.” Tactics and discipline are particularly important. There’s no change in my recommend stop sell level under the SPX’s 3-day swing low of 1019.75 on October 2. The equivalent figure for the Nasdaq 100 (NDX) is just below 1656.57, up from 1585.56 previously.

I wouldn’t initiate short positions until the trend turns down. When that occurs, I prefer ETFs tied to small cap indices (going after strength after the top) and cyclical issues in weak stock groups

For investors, it’s time to plan ahead as to what percentage of assets to hold in stocks once longer-term technical tools indicate that the cyclical bull market has run its course. From an old fashioned, long-term “buying a business” approach, it’s virtually impossible for me to find good businesses with a favorable valuation underpinning.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Not to Decide is to Decide

SPX: 1076.18

DJIA: 9885

October 13, 2009

“October. This is one of the particularly dangerous month to speculate in stocks. Others are November, December, January, February, March, April, May, June, July, August and September.”

-Mark Twain

Not to Decide is to Decide

Price persistence, broad participation (advance/decline strength) and expanding new highs support the case for a potential burst of momentum. I suspect short sellers are pretty battered. The S&P 500 (SPX) closed on new recovery highs the past two days. So have the Dow Industrials.

But a potential non-confirmation is brewing because the Dow Transports last closing high was September 15 at 4015.16. While it wouldn’t take much additional strength for the Transports to confirm, this is no time to get complacent and take your eye off the tape because volume indicators are also flashing a warning. Total volume is light, the five-day moving average of advancing volume declined on each rally since the early August high and most importantly, net volume in not in synch with price.

NYSE net volume overbalanced  to the downside on the last short-term decline with a (56.8) peak compared to a +56.2 figure into the September 23 high (1080.15). The peak reading so far on the current short-term rally is only +47.5. NASDAQ net volume hasn’t overbalanced yet but its +42.5 peak last week didn’t overcome a (43.4) hurdle rate.

The Market Trend Indicator (MTI) is signaling Uptrend. It remains on uptrend status until at least one index closes below its 18% weekly exponential average; then the reading shifts to neutral.If all three indices close below its respective 18% average, the MTI will signal downtrend; it hasn’t signaled that since the week ended March 20. The SPX’s 18% average is 1027.15 this week and the  DJIA’s is 9496. The New York Advance/Decline line is 8,844 net advances above its 18% average.

Could stock prices break out decidedly? The Investment Company Institute reported money fund assets rose $16.7 billion last week to $3.4 trillion, so there’s plenty of firepower. Important resistance above 1083.53 (5/8 the March 2009 low) is 1121.44, a level that marks the halfway point of the bear market. If the SPX were to trade in the top half of its bear market range, it would confirm, in my opinion, the belief that normal is back for the economy and stock market.

Tactics and money management count for far more than predictions. My plan is to raise stop sell levels to just under the SPX’s last 3-day swing low; see the conclusion section for specifics. The advantage of planned, deliberate speculation is being able to step aside if and when the stock market turns down while the disadvantage versus investing is giving up some profits if the weakness is just indeed a correction.

As for stock groups, there’s little change in leadership. As ranked by relative strength, the top ten groups are Full Line Insurance, Platinum & Precious Metals, Consumer Electronics, Airlines, Gambling, Coal, Hotels, Paper, Copper and Aluminum. Will these groups have legs if the cyclical bull continues? I have tough time with the rally in hotels picking up much steam from here. RevPar (trailing-twelve month hotel revenue per room) was $56.19 in August, down 15% year-over-year and following on the heels of a 13% decline in July and nearly 12% drop in June. Los Angeles Times reported that more than 300 hotels in California were in default or foreclosure at the end of the third quarter and the number is rising. At the same time, a study by The Wall Street Journal found that banks with heavy exposure to commercial real estate only set aside $0.38 for every dollar of bad commercial real estate loans in the second quarter

In other key markets, long-term government bond prices are bouncing in early trading but are nearing a point where they will have shown enough weakness to initiate short positions. Bloomberg columnist Caroline Baum wrote this morning, “Investors – dollar-recycling foreign central banks aside – are buying bonds because they’re pessimistic, not optimistic.”

