Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

A Few Observations On The Outlook For October

The complacency in the markets as we move into October suggest - to me at least - that we are in for a barn burner of a month. I have been offering warnings for about 4 weeks now and based on comments from my readers, a good number of them just don't buy into my warnings.

I have even noticed that SA is reluctant to feature articles that set forth the bear side of the argument. I won't elaborate by rehashing all the points I have tried to make for the bear side as the articles I have written are out there for those who care to read them. For today I just want to make a few points that suggest to me that we have already put in a market top and action since the Fed announcement on September 13, 2012 of QE3 has not been indicative of anything but a market teetering on the brink of collapse.

I will never understand the propensity for investors to embrace the bull side of the markets and despise the bear side of the markets. The ludicrous idea that you just can't time the peaks and valleys may apply to those who advocate a "buy and hold" strategy but "buy and hold" investors may just be reluctant to even consider the bear side of the market and therefore don't even try to time the peaks.

Buy and hold was a good strategy from 1980 to 2000. It has been a horrible strategy from 2000 to September of 2012. You would have made nothing with that strategy over the last 12 years.

Anyway, back to timing the peak. I have been short for about a month now and added my last short positions on the Monday following the announcement of QE3. Those trades are all showing profits today - some rather substantial profits:

  1. Crude oil - 7.6%.
  2. Apple - 8.6%.
  3. FAS - 6.4%.
  4. XLK - 2.5%.
  5. SCO - 16.4%.
  6. Dollar index - .03%

Maybe I am just a fool as many suggest or maybe I am right and the market is going to move substantially lower. I have obviously put my money where my mouth is and so far so good.

I use what I call a pivot point strategy to time peaks and valleys. It is based on statistical analysis. The chart below sets up the frame work. The center line on the chart is the 90 day mean value. The parallel lines above and below the mean represent 1 standard deviation above and below the mean and the outer lines represent 2 standard deviations above and below the mean.

Statistics tell us that 95% of the time the market will be contained within the outer boundaries. My rule states that I will reverse position and go counter to the trend when the current trend has enough momentum to reverse direction by 1 standard deviation.

The chart below has not done that yet but I also chart the 20 day mean and standard deviation and that chart has signaled a peak. In light of what I consider to be extremely bearish fundamentals I made the decision to add to my short positions off the signal generated by my 20 day chart.

The argument that most make against my suggestion that they get out of the markets and go to cash is that I can't time the top and will probably leave a lot of profit on the table. I will admit that most of the arguments I have made for the bear side have been based on the fundamentals. I am first and foremost a fundamental analyst.

However, I do recognize that the fundamentals only provide a warning of things to come. Entering a trade the moment you identify a strong divergence between the intrinsic price and the market price can prove costly. For that reason I use the fundamentals to determine the longer term trend and the chart above to make entry/exit decisions. The strategy has proven to be a good one.

Recent observations

I have written on the fact that the Dow Transports started signaling a downturn a few months ago. The divergence between the Dow Industrials and the Dow Transports is continuing to suggest we are at a top.

I have also noticed in recent days that someone has been spending a lot of money to keep the euro propped up and in so doing keeping a lid on the dollar. The stock market has been closely correlated to the euro with the euro taking the lead and stocks following.

Although the Fed is limited in what they can do with "Open Market Actions" they can buy and sell government treasuries and agency securities and they also enter the fray in the currency markets from time to time. I am suggesting that a huge whale (the Fed) has been effectively putting a floor under the euro and the truth of that has never been more evident than today.

The euro was higher throughout the night and at the open this morning stocks were higher as well. Shortly after the market opened stocks started down. The harder stocks fell the more money was put too the euro. It was interesting to see the euro suddenly surging sharply higher as stocks continued to sell off.

It was an obvious attempt by someone to stop the slide in stocks and today - for the first time - the strategy failed. As a futures trader for 40 years I have witnessed attempts by large traders to corner a market. That is what I believe the Fed - possibly in conjunction with the ECB - is trying to do.

It has never worked and although I will concede that the Federal Reserve is by far the largest trader I have eve seen that has tried to corner a market I don't think they are large enough to pull it off. The stock market worldwide has a valuation in excess of $50 trillion dollars. The currency and bond markets are much larger than the stock markets.

The Fed, as big as they are, just doesn't have the cash to effectively corner any of these markets. They can certainly move the markets with large orders but when the market moves back in the other direction - as the euro did today - after their orders are filled it can be a rather disconcerting feeling.

My point is that the Fed will soon give up this strategy if it quits producing the desired effect in stocks and today was the first day that happened. This unusual intervention by the Fed (assuming the Fed is the one) is an indication of fear and desperation. When our central bank is panicked it is time to give some thought to what that really means.

Final thought for the day. We are in October and almost all market crashes have occurred in October for some reason. John Coates is a former hedge fund trader turned neuroscientist and author. In Coates book "The Hour Between Dog and Wolf" Coates notes that October is known for it's market crashes:

"What is it about October anyway? Why is it always the scariest month for stocks? Almost every crash in the history books, at least those occurring in the United States and United Kingdom, has taken place in the autumn, and most of those in October. The Panic of 1907, the Crash of 1929, Black Monday in 1987, the Crash of 1997, the crashes of both 2007 and 2008 - all took place in October."

Well, that is at least food for thought. Coates offers some possible reasons for why October is the month of the crash. I won't delve into them as they don't seem all that compelling to me. Nevertheless it is an interesting phenomenon and I believe one that will occur again in 2012.

I will conclude with the following observations:

  1. The underlying fundamentals are absolutely horrible.
  2. The Fed has done all they can to take ownership of the stock market and attempts to corner markets always fail.
  3. The disparity between intrinsic and market value has pushed stock prices outside the 95th percentile of statistical probability.
  4. It's October.