7/29/07

There will be no report next weekend.

I believe last week’s link problems have been corrected. If you encounter any more problems, please let me know at [email protected]

7/6/08

A week ago I expected support levels to hold at a 10-wk cycle bottom after a few more days to the downside for stocks. Despite a tendency for stocks to rally going into a holiday, no rally has yet rally materialized. Instead, the SPX (http://www.geocities.com/petegersb/SP500.GIF) made a new closing low for this 9-month cycle on Wednesday, and a lower intraday low on Thursday. Ex-Energy stocks, the remainder of the SPX (http://www.geocities.com/petegersb/SPY-XLE.GIF ) broke down to a 3-year low as it approached the bottom of its bear-market trend channel. Of course, the worst performing sector, Financials (http://www.geocities.com/petegersb/Financials.GIF ), also has had the heaviest weighting in the SPX. If you equally weight the 9 sectors, you get a somewhat less grim picture. The equally weighted index (http://www.geocities.com/petegersb/SPDR-Composite.GIF ) currently resides a little above the March low and well above the January low. From its October peak, it’s down only 14.2% compared to 19.9% for the SPX and 23.3% for the SPX ex-Energy. The NDX (http://www.geocities.com/petegersb/NDX.GIF) and Russell 2000 (http://www.geocities.com/petegersb/Russell2000.GIF) also fared a little better recently, giving up “only” 60%-80% of the March-June rally phase of the17-week-old 20-week cycle. However the NDX is 18.9% below its October peak, and the RUT is 22.3% below its July 07 peak, so the only refuge has been energy and other commodities. Since mid-October when most of the market peaked, the XLE (http://www.geocities.com/petegersb/EnergySPDR.GIF) is up 8%, and Gold (http://www.geocities.com/petegersb/GoldBullion.GIF) is up 22%. There is always a bull market someplace.

There is some potentially good news in the status of cycle indicators for the broad market indexes. Not only are the 10-week and shorter cycle indicators deeply oversold, they bear a strong resemblance to conditions surrounding the Thanksgiving holiday. From there a 10 week cycle rally ensued that lasted 2 weeks, followed by a second rally attempt that produced a double top 2 weeks later and led to the steep January decline. A similar pattern this time would get the S&P back up to perhaps 1330 in late July before the next leg down for this bear market.

Unfortunately, that similarity does not carry over to the VIX and VXN. At the late-November 10-wk cycle low the DStoc on the daily VIX (http://www.geocities.com/petegersb/VIX.GIF) had already entered a clear downtrend, but currently it has turned up again after a brief dip in mid-June. That brief dip suggests that perhaps the 10-week cycle did bottom on June 12 at age 12 weeks, when I originally thought, and the ensuing 2-day rally was the best we could get out of the rally phase. If so, it implies the 10-week cycle is only 3 weeks old, and the worst lies ahead, not behind. The same holds true for the VXN (http://www.geocities.com/petegersb/VXN.GIF). Although the level of these indicators continues to suggest that stocks are near a 10-week cycle low, the time lapsed since anything that could be interpreted on the price charts as a 10-week cycle low, argues against a near-term bottom. The weekly VIX and VXN (http://www.geocities.com/petegersb/VIX-weekly.GIF, http://www.geocities.com/petegersb/VXN-weekly.GIF) suggest that the 20-week cycle is not yet near a bottom. A 17-week-old 20-week cycle fits well with the presumption of a 3-week-old 10-week cycle. Both are compatible with another month or two on the downside before we see a nested bottom of these two cycles. An August low for these cycles would then produce a second 20-week cycle rally off of the 9-month low established in March, and set these cycles up for a nested low late in the year. Given the time remaining for these cycles to play out, we could well see that 35% average bear market detailed in this week’s Barron’s – or worse.

