PRINCIPLES OF THE STOCK MARKET

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

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

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Monday, April 6^th, 2009:  It’s Master’s week so I’m pumped up.  It’s golf’s 1^st major of the year, tradition packed, for you non-golfers.  Should be great with Tiger back, Phil Mickelson saying he’s playing the best golf of his life, Paddy Harrington going for his 3^rd major in a row and lots of up & comers.  All I can say is wow!  Even just watching this old southern flower nursery turned into a golf course in the spring, lavished with money for decades, may be worth the watching for any non-golfers out there.  For me, it’s just heaven.

THE KEY QUESTION

Instead of discussing The Big Picture today, let’s focus on The Key Question.  Since that’s what I keep pondering.  Plus it has to be on every investor’s mind as well.  “Could this rally be the start of a new bull market?”  To intelligently answer -- as during every bear market rally -- necessitates rehashing all the available evidence.  I can make a solid case for a cyclical bull market having just started and I can make an even more solid case that this is just a normal bounce in a Papa Bear market.  Consider: 

MINI BULL MARKET HAS STARTED

·        The economic stimulus is now starting to kick in which will stabilize and bounce the economy.

·        The monetary stimulus, lower interest rates, is also now kicking in and housing sales are increasing.

·        Inventories have been drawn down and need to be restocked which will pump up GDP growth near term.

·        The US and other governments have done everything possible to mitigate this downturn.

·        We now have more coordinated and get along global leadership than in many years.

·        The US economy has proven itself wonderfully resilient to shocks in recent decades.

·        Markets can counter-swing at any time for long periods, posting mini bull markets, versus primary trends.

·        Almost two years has passed since the beginning of the credit implosion back in July 2007.

·        Many independent market gurus think the March 2009 lows will last for a good while, months or longer.

·        The latest government bailout plan has more enthusiasts and support for it than previous plans.

·        Oil stopped falling back in December and is now on the rise possibility indicating growth rebounding.

·        We have recently had a number of better economic data reports from both retail and housing.

JUST A BEAR MARKET BOUNCE

·        The bear market hasn’t lasted long enough to discount all the problems that have come to light.

·        More problems, coming as bearish ripple effects and because of long lag times, are due to show up.

·        The bear market hasn’t fallen deeply enough to factor in the sudden massive shock to the global economy.

·        There hasn’t been enough overall selling or liquidation for a solid  bottom.  Stock and mutual fund liquidation haven’t reached previous classic big bear market bottom levels. 

·        No solid bottom appears on the charts.  We need a climatic sell off or a long low volume erosion to bottom.

·        Interest rates have to go up at some point, soon – either with and because of  an economic rebound or from panic selling -- which normally depresses stock prices because of this new competitiveness from bonds.

·        The American consumer has suddenly stopped spending.  This has slowed down business all over the world and finally exposed the global imbalances problems.  Too much manufacturing in China and Asia and too much spending coming from America.  Now those imbalances are being forced to readjust.  Takes time.

·        The stock market is ignoring soaring unemployment.  Yes, employment is a lagging indicator but continuing jobless claims isn’t.  A new report just out says that in coming weeks and months, hundreds of thousands of jobless Americans will exhaust their unemployment benefits.  Finally, 600,000 new job losses each month is going to add to weaker consumer spending, problems for local communities and cause negative ripple effects.

SCHWARTZ CONCLUSION:  In review, we started this big bad bear market back in the  year 2000.  That was the peak of the last big bull market and thus the beginning of this big bear market.  This is evidenced by the benchmark S&P 500 Double Topping in March 2000 and October 2007 and then subsequently and decisively breaking below October 2002’s previous decade-long lows by over 10% in March 2009.  Showing that since 2000 and the ending of the Internet boom we’ve really been living on lower interest rates and big tax cuts, a false, “pump me up,” house of cards.  Really not any wealth building going on, just paper shuffling to make things look great fueled by easy money credit creation.  But now reality has set in.  Thus, looking around, we see we’re almost nine years into a bear market which has been interspersed with one bull market, running for five years.  So stocks were down almost two & a half years, up five years, now down about another one & a half years, sort of repeating The Visit of the Three Bears.  In that infamous and extended bear market run of nine years, netting a -50% loss, there were two cyclical bull markets sprinkled in and surrounded and book-ended by the three bears, Baby, Mama and Papa. 

