Extracted from the Sept 19, 2006 market update
"What to do if you find yourself stuck in a crack in the ground underneath a giant boulder you can't move, with no hope of rescue. Consider how lucky you are that life has been good to you so far. Alternatively, if life hasn't been good to you so far, which given your current circumstances seems more likely, consider how lucky you are that it won't be troubling you much longer." -- Douglas Adams 1952-, British Science Fiction Writer
Let's see what the markets are up to here in the U.S examining a few key global markets. Many of these markets have experienced huge gains in the last few years and they could possibly provide us with some clues as to what lies in future for the Dow and NASDAQ.
The Egyptian market is probably the biggest winner in the last 5-10 year period. It was up a whopping 500% from low to high in the last 5 years.
Another very strong mover; it took off like a rocket from Jan 04 and gained as much as 200% in under 2 years.
The Norwegian bottomed In Jan 03 and has never looked back since. From low to high it gained as much as 400% all in a matter of 3 years.
Another huge winner; gained as much as 300% from its low to high and in the face of a stronger local currency. But notice it appears to be topping and moving sideways. After huge rises markets move down slowly initially and then suddenly the downward force picks up strength. We suspect that all the world markets will correct in unison just as they all rose together at the same time. Hence more sideways action is necessary as markets where the currencies are weaker such as the U.S. play catch up and attempt to put in illusory new highs.
A nice move here; this move up is primarily due to the commodities bull. Australia is loaded with natural resources. This is also a true bull because the market put in a new high in the face of a much stronger local currency.
There is one major common theme here with all the markets listed above. They experienced gains of 50% plus in the last 5 years while their currencies actually became stronger. In other words unlike the US markets these markets were in true bullish Phases because they were rising in the face of a stronger local currency.
The markets listed below are markets that put in new highs but they are not as strong as the ones above.
It has just put in a new high but once again we can state that this high is actually a valid new high as it has taken place in the face of stronger local currency.
Even the Hong Kong dollar has appreciated slowly against the US dollar and hence this high can also be classified as a new high.
This high looks deceivingly insignificant until one examines how much ground the Canadian dollar has gained in the last few years. The Loonie (Canadian Dollar) has gained as much as 31% in the last 5 years which technically means that it could trade as low as 7000 and it would be at a break even point in comparison to its 2000 high of 11000. Or we could say that in terms of the value of the Canadian dollar back in 2000 the TSX composite is actually trading at the 15600 plus mark. When examined this way this new high it has just put in is indeed a pretty significant one. Currency devaluations or gains play a very significant role in market direction. The masses do not understand their significance and hence fail to recognize and understand what the main ingredients for a true bull are. Once you have knowledge of how currencies work you can then sit down and slowly position yourself for the larger long term moves. If the Dow should trade past 12000 almost every regular individual who has no knowledge of the currency markets will state that the Dow has put in a new high. If you try to correct them they will violently argue with you and might even suggest that you have lost your mind; be glad the world is full of such wise idiots for it's their follies that help the wise lock in massive gains.
The FTSE has still not put in a new high but the pound has gained so much in the same time period that one can actually state that it is currently trading in new high ground.
The Shanghai composite is one of the few strong emerging markets that did not seem to do much. In fact the main reason for this was the fact that the Yuan was firmly pegged with the dollar. Notice how the market started to take off after the peg with the dollar was loosened. In fact the current prices are actually a new all time high as the Yuan is trading about 4.5% higher after the peg with the dollar was loosened.
Finally let's take a look at the Dow. We notice that it appears to have put in a new 5 year high but this high is illusory as the Dollar has lost up to 30% of its value in the same time period. Another key factor to remember is that the Dollar itself topped out in 1986 when it was trading at a level of 129 on the USD index; it has never been able to trade to this level again. The highest it got to was to the 120 levels and this took place in 2001 and 2002. But the Dow compensated for this drop in currency value by rising twice as fast as the currency was being devalued. In 1986 the Dow was trading in the 1400-1900 ranges and it never really ever traded at those levels again. From 1986 to 2000 the dollar lost approximately 18% of its value yet in the same time frame the Dow gained almost 600%.
If we price the Dow in stronger currencies such as the Canadian dollar and or British pound one could say that for the last 5 -6 years it has done nothing much. (Do not mistake index gains for stock gains, the market can do nothing or actually lose value and you can still make a fortune if you are in the right sectors. The same rules apply to investing in a country whose currency is losing value. Hardly any developed nations currency has lost more then 10% in one year; it took almost 5 years for the US dollar to lose 30% which comes to about 6% a year so. All one has to do now is to compensate for this 6% loss which is normally not a very hard thing to do if one is positioned in the right sectors).
Every single high the Dow has put in the last 60-72 months has been illusory in nature. The same cannot be said for most of the major world indices in fact they have been putting a series of real all time highs as their currency have been appreciating in the process too. This means one of two things, firstly that the Dow needs to play catch up to some degree; we sincerely doubt the Dow could gain 30% plus from the highs it put back in 2000 to compensate for the currency devaluation as that would mean it would have to trade close to the 15000 levels. It could if all the conditions are right trade possibly another 900-1200 points higher.