The status of the 10-week cycle appears sufficiently precarious that attempting to play its next rally phase is fraught with risk. At worst, if it did bottom in June, July promises to be even worse than June. At best it will soon attempt to rally against longer cycles that are clearly in downtrends. A similar price and indicator pattern on the long-term weekly chart (http://www.geocities.com/petegersb/Overview-long.GIF) in August of 2001 led to a good bear-market rally into year end, but it did turn out to be only a rally into a continuing bear market. And at that time, the Fed was still 2 years away from its last rate cut of that cycle (http://www.geocities.com/petegersb/InterestRates.GIF ). It was then willing to continue cutting rates because inflation was not so threatening, and the dollar (http://www.geocities.com/petegersb/Dollar.GIF)) was only about a month into its 40% freefall from 120 to 72 under the weight of the Bush economic and foreign policies and the Greenspan monetary policies that together have helped bring us to the current sad state of affairs.

In summary, while some indicators suggest that stocks remain ripe for that summertime 10-wk cycle rally, a good case can also be made for a nested 10/20-week cycle low sometime in August. I don’t think we can rely of the normal election-year pattern (http://www.geocities.com/petegersb/ElectionYearPattern.GIF) to prevent worse to come as the 9-month cycle (http://www.geocities.com/petegersb/Overview-med.GIF) heads towards its next scheduled low sometime in the 4^th quarter. Conversely, we can probably rely on the normal 4-year election cycle (http://www.geocities.com/petegersb/4YearCycle.GIF ) to produce a very difficult market for the subsequent two years.

Unfortunately, the down slope may be buttressed by the late stages of a much longer cycle as well (http://www.geocities.com/petegersb/SPX-InflationAdjusted.GIF ). The similarities to the decade of the 70’s are indeed worrisome. Nixon and Ford had to face the inflationary consequences of Johnson’s ill-advised guns and butter policies during the unjustified Vietnam War. Similarly, Obama will have to deal with the inflationary consequences of Bush’s ill-advised guns and butter policies after his unjustified Iraq invasion, and of his spend and tax-cut policies that further accelerated his record deficits. Nixon and Ford weren’t very successful, but Obama is a whole lot more honest than Nixon, and a whole lot smarter than Ford. There is some hope for the next decade, because he can reverse Bush era mistakes. But there are some negative trends that government is powerless to reverse. The aging of our society will further strain our resources. The continued move of the developing world toward a consumer society means their workers will gradually be reducing their subsidy to our standard of living. Perhaps most importantly for the markets, they will not have the 80’s and 90’s tailwinds of interest rates that were dropping from high levels and price/earnings ratios that were rising from low levels. Instead, like the early 1970’s, interest rates are still near historical lows, and, ignoring the late 90’s, P/E’s are still near historical highs. Both have only one way to go over an extended period of time. During the 20 months from the end of 1972 to the 1974 market low, the P/E dropped from 19 to 7.2 while the 30-year treasury rate interest rate rose from 5.6% to 7.3%. At the ultimate inflation-adjusted market low in 1982, the P/E was still at 7.4, and the T-bond rate had risen to over 13%. Despite a 20% drop in the SPX, the current P/E remains above 20, and the T-bond rate remains below 5%. So a diversified portfolio will be no defense against rising interest rates and falling P/E’s. While it’s true that P/E’s have held at high levels and interest rates at low levels for many years, eventually the chickens will come home to roost. With both the Fed and the US Treasury out of ammunition to support consumption, the world running out of cheap energy, the rest of the world becoming more reluctant to lend to us, and the 4-year cycle due to reach bottom in about 2 years, the time may be now.

But won’t the predicted surge in earnings next year reduce the P/E without lower stock prices? That surge only appears in the bottom-up estimates (http://www.geocities.com/petegersb/EarnY-Y.GIF) that are usually wrong and are continuing to be revised downward to better conform to the flat top-down estimates. Last week, Standard & Poor’s adjusted its bottom-up operating earnings estimates for 2008 downward by another 20 cents and the 2009 estimate another 21 cents. The gap between these bottom-up estimates and the lower top-down estimates has narrowed to $7.43 but for the full year 2009 it has widened to an astronomical $29.22. The valuation models (http://www.geocities.com/petegersb/ValuationModels.GIF) that use those bottom-up earnings projections should be viewed with great skepticism. The trend in those models appears to have some value, however, and the current trend clearly remains very negative. If earnings were to continue declining, stocks would have to decline much more drastically to once again produce normal P/E ratios.

