"What if 6 Dow stocks went to zero?"

http://www.youtube.com/watch?v=ZHdXU0Tbo9w

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.

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.

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.

The end of an Era

It is my belief that we have reached the end of an era. Exactly when that ended (2000 or 2007) and to what degree is up for debate. However, what is evident is that we have reached the end of the era of low interest rates and easy credit that began in 1981. Likewise, if this turns out to be true, and interest rates have made a major bottom, that means U.S. Treasury bond prices have made a major top (since interest rates and bond prices are inversely correlated). The case for the end of the Bond bull market and the start of a major Bull market in interest rates can be made, I believe, from both a fundamental and technical perspective. From the fundamental perspective, the amount of outstanding U.S. Government debt issued is so large that it CANNOT be paid back and this type of fiscal situation is not sustainable in the long run, and I believe that eventually, the piper will be paid.In my view there is simply no way we can afford to pay back the debt when our GDP is 70% consumption. According to an official government website, treasurydirect.gov, the total public outstanding debt as of March 24, 2010 is $12,662,466,657,519.82. Bond Investors will demand a higher interest rate for the simple economic principle that risk requires compensation. If government debt is going to be considered high risk, you can bet high interest rates will come with it. In my opinion, it is only a matter of time before the Credit Worthiness of the U.S. government is put into question not just by foreigners (namely Japan and China) which fund a good portion of out debt, but by its own citizens. That is the fundamental part of the argument. From a technical perspective, above are two charts, both of the 10-year U.S. Treasury Bond yield. In Technical Analysis, we say that when downtrend lines are broken, they are retested, meaning the price of the security temporarily goes against the(new) trend to find support on the downtrend line in the case of a turn from a downtrend to an uptrend, and retest to find resistance at the uptrend line in the case of a turn from an uptrend to a downtrend. Granted, a break of the uptrend or downtrend lines are not guarantees that the trend has changed, but rather an indication of a possible trend change, hence the question mark next to the "retest after breakout" annotation on Chart 2. If the downtrend in interest rates is continuing, then the downtrend line will not act as support and the 10-year yield will break back below the downtrend line. However, if I am correct in my analysis and interest rates bottomed in 2008, the spike low in the Fall of 2008 was just a final thrust down in interest rates (and thrust up in bond prices) before making a major trend reversal. Chart 1 is the same as Chart 2 except that it is shown on Logarithmic Scale, while Chart 1 is shown in Arithmetic scale. Chart 1 illustrates the long term downtrend line on the 10-year Treasury yield. When that is broken, it will certainly be something to pay close attention to, because it will likely signal the start of a multi-decade move up in interest rates. In addition, on chart two I show a common indicator called the MACD, which stands for Moving Average Convergence Divergence. Without going into too much detail, this is an indicator of momentum. When price makes a lower low or higher high and the indicator does not confirm with a higher high or a lower low (depending on the trend), it is called a divergence. In this case price (Interest Rates) have made a lower low, but the MACD has made a higher low, creating positive divergence. This is another sign that the momentum in the long-term downtrend in interest rates is slowing dramatically and a turn higher is coming, possibly (likely in my opinion) as early as this year (2010). I will post an update if and when this happens. As a side note, rising interest rates are generally not positive for equity prices, and with the way things look now, if interest rates spike higher, it could be accompanied by a precipitous drop in equity prices and quite possibly a resumption of the bear market in U.S. equities. I will also post an update on the stock market soon.

The U.S. Dollar in a deflationary environment

Most people would think that the dollar would fall in value when the Federal Reserve is printing money. There are two problems with that assumption the way I see it. First, In a deflationary environment, banks don't want to lend. The money that the federal reserve is printing is being held on Banks' balance sheets and is not getting out in to the economy. Simply put, there is very little velocity. Second, the money that is getting out into the economy (increase in the supply of dollars) is vastly overwhelmed by the volume of credit contraction (decrease in the supply of money and credit). The supply of and value of credit is contracting as debts are either being restructured (partial value loss in credit) or defaulted upon (total value loss in credit). That is just the supply side of things. The demand for Dollars is also going up as debtors are scrambling for dollars to pay off their debts. So, there are two forces causing an increase in the value of the dollar: The contraction in the supply of dollars, and the increase in the demand for dollars. From an investment prospective, instead of keeping their wealth in long term bonds, investors are keeping their wealth in short term T-bills and other safe cash equivalents, even plain old dollar bills. Thus, the demand should be for safe dollars rather than for exotic financial instruments and debts. The effect should be rising interest rates and a rising Dollar. Time will tell If I'm right. I'll post an update when new developments arrive.

Interest Rates in a Deflationary Environment

People Normally Associate Rising rates with Inflation (Since the Value of Dollars is going down, people expect to be compensated with a higher rate of return.)However, This chart displays how it is indeed possible (and I think likely in this environment) to have rising interest rates in a Deflationary environment. When the Demand for money and credit goes down, one would expect the price of money (Interest Rates)to go down as well. However in this case I think the supply of Credit (people willing to lend out) is contracting faster than the demand for money and credit, so the price (interest rate) goes up.

DJIA, VIX and valuations

Lets take a look at the Dow Jones Industrial Average. As you can see, it is right up against the downtrend line from October 2007 when the Dow made its all time high at 14,198.10. This is no time to be buying stocks, it is the time to be safe. We are in a secular bear market, and if you are familiar with Elliot Wave theory the next big move in the market could be a decline of super cycle degree. After all is said and done, the Dow could be at 1,000 or below. Yes, 1,000. Don't listen to Cramer and others on CNBC and the media telling you this market is cheap. By NO means is it cheap. the S&P 500 P/E ratio is currently floating around all-time record levels. Unless earning soar, Prices have to fall to MUCH lower levels to get us back to bear market bottom territory. If you stay liquid, in SAFE cash equivalents, you will have your wealth safe to snatch up the bargains of a lifetime. A great book to read about this is Robert Prechter's book "Conquer the Crash: You can survive and prosper in a deflationary depression", in which he outlines exactly how to stay safe during this bear market so that at the bottom you will have a good portion of your wealth in tact. Back to the market, the preferred count at this time is that we are in an ending diagonal, which is a pattern that completes moves, and often leads to violent reversals once complete. Another indicator that is showing a sign of complacency in the market (and from a contrarian standpoint a sign of a reversal) is the CBOE Volatility Index (VIX), a measure of fear in the market, Shown above in Chart 2.The VIX is at levels not seen since before the 2008 crash. There is positive divergence developing on the weekly time frame, indicating a bottom is near. Stochastics, a measure of overbought or oversold conditions, are at extreme oversold conditions, indicating a turn up in the VIX is near. When the VIX starts to turn up, the initial move should be swift, along with a precipitous selloff in the market. This would likely indicate the bear market rally is over, and Primary wave 3 down should begin.