Positioning for Year-End and Speculating with EDZ

"An Emperor who cares for nothing but his wardrobe hires two weavers who promise him the finest suit of clothes from a fabric invisible to anyone who is unfit for his position or "just hopelessly stupid". The Emperor cannot see the cloth himself, but pretends that he can for fear of appearing unfit for his position or stupid; his ministers do the same. When the swindlers report that the suit is finished, they dress him in mime and the Emperor then marches in procession before his subjects. A child in the crowd calls out 'The Emperor is wearing nothing at all' and then the cry is taken up by others. The Emperor cringes, suspecting the assertion is true, but holds himself up proudly and continues the procession." (The Emperor's New Clothes by Hans Christian Andersen in 1837 from a collection of Spanish stories of 1330 as summarized in Wikipedia)

Somewhat like that little boy, I feel like crying out "Cash on the sidelines lost their opportunity to buy into the market this year; there won't be a year-end rally!" We, the market's towns people have been hearing stories about institutional money on the sidelines waiting to be put to work before the end of the year. There was going to be a blow-out top as money plows into the market because institutions "can't go into year-end with so much money not invested" and will "chase performance" by bidding up leading stocks.

I'm sorry - this royal idea wears no clothes. If they needed or wanted to put all that cash to work in stocks then institutions had many months already to do so. Furthermore, the market's stellar performance over the past 9 months is an invalid reason for institutions to start putting their cash hordes to work today. Everyone knows you buy stocks today based on expected future performance and not because prices have risen 65% over the past nine months.

With only 23 trading days left in 2009, there just isn't sufficient time left for sidelines money to be employed to generate any meaningful returns. Individual investors are going to be disappointed if they look to have bad investments salvaged by this sidelines money or hoping to piggyback on a year-end surge driven by the sidelines cash finally being put to work. Their emphasis should start shifting to become positioned for a clean start on the next year.

On this score, I was intrigued by a recap on the CNBC site last week of recent on-air interviews entitled "Everyone's Talking About a Year-End Rally". Recommendations these "experts" had for you, the individual investor, included:

• Robert Howe, CEO of Geomatrix: the November-to-January period are the strongest months for investors.
• Michael Hasenstab, co-director and portfolio manager at Franklin Templeton Fixed Income Group: Investors must diversify and invest globally to benefit from from higher interest rates.
• Graham Secker, European equity strategist at Morgan Stanley: Expect a 10%-15% upside in European stocks in the next quarter
• Rahul Chadha, head of India equities at Mirae Asset Global Investments: Long-term investors who missed the emerging markets rally should increase their exposure; Indian markets remain fairly valued even as they trade at the high end of the historical range.
• David Bassanese, founder of PennyWise Investments: is overweight on Australia.
• Alex Wong, director of Asset Management at Ample Capital: sentiment remains positive for the Hong Kong market.
• Sandeep Malhotra, head of global investment strategies at Clariden Leu: the dollar will continue to erode; the growth story is in emerging markets.
• Mat Kaleel, chief investment officer at H3 Global Advisors: expects a correction in both oil and gold.
• Robert Howe, CEO of Geomatrix: Buy banks but be wary of property stocks as it is a volatile sector,
• Ed Ponsi, president of FXEducation.com: The dollar could see some short-term strength.
• Adrian Foster, Asia Pacific head of financial markets research at Rabobank: the dollar is range-bound for the next few weeks to come.
• Ray Attrill, global head of research at Forecast Australia: Expect lows for the dollar by mid-year and new highs for Aussie in the early part of 2010
• Mitul Kotecha, head of global FX strategy at Calyon Hong Kong: China will likely allow the yuan to appreciate by 5%-6% in 2010

Phew! Confusing to say the least. Besides that, I wind up on the other side of most of their trades. For example, in anticipation of what I see as strengthening in the Dollar into next year (see "One Reason the US Dollar Index Might Increase"), I liquidated most of my foreign currency and markets ETF positions, even the BRIC ones; I even added some EDZ, 3x Emerging Markets Bear ETF.

This last one is a pure spec bet that everything must, at some put, in a correction. EDZ first started trading at the end of 2008, hit a high of 95.74 on March 2, and is now around 5.50. A 38% retracement is around 30 and 50% around 40 so there's plenty of upside potential if foreign market's top out and this extremely volatile ETF finds some firm ground. I'd be extremely happy if the ETF reached the lower resistance trendlines. I'm playing this but don't recommend it for any but those who have willing to take the risk and lose.