My conclusion remains that this bear market is not over.  But that the form and shape of it may get tricky going forward.  Because the market has a history of posting cyclical or short term or mini bull markets on the way down when the bear gets ahead of itself.  Which is why the stock market remains so fascinating!

THE ECONOMY

Well, the BUZZ has died down about how the economy is slowing its prior quick rate of descent.  Guess because we’ve started seeing more bad economic data pop up or because the conversation has moved on.  But some investors have decided an end to the economic collapse is out there, just over the horizon, so they are shifting into cyclical stocks now as a result.  One can see this money rotating out of defensive sectors such as medical care, consumer staples and even gold.  You know the concept, buying in advance of a recession’s end since history shows stocks rise roughly six months before the economy turns up.  But if we indeed are stuck with a very mild even “anemic” economic recovery, as many figure, then stocks could also soon level off to mirror that trend as well.  That is if the economic and earnings data don’t start sinking fast once again showing the economy is still sinking.  For example, last Friday it was reported that the ISM Non-Manufacturing Index which now measures almost 90% of America’s economy - America now being a service oriented economy instead of a manufacturing economy - fell faster in March than in February somewhat debunking the idea that the economy has stabilized.  Schwartz View:  Yes, there is the possibility that economy-wise we are going to V- back up because sharp moves, in whatever areas of endeavor, are generally followed by responding sharp moves back up.  We’re seeing that now in the stock market but after this bounce is over, I agree with the camp forecasting an anemic slow economic recovery.

THE STOCK MARKET

The stock market extended its rally to four straight weeks last week.  We did see the first crack in this rally a week ago when the market fell sharply for two days.  But then we quickly rebounded to new rally highs.  That’s normal, the first crack being overcome but it does show this rally may be starting to struggle.  We are getting closer to my minimum upside targets of Dow 8303 and S&P 1627, closing Friday at Dow 8017 and S&P 1621.  And one can note trading volume has been slowing some, another sign of sluggishness.  Or maybe cautiousness.  Makes sense as we’re now moving into another corporate earnings reporting season starting tomorrow, the 1^st quarter January-March 2009 report kicking off after the close with Alcoa (AA), traditionally the first of the 30 Dow stocks to report.  With the fall-off-the-cliff economy occurring early in last year’s fourth quarter, it only stands to reason that investors have to be wary of forthcoming earnings and thus wary of this rally as well.  Schwartz View:  It looks like the stock market has some more strength left in it so with stocks already having rallied beyond the 50% retracement level from their latest leg down, the early January peak, the teeter-totter phenomenon comes into play.  Getting halfway up means it’s very likely to go all the way back up.  Thus we kick off this week at roughly another key Fibonacci 61.8% price in both the Dow and S&P 500.  That’s about 8088 and 838 respectively.  If we break through those levels, then the next target is those January highs, Dow 9088 & S&P 944.  Not guaranteed but increasingly likely.

PORTFOLIO STRATEGY

2009 may indeed prove to be the year to trade.  If stocks fluctuate but go nowhere net, up or down, for many months ahead then it’s going to prove very frustrating for investors.  In these times and they do happen, more often than the uninformed investor may realize, the best way to make profits is to:  (1) trade individual stocks and (2) discipline yourself to continuously fade the market, buying on dips and selling on strength.  Toward that end I’ve started incorporating the Commodity Channel Index (CCI) technical indicator into my work.  Comes on most charting services like Bloomberg.  Basically it shows deviations from the moving average, when stocks get too far overbought or oversold.  Naturally you buy when a stock or index gets oversold.  For more on the CCI I suggest getting Oliver Perez’s Swing Trading Tactics DVD or Alexander Elder’s book TRADING FOR A LIVING.  Over the last month of rally for instance certain stocks have far outperformed the averages.  And numerous tradable asset classes or market sectors like the US dollar and oil have been both up and down offering trading profits but no net profits for buy & holders. 

Otherwise than scalping profits what should we do?  For now favor the long side and the cyclicals.  I like technology, renewable energy and natural resources.  Move up a notch in your market exposure to about 30% if you haven’t already but continue to hedge your bets and don’t get out on a limb by going too long.  Just subdue your ego, don’t think you know more than Mr. Market does and just go with the flow, modestly.  Bottom line take what the market gives you, right now there are some trading opportunities but don’t get carried away.  There’s lots more trouble to come but the path ahead is likely to get more tricky as well.  So don’t fall into the camp that says “fool me once, shame on you, fool me twice shame on me.”

Have a good week!

Go Tiger Go!