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Principles of the Stock Market

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Have You Seen This?

 

Richard Schwartz's

PRINCIPLES OF THE STOCK MARKET

A learning, teaching, always evolving stock market letter and advisory service

Eighteenth Consecutive Year of Publication; Letter #1; September 18th, 1990

 

 

Post Office Box 1236 · New Paltz, New York 12561 - U.S. A. · (845) 255-6894

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Wednesday, October 15th, 2008:  Leaf peepers drive up into the Hudson Valley in the fall to see this:   “Beginning with the September scarlet flashes of sumac & Virginia Creeper, the color show continues with the red-orange of Poison Ivy, the lemon-yellow of Elms, the bronze to eggplant purple of White Ash, the brilliant red of the soft Maples, the yellow of the birches, the golden orange of the Sugar Maples & finally with the crimson, maroon, and burgundy Oak leaves that hang on till they turn a warm, leathery brown.” 

 

UPDATE ON THE STOCK MARKET.  After eight straight days down, totaling a record -22%, then a record one-day bounce on Monday of +11%, which retraced 39% of the eight days total losses, it’s only natural that stocks quieted down some yesterday.  That’s how things work.  Markets get wild, swinging out to one extreme (especially when fear of the whole global financial system failing is a real risk).  Then they counterswing to an extreme in the other direction before investors finally get exhausted.  So yesterday, after a big +400 point upwards Dow opening carry over from Monday’s +900 Dow leap, markets started selling off.  By the close, we posted mixed results.  The Nasdaq with its heavy technology weighting took it on the chin along with mid and small caps while the banks finally did as they were supposed to, showed some strength since the government’s rescue plan centers around keeping the banks solvent.  Schwartz View:  Oh, oh!  Keeping the banks solvent?  Sounds frightenedly familiar.  Isn’t that same strategy which led to Japan’s lost decade of the 1990s?  Yep.  They refused to let their banks fail, for years and years, which meant the economy couldn’t recover since the Japanese banks were stuck with huge amounts of bad real estate debt.  Nah, we’re not going to follow that failed strategy for long.  Just for the moment while we get credit markets working normally again.  About this very important issue of bank loaning money again, the New York Post reports this morning that “Frozen credit markets eased slightly” [yesterday].  Yay!

 

TECHNICAL VIEW.  Remember BLACK MONDAY?  Here’s one historical example of markets swinging, then calming down.  After the record -23% one-day panic and loss back on Black Monday, October 19th, 1987, taking stocks to one extreme, stocks bounced back the over the following two days some +17%, retracing 57% of Black Monday’s loss, swinging out to the other extreme.  Then markets, exhausted, settled down.  Over the next month and a half, stocks quieted down and started base-building before posting a successful technical “retest” in early December.  And then started to tackle the job of recovering the rest of its lost ground.  (Took almost two years to recover fully as you might recall.)  Please note that the 1987 two-day bounce recouped more than 50% of its previous one day loss, which according to Charles Dow’s (the originator of Dow Theory) July 1900 observation which I quoted you yesterday, meant that the primary movement downward had likely run its course.  That indeed proved to be the case as the Dow close on Black Monday wasn’t seen again.  Schwartz View:  Anyhow, so far, we’ve only retraced 39% of the 2400 Dow points lost over the recent sequence of eight straight down days, so it looks like this current primary downtrend may not have fully run its course.  Unless we bounce big over the next few days.  And yes, yesterday’s 400 point opening spike can be taken as regaining a full 50% of our losses but only if you compare apples and oranges, meaning closing prices versus intraday prices.  No go.  Unhappily, I can't even say for sure this more than one day, this slow motion crash is over.

 

GLOBAL VIEW.  I read about a company yesterday which is BRINGING WORK BACK TO THE US!  Yep, unbelievable but true.  Bloomberg research reports Exxel Outdoors, a sleeping bag manufacturer, is cutting workers in China while hiring more workers in Alabama.  Because costs are lower in Alabama after (1) a 17% drop in the dollar versus China’s yuan since 2005, (2) rising wages in China which jumped 18% in urban China in the 1st half of 2008 and (3) a jump in freight rates.  Economists like former Fed head Alan Greenspan have predicted this, that low labor costs would eventually be outweighed by other costs and that manufacturing would eventually balance off globally, not all remaining in China, and we’re now seeing the first signs of that happening.  That companies would eventually need to revisit their outsourcing  policy in the always ongoing drive for efficiency.  In the same article it says Ikea just opened a factory in the US while Caterpillar and Home Depot plan to produce or buy more in the US.  Schwartz View:  So the balancing off process is underway.  Unfortunately this is a very long term macroeconomic trend.

 

*  Oh, before I forget, China expert Donald Straszheim, formerly Merrill Lynch chief economist from 1985 through 1997 and now vice chairman of Roth Capital Partners, a firm which specializes in emerging markets says  the coordinated move to lower interest rates is “ … an important part of the bottoming process that is going to occur over the next few months in equities.”  Schwartz View:  Stocks down below Dow 9000 or 8000 are now far ahead of the normal progression of a recession unfolding.  (Obviously because of the heightened fears and panic caused by fears of systemic risk.)  So they have lots of time to kill now to have the economic fundamentals catch up to prices.  So I wouldn’t doubt similar market action to back after the Black Monday crash in 1987, base building in effect from now ‘till the end of the year.   After this decline ends. 

 

SECTOR VIEW.  The Principle of Relative Strength.  Of my seven principles of the stock market, relative strength is the principle which clues us into just what to buy.  And it works well, maybe best, near the end or right after market declines.  Relative strength points out what is inherently strong.  So my next quest is to go through the various sector indices and the various specific sector funds today and in coming days to see if we are getting any particular sector strength, weakness or any other divergences from the pack.  For example, I’ve been thinking that the banks should now be one of the first group to stabilize or even bottom out what with government support.  There were big signs of that yesterday with the KBW Bank Index rising an amazing +12.16%.   While the REITs, another financial subsector, ended up falling a large -6.54%.  These are the types of divergences and happenings that I want to pick up quickly.  Schwartz View:  This relative strength concept doesn’t only apply to individual stocks and individual sectors.  It also applies to the bigger picture.  It applies to what regions of the world are going to be able to best handle this global slump.  Tipping us to where we want to be overweighted when this bear market winds up (down).  So far it’s been a worldwide stock market slump with double digit losses everywhere, with us, the US holding up a bit better than other regions.  But, now, as we move through this slump, a continuing study of relative strength should tell us if things have changed.

 

ECONOMIC VIEW.  Federal Reserve Chairman Ben Bernanke said yesterday that the government won’t “stand down” with their plans to unfreeze the credit markets until they “restore prosperity.”  That made me think.  Does Ben mean that when credit markets start working that will restore prosperity quickly, that the recession will just disappear?  I don’t know but that’s the exact possibility I proposed in this past Monday’s Weekly Overview in the Big Picture section.  Moving on, another economist says there’s no doubt that unemployment is going to rise and that corporate profits are going to keep slipping, that’s in the pipeline now.  I noted 3rd quarter S&P 500 earnings projections are now for a decline of -7.5%, “down sharply” from projections back on September 1st.   Schwartz View:  I don’t think the recession is going to just disappear, not with the consumer now cutting back.  But one never knows for sure when predicting the future.  I must say I don’t see many immediate signs of the economy falling apart here in the Hudson River Valley.  And we are a vacation home and bedroom community for New York city’s financial businesses.    

 

Have a good autumn day!

 





Posted 10-15-2008 12:51 PM by Richard Schwartz