Protect Yourself Against An Imminent Market Correction

Winning in this game we love means your portfolio out performs a benchmark index because if all you do is match the market, you might as well put your money in an index fund or market index ETF and not even go through the motions of playing. However, if you do play then beating the market when it trends up is tough and demands near perfect stock selection (pick stocks with positive relative market performance and cut losses from mistakes early). But beating the market when it trends down is easy .... if you successfully manage or avoid the downturns.

The important questions isn't if it’s true to the Lunar cycle theory or not (last week, the market has sold off 1.6% since the New Moon and there are still seven more trading days until Full Moon on Wednesday, December 2) but where the market will be in 3-6 months and how best (i.e., with the least risk) might we prepare our portfolios to make the best advantage of whatever move occurs.

Optimistically, momentum indicators have finally confirmed that a bull market is intact since the 200-dma just recently crossed above the 300-dma. This long-awaited cross puts all the moving averages in perfect alignment, fastest on top to slowest, with the Index above them all, an arrangement I’ve dubbed a "bullish cross". In March 2008, the mirror image of this alignment (slowest on top to fastest with the Index beneath all) confirmed the onset of a bear market of major proportions, the Financial Crises Crash. A final step to nailing down the bull market will be when the 300-dma finally turns up for the first time since January 8, 2008. Mathematical extrapolations (see my post "Mark These Dates") say the turn should occur around December 3 (just in time, coincidentally, with the new lunar phase).

Many traders and investors believe this bull market has unstoppable momentum and has now finally gained a permanence, overwhelmed the bears and will continue for the foreseeable future. But others who look at fundamental economic and financial indicators like P/E ratios or Fibonacci guidelines (50% retracement of bear market decline) argue the market is due for a correction.

I'm in the latter camp, albeit having arrived early (see “Begin Pruning, Trimming and Weeding Your Portfolio” of October 16, “Ascending Everest: the Mid-Station Rest Camp” of October 18, “More Evidence We're Approaching a Top” of October 23 and “One View of Market's Future” of November 9). I prefer both the simplest of momentum indicators (moving averages) and the simplest of trend analysis (resistance and support trendlines). They've suggested to me from the outset of this bull move in March that the 1125-1150 area could be significant because it is an area of past congestion and an area where equilibriums between buyers and sellers have ended in reversals (in other words, an area of many pivot points). There’s a strong likelihood, therefore, that the area can again produce a pivot point (why? because of market psychology and behavioral finance).

“If so, what’s our strategy”, you must be asking? How can we create some protection with minimal risk while at the same time leave room for upside opportunity in the event that our calculations are wrong? We know that the long-term momentum indicators point to further upside gains; it’s the 10-15% market correction we want to protect against. It’s at this point that the bald former football player on Fast Money shouts, “I hedge my bets through options!” Of course, he’s “selling his book”, as they say on The Street. However, this time he may just be right. What options do we have?

• "Buy and hold": only protects against opportunity losses in the event we're wrong and the market continues going up; but it provides no protection against real losses if the market goes down instead.
• Diversification: only a partial successes – if you select correct places to diversify into and if all asset classes don't move in tandem as they did last year.
• Sell positions and move into cash: outstanding strategy in confirmed bear markets but a less than optimal defense in corrections because it protects against losses but creates opportunity losses if our timing is off either in getting out or in coming back in.
• Hedge positions: Bingo! Involves limited risk yet offers upside potential

Assume that you have a $100,000 portfolio whose performance moves precisely in tandem with the S&P 500 Index. A simple and direct option hedging strategy is available: buy SPY puts. For about 9.5-10.00% of the value of the portfolio, or approximately $10,000, you could buy ten on-the-money puts with March expiration that would insulate a $100,000 portfolio through increased option value (beyond the cost of the premium). If you were wrong and the market moved up, at expiration you would retain the increase in portfolio value offset by the premium paid for the options.

But the “insurance” premium of the options and exposure to risk can now be reduced without giving up any upside potential because of the introduction of Ultra (2X) and UltraPro (3X) SPY longs and shorts. These ETFs also have call and put options available; because these ETFs themselves are leverage, ProShares now provides the means for a more efficienct leveraged investment “insurance”. This ability of buying options on double and triple ETFs appearsto be an inequality in the market that doesn’t appear to me to have yet been arbitraged away. Rather than costing 9.5-10.0% through options on the underlying security, and equal portfolio value can be “insured” with fewer on the money calls or puts on SPY UltraShort (SDS) or UltraLong (SSO) ETF’s, respectively, for about 4.5%, half the cost. [Because they are only less than 6 months old, I have excluded the UltraPro etf’s from consideration.]

