Tuesday, April 20, 2010

"What if 6 Dow stocks went to zero?"


What if they didn't? What if instead Citigroup rallied 460%?

This was the title of a Bloomberg Television segment on March 6, 2009, the exact day of the 6,470 low in the Dow Jones Industrial Average. The video shows how little impact 6 stocks, including, GM, Citigroup,and Bank of America, falling to zero would have on the dow, which is price-weighted. This means the lower the price of the stock, the less of an impact that stocks has on the Dow. These 6 Dow Stocks falling to zero would have taken just 47 points off the Dow. This video was talking about how these stocks falling to zero would indicate much larger problems in the economy and how it would suggest the rest of the stock market would fall along with it. Yet, the day of this gloomy outlook for 6 Dow stocks, the market bottomed and geared up for a 70%+ rally. Citigroup has rallied, low to high, over 460% since its bottom on March 6. Since its low on February 20, 2009, Bank of America has rallied an amazing 685%! Now that the market has rallied over 70% since the low, you don't exactly see this type of gloomy outlook from analysts and reporters on the financial media. Everybody is ready to buy stocks again at these over-inflated prices, but they hated them at the March 2009 low. This process is a natural human psychology cycle in financial markets. Financial market participants herd with the crowd, blow up a speculative bubble, only to see it pop. Yet, when investors get out at the bottom, saying "I give up!" They won't want to get back in until a top is close, and they will naturally try to rationalize it, saying "oh well, its lower than the last time I bought it anyway." This suggests that the traditional laws of supply and demand in an economy do not apply to financial markets. Rather, it suggests that markets "herd" in a series of Elliott Waves, as discovered by Ralph Nelson Elliott in the 1930's (for more on Elliott Wave Theory, see my first post). In the market for milk and other economic markets, consumers receive a certain amount of utility that they believe is more than the oppportunity cost they incur when they trade their currency for goods. They will wait until the price comes down if it is too high to buy it. But in the market for stocks, people don't want to wait for the price to come down, but rather they want to jump on board to ride the stock market higher. Soon everybody is buying into the market until it is up 400%, with no signs of heading down. But all of a sudden, the market reverses. Then it drops lower, and lower, and lower, until the same consumer who waited for the price of milk to come down before buying it didn't do that with his stock portfolio, and lost most of the money he invested in the stock market. at the bottom, he says, " I've had enough!" and sells it, only to watch it double in price off of its extreme price low. It is quite interesting how different financial markets are from economic markets, even though if they were treated the same way people would be much better off. This does not mean, however, that if an investment starts to go against an investor he should wait until the price bottoms and starts uptrending again. He should define his objectives and risk tolerances and set a stop loss, or have a money management plan in place BEFORE investing in the first place. This, I believe, is a key element to financial success.

Monday, April 19, 2010

Is Crude Oil ready to Roll over?

After Crude Oil's 78% decline in 2008, it has made quite a comeback, but is it ready to roll over? I have Daily and Weekly Charts posted. The wave structure is certainly open to interpretation, so comments welcome. Although this is technically not labeled as an ending diagonal since some of the waves sport a 5 wave pattern rather than a 3-3-3-3-3 (ending diagonals are supposed to be 5-wave structures, with each wave subdividing in a 3 wave (A up, B down, C up)manner) the move is very choppy and overlapping, telling us this is not an impulsive rise from Crude's $33/bbl low in December 2008. Another new low below $33 is quite possible. We'll let the market be the judge.

Tuesday, April 13, 2010

Dow 11,000, New Bull Market! Not so fast

Yesterday (Monday, April 12, 2010), the Dow Jones Industrial Average closed above 11,000 for the first time since September 2008. Most of the financial media is calling this a new Bull Market, and even the people who were bearish on the market the whole way up are being capitulated out of their short positions and into the "New Bull Market" camp. Now that investor sentiment has once again hit a territory of extreme optimism, everyone thinks this is a new bull market and good times are back. Earnings are improving, the economy is expanding, and we even had positive jobs growth reported a couple weeks ago for the first time since the recession began. People are optimistic that the economy is on its way back to sustainable growth. People seem to like stocks again over Dow 11,000. Isn't it funny, though, that on March 6, 2009, when the Stock market bottomed, none of that was true? All the news was bad news, the focus was on declining earnings, more job losses, and a contracting economy, not to mention credit markets that were virtually frozen. People thought the economy was going into the abyss, the Dow was headed to 5,000, and it was the end of the world. However, amidst all that pessimism, Ironically that was the time to be buying. The stock market has had a 70%+ rally since, then, and at these extreme prices once again, all of a sudden people like stocks again. Now that the news it good, people are just as sure that although it might be sluggish, the economy is on its way back to growth, and the Dow is on its way back to all-time highs than they were about a continued economic contraction back in March 2009. They are just as sure about the market continuing to go up as they were about the Dollar continuing to go down in late November 2009 with Inflation worries. Yet, the Dollar has rallied over 10% off its low, beginning only 6 days after my post on November 20, 2009 about the extreme pessimism present in the Dollar and the extreme optimism present in the metals markets. Even with optimism returning to Wall Street, the reality is, in my opinion, there are still many more problems with debt and credit markets that have not been solved, and we are still in a long term secular bear market. In 2003, the market bottomed and went to all-time highs, but just to fool everybody into thinking it was a new long-term sustainable bull market. What followed was the biggest decline since 1929-32, which produced the most oversold condition since that bear market. That gave this market the fuel to rally this high, but there are signs of waning upside momentum, just like we saw in 2007, and the wave structure is similar as well. Often times extreme optimism is accompanied by negative divergences in oscillators, such as the MACD, an indicator of momentum. A negative divergence in the MACD indicates waning upside momentum, when price makes a higher high, but the MACD does not. For more info on this, read my prior posts. Attached to this post I am showing a weekly chart of the Dow Jones Industrial Average, where negative divergence is clearly present. Sentiment readings are extremely high, and stock valuations are horrible. The next time pessimism is as it was in March 2009, and valuations are reasonable I'll be buying. A lot of people who cannot control their emotions (the vast majority of people, especially the mom and pop businesses and individual investors, who typically get in at market tops and out at bottoms), may not have the money to invest when the bargains finally do show up, but the people that are patient and keep their wealth safe will not have to worry about losing money and will most likely get rewarded with bargains on cheap stocks and receive good dividends on undervalued companies (high dividend payments relative to the price of stocks are an element of cheap valuations). The worst that can happen to someone who stays conservative, if I am wrong about the market, is missed higher returns. But someone who takes unnecessary risks can lose all or most of their money. In the mean time, don't be fooled by the market, because that is what the market does all the time. Keep your wealth safe, in safe cash equivalents(short term only t-bills) and at savings accounts at safe banks, and when the final bottom comes, you will have to money to invest for better times ahead.