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Market Commentary

"Life is 10 percent what you make it and 90 percent how you take it." ~ Irving Berlin 1888-1989, Russian Composer

We also stated last week that one of the negatives was the fact that our Smart money indicator had turned slightly bearish by validating the lows the markets put in the week before and in doing so there was chance that they could test their lows. Our smart money indicator is still bearish when viewed from the hourly charts (short term time frame) and so we expect more volatility in the next few days. Market update Dec 11, 2007

Despite the focus on the bad news, despite the so called build in emotional negative feelings which shout and haunt you at night and tell you boldly that the markets are destined to crash and despite the fact that the majority feel that the end is also near; there is something that everyone is missing. You ask what this is and rightly so? Hence without wasting anytime lets get into the meat of the matter.

The Dow put in a low of 12517 on Aug 16th; since then even more banks have come out to state that they are writing down billions from their books. The number of banks reporting negative news in regards to the housing and mortgage sector is triple if not quadruple that of which was reported prior to the Aug 16 meltdown. Yet no one has come out and stated the obvious; in light of all this negative news the Dow just traded a few points below its Aug 16 intraday low of 12517 (it traded down to 12508). In fact it would have been quite normal and acceptable for the Dow to have traded significantly lower on all this terrible news; note that now days markets have a tendency to overshoot on the upside and on the downside and thus one cannot come out state that a specific point marks the end of the bull and or the beginning of a new bear market and vice versa. This new development is simply due to the astronomical increase in money and market participants; this is also why 100 plus point moves in either direction are starting to become the norm.

The next interesting development and this we have already mentioned in the past is the fact that the Dow utilities have actually put in a series of new 52 week highs: in fact this Tuesday they put in a new intraday high before pulling back. Note that these chaps lead the Dow industrials and Transports by 6-12 weeks and sometimes by several months. So it means that at the very least the Dow has 6-12 weeks to play catch up and in the interim it's quite normal if the Dow were to re test its lows or even trade below them. Markets have tendency to overshoot in both direction these days.

One can clearly see that the transports went on to put in New lows after Aug 16 while the Dow industrials initially held (chart below) and traded above their Aug 16th lows. As the transports went on to put in new lows after their Aug 16th lows it indicated that they were not done correcting and as of late they have traded even lower. However the majority of our indicators did not confirm these new lows; in other words they flashed positive divergence signals. Our indicators were trending higher while the transports trended lower; this is usually a very bullish development. For the record we feel that the transports could dip all the way to the 3800 ranges without flashing a bearish signal.

As stated many times in the past we have identified our own Dow pattern and have found that it has held for decades without interruption. The primary premise of this pattern is that the utilities lead the way up and if they go on to put new highs it is just a matter of time before the transports and then the industrials follow suite. As the Transports went on to put new lows it signalled that in all likelihood the Dow would follow its lead and that's exactly what happened. On rare occasions the Industrials can lead the transports but usually it's the other way round.

Note that the 1 year low for the Dow is at the 12000 mark and from our point of view this level would have to taken out for over a week before one could start to think about getting terribly bearish. The Dow recovered and jumped up too fast in too little a time when it bounced from its low of 12517 to its high of 14200 plus; hence one should expect the same on the downside. Even though the Dow has traded lower than it August 16th low it's still holding strongly above the 12000 mark; it also flashed several strong positive divergence signals on our indicators when it traded below its August 16th lows.

One has to remember that we cannot tell the markets what to do we can only attempt to anticipate what they are going to do by looking at what they are currently doing right now. Properly studied the present is a window to the future and the past provides a window into the present.

Mass psychology is extremely negative and the fear is building and we all know by now that the masses simply can never ever win. They are doomed for failure; the destiny of the mass mindset is to lose; history has shown this and over a period of a thousand plus years nothing has changed.

There is one more very interesting development. Bond investors are extremely bullish and feel that the bonds can only trade higher; what makes this even more interesting is the fact that most bond newsletter writers are equally as bullish. This is a clear sign of a top; when the majority think something is going to happen mass psychology dictates that the opposite will occur. Once bonds top, this money will then flood back into the equity markets providing yet another source of upward force.

If you look at the 3 year chart above you will notice that bonds are now running into a zone of extreme resistance and in the last 3 years they have failed to take out this level. Bonds have also flashed a negative divergence signal; another sign that a top is not to far of in the makings.

The AAII (American Association of individual investors) 4 week moving average shows that only 32.7% of investors are bullish; note this is a moving average and not a daily figure. Thus this number takes on even more significance and it illustrates that the majority are now even more bearish; once again we have to be delighted by this number for the majority are never right.

Lets not forget to add in the other factors both NYSE members and NYSE specialists still hold a rather small short position; if they felt the markets were going to tank they would significantly increase the number of their short positions. Short interest ratio on the NYSE has put in yet another new high.

There is yet another longer term positive development and it goes by the name of Sovereign wealth funds (look below for more details on this); China started one with 200 billion dollars and is reportedly injecting 20 billion dollars every month into it. Then we have the Middle East home of 4 of the largest of such funds; the largest of all is the Abu Dhabi investment Authority which made head lines after taking 5% stake in Citigroup; these funds are so large that they make the largest state run pension funds look like Childs play. All these funds have one thing in common they are holding a ton of dollars and they are tired of getting a miserable 4% rate of return by investing them in treasuries when the Dollar has been losing value at even faster rate. Coincidently the fact that they have decided to jump out of dollars and buy real assets right at the so called bottom is a very bullish development for the dollar. These funds as a group are looking to take stakes in large American corporations and are also looking to provide lines of credits to banks that are in sore need of them as a result of the mortgage crisis. However in return for this money they want huge stakes in these companies; in effect they are taking their useless dollars and now making them useful. (Look below for a more detailed take on these new powerful funds). Bottom line is that these funds are going to provide a huge amount of liquidity for the US markets and provide yet another massive source of upward force.


