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Lance Roberts
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After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; I have pretty much "been there and done that" at one point or another. I am currently a silent partner for an RIA in Houston, Texas. The... More
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  • Market Breaks Its Neck
    For the second time this year the market has broken the neckline of a classical "head and shoulders" pattern.  For you non-technical investors this is simply a pattern of price movement that has been indicative of market topping patterns in the past.   In fact, outside of the two times this year, the last time we witnessed a clearly defined "head and shoulders" pattern was at the peak of the market in 2008 just before the major crisis hit.   

    Back in April we first began to recommend overweighting cash and fixed income relative to equities due to the fact that the Quantitative Easing program by the Fed was coming to an end and the lack of stimulus was going to act like a vacuum on the markets.  This was a highly unpopular position at the time, especially with the media, but has saved us lots of grief over the summer.  

    After the initial break of the "neckline" in early August during the midst of the "debt ceiling debacle" the market plunged to 1120 on the S&P 500 index.   The market then remained range bound between the lows of 1120 and highs 1220-1230.  After the initial plunge we began to repeatedly make calls in our weekly newsletter to sell into rallies due to the overriding weakness in the domestic and international economies.   Furthermore, when trends are negative in the market the primary trading rule becomes "selling rallies" rather than "buying dips".   Each attempt at a rally in the markets failed at critical levels of resistance but repeatedly found support at 1120...until today.

    The break of the "neckline" today leaves the market in a very tenuous position flirting with the August intraday lows of 1103 on the index.   In our opinion  this level most likely will not hold and we could well see the markets decline to the next major psychological level of 1000 on the index.  This will be consistent with both the retracement of the initial selloff and the break of "neckline" support which should lead to a decline of the same proportion as the original decline.   This will also be consistent with traditional bear market declines of 30% from peak to trough.

    With the markets now negative for 5 months in a row a sharp decline to flush out investors could well set a short term bottom in the market.   However, as we showed in our post on Friday, after 5 or 6 months (depending on how October ends) the markets have always rallied for 3 to 6 months before declining to new lows before finding THE longer term investment opportunity.

    The point here is that many investors are now trapped in the market and are hoping for a rally so they can get out.   This is why the next rally that we likely see will be into the the end of the year.  This will most likely be a "suckers rally" as it will suck investors in as the media bleets about the end of the bear market.   Unfortunately, that will be the set up for the decline to the longer lasting bottom.  This was very much the same pattern that we saw play out at the end of 2008 as the rally abruptly ended and the markets declined 22% from January to the final low on March 9th.

    Caution is highly advised.  Having a hefty hoard of cash will provide the ability to take advantage of the next buying opportunity whether it comes sometime this month or next year.   There are many threads of this finely woven economic fabric that are now unraveling.  As such it will pay not only to be patient but "fashionably late" to the next buying opportunity to make sure it isn't a "suckers rally".

    Oct 03 6:26 PM | Link | Comment!
  • 5 Months Down - Time For A Bounce?
    5 Down MonthsGoodbye September!  The S&P 500 is sporting a healthy 10% decline for the year and nearly an 18% drop from the peak.  The recommendation to move primarily to cash and fixed income back in April has served us well.  So, what about October? 

    October has been the month that has seen the end of bear markets more often than not.  Unfortunately those bear market endings generally consisted of very large declines.   The month of October this year is, unfortunately, laden with risks.   The government is still engaged in trench warfare which means little assistance from the Whitehouse.  The Fed has effectively thrown the towel in at this point with "Operation Twist" which will do little to bolster the economy or the financial markets.  The Greece/Europe standoff is quickly coming to a head and Greece will most likely have to default which will put tremendous pressure on the European economy.   Europe and China are slowing rapidly and it is a race to see whether it will be the US that drags the world in to a recession or vice versa.  As you can see there is more than enough systemic risk to disrupt the markets.   Unfortunately, we are going to plaster those systemic risks with a good solid coat of financial risks as the 3rd quarter earnings season kicks off.   Analysts estimates remain very high and earnings season could prove to be a disappointment with the slowing of corporate profits combined with a weakening of incomes and a despondent consumer.

    Post 5 Month Negative ReturnsNow for the stats.  September was the 5th negative month of returns in a row which has only happened 5 times previously.  The reason I point this out is twofold. 

    First, there have been numerous analysts pointing this fact out lately touting that this is the time to get back into stocks because of the rarity of 5 month negative return periods.   However, a look at the data tells us a potentially different story.  

    If we average each of the 12 months following 5 months of negative declines and look at average monthly returns we find  that the better buying opportunity generally comes after a reflex bounce.  

    This is assuming that September was the bottom. 

    Which brings me to my second point.  What if September wasn't the bottom?

    6 Month Negative ReturnsWhat these analysts don't tell you is what happens if October turns out to be a negative month as well?   There have been four 6 month periods of negative returns the markets since 1930.   After each 6 month period the market did indeed bounce.  Unfortunately, 3 out of 4 times those bounces let to brutal market declines with one of those 6 month periods bouncing before starting a slide into the 9 month long crash of 1974 which still holds the record.

    Also, what is interesting is that after 6 months of negative returns a 3 month bounce occurred 3 out of 4 times which turned out to be a suckers rally.  The subsequent six months led to negative return and that second bottom, with the exception of 1974, was the better buying opportunity.

    With the both a high level of financial and systemic risks in the market today combined with a lack of support from the Federal Reserve, the odds of a strong rebound from these levels looks questionable. 

    If September turns out to be the bottom of the market then our technical indicators will signal to us a better time to wade cautiously back in to the risk pool.   However, if October turns out to be negative then most likely we have much more work to do before a better buying opportunity presents itself.  

    Finally, if our economic models are correct and we are on the verge of a second recession then stocks do have further downside risk.  A reflexive rally is certainly possible BUT should be sold into.  This is the first rule of trading during negative market trends as we currently witness today.  During an average recessionary bear market stocks decline by 33% on average.  As stated previously, with the markets currently down around 18% from the peaks this year, this leaves roughly another painful 20% to go.  Of course, I did say "average" recession.  In the current economic environment my concern is that the next recession will be anything but "average". 

    Oct 03 1:49 PM | Link | Comment!
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