Sentiment has become deeply pessimistic, but until there is some indication of a reversal in that trend, it’s probably too early to buy. After the worst June for stocks since the depression era and the worst 1^st half since the stagflation of the 1970’s, Barron’s finally recognized the bear market with a front page headline proclaiming: “The Bear’s Back”. While popular magazine headlines are frequently a good contrary indicator, Barron’s has relatively small circulation, and the article does provide historical data that makes a case for continuation to lower prices after stocks reach the proclaimed 20% bear market threshold. On that point, there’s no disagreement from Advisory services (http://www.geocities.com/petegersb/InvestorsIntelligence.GIF) and AAII members (http://www.geocities.com/petegersb/AAIIsentiment.GIF). They are very pessimistic and becoming more so. As long as that trend continues we can expect stocks to continue to decline. Furthermore, despite a price level that is below the March lows in the DJIA and the SPX, pessimism is not yet as deep as it was at that time (http://www.geocities.com/petegersb/SurveysCombined.GIF). Expect new depths before a significant turn.

Government Bonds were fairly flat for the week as a correction in the overbought 13-day cycle stalled the rally in the longer cycles. TIPS (http://www.geocities.com/petegersb/TIPs.GIF), benefiting from heightened inflation fears (http://www.geocities.com/petegersb/CPI.GIF ), managed a small gain. Conventional T-bonds (http://www.geocities.com/petegersb/Treasury-20yr.GIF) lost a little ground – enough to turn the short-term composite downward. The 26-day cycle remains overbought for both, and will probably produce a minor decline this week and limit any gain from the up trending longer cycles. Corporate bonds (http://www.geocities.com/petegersb/CorporateBonds.GIF) are another story. They declined sharply to another new multi-year low. All the cycles are now oversold except for the 26-day cycle. The intermediate composite is very oversold, and a little more decline this week will produce a short-term oversold condition as well. Perhaps then they can join treasuries in an intermediate rally. Bond sentiment (http://www.geocities.com/petegersb/BondSentiment.GIF) has now improved enough to produce a crossing of the moving average to produce an intermediate-term buy signal.

The dollar (http://www.geocities.com/petegersb/Dollar.GIF) gained slightly for the week on the strength of a good Thursday rally off of a short-term low that essentially matched the May low. The short-term rally should be sustained this week, but the intermediate downtrend remains intact.

Gold (http://www.geocities.com/petegersb/GoldBullion.GIF) moved above its May short-term peak, and pulled back to it as the short-term composite peaked. A further pullback appears likely as the overbought 13 and 26-day cycles correct, but the intermediate uptrend should remain intact. Gold should again become a buy near its 10-week moving average. A break below the June low, which is near the 9-month moving average, would be cause for concern. Gold stocks, as represented by the XAU (http://www.geocities.com/petegersb/GoldStocks.GIF), turned down from a higher 26-day cycle peak within a continuing intermediate uptrend.

Another week, another five bucks and another all-time high for a barrel of Crude oil (http://www.geocities.com/petegersb/CrudeOil.GIF). Although the 13 and 26-day cycles are overbought, the rising short and intermediate composites are not. That $150 level could easily be hit this week before a short-term peak is established.

Natural gas (http://www.geocities.com/petegersb/NaturalGas.GIF) gas hit a new multi-year high again last week. Although 3 of 5 cycles are overbought, the relatively fresh 26-day cycle should sustain the uptrend this week. One of these weeks we’ll see a break below the narrow trend channel that has characterized this move for the last 16 weeks. That will probably signal an extreme right-translated peak for the 20-week and 9-month cycles. For now, Natural Gas remains a hold.

Once again Energy stocks (http://www.geocities.com/petegersb/EnergySPDR.GIF) couldn’t come close to matching the performance of the underlying commodities. They moved down to the bottom of their 2-month trading range as they join other stock indexes in searching for a 10-week cycle bottom. The difference is that Energy Stocks are accomplishing their intermediate correction by moving sideways over a 2-month period, while most non-energy stocks have been moving sharply downward. If broad stock indexes can find that 10-week bottom, Energy Stocks appear likely to surge to new highs again.