As we stated in the last two weeks it appeared that the Dow was set to pull back due to the rapid pace at which it had advanced and due to the sell signals our smart money indicator had flashed on the hourly charts. Our volatility readings are still sky high and this suggests that the markets are going to continue to remain highly volatile; hence continue to expect huge up and down moves but eventually the moves will start to occur more in the upward direction than the downward direction.

All charts provided courtesy of www.prophetfinance.com

Note the Utilities have gone to put in at least three separate series of new highs (Purple boxes); the first took place in Nov, the second set in December and the third one in Jan 08. This is very bullish for it shows continuity and illustrates that this was not just some isolated event. In turn this means that the Dow and Transports should follow suite. What is even more important than the three series of highs is the series of higher lows that the Utilities put in (green boxes; it has put in 6 higher lows so far in a span of just 3 ½ months. When an index or stock puts in higher lows it usually indicates that series of new highs are just around the corner. In the case of the utilities this observation has held and now all that is left is for the Dow transports and Industrials to follow the lead of the utilities. In the end one must remember that these markets move fast and rapidly they can be down 1200 plus points and then a few weeks later they are trading up 1500 plus points. From July 07 to August 07 we went from 14000 to a low of 12517 and then we moved up and put in a new high of 14200 before pulling back and testing the lows. All this has taken place in less than 6 months. If one adds the combined move we have seen a 4800 point move in such a short span of time ( from 14000 to 12517 its about 1500 points, from 12517 to 14200 its about 1700 points and from 14200 to our current level of 12589 its about another 1600 points ). In the old days such moves would take years and if one goes back 30 plus years one could say such a move could take a decade. When one looks at the amount of activity that is taking place in a short period of time its easy to see how the masses can rapidly shift positions from being bearish to wildly bullish in just a matter of weeks. Our job as objective observers is not to allow our emotions to do the talking but to instead watch what the masses are doing and try to do the opposite.

Final note

When fear rules the best opportunities surface; the opposite holds true when Euphoria rules.

Sovereign wealth funds (SWF)

These funds are so huge that they could effectively eliminate the need for the Federal Reserve in the short to midterm time frames. These firms are buying stakes in banks that have experienced huge loses in the mortgage markets; in effect they are telling these chaps that they will provide them a life line if they in return offer them a great dividend and a stake in the company. For example the Abu Dhabi Investment Authority (ADIA) took a 5% stake in Citigroup for 7.5 billion dollars. In return for this Citigroup gave them convertible stock yielding 11% annually and the shares are convertible to common stock in prices ranging from 31.83-37.24 from March 2010 to Sept 2011. Just on the dividend alone they are making out like bandits and if their shares should take off they will lock in even more profits. These deals will spur other SWF's to go after similar acquisitions. The Government of Singapore investment corp. took a massive 10% stake in UBS for 10 billion dollars, China Investment Corp took a 10% in black stone group, UAE's Istitmar group bought Barneys of New York for 942 million, Mubadala Development Corp took a 622 million stake in Chip Maker AMD and the list goes on.

The Wall Street Journal reports that Government SWF's have invested over 46.8 billion in European and American firms since 2006; based on the current trends it appears that this spending is only going to gather momentum. If one looks at how much money these funds have one will see that the current situation is just the tip of the Ice berg; ADIA's huge investment in Citigroup amounted less than 1% of its total assets.

In terms of size ADAI is the heavy weight of them all as it has an estimated value of 625 billion dollars and could easily reach a trillion in a few years based on the high price of oil. The next contender which is Norway comes in at a distant 322 billion, Singapore has 215 billion, Kuwait has 213 billion, China is at 200 billion (though they are reportedly adding 20 billion a month and have 1.23 trillion in reserves from which they could draw additional funds) and Russia comes in at 127 billion. There are more but these are the top contenders. If you add up all this money there is a ton of purchasing power just waiting to be deployed and all these funds have one purpose in mind and that is to obtain a better rate of return on their dollar reserves. This means that these chaps are going to be ready and willing to take on more risks which means that they will be eager and ready to provide lines of credit to all the major ailing banks in the US and Europe in return for hefty dividends and for huge positions in these banks. Slowly but surely America and Europe are going to be owned by foreigners. The irony is that congress is trying to keep immigrants out of this country but right in front of their eyes foreigners are slowly gobbling up huge chunks of this country. We expect this buying spree to pick up steam as all these countries now want to earn decent returns on their dollars but remember eventually greed kicks in and then these investment corporations will start to look for outstanding returns which mean they will start speculating aggressively. This in turn will suddenly provide a huge source of liquidity that temporarily evaporated after the mortgage crisis; once the financial markets are flush with money all hell will break lose and the markets will start to heat up. We are entering a new paradigm where the Feds will no longer be the only ones capable of injecting huge sums of money into these markets; SWF's will soon be the masters in this field.

"Most people grow old within a small circle of ideas, which they have not discovered for themselves. There are perhaps less wrong-minded people than thoughtless." ~ Marquis De Vauvenargues 1715-1747, French Moralist


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