Is It June 4, 2010 or August 8, 2008?

Includes: BA, CAT, DIS, MMM
by: Danny Furman

I probably won't be logging into my Sogotrade account today. As my investing outlook has changed over the last year from "emerging market bull" to "brazil bull in a fairly valued global market" to "skeptical growling bear" I've stared at quite a few charts. Along the way these "linear studies" (there could be a pun there, but it would be beyond me) have become more and more prevalent in my daily routine, primarily in watching worldwide indexes when markets are open and studying long and short term charts of individual stocks that interest me.

My focus lately has become somewhat different as I believe dwindling consumer demand will lead to a nightmarish "double dip" recession. Even though charts are not the reason I've arrived at that conclusion, I do need them to confirm any trades I plan to make.

Since I believe stocks are generally way overvalued and due to crash, my objective should be to find past crashes with preceding market action similar to current action. Obviously such patterns become easier to recognize as we get closer to a crash, and it looks like one is waiting right around the corner.

Indexes and leading stocks, not necessarily growth stocks but rather stable companies with diversified "best-in-class" output, such as MMM, CAT, DIS and BA, are the best gauges of market direction. These leaders are well liked by retail and institutional investors and are relatively thoroughly understood, so action in them tends to be very indicative of overall sentiment. These are therefore the stocks that, if they crash, will most likely do so in the same way they did in the past.

Trading after the May 3, 2010 peak has led to continually lower lows made on higher volume than up days. Weekly volume has increased since the peak. Action was very similar following the October 2007 all-time high and from June through early August of 2008, both followed by more severe sell offs.

Fitch has a negative outlook for BA (see here) and so do I. The pattern since peaking in April is, like MMM, almost identical to how the stock traded in mid 2008 and late 2007. More specifically, exactly how they traded prior to December 7, 2007 or August 8, 2008, which other leaders also confirm.

If ever there were a global economic bellwether, it's CAT (I may be biased). The global construction giant, too, has shown the beginnings of a high volume sell off reminiscent of late 2007 and mid 2008.

Volume in DIS has been through the roof the last month as the market cap has taken a haircut. Notice how, like MMM, the chart since the May peak is nearly identical to the two month sell off that started June 13, 2008.

These common historical date ranges also have an important relationship with psychologicaly critical levels on the Dow Jones Industrial Average:
After the DJIA peaked over 14,000 in October 2007, that level was never reached again. In the following months, bounces above 13,500 were sold fast and heavy with 13,000 becoming the new ceiling once 2008 started.
The sell off beginning in June 2008 took the market significantly below 12,000 for the first time since October 2006 and struggled in the months that followed to break far above 11,500, a level we haven't seen since late August 2008.

What determines price movements is flows from retail and mutual fund investors. If these groups are net buyers, prices escalate as market makers are forced to be net sellers. But if the same groups are exiting the market, forced buyers will not give them top dollar. The big round numbers on the DJIA matter because they are what retail investors, especially mutual fund investors, use as sell targets. It's not good investing, it's human nature.

The reason I probably won't be looking at my account today is because, while around 50% cash, it is net short. President Obama gave more than a wink indicating the June 4 jobs report will be a home run and the last few days have given bulls a lot to feel good about. I'm honestly expecting up to a 5% explosion to squeeze out shorts and convince fence sitters that we are on our way back to 14,000 after all. I'm admittedly not positioned optimally but am not interested in going long at the moment and will simply accept poor entry points in trades I am confident in.

With leaders showing extreme weakness and DJIA 11,000 a level similar in the current economic environment to what 14,000 represented a few years ago, the pieces are in place for continued weakness in US stocks over the medium and long term. As for tomorrow, however, I could care less.

Disclosure: Short CAT