Leaders also look bearish
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Leaders also look bearish

Week Ending July 10, 2009

Bearish head & shoulder patterns abound...
Leaders also look bearish
Are earnings finally showing signs of life?
Manufacturing and service sectors improve, trade gap narrows
Pollyannas caught on tape


Last Week

Quote of the week
"Everyone is trying to jump on that bandwagon. There are projects in emerging markets in which I can make more money than I can in the West at the moment." - Nicholas Field of Schroders Plc, London, manager of approximately $11 billion in emerging-market stocks (see article below - Emerging Market Take Record Share of World Equity).

Head & shoulders patterns abound...
The benefit of using technical analysis to make investing and trading decisions is that it removes emotion and the necessity to interpret reams of fundamental and economic data from the decision-making process. The downside of using a technical only approach is that it often provides only short-term insight. As a result, investor and traders with longer-term horizons should use both but as readers of this newsletter witness first-hand each week, the workload and time required to do this type of analysis can be greatly streamlined by relying on charts. Fundamental and technical charts quickly provide an overall snapshot of trends in both stock prices and in fundamentals like earnings and key economic indicators which is far more useful information than single data points.

Last week we were watching and waiting for a series of bearish head & shoulder patterns to either be confirmed or be invalidated on daily charts of such indexes as the Dow Jones Industrial Average, S&P500 Index, Dow Jones Transports Average, Russell 2000, New York Stock Exchange Average as well as a host of stocks. This week a number of those patterns were confirmed with a downside break of neckline support (see next chart).

Figure 1 - Dai1ly chart of the S&P500 Index showing phase one of the bearish head & shoulders top patterns which was confirmed with the breach of the purple neckline on Tuesday. As the circles in the volume subgraph show, volume at first increased on upside moves in the left shoulder and head but then bullish volume was absent when the right shoulder was formed. This shows bullish participation in the last rally waning. But to fully confirm this pattern, we should see increasing bearish volume (increasing volume on drops) especially if the neckline is retested in the coming days. This pattern has a minimum downside target of 820 based on the height of the head from the neckline. Chart courtesy of GenesisFT.com

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Next week will test this pattern. If we get a brief rally to neckline resistance and stocks again break down, the bearish head & shoulders pattern will be confirmed but volume is crucial. As the next chart shows, volume has been anemic bringing the validity of this pattern into question. Bears will want to see lower volume on rallies and higher volume on downside moves with volume moving above the 50-day average volume line (blue) on price drops.

Bulls will be looking for higher volume on rallies and a decisive upside break through neckline resistance in the coming days which will invalidate the pattern but this rally has to occur on rising volume or it could be another bullish ‘fakeout.'

Technically Speaking
Leaders looking bearish
In his Sunday July 5 newsletter, Dan Zanger's Sunday featured a number of charts showing bearish double top and head & shoulder patterns setting up. None were making new or even short-term highs and that has bearish implications for the market, especially now that a large number of these patterns have been confirmed with neckline breaks.

Q2-09 earnings reporting season began this week which will strongly influence index movement short-term but their longer-term impact will depend on how this earnings diary unfolds, especially for the larger universe of stocks.

Weekly volumes for the major indexes were better than last week thanks to a five-day week but remain below their 50-day volume moving averages. However, the fact that prices moved down on rising volume is bearish as it shows increasing selling, especially when indexes break major support, which has been happening on a number of major indexes last week and this.

Not surprisingly, the Market Volatility Index (VIX) ticked up again this week to close at 29.02 up from 27.85 last week and 25.93 the week before as more fear continued to creep into the market.

This week the CRB Index slipped again to 388.78 from 398.79 last week and 400.70 the previous week. But what is more bearish is that this index is that like stock index, the CRB also confirmed a bearish head & shoulders top pattern this week on the daily chart as the pattern's downward sloping neckline was broken after the index peaked at 430.04 June 1. A downward-sloping neckline makes the pattern even more bearish than a horizontal or upward sloping one. Since bottoming December 5, the CRB index is still up 21%.