Click here to download a spreadsheet summary of this SDS calls hedge strategy (with comparison to SPY puts), plus this graph:

Note that the spreadsheet is an example using data as last week when I purchased these options. Before you pursue the strategy, you should do your own analysis and evaluation for correctness and appropriateness for your own situation. I welcome comments and suggestions on why my analysis might be faulty or how it might be improved.

One Reason the US Dollar Index Might Increase

Have you heard the story about the man who bought a U.S. Treasury Bill for $1000 knowing before hand that he'd only get back $995 at the Bill's maturity. "What kind of idiot would do something like that?", you ask. It's irrational, it doesn't make sense. Give someone $1000 knowing you're going to get back - not more money in the form of interest but less money. You're paying someone to take your money. Again, it makes no sense.

I pondered how and under what circumstances something like this might make sense and then - I figured it out. No one living in the US would do something so irrational. But there are some who would. People who live in, do business in and aren't dependent on the $US might do it. If I lived in the U.K., for example, I might convert my Pounds into $US in order to buy some Treasury Bills if I thought, or knew, that when I converted those Bills back into British Pounds they converted back into more Pounds than I original paid. As a matter of fact, if I lived almost any place in the world other than the U.S. (or China, for that matter) I could see making a profit by parking my money in $US's if I had a fair degree of certainty that $US's become more valuable to me in my currency down the road. What I gave up in interest (or paid in "negative interest") I might recoup in exchange conversions.

That's what I'm guessing might be happening. Foreign investors or sovereignties are looking at the distinct likelihood that the $US will soon increase in value, more than the increases over the past 4 days (the DXY, US Dollar Index, is up to 75.61 from 74.88, or 1%, since November 16).

Does this signal the end of the Dollar's decline? Has a deal been made to prop up the $US. Does this have anything to do with negotiations to have the Chinese allowing the Yuan to edge up in value also?

One can speculate about all sorts of conspiracy theories that are way beyond our understanding or comprehension. What we do know and fear, however, that a rise in the $US, a rise in the US Dollar Index, will probably be detrimental to US stocks. Perhaps that's what has lead to the market's recent weakness.

Something like this was last suspected about a year ago (November, 2008) when the rise in the Dollar's value of came to a surprising, abrupt and screeching halt. Perhaps its mirror image has begun to be re-enacted today. And what better time to pull something like this off than Thanksgiving week, a time when many have already begun taking time off for an early Holiday break.

By the way, while you're contemplating, look at the tops that have been made in the graphs of most of your foreign exchange and foreign market ETFs. Conspiracy theories are so much fun .... unless you're counting on a continued fall in the $US.

Lunar Phases and the Stock Market

Let me start out by admitting my reluctance in submitting what you're about to read because those naysayers, those doubters, those who consider "technical analysis" to be almost on a par with tarot cards and astrology, they all will use this piece as further evidence or proof for their disparagement. They will use what follows to undermine whatever credibility and currency I may have gained through 400+ postings in this blog over the past 4 years.

For the rest of you, however, those of you who are willing to expand your mind and are a bit more open-minded about looking for a wider than typical range of indicators and statistics to guide your investment decisions I offer the following interesting curiosity (click on image to enlarge):

Early Christmas greetings, you ask? No, actually this is a chart of the S&P 500 Index since May 28 to current. More importantly, it is the S&P 500 Index through the past 6 full lunar cycles. Each read bar represents the trading days during which the moon was waxing (growing from new to full) and the green bars cover the trading days during which the moon was waning (shrinking from full to a mere sliver).

Hold on, don't hit the "close window" icon just yet; let me explain. On inspection you'll see that there's been an interesting correlation over the period. The market finished higher than where it started in 5 of 6 green periods and finished lower than where it began in 4 out of 6 red periods. Assuming that waxing periods (growing to full) are coincidental with market declines while waning periods (shrinking to new) are coincide with market increases, then market has been in sync with the lunar cycle 75% (9 out of 12) of the time for the past 6 months. I'll take those odds any day, that's enough for me.

