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Wonderful World

"And I think to myself, what a wonderful world..."

In this weeks wrap-up -
In this weekends newsletter we will cover

1. Fundamentals - Weekly Recap
2. The Current Technical Outlook -
       2.a. Short term Perspective - Channels,Indicators, Counts
       2.b. Long term Perspective - ElliottCounts, and some targets
       2.c. Gold and Silver
       2.d. Leaders and Shakers
3. Sentiment Indicators
       3.a. Volatility Studies - VIX
       3.b. Put / Call Ratio
       3.c. Summation Ratios and other Oscillators
       3.d. Commitment of Traders
4. Conclusion


It was a week of disappointment as neither the bulls nor the bears managed to take control of the markets. The big story this week was of course Friday's unemployment report that clipped in at a surprising 6.0%, sliding down from 6.1%. Despite lagging performance in manufacturing, hours worked, and average work week, the employment market is without a doubt stabilizing for the time being. It struck me as a bit odd, however, since it was only a week ago that a research firm reported record job losses for the very same month - go figure.

I wouldn't claim that the job market is necessarily "growing" yet, since according to Bernake we are going to need 100,000 - 150,000 new jobs every month just to maintain the current rate - sustainability being the question. However, with the "unemployment thorn" gone, the bulls have taken to the streets once again in a very liberal manner. We will no doubt see "Dow 100,000 - 2nd edition" hitting the shelves in December. There is, however, a certain uneasiness to the bulls optimism grounded in the fact that despite the rush of good reports, the market just seems to yawn and shrug them off. This leaves the poor folks at CNBC with a lot of explaining to do - which leads us to our first topic.


"Why aren't the markets rising?" is the question that just surpassed "what stock should I buy" as the most asked question of the week here on campus. The situation is no doubt perplexing with GDP coming in at a hefty 7.2%, unemployment recording it's first reversal in a long time, with the markets sagging on the news. This is all very reminiscent of all the horrible news coming out 9 months ago, that the market just discounted and rose 150 points on.

CNBC tells us that "the good news is already priced into the market, and investors are worrying about how sustainable this rise is." To a degree I would agree with them and would in a way applaud whoever came up with that for thinking of it. Sustainability is a big issue, since a lot of the GDP gains can be attributed to one time factors such as child tax credits, the mortgage boom, tax cut, and the generous liquidity flood from the FED, that had to find a home somewhere. Unemployment is also questionable, as I mentioned above, requiring a large amount of new jobs every month just to sustain our current levels. However, the market is forward looking, due to the fact that everyone is trying to out guess, and get in and out of the market ahead of everyone else, which would therefore suggest that investors are not expecting many blockbuster reports to be coming out in the coming weeks. Seems that people (as in the big investors) are becoming wary of buying at a top despite the bullish seasonality.

Could it be? Are investors a little bearish?

Being a 'contrarian' investor, this leaves me to wonder what side of the market I should be on - what is the real sentiment of the market at the moment. Spending the day skimming newspaper articles and watching CNBC, I took the time to try and gauge just what the big players were feeding to the public. Although the markets have failed to rise on the good news, it seems that they are also failing to fall on bad news - such as the mutual fund scandals that have failed to cause a dent despite the shower of publicity. In that sense there is still plenty of bullishness out there - or at least apathy. Analysts are still touting buy recommendations on the air, displaying nothing but the most outstanding confidence in a parabolic rise in the market. So are we climbing a wall of worry or a wall of hype?

Joe Duarte comments "This market is beginning to get that bullet proof feeling. It shakes off just about everything with mild to moderate morning corrections. Investor's Business Daily's take on things, that volume trends and small company break outs are the lifeblood of bull markets, is becoming a mantra. And CNBC is once again starting to cheerlead. Sound familiar? Yes, it feels like the halcyon days of November and December 1999." (http://www.joe-duarte.com/)

So after a lot of hand-waving, my opinion of the situation is as follows. It seems to me there is a strong sentiment split between the consumer/mutual fund side, and the bigger corporate side. The consumer is without a doubt optimistic.

 • Mutual fund inflows are still high despite the recent scandals.

 • Margin debt on online accounts is at record highs (higher than 2000) as everyone is leveraging to the hilt in order to play catch-up.

