Three Month Market Topping Pattern

While we often tend to look at fundamental analysis to determine the direction of the stock market, such as heading for the “fiscal cliff” or problems in Greece, it is sometimes a good idea to check on technical analysis. This blog will give an overview of where I believe technical analysis appears to be pointing at this time. On average, a bull market lasts about 39 months, sometimes longer or shorter. The current bull market began in March 2009 and reached its 39 month point in June of this year. For three months, from August until recently, some of the equity indexes reached new highs, seeming to show a robust equity marketplace. During this same three-month period, signs indicated that all was not well with the majority of underlying equity issues. The S&P Mid Cap and Small Cap indexes did not significantly break out of the highs from 2011, and selective buying was occurring. Selective buying indicates that buyers have become picky, and is usually a harbinger of a downturn in the markets. The NASDAQ Composite was showing greater signs of weakness as it dropped steadily. All of this produced what technical analysts call a topping period, where some issues continue to rise while most have hit their peak and are headed downward. What some long-term investors like to look at are the 200-day moving averages of various indexes. The idea behind the 200 day moving average is that it gives a clearer picture of the long term patterns of the market represented in an index. The daily movement on the NASDAQ Composite broke well below its 200-day moving average in October. The Dow Jones (DJ) Utilities average, DJ Transportation average and DJ Industrial Average have all broken below their 200-day moving average. Increased selective demand, coupled with the drop of most averages below their 200-day moving average and the impact of the weakening European markets on the U. S. markets all point to an extended bull market. What we saw last week was likely a correction in the market and not the start of a bear market. Given the extended nature of this bull market, caution should be exercised.
Ed Mallon

The Financial Cliff!

The term “Financial Cliff” is being bantered about quite a bit lately, but not all Americans really understand what it is, let alone the implications. The “Financial Cliff” refers to two separate developments that will take place unless Congress acts to avoid one or both of them.
One of the automatic changes that will occur, without action by Congress, is that the tax structure currently in place will expire at the end of this year, to be replaced by the old tax structure that existed in 2001. This means substantial increases in taxes for most Americans. At the same time, the payroll tax, which has been reduced for the past two years, is due to rise to its previous level. These tax changes mean less take home pay for every American worker. A reduction in net earnings will mean that consumers will have less to spend (and save) and economic growth will decline.
The other automatic cut that will occur at the end of the year is in Federal spending, with one half coming from the defense budget and the other half coming from mandates such as Social Security, Medicare, Medicaid and other basic services. This cut will also have a negative impact on the economy, as federal government spending that goes into the economy will be reduced.
To put this all in perspective: the growth we have been experiencing this year is roughly 3.1% with expectations that it will be similarly slow next year. If these two automatic changes go through, it is possible that the economy in six months could be negative 3%. Following the downturn in economic growth, the economy would be expected to begin increasing, and by 2014 to 2015 it could be growing better than today.
Will Congress act to change or eliminate these two automatic actions? At this point, no one really knows, but what if they don’t? In that case, we are likely to see unemployment increase again, housing values decrease and everyone will feel the pinch! It has also been suggested that if this is allowed to happen, long term benefits to the economy could be better than if Congress were to attempt to blunt the initial pain. The reason is that if we had a reduction in government spending and an increase in taxes the national debt would begin to fall. The financial strength of the United States would grow, and ultimately it would be favorable to business and consumers.
Part of this hinges on what I have been saying for most of this year: the United States has the highest productivity in the world, the best quality in the world, a stable government, and cheap energy in the form of natural gas. But our financial strength is being sapped by overspending and under-taxation. When you couple these with a strengthening financial situation, we cannot be beat! Many parts of the world are implementing austerity measures, while we in the U.S. have continued to have low taxes and high government spending. At some point and in some way, we too will have to feel the pain. So will Congress now let things go without intervention? Do politicians understand economics? Does any politician want to take away benefits and increase taxes?
One last comment. If the tax changes take place, the capital gains tax will rise to 25% and the taxes on dividends will go from 15% to a maximum of 42.5% (almost triple) and everyone will be paying more taxes on income. Are we a country that thinks long term (take your pain now) or short term (send the pain to another generation)? The “Wealthiest 1%” are not going to get us out of our mess. We all have to participate to make it happen!
Ed Mallon

Will They or Won't They

Currently the big question is: Will the Federal Reserve step in with a stimulus package or won’t they? Given the sad state of job growth, as reported last Friday, and the number of people still out of work, it seems likely that the Fed will do something. The next questions are: what will they do and what will be the impact? It appears to me, from reading reports since late August, that the Fed is likely to begin a new bond buying program that will push down interest rates on bonds, which have been rising. This in turn will make borrowing cheaper, helping to stimulate the economy and driving equity prices higher. That at least is the theory. The reality may be that stock prices have already accounted for the Fed’s action since it became clear at the August Fed meeting they would do something to stimulate the economy. When the Fed does announce their plan, equity markets may be susceptible to disappointment. That in turn could drive equity prices down. Across the pond the question is: Will the Central European Bank buy more Greek bonds and will they give additional help to Spain and Italy? Based on reports late last week, the Spanish and Italian governments got a clear sign that what they were doing for austerity was sufficient, while the results in Greece were disappointing. Looking at Greece’s issues it seems more and more likely that they will leave the European Union. Many large companies are already preparing for such an event. The impact of such a move on Europe and the U.S. is unknown but will likely be negative in the short run. All of this is in part due to the aftershocks of the subprime mortgage fiasco of 2008. Have we learned anything? Today the Wall Street journal reported that the booming car sales of August were helped along significantly by lenders making significant subprime car loans. Ed

"Stocks are Dead!"