I didn't discover or invent this relationship but it is something that I've been thinking about and research for over three years, ever since a NYTimes article by Mark Hulbert entitled "Fly Me to the Moon, and Let Me Profit on My Stocks" in which he quoted the findings of a number of academic papers. O.K., I was skeptical myself so rather than accept others' conclusions at face value I replicated the studies and found that that intervals between new and full moon were more reliable than the interval of "7 days before and after a new moon" that the academicians used to "predict" these market ripples.

At this point, skeptics usually interject that going backwards proves nothing since almost anyone can support almost any hypothesis if they structure their data correctly. So I started tracking my model through each succeeding moon cycle. Honestly, sometimes it worked better than other times. But even through the last market Crash, I still mental noted that the moon cycle coincided with the market's swings more often than not.

The market has risen around 25% since June so the lunar cycle clearly don't pinpoint major market turns. What they might do, though, is show you what you might want to expect over the very near term.

Where are we now? Tonight will be a new moon and, according to the Lunar Cycle advocates (as represented the chart above), we're embarking on a cautionary 15 days. We're having a very good day today (market is at 1111, up 1.67% as I write this) and the market is approaching the 1125 target of my "road map". What will the coincidence of this road map destination and the Lunar Cycle new moon bring? Can't wait to find out.

One View of Market's Future

I first started writing about the critical area between 1150-1200 on August 7 (wow, doesn't seem like 3 months ago), the day the Index broke through 1000 for the first time since the March 9 bottom and closed at 1010.48, or 7.6% below today's close. In "Difference Between Correction/Consolidation and Reversal" I wrote,

"The recovery from the Tech Bubble Crash saw a major correction that lasted most of 2004 between 1050-1150; my interim target for the first one ...... is the 1150-1200 area. What will this correction look like? It could be a wedge, a pennant, a channel or merely a return to a trendline or moving average ... but it won't be a head-and-shoulders."

Many readers then were skeptical and wondered whether the market would be able to cross above the 300-DMA or to stay above 1000. But the market labored ahead and three successive surges (the current surge since November 1 will the fourth) each ended at successive new highs.

A couple of days ago, I outlined a "game plan" which appears so far to be working and close to hitting the goal of 1125 (I beg some lea way to extend the target range to 1150). As the market approaches the target, it's time to start speculating about what might come after. To repeat, this is mere speculation and guesswork as no one can predict the future but we have to some view so as to develop an action plan. If the view turns out to be wrong (and we'll know when that is), we modify the action plan:

• The market begins to stall out in December as:
• the door for the sidelines-money slams shut for the year
• tax selling begins to capture losses and record gains in anticipation of possible higher 2010 tax income rates
• The 1150-1200 is a critical area for past pivot points where the market turned in 1998, 2001, 2002, 2004, 2005, 2006 and 2008. These pivots occurred both when the market was trending up and down.
• The turn is usually caused by an economic catalyst and one that could fit the bill perfectly would be:
• The $US Dollar firming and possibly reversing its descent.
• The "Soft Dollar Trade" (buying foreign currencies, gold and commodities), considered by many as "over-crowded", begins to unwind and the market begins to decline.
• A logical target for the bottom of this correction is the neckline of the market's inverted head-and-shoulders bottom, or approximately 950 in the S&P 500, a 17% decline from the high.
• The decline fall within the definition of a correction falling short of the 20% required to considered a "Bear Market".
• The Index will find support on the 200-DMA, the crossing of which is a key indicator identifying Bull and Bear Markets
• The 200-DMA will have crossed the 300-DMA by then
• The 300-DMA will have turned up, the final hurdle before the book on the Crash can be finally closed.

For those who are habitual chartists and think in terms of graphs rather than words, here's a depiction of what the above scenario might ultimately look like (click on image to enlarge):Many out there will scoff and say this is pure fiction, nothing more than reading a Ouija board. But is it any more fictional than some of the stories that are spun by the "talking heads". They represent prestigious firms with large research departments but I write this blog. We'll follow the future unfolding and learn who's projection, given when, winds up being closer in the end.

The corrrection or consolidation could be short lived as the true top of this bull market could be nearer 1350 with the neckline at 950 being half-way between the bottom at 660 and the top on a percentage basis but a potential 17% correction demands an action plan. Help us all out. What will the market correction look like and what actions will you be taking when the arrives?

Note: I refer the scoffers out there who brush off this exercise you to "Fairy Tale with a Happy Ending", something I wrote on November 6, 2008. I inserted a chart in that article similar to the one above. That chart turned out to be uncannily similar to the market's actual ultimate course with the major difference being that it took longer to get here than I had projected. So be careful in rejecting this exercise too quickly.