Gold slipped again this week to $912.50/oz from $929.40 last week. Since surging to a high of $1001.10 February 20, the precious metal has made two serious attempts at the peak but has failed each time. Volume and open interest continue to look anemic and that is also bearish. Gold normally has a seasonal low in July and then rallies into year-end so there is still a chance for another rally and attempt at $1000/oz in the short-term.

Meanwhile, the U.S. Dollar Index hung on closing at 80.28 down slightly from 80.30 last week - strength thanks in a large part to the enthusiastic showing at Treasury auctions this week (see article below - Treasuries Rise as Refuge Demand Bolsters 10-Year Note Auction). A steadily weakening dollar is inflationary and generally bullish for commodities, interest rates and U.S. multinational corporations with a larger share of their revenues derived from overseas sales but bearish for stocks overall.

Crude oil futures also weakened again this week, dropping from $67.42/bbl last week to $60.71 this week due in large part to weak demand. July 11 marked the one-year anniversary of the all time high in crude futures of $147.90/bbl and crude is still down more than 50% from that high.

The Baltic Dry Index, an indicator that tracks the cost of shipping dry goods by sea, slipped again this week to 2985 down 18.7% from 3672 last week. Continued declines in this index is bearish for both oil and the economy. This bearishness is further highlighted by 19.2% tumble in railroad freight shipments from a year ago according to the Association of American Railroads. It is interesting to note that Canadian rail carload traffic was down 25.7% suggested in June compared to the year before indicating that economic weakness is converging on that of the U.S. (see article below - Buffett's Most-Watched Index Takes a Tumble.)

The U.S. bank prime rate and the Fed funds target rate held steady at 3.25% and 0.00% - 0.25% respectively while the effective Fed funds rate slipped to 0.16% (from 0.20% last week). Meanwhile, the 3-month London Interbank Offered Rate (LIBOR*) continued to fall closing at 0.5050% (from 0.5775% last week) to another new 52-week low. This compares to LIBOR 52-week high of 4.81875% last October.

On the mortgage front, Freddie Mac mortgage rates slipped this week to 5.20% (from 5.32% last week) for the 30-year fixed mortgage while the one-year adjustable rate mortgage (ARM) slipped to 4.82% (from 4.94% last week).

*LIBOR is the benchmark for $900 billion in subprime mortgage loans which typically adjust to it every six months. Corporations around the world have the interest rates on roughly $9 trillion in debt pegged to LIBOR and rates on more than $380 trillion in derivative interest rate swaps also are based on LIBOR. About 6 million U.S. mortgages, including the vast majority of subprime home loans as well as 41% of prime ARMs are linked to LIBOR.

But are earnings beginning to show signs of life?
This week, earnings ticked up for the second time in three weeks. Earnings for the 8,011 US stocks of the VectorVest Composite Index (VVC) moved up to an average $0.16/share from $0.13/share last week pushing the average VVC-PE down to "just" 118.42. June 5, 2009 proved the all-time high water market for average PEs of 155.58 for the VVC Index with average earnings of just $0.13/share. Over the next three weeks earnings began to firm hitting $0.14 then $0.15. But that trend reversed last week as earnings retraced to $0.13/share pushing the average PE back up to nearly 150. However, earnings growth which tells us how fast earnings are appreciating remained stuck at just 1% this week, which is the lowest growth rate in at least 15 years suggesting that this increase could just be another temporary blip.

These highs compare to a previous peak PE of 60.51 in mid-May 2003 during the last recovery. But the difference is that during that period, earnings growth remained much healthier 8% and earnings had begun improving nearly a year prior after hitting a low of 3%. The next chart shows how the 50-week moving average (purple line) acted as support (green arrows) during the last rally and has acted as resistance (red arrows) since October 2007. Looking back to the price peaks in March 2000, average PEs were 32 and earnings growth was 11%.

