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Over The Last Month, We Have Moved From “Hope-ium” To Despair. Put Down The Bottle, Pick Up Your Reading Glasses, And Get To Work ($SPX from 50,000 Feet)

I decided to do this post about a week early (as next week is Thanksgiving and I have a lot of things to do in between now and then on a lot of fronts). For the average long-term investor, particularly those very close to retirement (as most boomers are) may feel a bit like Judge Elihu Smails (Ted Knight from Caddyshack) when christening his sailboat. Things look relatively positive over the last couple of years, and then all of a sudden the algorithmic traders, sovereign concerns, and debt maladies swing in to his retirement plan like Al Czervic’s yacht. Many who have the cash available to invest in this market have made this decision. Drinking is definitely NOT the solution to the problems associated with trading and investing. Good analysis is.

I think the point of this post today is to demonstrate that all we have seen since the first large crack in bullish momentum that we experienced in August 2011 is random price movement in a period of deep and even panicked uncertainty in the context of a larger and perhaps more ominous pattern for the $SPX (Standard and Poor’s 500 Cash Stock Index). Perhaps the best aggregate summary of the current volatility is found in Michael Santoli’s Streetwise column in this week’s Barron’s. What I will do with a host of daily, weekly, and monthly, charts today is to show what little progress we have made in resolving direction in the past three months (regardless of what anyone’s opinions might dictate from a fundamental or technical basis), and what things must be resolved for a resumption of a major trend. For the sake of time, I will not post all the momentum charts.

Daily chart: Current momentum trend is bearish. Take a quick look. Regardless of the amazing amount of volatility, we are still trading within the broad ‘box” that includes current resistance at 1292.66 and  support at 1074.77. What I think is most critical is the fact that (using the greatest technical analysis tool known to man, a ruler), you can see that the general trend since August is now accelerating downward. What is even more critical at this point is that there is decent confluence between the 0.786 retracement of the July 1, 2010 low (the Tepper low after the flash crash) and the April 29, 2011 high at 1370.58. That confluence level is between 1293.61 and 1308.58. That would coincide pretty well with key resistance at 1295.92 on July 18, 2011. When markets accelerate in a bear market rally, they often overshoot the 0.618 retracement to a 0.786 retracement. In this case we have resistance right at that point.

Weekly Chart: Current momentum trend is bearish: Here is the bearish scenario. Because the $SPX has not taken out 1292.66, that still remains the C pivot of a potential AB=CD Fibonacci pattern in context to a bullish impulse between X and A as shown on the chart. Symmetry would place a near-term momentum low if that pattern works out at roughly a support level of 996. 68. Momentum suggests for now that this pattern should occur. Anything is possible, but the odds favor this outcome if bearish momentum persists on a weekly basis. IF we were to see continued selling, even in the midst of a potential rally from the low shown at B (1074.77 on week of 10/2/2011), then a possible three drives to a bottom would put a longer-term low of approximately 936.50. If we were to sell off rapidly as we did rallying back from the October 2011 lows, an extended target of 817 is not impossible.

What about the bullish scenario? It is shown here. If we were to hold the October 4, 2011 lows, assuming the markets can blow out 1292.66, then symmetry suggests a high near 1440.24, extended to 1469.77 at the 127.2 extension of the A to B line, and perhaps even as wildly high as 1594.21 at the outside 161.8% extension. That could take 35 weeks to get there, but, that would put you into the March April 2012 time frame.

Monthly chart: Shown for completion. Momentum neutral to bearish. Bottom line here is that if you do not take out 1370.58, then the $SPX is simply going to churn at best, or perhaps complete a right head and shoulders top. I have run some neural net analysis on patterns like this one (and in fact ON this one, but the statistics are not all that solid, the last buy signal was at the end of September, but that would have been a hell of a ride until now). No sell signal is given, but the output of the net is turning negative and could signal soon. It hasn’t YET though.

Basically, with the exception of the neutral momentum on the monthly charts, the combined momentum model would favor the bearish outcome outlined in the weekly chart analysis. Still, I think anyone who can call this market in one direction or another at this point is probably going to be lucky until we get some resolution on the debt crisis in Europe, our own debt crisis here (the Super Committee, which seems to be more of an embarrassing circus act every day), and some sense of confidence that the U.S. economy is not still going to stall out at some point in 2012.

What evidence do we have to support either case?

What about the EURO? Perhaps the best thing I have read this weekend is found here from John Mauldin (who would like to sneak in a sales pitch for alternative investments whenever he can). If Germany balks and does not agree to printing Euros in some kind of agreement to inflate its debt into non-existence, then the Euro will weaken, the dollar will strengthen, and we will likely see the current correlations kick into the market. For a simple explanation of how that works generally, here is (please don’t hurt me) Jim Cramer. (Watch the video to 7:36). Bottom line is, the correlation between a weak US dollar and better exports abroad for multinationals is the paradigm that institutional traders are sticking with. You have seen my evaluation of the EURUSD from last week, and it still holds. If Germany somehow does not agree to print EURUSD through the ECB, then the 1.2395 handle on the EURUSD is a distinct possibility, and that would very likely be bearish for the U.S. equity markets, and particularly the $SPX with its large multinational company exposure. Nothing is outside the realm of possibilities. The German taxpayer is on the line as the Eurozone drowns in its own debt and unwillingness to take the pain of fiscal discipline. Really the only thing left is not avoiding pain, but figuring out HOW much pain there is going to be. Pollyanna has been reported missing in the EU and assumed debt (that was bad, but it was the only pun I could make work).