Using TLT as a proxy, I would initiate short positions if TLT close below 94.60 and add to that position if TLT prices trade below the September 9 low (93.52). A short position can be established by going long TBF (ProShares Short Barclay’s 20-year+ Treasury ETF) and TBT (ProShares UltraShort Barclay’s 20-year+ Treasuries). There’s also a Direxion ETF with triple leverage but I prefer not to play in that sandbox.

As for the dollar, TurboTax Tim reiterated last week that “it’s important that America continues to have a strong currency.” Of course that’s a little tricky when the final estimate by Congressional Budget Office (CBO) for the fiscal 2009 year ended September was $1.4 trillion compared to a $459 billion deficit in fiscal 2008.

Economist David Malpass (Encima Global) explains, “Washington’s current economic program pushes capital away by weakening the dollar, threatening higher tax rates, borrowing short (the Fed’s near trillion-dollar overnight debt, Treasury’s mounds of bill and note issuance) to lend long (mortgages, student loans, entitlements), doubling down on government subsidies, and rechanneling bank loans to governments and big businesses instead of the small business job-growth engine.”

The dollar might be universally hated but a if the U.S. Dollar index trades above 77.47, it would indicate an intermediate-term swing up is underway. A rally is long overdue but I plan to wait for confirmation.
If the dollar manages to rally, it could be telling as to how gold reacts. Gold has been a bull market since July 1999 ($252 an ounce, 2^nd London fix) and, in my opinion, this market is in the psychological phase where public participation (already feeling their oats) takes hold, much like Internet in mid-1999 and housing in 2005. The stage is set for gold fever and prices could overshoot. For speculators, I recommend keeping trailing stops loose, or  just beneath the August 17 low ($932.75 2^nd fix) to accommodate any possible correction.

In international markets, and helped by demand for commodities, Brazil, Russia and Australia have moved to the top of the best performing country list. Could China be the “canary in the coal mine?” The Shanghai Composite and Shenzhen and Hong Kong markets  bear close watching over the next two weeks. Through September, China’s economy grew about 9% this year but The Economist reported lending is up 34% through or nearly four times GDP through August.

Jim Rogers was interviewed by Maria Bartiromo on CNBC last week. He said his contrary view is to not buy stocks in any world market. It’s no surprise he favors commodities. He reasons if the world economy gets better, commodities will lead because there are shortages. If the world economy stays depressed, commodities could do well because the government will print even more money.

Switching continents, Spain has the highest unemployment rate in Europe (18.5%) and its economy is still contracting. Bloomberg reported Spanish lenders acquired $29 billion of real estate in the past 18 months to keep the losses off the books. Instead of cutting prices on homes, the banks are offering variable rate 100% financing.

In the U.S. housing market, the Mortgage Bankers Association disclosed that prime loans accounted for 58% of new foreclosures in the second quarter, up from 44% the year before. Zillow.com figures 30% of the foreclosures in June were in houses in the top third of local home prices. Someone figured (and I haven’t confirmed the number) there’s a foreclosure somewhere in America every thirteen seconds.

As for streaks, the Federal Reserve reported consumer credit fell for the seventh consecutive month in August, the longest run since 1991. Including a 13% drop in credit card charges, total consumer credit was off $12 billion or 5.8 % seasonally adjusted.

September was the sixth consecutive month in which corporate America sold more than it bought. According to TrimTabs, corporate selling (new offerings + insider selling) was $34.4 billion or more than two times corporate buying (new cash takeovers + buybacks) of $13.4 billion.

A lawsuit brought by Citadel alleged several former employees of its Tactical Trading high-frequency trading fund violated noncompete agreements when they set up Teza Technologies. Tactical Trading earned $892 million in 2007, up from $75 million in 2005 and $3 million in 2004. It was spun out as a separate fund in 2007.

Let’s close with a comment from the healthy living file. Apparently, fried ribs, fried bacon and fried ice cream are popular items at the Texas State Fair; I discovered corn dogs there when San Rafael’s Eddie Lebaron and Len Dawson were quarterbacking the Cowboys and Texans (now the Kansas City Chiefs) respectively. I read in The Economist that the winner of this year’s creativity award was fried butter (balls of butter dipped in dough, deep fried and dusted with powdered sugar)!

Conclusion: Given the light volume as the stock market enters third-quarter reporting season, I think it makes sense to raise trailing stop sell orders to a point just under the SPX’s October 2^nd 3-day swing low of 1019.75. The equivalent figure for the Nasdaq 100 (NDX) is just below 1656.57, up from 1585.56 previously. I wouldn’t initiate short positions until the trend turns down; if and as that occurs, I prefer ETFs tied to small cap indices.