Figure 2 - Chart showing weekly prices, average Price/Earnings ratios for 8,011 US stocks tracked by VectorVest showing the average PE for the broad range of publicly trading companies. Chart courtesy of VectorVest.com

Meanwhile average earnings for the 2,969 stocks in the Canadian Toronto Stock Exchange (TSX) tracked by VectorVest remained underwater at -$0.01. The good news is that is up from -$0.03/share last week but only back to where it was two weeks ago. Earnings for the nearly 3,000 stocks of the VectorVest Canadian Index (VVC/CA) peaked at an average $0.73 per share in September 2005 and have steadily fallen since. By the week of March 6, 2009 they had fallen to $0.16/share and on June 12 to -$0.02/share during a period in which the TSX exchange index rose more than 40%.

Economic Reports
Manufacturing and service sectors showing life and trade gap narrows
Jobs losses may still be plaguing the economy and average hours worked at all-time lows but there was another glimmer of hope this month with the release of the June Institute of Supply Management numbers. Last week we learned that ISM manufacturing moved up to 44.8 from 42.8 for the highest reading since August 2008. And this week we discovered that the ISM non-manufacturing (service) index a high of 47 in June from 44 in May for the strongest showing since last September. Both have been moving slowly but steadily higher since the ISM service hit a low in November and ISM manufacturing bottomed in December.

Other economic reports of note included the international trade deficit which hit $26 billion in May down from $29.2 billion in April for the smallest deficit since November 1999. The drop occurred due to a fall in imports (especially oil) and a 1.6% rise in exports.

Finally, for what its worth the Reuters/University of Michigan consumer sentiment index was 64.6 in July down from 70.8 in June after hitting a low of 55.3 in November.

Pollyannas caught on tape
Every once in a while we come across an article that is simply too good not to pass on to our subscribers. This one appeared on the Bullion Management Group website July 6 at (http://www.bmginc.ca/) and was written by the BMG Group's president Nick Barisheff. His message is quite clear - listen to those who are "talking their books" at your peril. This is also important in light of all the "green shoots" comments from Ben Bernanke and other government and quasi government economic spin doctors who would have you believe that the worst is over yet again. We have another name for such individuals - Perennial Pollyannas - those who have open or in some cases hidden agendas in shamelessly waxing optimistic ...

Pompous Prognosticators 2004 - 2009
The experts go into denial as the credit crisis unfolds
By Nick Barisheff

In 2001, Colin Seymour published an article entitled 1927-1933 Chart of Pompous Prognosticators. In it, he documented the many Depression-era assurances given by politicians, economists, financial experts and the media to the public, protesting that everything was fine and there was nothing to worry about. Meanwhile, the stock market would decline by 92%, the US dollar would be devalued by 40%, real estate would drop 30% and unemployment would soar to 25%.

Today, we have a similar situation. Politicians, economists and the media are assuring the public that everything is fine. But governments around the world are frantically borrowing trillions of dollars to fund bailout and stimulus plans, the stock markets have lost over 40% of their value, real estate over 50%, and unemployment is approaching 10% in most major countries.


1. "The ability of lending institutions to manage the risks associated with mortgages that have high loan-to-value ratios seems to have improved markedly over the past decade."
- Alan Greenspan [February 2004]


2. "Home sales are coming down from the mountain peak, but they will level out at a high plateau, a plateau that is higher than previous peaks in the housing cycle."
- David Lereah, Chief Economist, National Association of Realtors [December 2005]


3. "I don't know, but I think the worst of this may well be over."
- Alan Greenspan, [October 2006]

4. "The fallout in subprime mortgages is "going to be painful to some lenders, but it is largely contained."
- Treasury Secretary Henry Paulson [March, 2007]

5. "The impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained."
- Ben Bernanke [March 28, 2007]

6. "This is far and away the strongest global economy I've seen in my business lifetime."
- Treasury Secretary Henry Paulson [July 12th, 2007]

7. "In today's environment, it is virtually impossible to violate rules."
- Bernie Madoff [November 2007]


8. "Over the next few months, existing-home sales are expected to hold fairly steady as indicated by pending sales activity, then rise later in the year and continue to improve in 2009."
- National Association of Realtors [January 2008]

