By proceeding, I acknowledge that I have read and understood the Disclaimer and Copyright Statements .

In determining the risk/return opportunities in our stock market, I consider both market fundamentals and the technical strength of the market. However, I primarily use market technical indicators to determine when to get in and out of the market.

Before we get to technical indicators, let’s first look at the market fundamentals - cuz they stink!
• The market has had only 4 fed tightening cycles in excess of 2.5% and in every case the market was down 6 months later.
• P/E ratios for the S&P are in excess of 18 which are at the high end of their historic averages.
• One-half of all bear markets begin in a year after an election. (Presidents tend to over-extend spending to get re-elected.)
• Any weakness in the dollar could lead to foreign investors pulling out of US treasury bonds and other dollar denominated assets causing bond yields to shoot up. The repercussions would be a significant slowdown in home re-fi’s and a move into higher-yielding bonds and out of the stock market. The rise in energy prices will certainly lead to an acceleration of dollar depreciation as we continue to export more and more of our wealth.
• Finally, our country is incurring trade deficits and budget deficits that are spiraling out of control.

I struggle to find one good fundamental reason to stay invested in US Equity markets. I’m convinced that the longer term outlook of the market is dim. The only thing that would change my sentiment would be some drastic change by our government such as a full pull out of Iraq or sweeping tax code changes. A minimum wage in China would also help out (credit idea to Richard Duncan – The Dollar Crisis).

However, fundamentals are only good at predicting long term market directions. In the intermediate and short-term, only technical indicators have historically been good predictors of market movements. Take the 90’s, the fundamentals of the market looked lousy starting in ’96. Even Greenspan realized that the market was overrun. Of course, we know that the market continued to run up into 2000. Had we relied on Market Fundamentals, a lot of profit opportunity would have been missed.

Historically, I and many others have relied on technical indicators to decide when to invest in the market as they have been the most accurate predictors of market movements. Despite lousy market fundamentals, the market has shown remarkable technical strength. So, I’m struggling with the following question – Have the technical indicators that I and countless others use become obsolete or is the investing public become just as irrational as they were in the 90’s. (Another possibility is that I’m just becoming impatient.)

Here’s my theory of what’s going on and why I’m so scared. One of the most accurate technical indicators signaling the onset of a bear market is when stocks hitting 52 week lows significantly outnumber the stocks hitting 52 week highs. This occurred in spades well before the market downturn in 2000. The final run-up in 2000 was isolated to a handful of very large and very well-known stocks. The rest of the market was well on it’s way down but since the indexes that the general public watch are weighted, it wasn’t clear to everyone what was going on.

The problem with this indicator, which is currently positive, is that market strength – stocks hitting 52 week highs - is currently isolated to defensive sectors – energy, real estate and too a lesser degree health care. In the 90’s tech bubble, tech stocks were the ones hitting 52 week highs. Tech companies contributed to the economic well being of the economy. They were the engine for growth. Now defensive stocks are on a tear. Companies that prosper when the economy turns down are ones topping the charts. Energy in particular is causing me the greatest amount of anxiety. Energy stocks going up is not good for the economy!

So what does that say about the market and our economy when the strongest sectors are defensive? I can’t say for sure but I don’t think it can be good. I’m afraid that market technicians are being fooled by the indicators. I don’t want miss out on any appreciation opportunities yet I certainly don’t want to put my clients at risk. Therefore, I decided to pull out of the market last Tuesday, the day of the fed announcement. I figure it’s better to be safe than sorry so I’m headed to the sidelines until I can get further confirmation of which way the market is headed. Stay tuned!!!

Tell a Friend | Bookmark this Page

This entry was posted on Sunday, September 25th, 2005 at 4:18 pm. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.