The Simple Acco...'s  Instablog

Here is some material to consider. Have a look at these arithmetic scale 30 year charts, monthly closing basis, of the Dow Industrials, S&P 500 and NASDAQ 100.

(click on each chart to enlarge)

Now, a reader may note that on such a long time line, we should be looking at a logarithmic scale, but bear with me for a moment.

What do you see here? I see each of these three major stock indexes saying something rather different:

Dow – possible head and shoulders top forming

SPX – double top has already formed

NDX – slowly recovering from a huge spike

Why so different? It’s the parabolic spike in the NDX from 1998 – 2000 driven by the tech mania and Y2K scare. In particular, consider the difference between the Dow and SPX, which typically are highly correlated – the R squared is in the high 90s.

The SPX, containing a higher proportion of large cap tech stocks, rose faster and fell harder than the relatively conservatively constituted Dow during the tech bubble and bust. Could we say then, that the long term price pattern of the SPX is more “distorted” by the tech mania than the Dow?

Following on that, which is the more valid long term chart pattern for analytical purposes: the head and shoulders or the double top? Does it matter, since both patterns are normally bearish? Possibly yes, as the Dow is now in the range of resistance at 11K where it’s forming the right shoulder.

Another question: does the NDX, having already had its monumental crash, look like the most constructive of the charts post Y2K? Doesn’t it make sense, as it includes more growth companies, and fewer of the old economy and financial firms that were hammered in the financial crisis?

So, what is your investment stance? Which charts are you looking at?

If we could summarize yesterday’s Fed statement in a single sentence, it might well be “we are committed to producing a little inflation here.”

Now lets put some of the other policy pieces together. President Obama has said on a number of occasions that his administration’s goal is to double US exports (lets put aside for a moment the question of how they will accomplish it when every other nation in the world expresses similar intentions). Influential members of Congress are hammering the Chinese currency and trade issues. Adding it all up, here is what it seems to imply:

The US Dollar will weaken, and indeed is already threatening to break below 80. Investment stance: short the Dollar. Potential pitfalls: some sort of crisis breaks out – lets say Europe again, or a Middle East drama – and spurs a flight to perceived safety.

Precious metals and commodities, which are after all priced in those Dollars, will go up. Investment stance: long the metals, commodities and stocks of miners and producers. Potential pitfalls: economic weakness drives down demand and prices soften, i.e., prices get ahead of fundamentals.

Cost of borrowing, for firms which are able to borrow, remains extremely low. Investment stance: long the stocks and lower grade bonds of highly leveraged and capital intensive firms – banks to be sure, as well as industrial, , energy and utility firms. Potential pitfalls: some banks may yet have trouble with bad assets, some leveraged firms will have other issues. Stay with the high quality names and be sure they can generate adequate cash flows.

Update to yesterday’s morning post: Apple shares continued falling through the day and closed below the 50 day SMA. Not the kind of reaction we wanted to see after that type of earnings call. Meanwhile, the broader market gave it up after Fed Chairman Bernanke’s Senate banking committee testimony. The SPX, which had opened at the 50 day and top of the downtrend channel, rejected that level and headed back down. The VIX bounced off support at the 200 day for the third time in a space of one month.

On the other side, with “double dip” fears taking center stage, Treasuries broke out to new highs. Defensive positioning remains the order of the day. My near term target for the SPX is in the 1000 to 1008 area, ~6 to 7% down from Wednesday's close. 1008.55 is the Fib .382 retracement of the move from the March 2009 bottom to the April top (intraday basis).