More Stocks on the Move

I did a little market researching this weekend and visited two, outstanding but dramatically different retailers: Whole Foods and Ikea. And even though they cater to two different clientele, I found one thing they had in common: both were filled with shopping families lugging their kids and totting bags full of stuff. It sure didn't look like these stores were suffering much from the 10.2% (or close to 17% as some say when you add in those who stopped looking) unemployment.

At the end of October, I inserted some chart projections and outlined the following game plan:

"If the market successfully bounces around 1018, there's a possibility it could then lunge ahead .... for a final gasping 10.5% gain to 1125..... The 1125-1150 range of significant for several reasons: 1) it's been mentioned by many analysts as the high for the year and 2) it's on the extension of top boundary of that channel....Violating the 50- (and 200-) day moving average wasn't calamitous in July (the market then proceeded to surge ahead by over 25%). Another big, though not as extreme, move may follow this violation. Simultaneously, the 200- may cross the 300-dma and the 300-could turn up paving the way more gains later."

The market did touch an intra-day low of 1029.38 (pretty close to 1018, wouldn't you say) a couple of days later and has since jumped to 1069.30. Even with a consolidation or correction anticipated just over the horizon (I can't tell just yet how severe or deep it will be), it's might also be prudent to replace some of the stocks that you're pruning some of the losers out of your portfolio with better performers just in case the bull market surprises us all and continues moving higher and longer than expected. If there's another 6-7% left before a correction begins (or, if I'm wrong and the market continues heading even higher) then what sorts of stocks might lead in addition to the precious metals, energy and other groups or stocks mentioned here previously.

Last July, I outlined a screen called "Stocks on the Move" and presented a spreadsheet of 135 stocks meeting the following criteria:

• Price per share > $15
• Price percentage change today > 0.5%
• Relative Strength Indicator today > top 50%
• MoneyStream Surge for past week > top 50% (proprietary to Telechart grew out of joint venture with a large regional brokerage firm to develop a price/volume indicator. The result is an indicator with much the same objectives as OBV and is interpreted in the same way you would interpret OBV. Generally, you look for divergences.)
• EPS percentage change from 4 qtrs back > top 50%
• Volume surge over past 5 days > top 50%

Since then, those stocks have appreciated, on average, the marginally more than the S&P 500 Index (12.9 vs. 12.0%). However, relative to the high price during the period (July 22-Nov 6) the group's performance, on average, more than doubled that of the Index (25.0%). If STEC, DRIV and ICON had been excluded from the original group, the groups average performance had been appreciably better than the index (for an updated spreadsheet of these 135 stocks, click here).

A new "Stocks on the Move" screen now produces a list of 107 stocks, of which only 7 stocks were on the previous list (the list is on the second tab of the spreadsheet). Of the total, only 39 stocks are trending such that the moving averages are aligned in a Bull Cross (P>50DMA>100DMA>200DMA>300DMA) and the 300DMA has turned and is now rising. Based on these technical indicators, these 39 might have the best chance of smallest impact of any market correction. A short list of these stocks might include:

• AMZN
• ATHN
• BIDU
• DGIT
• GG
• IAG
• LL
• MELI
• SYKE
• TEVA

Another Basket of Speculative Low-Priced Stocks

I don't know how many of you were readers back in the depths of November 2008 and February 2009 but I floated the idea of assembling a basket of low-priced stocks, something I called "Perpetual Call Options". Well, it seems that there's a lot of truth in the saying "timing is everything" (or "don't fight the tape" or any others of the many sayings around Wall Street).

Back then my thought was that there were just too many stocks that had been beaten down by the extreme general pessimism everywhere in the air and that while one or two of those companies might fail (ala Lehman, GM or CIT), they wouldn't all disapper; some would eventual recovery and their prices would rise sufficiently to offset the ones with losses. Here is a recap of the results of both lists (click on image to enlarge):

The market is up 19.8% since February 9, the day I wrote about both the second (coincidentally, the market was at approximately the same on both dates). Over the same period, both of the lists have appreciated over 60%. As expected, three of the stocks in the November lists declined since November but the gains on the others more than offset those losses. Likewise, three of the stocks in the February list underperformed the market but, here too, several others did significantly better that the market.

Others gave a pejorative label to the strategy, they dubbed it the "dash for trash" - the strategy of buying low priced, high volatility stocks, with barely any regard for the fundamentals in the hope that market momentum will cause them to appreciate. Well, guess what, if my sample of two is any example, it worked.