For investors, I think it’s best to hold quality merchandise. It’s also time to plan ahead as to what percentage of assets to hold in stocks once longer-term technical tools indicate that the cyclical bull market has run its course.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.

Business-Stock Market Disconnect

William Gibson, CFA (415)515-8074

3450 Sacramento Street #337 wtgcfa@yahoo.com

San Francisco, CA 94118 October 6, 2009

(SPX – 1040.46)
(DJIA – 9599)

BUSINESS-STOCK MARKET DISCONNECT
Wall Street started a new month and quarter with a 90%-down day; it didn’t take much disappointing economic news to instill doubts about the recovery. The financial press abruptly latched onto predictions that the top is in and new lows await the unwary.

My technical work doesn’t support that view and fundamentally, any backsliding keeps the Federal Reserve from entering rehab to kick its Treasury and asset-backed purchasing habit. Liquidity is driving this market and those proceeds have few places to go besides the stock and commodity markets.

Steve Leuthold explains, “The stock market turned up before the economy did. Now, the economy is improving. It might be a little better than most think. It ain’t wonderful, but it’s a lot better than it was.”

The freeze may over, but I don’t buy JP Morgan strategist Tom Lee’s assertion yesterday on the Bloomberg channel that the “old normal” is back. Without job growth, a home equity ATM machine and liar loans, people are forced to live within their means like it or not. Leuthold’s S&P 500 (SPX) price targets are higher than Lee’s, 1200 by year-end and 1350 next year, but no one really knows.

The Market Trend Indicator (MTI) reading remains Uptrend. The SPX, DJIA and New York Advance/Decline line are all above their respective 18% weekly exponential averages. The SPX’s 18% average is 1017.42 and the Dow’s is 9415. The A/D line is 6,464 net advances above its 18% average.

There’s no change in net volume readings. The NYSE peak on this decline, (56.8), was greater than the +56.2 figure into the September 23 high (1080.15) and it continues to warn further weakness lies ahead. NASDAQ net volume is in synch with the MTI’s uptrend as its peak reading on this decline is only (43.1) so far compared to a +61.3 peak into the September high.

A lower high and lower low and break of the 20-day moving average for the SPX turned the short-term trend down. Note how the VIX (volatility index which trades inversely to the market) looks like it’s building a base (bottom), so intermediate-term stock market weakness may not be over.

I thought the rapid advance from the March panic low through June was a bear market rally because the bear market pattern looked incomplete and technical signals to indicate bull market (price & time overbalance) were missing.

When the second section of the advance started in July, time (more important than price) overbalanced, indicating a change in the primary trend. There was also a Dow Theory buy signal and moving average cross over (18% exponential average moving above the 5% average and both trending higher) as well as a NASDQ weekly net volume reading that exceeded any negative figure during the bear market.

I switched my bias to the cyclical bull market camp and subsequent market action seems to be bearing out that view. Although the stock market may have completed a two section advance, the rule is to count three sections and expect a fourth, so any weakness from here would likely be a correction in an ongoing cyclical bull market. It would be positive if any decline holds above 944.74, the halfway point of the second section advance.

As for group action, leading groups haven’t pulled away from the pack and a contrary investment style has been the way to go. “The main event featured rebounding laggards, and relatively strong groups were a side show,” wrote Gary Anderson (www.equityPM.com).

Charles Kirk (www.kirkreport.com) runs all sorts of screens for various fundamental factors and during the second quarter, the screens that performed the best were those that looked for recent relative underperformance. In essence, today’s momentum leaders were yesterday’s losers and vice versa.

From a broader perspective, the following table shows the performance of important indexes and a ranking of S&P sector performance. Financials led by a wide margin, followed by Materials and Industrials, both beneficiaries of recovery and a weaker dollar.