In section C of the Wall Street Journal on Wednesday, August 1st, the headline read: "Bill Gross: Stocks are Dead and Operate Like a 'Ponzi Scheme'”. It notes that Bill Gross is co-founder and co-chief investment officer of Pacific Investment Management Co., or PIMCO, the largest bond fund in America. His belief is that the rates of return seen with stocks cannot continue and in the long run will come down. At the time this was reported, the 10-year Treasury bond was yielding about 1.5%. As of today, the same bond is yielding 1.84%. While this may not seem like much of a change, it means that the 10-year Treasury bond has decreased in value in a matter of 17 days. With bonds, when the yield rises, the value of the bond declines. Putting it in dollar terms, if you hypothetically purchased $100,000 of 10-year Treasuries at the beginning of the month, the value of your money would have decreased about $2,800 by last night. Because Treasuries impact most bond yields, we have also seen similar drops in value for most bonds. During the same period, the S&P 500 has risen 36 points for a 2.6% increase. If you had hypothetically purchased $100,000 of the S&P 500 Index, your money might have increased by about $2,600. Trying to guess the direction of the stock market or bond market over short periods of time is futile. I do believe there are long term trends that need to be watched, as well as short term events that must be taken into consideration. For bonds, with the long term trend from 1981 until now, we have seen interest rates continue to fall and as they fell, the value of bonds increased. Will this hold for the future? I don’t think it will. I believe bonds must ultimately begin to have increasing interest rates and reductions in value. The reason for holding bonds now is because of the uncertainty in the U.S. and the world, and the long term stability of bonds is because of the priority in payment, both interest and principal, of bonds over preferred and common stock. As greater stabilization comes to the U.S., and the world situation plays out, the benefits of stocks, dividends and growth, will be more likely to outweigh the stability of bonds. The ultimate answer to our current situation and long term investing is diversification. Bonds go up and down, stocks go up and down, real estate goes up and down, currencies go up and down and commodities go up and down! These changes happen because of economic trends but also because of human emotion. The three rules of investing are: Diversify, Diversify, Diversify! Have a great weekend! Ed

A Perspective of Value

The stock market works primarily on the idea that equities and fixed income securities have value. As the perspective of value changes the pricing of each of these two types of securities changes. Recently Spain has been under a great deal of pressure because the perception is that their banking system and economy are in poor shape and are more risky than what they were before. With this in mind you can understand why the interest rates on Spanish bonds has increased dramatically. Early this morning Italy was downgraded by two levels with a statement indicating it could be downgraded more in the future. This undoubtedly will have a negative impact on Italian bonds in today’s market, especially as the government there is doing a major refinancing of debt. In the U.S. the Federal Reserve (FED) has been holding short term rates at about zero and 10 year Treasury rates at all time lows, as of this writing 1.479%. The FED is doing this in the hopes that it will stimulate the economy, particularly the housing market. Thus, we have seen the lowest mortgage rates in 70 years. All of this points to the real problem. Worldwide economic growth is stalled. This in turn has lead to very high unemployment worldwide. This decline has been going on for some time. In October of 2007 the S&P 500 reached a new high of 1549.38. By February of 2009 it was down to 735.09 a staggering drop of 814 points or 53%! A bear market is one where the drop is 20% or more. This one was a duzy! During the recovery over the next three plus years the S&P reached 1419.04 on April 2, 2012. This was still 8% below the high in 2007. Since then with fits and starts the S&P has drifted down and is currently about 6% below the high of April. As we wait to see what earnings will be for the second quarter of this year it appears that the economy grew at a lack luster pace and that earnings for companies will likely follow with less than original estimated earnings. This is likely not to have a positive impact on stocks. The worries about equities is likely to continue to have a positive impact on higher quality bonds, especially U.S. government and corporate bonds. Historically the market goes up before a Presidential election and this may be the case this year. Looking at the fundamentals of the economy and the long term trend in the supply and demand for stocks I think this will remain a hard period for stocks to show significant gains and more likely trend down. My guess is that we may have entered the beginning of a bear market on April 2nd and are now going thru the stages of reaching a bottom. If that is the case then we could see the stock market lose about another 14% from where we are currently. Ed Mallon

Wildfires in Colorado

I wanted to take this opportunity to let our friends and clients in Colorado know that you are in our thoughts and prayers as you go through the tragedy of the wildfires in Colorado and especially in the Colorado Springs area.
Ed Mallon

Position Clarification

Many of us are feeling ”overloaded” by what we read and see about the U.S. economy, as well as what is happening in Europe and many third world nations. To put it as succinctly as possible: I am bearish on where the world stands currently. Accordingly, I will be taking a more reserved position. I have begun to underweight--by a substantial amount--the equity positions in each of our four fundamental categories (Conservative, Moderate, Growth and Income, and Aggressive). To give you an example, the allocation for a Growth and Income portfolio would normally be about 60% equities and 40% fixed. With the changes we are currently making, that portfolio will only be about 20% equities, about one-third of what I would normally allocate. You might wonder why I wouldn’t just get rid of all the equities. The answer is, I could be wrong! In addition, I am moving away from indexing, such as the S&P 500, and small stocks, and am going with managed portfolios of large- and medium-sized companies. I believe that, in times like these, the actual management of large stocks will offer better performance. I also like dividend-paying stocks. In the portfolios for which I have discretion, I have allocated few or no international equity positions because I believe they are too risky. In the long run, I am very bullish on the U.S. as I believe that the U.S. has four major attributes that no other country can equal: a stable government, the highest productivity in the world, the best overall quality of goods produced in the world, and inexpensive and plentiful energy supplies (especially natural gas). My perspective is that, once we are past the upcoming U.S. elections, Europe quiets down, and a decision is made on federal taxes and spending, it will be time to re-enter the stock market in full force. I expect these issues will all be resolved by the early part of next year. In the meantime, I remain cautious. Ed Mallon