Let's Get Technical

On the surface thus far, September has seemed to be a very normal month.  Below the surface, it has been far from it.   Coventional wisdom is aware that, historically, it is the weakest calendar month in terms of average stock market performance and, therefore, there was a decent level of angst about what would happen when traders and portfolio managers returned from their summer vacations in the Hamptons.

The market has been up 9 of the last 11 days.   These extreme strings of near-consecutive days up or down are very often signs of exhaustion.  Market tops tend to be rolling like an upside down arc or parabola.  Significant bottoms, on the other hand, are very often V-shaped, characterized by panic selling.

If we put those two observations together we can form an educated opinion as to the technical health of the stock market.  In the last 11 days, the Dow Jones Industrial Average has gone up a mere 6% the Standard & Poors 500 has risen 7%, the Russell 2000 8% and the Nasdaq 100 11%.  If the market was firing its thrusters for a huge move up, we ought to have seen gains of about double those just experienced.

A 9 of 11 exhaustive string on the downside could potentially result in drops of 20% or more. 

Somewhat disturbing is the behavior of the Gold Bugs Index (HUI), especially in light of the move in Gold itself.  The HUI is up only 1% despite a 3% advance in Gold and a 10% gain in Silver.  In addition, the Dollar index is down 2%, which should have provided a modest tailwind.  This is NOT healthy action.  The breakout of Gold above $1,250 was NOT accompanied by a breakout of the HUI above 500.  For a true bull market to have begun, the twin conditions of Gold above $1,250 AND 500 on the HUI should have bene met.  That a breakout didn't occur was quite surpising. I guess Gold 2K will have to be put on hold.

Therefore, while the likelihood of a MAJOR drop in Gold or the HUI is small, we ought to remain on alert that a correction of some sort has become highly probable.  In combination with a waterfall decline in stocks, precious metals are better avoided than ridden-out except with long-term money. More importantly, whatever correction occurs will represent yet another low risk entry point.

The other key reason to argue for extreme caution at this time is the major headwind created by the plunging money supply.  The most recent figures and the implications are covered here:  (http://markostake.blogspot.com/2010/09/turning-economic-titanic.html).

The deflationary forces are confirmed by the action of the bond market which has made new highs after a nearly 30 year bull market.   In addition, longer rates have come down much more than short-term rates flattening the yield curve.  The slope of the yield curve is particularly critical to the financial sector as the bulk of borrowing is done on the short end, while lending tends to be longer term.  The spread between the two creates the level of profitability.

So, it continues to make sense to stay liquid.  There will be a better time to take risk.

Marko's Take