Don’t Get Too Comfortable

Don’t get to comfortable just yet. There is a battle raging between the bulls and the bears that is far from over. It is a high stakes battle. If you look at the chart of the S&P 500, the bears were in control January and most of February. The bulls took over from February until mid April. Then the bears took over between April and June. Since then, the bulls have been in control. Is that about to change?

Well, let’s look at where we are in the calendar year. August through October has proven to be a dicey time for the market. The decline that preceded the October 1987 stock market crash began in August. The meltdown in 1998 actually started the last part of July and then ended in October. The decline that turned into the huge financial crisis drop started in August 2008. Finally, the 2000 bear market right after a September 1st high.

Then you have another interesting pattern that can be found during the tenth years of decades. Tenth years have the worst record within the Decennial Cycle and 2010 is a midterm election year, which has the second worst record of the 4 year presidential election cycle. Of the last 12 occurrences dating back to 1890, the stock market lost money 8 out of 12 times during the 10th year. The average loss has been -7.2%.

Year	% Gain or Loss	Year	% Gain or Loss	Year	% Gain or Loss
1890	-14.10	1940	-12.70	1980	+14.90
1900	+7.00	1950	+17.60	1990	-4.30
1910	-17.09	1960	-9.30	2000	-6.20
1920	-32.90	1970	+4.80	2010	???
1930	-33.80

 

If the conditions outside are ripe for a severe thunderstorm, would you take an umbrella or just assume the weather forecasters are wrong? The conditions of risk are very high right now. We are in the time period that carries the same amount of risk as does hurricane season for the folks living on the coast. Maybe nothing happens and all of the taking heads on Wall Street are right. At the same time, it pays to be prepared by always having an exit strategy.

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Red Flags for the Stock Market

You might want to put that Dow 11,000 party hat away for the time being.  Evidence of trouble ahead is getting much louder.   There are predictive indicators that would suggest that trouble is on the horizon.  These indicators simply suggest that risk levels are escalating.  They aren’t necessarily a great timing mechanism.   At the same time, as a stock market investor, you don’t want to ignore them.

They have been appearing throughout the first quarter. 

(1)               Percentage of Mutual Fund Managers in Cash Holdings

This has always been a great indicator.  When mutual fund managers hold low levels of cash, it has always been a sign that the market is headed for trouble. 

We are currently at the record level of low cash reserves held as in 2007 when the market turned into a bear market and in 1987 when we experienced the second greatest stock market crash of all time.

 (2)               The January Indicator

The old saying goes “so goes January so goes the rest of the year.”  During the last 59 years, January has had a negative return 23 times.  If you will recall, we had a negative January this year.  Of those years where there was a negative January, 56%  the stock market produced a negative result for the year.  

 (3)        P/E Ratios

I will resist getting into the mechanics of how a Price to Earnings Ratio works and its relation to the stock market.  You don’t need to understand how all of that works to get the point.   The bottom line is that new bull markets start when P/E ratios are low.  Bull markets end when the P/E ratio gets too high.

 The top of the bull market in 2007         P/E was 25.5

The top of the bull market in 2000         P/E was 44.2 (due to internet bubble)

The top of the bull market in 1966         P/E was 24.1

The top of the bull market in 1937         P/E was 22.2

The top of the bull market in 1929         P/E was 32.5

The top of the bull market in 1902         P/E was 25.1

 According to Robert Schuller’s valuation model, which looks at reality and makes no assumptions about the future, the current P/E ratio is 25! 

(4)               The December Low Indicator

 Lucien Hooper, a Forbes columnist and analyst, coined a stock market warning sign called the December Low Indicator.  If the stock market anytime during the first quarter goes below the lowest price level of the preceding December, a sell signal takes place.  This occurred during the first quarter. 

 The Stock Market Almanac further researched this sign and found that this has occurred 30 times since 1952.  If you get the combination of a negative January along with the December low indicator, the stock market has ended negative for the year 75% of the time. 

(5)               Decennial Cycle – 10^th year of the decade

The 10^th year of a decade has carried some significance.  Tenth years have the worst record within the Decennial Cycle and 2010 is a midterm election year, which has the second worst record of the 4 year presidential election cycle.  Of the last 12 occurrences dating back to 1890, the stock market lost money 8 out of the 12 times during the 10^th year.  The average loss has been -7.2%.  

 Year                 % gain or loss

 1890                       -14.10

1900                       + 7.00

1910                       -17.09

1920                       -32.90

1930                       -33.80

1940                       -12.70

1950                      +17.60

1960                         -9.30

1970                          4.80

1980                        14.90

1990                         -4.30

2000                         -6.20

2010                        ?????

(6)  Low Volume

This is one thing that really perplexes the market pros.  If you have a strong rally, typically you have strong buying volume.  There are a lot of buyers stepping up to the plate.    A hallmark of market tops is a rising stock market on low rally.  If anything, it is a warning sign.  Today, we have very low volume on the way up. 

The number one job of Wall Street is to convince the world that risk doesn’t exist.  They would prefer if investors just go back to sleep and not pay attention.  The signs of risk are building.

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The Signs are Painting a Negative Picture for the Stock Market

There are hundreds of signs and indicators that can be predictive.  I wanted to run a few by you this week as food for thought.

(1)               The January Indicator

The old saying goes “so goes January so goes the rest of the year.”  During the last 59 years, January has had a negative return 23 times.  This was the result of those negative first months of the years:

13 of those years ended negative

4 years had a greater return than 4.5%

6 years finished the year with a return of less than 3%

On the percentages, it has been a pretty accurate predictor of things to come (Stock Market Almanac).

(2)    The December Low Indicator

Lucien Hooper, a Forbes columnist and analyst, coined a stock market warning sign called the December Low Indicator.  If the stock market anytime during the first quarter goes below the lowest price level of the preceding December, a warning sign appears.  This occurred on January 22^nd.  The Stock Market Almanac further researched this sign and found that this has occurred 30 times since 1952.  When you combine a negative January and the December low indicator, the stock market ended those year negative 75% of the time. 

(3)  The Decennial Pattern

There are many studies that look at the significance of cycles.  For instance, there are studies that determine which year of the 4 year term of a President is likely to be either positive or negative.  There is a look at the 7th year of every decade.  The number 7 stands for panic.  You can literally go back and look at every 7th year dating back to 1887 and see some type of panic.  The two more famous panics would be the stock market crash in 1987 and then the start of the financial crisis in 2007.

There is also a look at the tenth year of every decade.  Out of any year of a decade, the 10th year is by far the worst year on average.   Tenth years have the worst record within the Decennial Cycle and 2010 is a midterm election year, which has the second worst record of the 4 year presidential election cycle.  Of the last 12 occurrences dating back to 1890, the stock market lost money 8 out of the 12 times during the 10^th year.  The average loss has been -7.2%.   

 Year                 % gain or loss

 1890                -14.1

1900               + 7

1910                -17.09

1920                -32.9

1930                -33.8

1940                -12.7

1950                +17.6

1960                -9.3

1970                4.8

1980                14.9

1990                -4.3

2000                -6.2

2010                ???

 These warning signs might end up amounting to nothing.  At the same time, it also might be prudent to pay attention to what the signs are saying and making sure that you have a Plan B.

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