But I'm not like another blogger elsewhere who continually writes "I bought them (yesterday, last week, or whatever) and just sold 'em (yesterday before the close) and pocketed a huge profit" (sound familiar TK?). Unfortunately, I was too conservative myself and only bought and still have a couple of them. I wish I could say my picks were based on skill but it really wasn't. The selection was made when the market was a very depressed and-remember-stock selection was like shooting fish in a barrel.

As the market moves into a new phase, will the "perpetual call" or "dash for trash" strategy still pay off? Are there any stocks left that are suitable for another highly speculative basket? Interestingly, there are still over 1400 stocks (about 30% of the total) under $5 and around 2400 (almost 50%) under $10. So why do we always chase after the likes of JPM, PG, AMGN, AAPL or AMZN.

With the economic productivity numbers coming in today better than anyone expected, some are now talking about a real burst in profits as volume begins to build faster than people costs across the economy. It's the sort of environment where the stocks of survivor companies, those have been left behind for dead, can start shining again because they're starting from a low profit base, low valuation and low stock price. The upside potential is great and the downside ... well, they're not far from zero now.

If you put an equal small dollar amount ($1000 for 625 shares of stock selling at 1.60, for example) in each of about 10 highly speculative stocks together a small basket you might wind up in 6-9 months with the basket having grown in size, much more than had you put that same money into SPY. You probably will get some duds or failures but you'll also have one or two stars.

I trolled the charts of stocks under $2, stocks that look they're making an effort to start heading up. I came up with a typical list of random stocks:

Stop! Before you go out and buy these stocks, memorize these caveats:

• The stocks were selected randomly and not based on any fundamental analysis (or rigorous technical analysis either).
• Success on the prior lists above are no guarantee that any other list of "perpetual call options" or "dash for trash" will produce equal results or positive results at all.
• This discussion is more about a tactic rather than about specific stocks. There is a large universe of stocks to pick from and you should make your own selection.
• You know your own tolerance for risk so, if you do something like this, you have to decide on how large the basket could be and how many stocks in that basket to spread the risk.
• Many low-priced stocks are thinly traded so you should set the price you're willing to pay and use limit orders.

Most importantly, the two "baskets" I described above were started at the beginning of one of the best bull market recoveries in stock market history (over 60% in 7 months). Basket 1 above actually took a large loss between November to February and only started appreciating as the market recovered. There's no need to hurry and put something into place because the best time to launch a strategy like this is at the beginning of a bull market trend. It's perhaps best to stick this in the back of your mind and pull it out after the consolidation.

US Dollar Index (DXY), Gold (GLD) and the S&P 500 (SPX)

Several days ago, in "Managing Portfolios Today With Three Indicators", the first indicator in the list of three indicators impacting today's market listed was $US. You've heard the talking heads say this and you read other blogsters write about this but have you seen the relationship presented graphically. I haven't so I thought I'd research it and bring the results to you.

The charts below are the value of the S&P 500 Index (.SPX) and the price of the gold etf (GLD) in both cases compared against the US Dollar Index (.DCX) which measures the performance of the Dollar against a basket of currencies: EUR (Euro), JPY (Yen), GBP (Pound), CAD (Canadian), CHF (Swiss)and SEK (Swedish).

Each panel contains trading over the past three trading sessions for the S&P; you should note that currencies trade 24-hours/day so you'll see gaps between the Dollar Index on one day and it's value at the opening of the US market's the next day. The Dollar Index is the blue line; the S&P Index and GLD are the multi-collar (or tan) lines.

• S&P Index vs. US Dollar (click on chart to enlarge): Sure enough, there is a pretty distinct inverse correlation these between the value of the dollar and the US market (most clearly seen in last Thursday trading). Today, the market had a terrific first hour and a half of trading as the Dollar Index was declining. But at around noon, the Dollar Index starting rising and the market starting falling. It continued until 2:10 when both reversed direction. Is the tail (dollar) wagging the dog (market) or the other way around?

  I'm sure the reasons are complex and convoluted but there's no mistaking the fact that as the dollar's value drops, US stocks become more valuable because of the large percentage of profits made overseas, because its less expensive for foreigners to buy stock in US companies .... all the above reasons and more.