The second interpretation is rather bleak and here we have two possibilities too. Notice that almost every single market after putting in a new high started to pull back. In fact many of them are now trading below their highs. The key thing to notice is that they have almost all risen in the same manner (pattern). This suggests that individuals were attacking all these developing markets at the same time. Note many of these markets are tiny and just a small cut of inflow say from the U.S. or U.K would be more then enough to drive some of these markets to incredible levels as was the case with the Egyptian markets. The problem with this is that there is only so much money to go around and now that almost all the major markets in the world have experienced huge gains there are very few places to invest large sums of money. Hence when this money starts leaving these markets it might have only one place to go and that most likely will be in cash. To make matters worse commodities have been rising with the equities markets so in the short term most of these markets are overbought too. Another thing to remember is that not everyone will invest in commodities as easily as they invested in equities; only a fraction of these individuals will re deploy their money into the commodity sector. The main rush will come towards the end of the commodities cycle. So the Dow plays catch up and then starts to correct with the rest of the world indices. When the Dow enters an accelerated mode of correction the world markets will follow it instead of lagging.
The other possibility under this bleak scenario is that the Dow actually led the way up. Look at the graph below.
Yes the Dollar did peak back in 1986 (well that's how far we can get data on the US dollar index, it probably peaked even before that) but the Dow rose almost 600% from its 1986 low to its high in 2000. In the same period the Dollar only lost 18% of its value (value of U.S. Dollar index in 1986 129; value of U.S. Dollar index in 2000 105); hence it was actually putting in a series of true all time highs until about 2000. Under this scenario it appears that the Dow does not have to play catch up as the world indices were the ones that needed to play catch up with it. It appears that this is what they have been doing all this time. Under this scenario we have to imagine that the Dow was actually at say at least in the 14700 ranges (when priced in 2000 dollars) and that all its doing now is experiencing a move up after a serious pull back. Sounds complicated but its not. In reality all you have to do is understand that the level the Dow was trading back in 2000 equates to a value of roughly 14700-15000 when priced in today's dollars. Under such circumstances it's not impossible to see the Dow trading up another 900-1200 points as it will simply amount to a bear rally. So what appears to be bullish is actually bearish but the funny part is that the bears will lose and the bulls will win at least for now.
There is more information that we would like to talk about but it might be too much information for most to handle in one shot. So we will let everyone digest this information for now and then talk about the additional piece of data next week. Also review last weeks market update again, especially the market commentary section.
Let's see if we can summarize the above data into a few key sentences.
The first scenario suggests that the Dow has to play catch up to the major world indices as it has been putting in nothing but a series of illusory highs in the last 5 years. The second scenario which is divided into two parts states that all the major world indices are now trading off their highs and this move down will accelerate as there are no new places to deploy all this money. The Dow might move up a bit more but will probably lead the way down and drag the major world indices into a huge painful correction. The second part to this is that the Dow has already put in a series of new highs (from 1986-2000) so in other words it does not have to play catch but all its doing is experiencing an upward bounce in a downward market. One has to imagine that the Dow is in the 14700-15000 ranges for this. This suggests that once this upward bounce is over the move down will be rather vicious. The main thing to get from all this is that all scenarios are basically stating that the most the Dow could gain at present is 900-1200 points.
Factors that support a 900-1200 point plus move are the following. We will look at them in more detail next week.
There are two sectors right now that have enough juice in them to drive the markets up. The first one is the Semiconductor sector (oversold, series of positive divergences flashed) and the biotech sector (not as oversold as the semi conductor but its still looks pretty good, also flashed a series of positive divergences). We also have the Drug sector which still has enough strength in it to possibly test its old high.
Deflationary forces are starting to rear their heads. The feds as usual overshot their mark. They are always too aggressive or extremely lax. The above factors could provide the steam the markets need to surge higher and make it appear that the Dow has put in a wondrous new all time high, but Tactical Investors will know better.
"If we do not rise to the challenge of our unique capacity to shape our lives, to seek the kinds of growth that we find individually fulfilling, then we can have no security: we will live in a world of sham, in which our selves are determined by the will of others, in which we will be constantly buffeted and increasingly isolated by the changes round us." -- Nena O'Neil American Anthropologist
Here are a few past excerpts from the market update illustrating our bullish stance when things looked rather bleak.
We therefore believe that the current sharp pull back is a fake trap for all the dumb money and that we should witness a rather massive short squeeze in the not too distant future that might push the Dow to a new all time high. Market update June 14, 2006
The situation looks bad, the crowd is frothing, the Market pundits are spewing negative news constantly and it looks like all hell could break lose any time. We must remember the proverbial old saying, which states that markets usually climb a wall of worry to which we added the following and crash down a cliff of Joy. Since everyone appears to be worried we have to remain calm and study the action carefully. Our analysis reveals that for now the best stand is to remain bullish. Traders willing to take on higher amounts of risks can use all pull backs to open up new longs on the Dow or other indices via call options or via futures. Market update June 28, 2006
Don't even think about shorting the markets right now; the huge massive turnaround in the moving averages of new highs should be a warning to all potential bears. If you are nervous sit tight and wait for a full fledged sell signal. Risk takers can use all big pull backs to add to your current long positions via Index call options or futures. So far this strategy is paying of rather well. Mkt update July 4, 2006
We still consider that shorting the market is not something the wise should get involved in right now. Market update Aug 1, 2006
Once again we have to state that shorting these markets is not the way to go unless you are a very fast, clever and a nimble trader Aug 29, 2006
Now that most of the big traders are back from vacation we feel that there is a good chance that they will attempt to drive the markets up in order to trigger all the stops that have been placed around the 11685-11720 ranges. Once these stops are taken out we feel that the markets will enter into another sharp and fast corrective phase. Hence all traders who bought QQQQ calls, Dow calls, futures, OEX calls etc should close these positions if those ranges are hit. Sept 05, 2006