 • Bullish Sentiment numbers, VIX, VXN, and newsletter writers are predicting a return to Garden of Eden style conditions

 • If CNBC is any measure of consumers spirits, they are without a doubt very bullish on the markets - not to mention the kings of the bulls - Kudlow and Cramer who are so happy with themselves these days they can barely stand it.

However, the larger, more secretive players are sending a different message.

 • Some of the worlds greatest investors such as Buffet and Tempelton see nothing but a sucker rally. Most of the very well informed investors I know at banks, hedge funds, or other professionals are also not looking to invest in stocks at these levels.

 • Corporations and CEO's have definitely been in the bearish camp, and still are to a large degree. They haven't been hiring because they either don't see any rising demand, or are skeptical of it. The insiders working at the very same companies CNBC is touting are selling their shares at a historic pace - we hit a new record of 56$ sells for every 1$ bought.

 • Despite bullishness being higher now than ever before during this rally, the big money has obviously stopped buying into the market, if it's not selling, since there is no enthusiasm on seemingly great news.

So is the market climbing a corporate wall of worry? Is the consumer, for the first time ever going to get in on the ground floor of a new bull market? Maybe, but if market history is any guide, I would have to be doubtful. Just looking at volume, and price patterns (we will get into that below) I think there is a significant amount of distribution going on at these levels, and there are a lot of signals popping up that are distinctly reminiscent of the 2000 top. Zoran Gayer points out in his most recent publication "The GDP improvement is not a sign of more good things to come. It may in fact be an indicator that the top is in. GDP hit the peak just over 7% at peak in 2000, and 1987 just before the crash (from YELNICK). In one of the Japanese BEAR recoveries GDP also reached just above 7% before resuming a fast down move. The fact that everything is rosy is no guarantee of further up moves but in fact more likely an indication that the top is in Tops are made when the public view is most optimistic."

With bonds breaking down out of consolidation, and plenty of ending patterns in a number of markets, the charts are telling their own stories.

2. The Current Technical Outlook -

2.a. Short term Perspective

I threw in a longer term chart this week just to get a better perspective for where we have been. The rising wedge that we noted last week is looking more and more probable every day as the market seems its weakest on this latest rise - a wedge within another wedge for that matter. However, we aren't going to let our seeming bearishness get us in trouble, and I would therefore not recommend throwing on any serious shorts until we decisively break both the red and the blue supporting trend line. The count above has us in wave 5 of either 3, or C. If we break down from here, choppy movement would suggest that we just finished 3, while a very impulsive move would suggest that we just finished wave C, and can expect plenty of downside from then on.

Don't forget, however, that we have been in a VERY strong uptrend for over a year now. One is almost tempted to call this a true bull run - and that is why we have stayed mostly long the market on the way up, despite fumbling a supposed top or two. Personally I don't expect a huge down move from here, but a gradual easing to the downside that will eventually lead to some capitulation - I don't think the market is going to make this easy for the bears either. But whatever the market does, we don't make a move until the technicals suggest that the odds are in our favor.

With the MACD diverging steadily along side the RSI and Money Flow, I would suggest caution to the longs, and patience for the bears - for they are without a doubt suggesting that a correction of some sort is just around the corner.

Last Weeks Forecast : Keep a look out for one more wave up that should set up a good deal of divergence. What we are looking for is a break below the 1915 level, and then a break of 1840 to set us up to bypass 1775 and establish a new low - breaking the higher high, higher low pattern we've had for over a year. Nothing wrong with standing aside in cash at the moment.

We got the new high that I was looking for with a good deal of divergence too. What is most telling on this chart is the decline at the end of the day Friday. We all know that the big players usually conduct their business during that time (mornings are called "dumb money" and the close is the "smart money.") Things definitely did not pan out as the bulls expected them too. Therefore, looking eerily similar to the Oct 2nd-5th top, I think this market is prime for a correction. I'm not saying that this is going to be "the" correction, for that is something we can't decipher until we see the form of the decline, but I wouldn't be surprised to see 1920 revisited sometime soon, if not 1900.

Next Week : Things are looking pretty top-e already, but the market could pull out a hat trick here and jump. However, if we decline past 1950, I think 1900-1920 would quickly be next. If the decline looks fast paced, it could very well be a start of something new - which a decline past 1850 would suggest.


Looks like we might have a breakout on our hands. Bonds had declined steadily right up to the unemployment report after which they declined pretty abruptly. Although I'm not looking for a crash, or even a move as fast as the previous one, I think bonds are in for a sizable decline that could last a while. My shorts are ready.