  
• Gold vs. US Dollar Index (click on chart to enlarge): Underlying worldwide supply/demand factors (industry and jewelry usage, sovereign demand) impact the price of gold and gold is also traded around the clock so the relationship between Gold and the US Dollar Index, although inversely correlated, is less direct.

  Each time the US Dollar index increased, the price of GLD (in $US) went down and vice versa.

Granted, three days offer only a peak and more data over longer periods are needed for sound economic or academic conclusions. But when I looked at the same data others have been looking at, I clearly see the relationships.

Editorial Comment: I feel somewhat unpatriotic but, for the sake of exports, our stock market seeing higher earnings, improved ability to pay our debts to foreign holders (in cheaper dollars), and improved export opportunities I'm rooting for a weaker $US.

The biggest risk will be in the importation of inflation through higher worldwide commodity prices (expressed in the lower valued $US Dollars) and higher cost of all the cheap goods we've come to expect flooding our retail stores. It may be a simplistic, short-term perspective but a weaker Dollar may actually help rejuvenate our industrial sector by reducing our reliance on imports.

What do you think?

Stock Market Road Map

Has a consolidation correction actually already begun and we just don't realize it?

We've been in an uptrend frame-of-mind for so long, that it's sometimes difficult to fathom that something might have changed or that the current market just isn't what we've grown pleasantly accustomed to over the past seven months. But my sense over the past several weeks is that something has changed. Besides the nearly 3% drubbing the market took on Friday and the whipsawing swings of sentiment on Wednesday and Thursday, are being broken and there's increased risk of moving averages being crossed.

So let's zero in more closely than usual, step by step, on the market's recent action to see if we can distill out clues to whether the market is possibly in the early phases of an emerging chart pattern or whether the uptrend is still intact so we don't feel like we're wondering aimlessly:

• End of Month Patterns: This is probably the first time you will have heard this but the Sept-Oct had a distinctive bend to them this year. Instead of following historical precedent as the "worst months of the year", September and October (and to a lesser degree August) had awful end-of-month cycles. The last 7 trading days of September plus October 1 and the last 9 trading days of October turned in 3.9% and 5.62% declines; the final 3 days of August plus September 1 likewise saw a 3.2% decline. The first portion of both months showed respectable gains. If November follows suit, Monday won't be good but the remainder of the month to around Thanksgiving could deliver a sizable gain.
• Trendlines: I've inserted an upward sloping channel by connecting the pivot points (points where balance of power flipped between buyers and sellers) at the beginnings and ends of those end-of-month declines discussed above. Since Friday's close violated the bottom support trendline, the obvious question is where will be the next low. My guess is that Monday, November 2, could see an intraday low at a key level, 1018, another 1.7% decline, since that was the intraday low on October 1 and a level the market gaped through in August. It seems to be an important play area for the market. [Coincidentally, my Elliottician friends are quick to point out, 1014.8 is a 38.2% Fibinacci retracement level between the 1098.74 close and the 879.13. A bounce at this level with conviction will support a continuation of the trend.]

  If the market successfully bounces around 1018, there's a possibility it could then lunge ahead following the September-October routine for a final gasping 10.5% gain to 1125, with the sidelined cash finally being put to work before year-end. The 1125-1150 range of significant for several reasons: 1) it's been mentioned by many analysts as the high for the year and 2) it's on the extension of top boundary of that channel.

• Moving Averages: Although the 50-DMA was violated last week, the 100-DMA is still intact and will probably remain so in the near term.

  Violating the 50- (and 200-) day moving average wasn't calamitous in July (the market then proceeded to surge ahead by over 25%). Another big, though not as extreme, move may follow this violation. Simultaneously, the 200- may cross the 300-dma and the 300-could turn up (as described in "Mark These Dates .....") paving the way more gains later.

• A Reversal Formation: If the market does bounce around 1018 either Monday or Tuesday, then the level becomes an important element, along with the October and November peaks in defining a pattern that could dictate the course of the market during the first half of 2010. Will these precursors become the early phase of a reversal or merely the beginning of a consolidation pattern. We'll leave predictions like that for economists (and stock analysts focusing on fundamentals); for chartists, all we can do is anticipate and be prepared to react when it happens.

Some inquisitive readers may question "What happens if you're wrong? How will you know if you're wrong?" Agreed, this is pure speculation but it's a plan, a map, and we use maps to help us know where we are and find our way to where we want to go. If the map indicates a turn but the road goes straight or if it indicates straight but the road has a bend then .... we know we're in the wrong place and we have to change our course.