What about the Super Committee and its quest to reduce the U.S. federal deficit? The odds of avoiding the sequestration that leads to budget cuts in defense and other programs (besides the ones that really need to be curtailed in entitlements) is not going to happen. The entire constitutionality of the thing is certainly questionable, but the politics is virtually guaranteed, as our elites shaft the American public to secure the votes of those who will re-elect them. That, in the very short run, could also have a negative impact on stocks.

And what about S&P 500 earnings? Well, they’re OK for this quarter so far, but what about the future? The Wall Street Journal lately questioned earnings momentum of late despite the good news regarding U.S. industrial output of late. The real question going forward is whether we can last another year without some kind of slowdown, and that news could work either way, depending on how the other world events described here play out.

General valuations: I am not going back into that discussion in depth here, but most of you understand my concerns about inflation-adjusted price/earnings ratios and how all that compares to the risk-free rates of interest (at zero) currently. I still do not think we are in any sort of “buy and hold” territory unless you absolutely know that you are going to be invested for perhaps 15 to 30 years and can ride out what I believe is the second half of what could be a two-decade long secular bear market. What I want people to do now is to hedge themselves against what could be a very wild ride as we move into 2012 and 2013. Or you could decide to believe and act upon the fact that cash IS a position. Some billionaires do.

So what is MY conclusion?

I think there is still considerable risk of a drop in the $SPX below 1000, perhaps to 936 or so, in the next year. If typical pattern symmetry takes hold, the price action could play out exactly as I have outlined in these charts, but I cannot be so sure, since the news flow from around the world is rapid fire. I have not even included all the international messes that are piling up (Iran-Israel being one of them). So much will have to go right for a major rally to occur. The certainty of that happy ending is simply to complex to calculate. So, for now, if one is worried about a downside, the maximum I can see at this point is around 817. I really think either wild temporary optimism or just plain momentum could also press the $SPX  to 1440 at some point, but not until there is a resolution to the Eurozone debt crisis. Remember, when the Eurozone crisis is over, which one is next? Yep, the US Dollar crisis. The U.S. Congress cannot even get its collective head around the fraud of baseline budgeting versus bottom dollar accrual budgeting and we have a President who uses Executive Orders to subvert the will of the people via fiat regulation. The solution of this problem, in my opinion, could set us on a course of conflict we have not seen since the American War Between the States.

We are only in the second inning of a game that will change this country and the world forever. I love a good ballgame, I just wish I didn’t have to live with what could be some not-so-favorable results.  I still believe, though, that the United States will be stronger on the other side of it, as long as our selfish Machiavellian political elites do not destroy the essence of free expression and economic liberty. If you read the Mauldin article, you noticed the rather obvious tints of German statist notions with regard to “fears that German plans to deal with the Eurozone crisis involve an erosion of national sovereignty that could pave the way for a European “super state” with its own tax and spending plans set in Brussels.”  To me, freedom is the only answer and ethical sovereign management is the only tool that can be used to fix problems.

That is it for now. I hope U.S. readers have a happy Thanksgiving! Thanks for supporting this blog!

{ 2 comments… add one }

  • Frank Mangano November 19, 2011, 10:00 pm

    I have always been an eternal optimist on the U.S.,. and all of its investment oppurtunities. I have lost money many times, but my net gains are in the 10 milliom range. Currently though, the multitude of variables, domestic and foreign, have me perplexed. I would “value” any guidance that you and your collegees could help me with. Thanks

  • admin November 20, 2011, 4:35 pm

    Frank, I am still optimistic about the US as long as our politicians do not destroy the economy through hyperinflation, over-regulation, or over-taxation (the last two I am really worried about). I do not know exactly what your tax situation (or your funds flow situation is), but I would evaluate all of your investments on a one by one basis. If you have a way to calculate what you think your investments are valued at on a free-cash-flow basis and you find some are more expensive than others, then I would consult your CPA and investment adviser and pare back on some of those while capital gains rates are favorable. What is so difficult to calculate right now (as you can imagine) is what kind of new tax regime will be put into place after 2013 and how that will affect what you pay). If you are not in need of the cash from investments, you can probably ride out those investments as long as, within the context of the timeline in which you might need cash, you do not need to sell. I did not massively reinvest in stocks after 2000, knowing that valuations were stretched and that I wanted to spread my investments into areas where I could guarantee myself a return (some of those are pretty technical, but I am comfortable with them from MY risk tolerance perspective). At some point down the road, I will reinvest in stocks as long as there is a really solid value proposition attached to them. I own land, I am a banker or last resort in real estate that I understand and can obtain a nice return from (and that I own outright if the loan fails), and I have a couple of small start up businesses that I am running now. When I feel the time is right to run whole hog into stocks again I will. For now, though, I will trade at the margin, and wait for better value down the road. It is a tough time for investors to make large commitments, particularly if one is close to retiring.
    I hope that helps a bit. Let me know and I can elaborate a little further. Thanks for taking the time to comment.

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