Note: Yeilds should not fall back down past 42.5 or something more bullish is going on (for bonds)

Note: There are A LOT more charts on my stockcharts page - support resistance, more wave counts etc. Take a look at them here :


If you like the charts, please vote by clicking here!

2.b. Long term Perspective

We have come a long way, although the previous top back in December 02 is providing some resistance. Something to keep an eye on technically, is the MACD wedge and the RSI divergence. We are also approaching the top of the pitchfork which would suggest a move back down to the median, if not an end to the move.

2.c. Gold and Silver

The HUI began the decline that I was looking for, and I think that it could very well continue all the way down to the 180-190 level before rebounding once more. Remember, Gold should spike down a good number of times if it is really in a bull market - getting rid of all the shaky hands. That's why I am beginning to anticipate a correction in Gold, although I still believe that it has bull market status. We have both a rising wedge, and divergence calling for a correction. This does contradict a decline in the market since the two usually have an inverse relationship, but then again, they have been rising at the same time. What could happen, is an advance in the dollar that would pull gold back down to the 355-365 level. We shall see however.

Dollar looks like it could be in for a rebound. This would not surprise me one big judging by the steady downtrend we have had for almost 2 years now. I believe that the dollar is in for a longer term bear market, but it is no doubt going to rally every now and then. Although it is not very extreme, we do have some bullish divergence on both the RSI and the MACD, as well as strong support at the 92.5 level. How should you play this? Both Buffet and Tempelton (two famous investors) are bearish on the dollar. Tempelton has even gone as far to say that the dollar will decline 40% in the next year or so. Although I think that is a bit much, it would not surprise me one bit (such a decline would cause a blast off in gold and commodities, a sell off in bonds and stocks.) However, as long as the dollar manages to hold on to the 92.5 level, I can not be bearish in the short term. In fact, everyone has been VERY bearish on the dollar lately, and nothing would suit the mood of the market better than to shake things up a bit and rally the dollar for a couple months. This is all opinion though; keep an eye on the upper trend line for a break, and the 92.5 level for support.

3. Sentiment Indicators

3.a. Volatility Studies

What goes hand in hand with marginal new highs in the market - why, new lows in the VXN and VIX of course! This index took yet another dive this week as the market rose. These are such extraordinary lows for this indicator, that we are practically giving options away with a "buy one get one free" sort of deal. Can't go on forever though - but it sure is biding it's time.

3.b. Put / Call Ratio

Although this index has jumped around quite a bit over the past few days, the averages still indicate that there is a large amount of call buying going on. If this indicator becomes very negative on a decline, it would mean we probably have a correction on our hands. What the bears want is for this to stay as bullish as possible during a market decline, because that means no one is worried.

3.c. Summation Ratios and other Oscillators

The summation ratio's have really just stagnated at the 350-400 level and are refusing to go anywhere. That's neither bullish nor bearish really although I think that this thing is going to resolve down.

3.d. Commitment of Traders

There has been a sizable increase in the commercial and large investor short positions lately while the trigger happy small investor scooped up some more longs. The commercials have definitely had their accounts handed to them since they went very short right at the bottom of this run - shows us that they aren't the genius's we though they were ;-). The large category seems to have played this market the best so far, and have recently inched to the short side.

Charts available from http://www.vtoreport.com/.**

4. Conclusion

These are definitely confusing times for the average investor, with a number of well respected sources pulling them in many different directions. Things aren't any simpler, at the moment, for the professionals either - wondering whether they should join this rally despite their best senses telling them that this is just another bubble. Patience is difficult, and the temptation of joining in the mania can be difficult to resist, with "wild profits" being made left and right. However, history urges us to maintain our cautious stance at the moment, with a lot of dangerous factors coinciding with hysterically bullish public sentiment. If you are a technician, stay true to your signals, and if you're a fundamental investor, don't be tempted by the "new fangled" valuation models that claim that negative earnings are a prosperous thing to be a part of.

Considering the markets recent behavior, this call for caution has never been more pronounced. Both technical, fundamental, and behavioral factors are all beginning to line up to a dangerous situation. There are plenty of investment vehicles out there for you to invest in that carry a lot less risk and chance of failure than the market at the moment - and believe me, you will take a 3-4% gain over a 8% loss any day.

The media would love for you to believe it's a "wonderful world," but if you dig a little deeper, things aren't as rosy as they would seem.

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