That's the same with this fictional market road map for the next couple of months. Rather than a prediction, it's a plan of action for managing risk and measuring expectations. As of Wednesday next week, we'll know whether the risks are higher and plans and actions have to change or, if we're lucky, we'll see higher prices by Thanksgiving.

Managing Portfolios Today With Three Indicators

I don't know how many of you are full-time traders, how many self-manage your portfolios on a part-time basis or how many visit here only periodically to get a different take on the market, something that you can take back to your financial advisers just to let them know you're looking over their shoulder.

But I spend most of my day with my Fidelity trading platform (Active Trader) running on one screen and my charts or whatever else I might be working on, reading or playing (I'm a mediocre chess player) on another screen. Furthermore, as the day progresses, I have either Bloomberg or CNBC running muted over my desk so I can see how the market is doing and watch for any major news headlines. Periodically during the day, I calculate how closely my portfolio tracks, percentage wise, the S&P in the hope that it does better than the benchmark index (either gaining a greater percentage or losing less of a percentage).

The reason I tell you this is that I find that my portfolio rarely ever moving opposite the benchmark. They usually move in tandem, it's only a matter of degree. So managing my portfolio is rather simple. It's essentially a cash, or risk, management decision: how much do I want to have at risk given what I see happening in the market and only secondly in what types of assets it should be invested. In short, the portfolio management decision is essentially a market timing decision. I spend most of the time trying to figure out whether the direction of the market's trend has changed (the answer I share with you).

As an aside, I went to an MTA (Market Technicians Assoc.) meeting last night and heard an excellent presentation by Frank Teixeira, of Wellington Funds and the manager of John Hancock's new Technical Opportunities Fund that I'd like to share with you. One of his points that obviously resonated with me, is that more and more institutional investors are disappointed with Index funds or the notion that "there's always a bull market somewhere" and it's only a matter of finding it. They're disappointed in "buy-and-hold" since the strategy since 1999, a long ten years, has led to returns only marginally above break even. Given the two market crashes since 2000, the objective now is managing risk and the tactic is to consider cash a safe default investment.

He also said that the world of investment alternatives has greatly expanded with the introduction of all sorts of etf's and adr's. There's no way one person can become familiar with all industries, all commodities, all interest rate trends, all currencies around the world. But the worldwide search for investments can be narrowed by using technical analysis (studying trends) and looking at charts. Human behavior, as represented in price trends (charts), is the same around the world for all assets.

Having said that, the key to where the market will be next March can be found, I believe, in essentially three areas: 1) the foreign exchange value of the $US, 2) monetary policy as reflected in interest rates and 3) the US economy as reflected in the S&P 500 index. [The only thing that has a significant impact on our portfolios but we have no way of predicting or monitoring is what Congress does with income taxes.] Here are the relevant charts:

• $US: If this were a stock chart you wouldn't consider anything in the price action to indicate that a bottom has been reached and that a reversal pattern is being formed. If this were a stock, the only safe assumption would be that, at best, the downward trend remains in tact and, at worst, it will remain at current levels for a while (a couple of months) before turning back above 78.
• 20+ Year Long-term Treasury Rates: When interest rates increase, bond prices fall and vice versa. If this were the a stock's chart, I would sell or short it. Moving averages indicate that longer-term trends have turned down (how could they not have from the historically low current rates) and there's higher interest rate (lower bond prices) since the chart depicts a possible head and shoulder pattern. [A caveat is warranted here. Treasury Bond ETFs are relatively new so there's no history of how the ETF will perform over a wider range of interest rates.]
• S&P 500: This is what we're all interested in. If the neckline of the inverted head-and-shoulder that everyone now believes was the bottom is the mid-point of the move from bottom to top (a standard technical charting conventional rule), then the full extent of the bull market run could be to 1328. But the full move can be divided into two, separated by a period of consolidation. We could no be seeing the beginnings of that consolidation (given that volume supporting further upside is waning as indicated by OBV diverging from price).

Bottom line? We are in or very near a consolidation. It's best to reduce exposure to risk by increasing cash relative to investments (I'm currently at 10% and plan to increase to 25% at the next opportunity). Looking at the above exchange and interest rate trends, I will look for investments that take advantage of those trends. But until the market indicates otherwise, the correction should be short with another leg up possible sometime in 2010. As Teixeira said, this first phase of the recovery has seen "a rising tide lifting all boats"; the next phase will see much more divergence among stocks, between the leaders, the average and the laggards.