Index & Sector Performance

Index Mar-Sep 1st Section Jun-Jul Correction 2nd Section

S&P 500 (SPX) 62.0% 43.4% -10.0% 24.3%
DJ Industrials (DJIA) 52.3% 37.2% -8.9% 21.9%
Nasdaq 100 (NDX) 72.2% 48.3% -7.7% 25.8%
S&P Mid Cap (MID) 77.6% 51.8% -10.8% 31.2%
S&P Small Cap (SML) 80.4% 56.2% -11.0% 29.7%
Russell 2000 (RUT) 82.5% 56.4% -11.6% 32.1%

SPX Sector Ranking

Finance 162.6% 122.4% -17.2% 42.6%
Materials 83.8% 60.7% -16.8% 37.4%
Industrials 82.0% 59.4% -16.2% 36.3%
Information Technology 77.7% 52.6% -7.9% 26.5%
Consumer Discretionary 74.3% 53.3% -12.2% 29.4%
Technology 64.1% 44.0% -7.9% 23.8%
Telecommunications 51.0% 48.5% -12.1% 15.6%
Energy 50.5% 46.6% -20.4% 28.9%
Healthcare 34.8% 21.7% -5.6% 17.3%
Utilities 33.9% 26.2% -5.9% 12.8%
Consumer Staples 33.2% 24.3% -5.5% 13.4%

In other markets, a headline in a quarterly review last week in The Wall Street Journal sums up the credit market, “Treasuries Buoy Credit Markets, but Junk Is King.” The intermediate-term trend remains up for long-term government bonds but I’m keeping my eyes peeled for technical confirmation that the move is complete.

The Wall Street Journal also reported that Invesco and TCW qualified for the Treasury program by raising at least $500 million each to buy toxic assets; they raised $1.13 billion, which gives them $4.52 billion of buying power with a dollar-for-dollar government capital match and debt financing.

Further down the food chain, Meredith Whitney wrote, “Access to credit is being denied
at an accelerating pace. Large, well capitalized companies have no problem finding
credit. Small businesses, on the other hand, have never had a harder time getting a
loan…In the U.S., small businesses employ more than 50% of the country’s workforce
and contribute 38% of its GDP.”

The dollar closed out the quarter falling against virtually all currencies, a rare occurrence.
Yet is held above its September 22 low and the falling wedge pattern is the sort that is often followed by a sharp rally. It will be key to watch how gold reacts if that occurs.

The breakout in gold looks better on my chart of the second London fix than it does on the continuous contract. It looks like it could pull back to $975 (2nd London fix). While I expect sharply higher prices in coming weeks and months, my recommended stop sell point for speculators is just under the August 17 low ($932.75 2nd London fix) and for investors, under the July 13, 2009 low ($908.50). I don’t want anything to do with the gold market below these levels.

The International Monetary Fund (IMF) raised its global 2010 growth forecast to 3% from 2.5%. Australia became the first country to raise interest rates since the meltdown began with a quarter-point hike from a 49-year low.

An initial public offering (IPO) for Chinese Resources Cement closed down in Hong Kong, the fifth IPO in a row to do that in that market. Note how Shanghai market turned down ahead of ours.

I attended the ninth annual “Hardly Strictly Bluegrass” festival in Golden Gate Park over the weekend, a free concert with about 80 acts sponsored by Warren Hellman. What a great gift for the city of San Francisco!

Listening to Boz Scaggs and the Blue Velvet Band (James Cotton, Nick Lowe, Austin De Lone, Buddy Miller, Derek O’Brien, Wes Starr, Jimmie Vaughan and Jack ‘Applejack’ Walroth) perform “Big Boss Man” on a sunny afternoon took me back to listening to Jimmy Reed at the Savoy Tivoli in 1976 when I was a rookie analyst with San Francisco Investment. Reed looked the part of a hard drinking, chain smoking Chicago bluesman in a smoke filled night club in North Beach. He died a few weeks later in Oakland just before he turned 51.

Back to stocks, the monthly charts for the SPX and NDX look positive, which fits into the higher prices lie ahead them. I’ll close with the quarterly chart for the SPX from the 1974 low.

CONCLUSION:
My recommended stop sell levels are unchanged, just underneath the September 9 low (991.97) for ETFs tied to the SPX and just below 1585.56 for the NDX. I think the market is setting up a buying opportunity but it’s ok for speculators to initiate appropriately-sized short positions if and as technical tools indicate an intermediate-term downtrend. For shorts, I favor ETFs tied to small cap indices.

For investors, I think it’s best to hold quality merchandise. It’s also time to plan ahead as to what percentage of assets to hold in stocks once my technical tools indicate the cyclical bull market has run its course. We’re not there yet.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee

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