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02272012 February 27, 2012

Posted by easterntiger in economy, financial, markets, oil, stocks.
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Current Positions  (No Changes)

I(Intl) – exit

S(Small Cap) – exit

C(S&P) – exit

F(bonds) – up to 40%

G(money market) – remainder

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Weekly Momentum Indicator (WMI***) – last 4 weeks, thru 2/24

+21.75, +11.14, +19.51, +10.67

(3 wks ago/2 wks ago/1 wks ago/last week)

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Current positioning in the F fund has fluctuated between slight gain and slight loss in the past month.  This positioning is set to take advantage of an expected, large move in anticipation of a sudden stock breakdown, which is due within the next few weeks.  Should this breakdown fail to occur, it’s also possible that the markets are headed for a 6-8 month extension in these upper trading ranges, bound by current 1-4 year highs.

Stock market participants playing for more upside continue to ‘whistle past the graveyard’, thumbing their noses at the thought of risk and buying every dip.  There are far too many who are simply hoping that we don’t wake up one morning to a calamity in the markets.

Here is an idea of just how rabidly bullish some small investors are: the Rydex Nasdaq non-leveraged funds indicates that there is now $80 invested in the bull funds for every $1 invested in the bear funds (!). This is a record extreme, and it illustrates that a ridiculous number of investors are betting on the bullish side of the trade.

Read more: http://www.minyanville.com/businessmarkets/articles/elliott-wave-elliott-wave-theory-technical/2/15/2012/id/39415#ixzz1mlGSoult

There are two possible scenarios behind us, starting from the October 3rd low.  Either the rise since that one-year bottom is a ‘correction’ from the deep May-to-October downtrend with a continuation of the downtrend to follow, or, that low forms a basis for more upside and further highs.  I suspect that the first scenario is appropriate.

The DJ Total Stock Market index (DWC), was once the Wilshire 5000 index. The rise from October has now stalled at a point that has acted as support in the past (and also acted as resistance in early 2009 and mid 2010).

For the move up from October,  two equal ‘legs up projects’ to 14483, about 150 points above today’s (Monday) opening. A rising ‘wedge’ pattern shows price is getting pinched.  Wedge patterns are often bearish, pointing toward lower prices.  Assuming the market will start at least a pullback soon (unless they’ve been completely outlawed) we’ll then have to wait for further evidence as to whether it will be the start of the next major decline or just a pullback before pressing higher again in March.

Failing to break through this ceiling/resistance makes the current rise from October much more likely to be part of a larger corrective pattern, and NOT the often overused ‘rally’ as indicated through most media financial media since that time. –  A correction indicates a near-term end to the current trend, with a deeper downside pattern that will exceed last year’s May-October downtrend..

The S&P500 looks very similar and like the DWC has only been able to get above its May 2011 high by 2 points.  There is an expectation for a minor poke above that high (1370.58) to reach the projection at 1376.55 for two equal legs up from October. But if it first drops below 1340 it will tell us the high is already in. From there we’ll have to see what kind of pattern develops for the decline as a way to help determine whether or not we’re going to get another rally leg in March. A break below the mid-January levels, near 1297, would be very bearish. (At 21 points from 1376 on today’s opening levels, and at the current rate of progress, the markets could very well move lethargically for another TWO WEEKS to get to this 1376 level, IF the progress of the past two weeks is a reasonable measure, and IF this mornings pullback does not continue.)

There can be no overemphasis of an image of high risk against tiny rewards during the current environment.  Being unaware of this high risk will play into the ‘strong’ hands of those who are in position to move rapidly to protect positions when necessary, unlike most retail investors, or those with retirement plans at risk.  The picture of holiday-like overall volume in the current equity space can be dramatized in the following table of tiny movements during the past few weeks.  This table presents a rather remarkable sequence of just how little the market is moving.

………………………2/24/12 Close — 2/9/12—15 day change—Change per wk

S&P500 1365.74 1354.32 (high) 11.42 points 5.329  (0.39%)
S&P100 617.67 612.39 (high) 5.28 points 2.464 (0.39%)
Nasdaq 2963.75 2930.68 (high) 33.07 points 15.43 (0.52%)
Banking Index 44.7 45.47 (high) -0.77 points -0.36 (-0.8%)
Dow Transportation 5139.14 5328.96 (high) -192.82 points -89.98 (-1.75%

With so little upside, risk of sudden and significant downside risk is all that remains.

The S&P closed at 1365.74 on Friday, after trading as high as 1368.92. The high close in April of 2011 was 1363.61

The Dow traded over 13,000 several times last week, for the first time May 20th 2008, but, so far, cannot hold the gains. Some consider the Dow to be in breakout mode in spite of the failure to close over 13,000. I do not agree with the ‘breakout gang’.