9. "Although recent data suggest that the probability of a recession in 2008 has increased, CBO does not expect the slowdown in economic growth to be large enough to register as a recession."
- US Congressional Budget Office [January 2008]

10. "I don't think we're headed to a recession."
- President George W. Bush [February 2008]

11. "I don't anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system."
- Ben Bernanke [February 28, 2008]

12. "No! No! No! Bear Stearns is not in trouble."
-Jim Cramer, CNBC commentator [March 2008]

13. "The worst is likely to be behind us."
- Henry Paulson [May 2008]

14. "Despite a recent spike in the nation's unemployment rate, the danger that the economy has fallen into a "substantial downturn" appears to have waned,"
- Ben Bernanke [June 9, 2008]

15. "Fannie Mae and Freddie Mac are fundamentally sound. They're not in danger of going under.... I think they are in good shape going forward."
- Barney Frank, chairman of the House Financial Services Committee [July 2008]

16. "We have no plans to insert money into either of those two institutions." (Fannie Mae and Freddie Mac)
- Henry Paulson, [August 10, 2008]

17. "My own belief is if we were going to have some sort of big crash or recession, we probably would have had it by now."
- Canadian Prime Minister Stephen Harper [September 2008]

18. "We're probably somewhere pretty close to a bottom."
- Fund manager Barton Biggs [September 2008]

19. "The fundamentals of our economy are strong."
- US Senator John McCain [Sept 15, 2008]

20. "We remain committed to examining all strategic alternatives to maximize shareholder value."
- Lehman Bros. CEO Dick Fuld, shortly before Lehman went bankrupt [Sept 2008]

21. "It's a huge bull market rally."
- Jim Cramer, CNBC [June 2009]

Just as Seymour's Pompous Prognostications proved devastating for those investors who remained complacent due to those false assurances, today's investors would be wise to educate themselves on the real risks and vulnerabilities they face today. In order to preserve their wealth over the coming years, investors need to make wise, informed decisions, stop being complacent, and avoid following the false assurances of politicians and financial experts. With countless risks and vulnerabilities facing the world, the next 20 years will not be the same as the last 20 years.

Just as Seymour's Pompous Prognostications proved devastating for those investors who remained complacent due to those false assurances, today's investors would be wise to educate themselves on the real risks and vulnerabilities they face today. In order to preserve their wealth over the coming years, investors need to make wise, informed decisions, stop being complacent, and avoid following the false assurances of politicians and financial experts. With countless risks and vulnerabilities facing the world, the next 20 years will not be the same as the last 20 years.

On the lighter side...

BULL MARKET - A random market movement causing an investor to mistake himself for a financial genius.

BEAR MARKET - A 6 to 36 month period (and hopefully not more) when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.

Stories of interest this week...

Pompous Prognosticators 2004 - 2009

More Pompous Pumping? Economists Raise U.S. Outlook as Recession Fades

Pessimist or Realist? Lost ‘Animal Spirits' Worsen Economy

A Goldman trading scandal?

New Evidence on the Foreclosure Crisis - Zero down, not subprime loans the culprit

Glut of $4.5 Trillion Will Haunt Obama's Dollar: William Pesek

Treasury's Distressed Debt Plan Said to Begin With $20 Billion

Bonds Face Future-and Cower

U.S. House May Include Surtax on Wealthy in Health-Care Package

Apartment Vacancy at 22-Year High in U.S.

Treasuries Rise as Refuge Demand Bolsters 10-Year Note Auction

Emerging Markets Take Record Share of World Equity

U.S. Treasury Opens Distressed-Debt Program Without Pimco

Obama's Jobless Safety Net Torn by Rebecca Alvarez

Buffett's Most-Watched Index Takes a Tumble

ISDA Hires Rosen to Fight Obama OTC Derivatives Plan

FDIC Said to Withhold CIT Debt Guarantees Due to Risk

GM Sleepy Hollow Nightmare Shows Peril for Factories

Working for your wealth,

John M. McClure
John M. McClure, President & CEO
EquiTrend, Inc.

Posted 07-13-2009 11:55 AM by John M. McClure