If upside continues, the next major psychological level for the Nasdaq is 3,000. The last time the Nasdaq saw that level was November 2000 and it closed Friday only 52 points lower. The Nasdaq is at 11-year highs after a +25% rebound from October.

The Russell 2000, like our S fund, is telegraphing increased concerns with the inability to break higher, flattening the past two weeks. The three month uptrend support is in danger of being broken on any further declines.

The Dow Transports failed to confirm the Dow Industrials gains again, (the Dow Theory), but this was a reaction to rising oil prices rather than a sudden urge to sell transport stocks. There was a clear reason since high oil prices mean lower profits for the sector. The airlines were the primary reason for the decline.

Through the Dow Theory, there are bearish implications of a rising Dow Industrials and a falling Dow Transportation index.  This directly indicates weakness in one significant sector of the economy, movement of goods, that cannot continue to diverge from other sectors, such as production.  Although this is partly due to airline stocks reacting to higher oil prices, other factors can’t be ruled out as contributors.

The bluster out of Iran along with the Greek bailout approval helped to push the dollar lower and oil prices to new nine month highs.

Cash is close to trash and fixed income is not far behind. The yield on the 30-year bond is very close to breaking higher from four month highs despite the Fed’s buying.  If the U.S. economy continues to improve and equities do move over Dow 13,000, and S&P 1365, we could see some serious flight from fixed income assets.

Reports from around the globe show some slowing in economic activity.  A report from Europe shows the eurozone’s private sector growth climbed slightly in February, but the manufacturing index came in at 49.5 and remains in contraction territory (below 50).  Italy may be leading the way into a recession but the rest are not far behind.  Even Germany, which has remained relatively strong (but dependent on exports), came in at 50.1 vs. expectations for 51.5.  Chinese manufacturing activity also slowed and while their index climbed slightly to 49.7, it is still below 50 and has been below 50 for four consecutive months now.  Many believe the U.S. will avoid a recession even if the rest of the world slips back into one.  I think that’s a bit of wishful thinking

As for the continued impact from the Eurozone, the terms of the bailout agreement are onerous at best for Greece. Not only does it not help them pay for ongoing costs (for which they’ve been borrowing more money each month) but they also lose control over how they get to spend their money.  A large team of German tax collectors is on the way to Greece to help get German banks their proper share of uncollected taxes.

In January, Italy was downgraded to A- from A+; Spain was downgraded to A from AA-.

Fitch, the smallest of the three rating agencies after Moody’s and S&P, says two-notch downgrade reflects re-assessment of potential financing and monetary shocks from diverging economic and credit conditions in the eurozone.  Belgium, Slovenia & Cyprus were downgraded one notch.

****For reference, here are the broad categories of credit grading****

AAA-AA-A – AAA to AAa is top level;

BBB-BB-B – BBB through Baa3 is still considered safe;  BB or Ba1  and below are not so safe

CCC-CC-C – speculative, junk

D – worse than junk.

Each single notch downgrade raises interest costs by 1/2 of a percent.

Greece made a formal offer to creditors to swap their Greek government bonds for new ones, another step toward knocking $142 billion off its debts. The swap is part of a deal to prevent Greece from defaulting on a debt payment due next month.

The European Central Bank (ECB) has declared itself as immune to many of the risks of a Greek default.  The last time the ECB pulled this stunt, by demanding private investors take a large loss on their investments (making it a “voluntary” loss) they later admitted that it was not the right thing to do since it makes it more difficult to get private investors to take on the risk of buying a financially weak country’s bonds.

So, if the ECB has declared itself immune from loss, who’s actually going to take the loss?

Other than actually paying down all the debt, the only viable plan is for Greece to default and force the banks to fail (as Iceland did a few years ago).

And, by the way, don’t fall for the rhetoric calling the US the ‘next Greece’.   You should believe this only if you believe that US output will fall dramatically over the next decade (Greece has a negative growth rate),  AND that the other dozen countries ranked in between the US and Greece, such as, Canada, Germany, UK, Austria, France, etc. will not give us some warning, since each of them is closer to being the ‘next Greece’ than the US.

Countries with debt-to-GDP ratios above 90% find themselves in a lot of trouble. Once it becomes too expensive to pay the interest on the debt the country’s politicians are forced to raise taxes and cut government spending. Heard any of that lately?

The U.S. public debt is currently running over 60% of GDP, but, not counting future obligations, such as Social Security payments.  By comparison, Greece is hoping to get their level DOWN to 121% by 2020, IF planned austerity measures are successful. (bring your optimism on that one). So, again, no comparisons here make sense.

Also in January, the Fed once again committed to keeping rates low until 2014.  This continues commitments going back to 2008 where the Fed has committed to keeping rates low, but, normally he only commits to only a couple of quarters at a time.  This is practically an admission of an expectation of a fragile environment now and forward.  Solid F fund returns are still in the cards for the foreseeable future.

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