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All is OK when it comes to the stock market. Wall Street is urging you to jump in with both feet and get fully invested. The market is going to the moon. Foreclosure mess? Not a problem says the street. Unemployment? We are already use to it and not a problem. Just name the problem and you get the same answer. I guess to be fair the same could be said for anyone holding the same position as I. At some point, however, the risk tips the scale.

I would look at jumping into this market as the opportunity to run down the prosperity with your neighbor who has been making big bucks in the market. Just have one question when it comes to running after your neighbor. What if you are running down a road that eventually leads to a steep drop-off?

OK, candidly, I have not been right on this current advance at all. However, something could be occurring right now that is characteristic of how most big advances end. In the world of managed money and technical analysis it is called a “blow-off” top.

A “blow-off top” is defined as a rapid increase in price of the stock market that precedes a steep drop in price. It doesn’t always have to precede a change in direction. However, in many cases it does.

Playing blackjack, poker, etc., offers a great example of what this looks like. You get a hot-hand at the blackjack or poker table and feel like you are invincible. You are winning hand after hand. Then you start to lose a hand or two and then the trend reverses. After you know it, you have given back all that you won. The house always wins.

I think that the same applies to the market in this type of environment. Without a Plan B, (what you use when Plan A doesn’t work) most investors make money and then give it back.

Let’s look back to 2007 as a good example. Starting on 8/15/07, the market started a real nice bullish market rally (it went up). This ended October 9th, which marked a top in the stock market that, I believe, will be the highest level this stock market will see for many years to come. It went up 11% in 55 days.

Fast forward to today (as of the day this was written) – On 08/31/10, the market started a real nice bullish market rally. Thus far, it has been 53 days and the market has gone up 13%. This is not unusual by any means to see the market have such a big rally that should precede a pretty substantial market drop.

What do I mean by substantial market drop? I would say that a minimum from where we sit today would be a 26% to a 40% decline in value. Although that doesn’t even seem possible at this juncture there is plenty of evidence that would suggest that it is more than possible.

At the risk of sounding like a broken record, watch your risk levels.

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My two sons love this book that I would read to them called The Bear Snores On. The story starts out with all of the bear’s friends sneaking into his cave and throwing a party while the bear “snores on.” They would do something outrageous and the author would note and the bear snores on. They would pop popcorn and sing and dance and the bear snores on. Everything is great until the angry bear wakes up.

Well, our bear on Wall Street took a nap back in March 2009. He briefly started to wake up April of this year. Since then, our bear has been in and out of sleep as everyone has been partying in the bear cave.

The unemployment numbers showed continued losses of 95,000 jobs last month…and the bear snores on.

Countries are saber rattling about a currency war…and the bear snores on.

The foreclosure process is in crisis as it has been halted in states all over the country…and the bear snores on.

Middle and lower America continue to face personal financial crisis…and the bear snores on.

The politicians have an agenda so big and it doesn’t include real recovery…and the bear snores on.

The Fed prints money, continues to accumulate at alarming levels, and there is talk about a second stimulus package…and the bear snores on.

Healthcare…and the bear snores on.

Higher tax rates next year…and the bear snores on.

An investor community oblivious to the risks in the structure of our economy system…and the bear snores on.

The problem is that the bear will not hibernate forever. My guess is that he will wake up in a very bad mood considering everything that has happened in his cave. You see, I don’t think that we ever left his bear cave as investors. He has just been asleep. Yes, I know, I have been talking about this risk with nothing materializing and the market continuing to go up. However, keep one thing in mind:

In the book The Bear Snores On, it was a small spark from a fire that woke him up. It wasn’t the big events happening all around him. It wasn’t the loud music or the dancing that woke him up. All it takes is the smallest problem to surface and the house of cards will come tumbling down. As an investor, what is your Plan B?

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You have probably read that September’s performance, after having a horrid August, was the second best on record for the Dow Jones. The bulls are running hard with this headline as means to spur optimism. They want you and all of your money invested. It is the good times again and we have momentum in our sails. Well, I went back and did a little research. Dating back to 1929, there have only been 4 instances where the stock market has increased greater than 5% in the month of September.

1939 = 13.47% record – occurred during a long-term bear market
2010 = 7.7% – occurred during a long-term bear market
1954 = 7.36%- occurred during a long-term bull market
1973 = 6.7% – occurred during a long-term bear market

1939 and 1973 were both years that were caught up in a long-term bear markets. What is a long-term bear market? It is a long period of time (usually on average of 15 to 20 years) where the market goes either down or nowhere at all. I would suggest that we started a long-term bear market in January 2000.

You can contrast long-term bear markets with a long-term bull market where the market goes up over a long period of time. Said another way, they both represent long period of times where it is either good or bad for investors.

Following those big September months, the following occurred:

September 1939 – The Dow Jones made a top in that month and proceeded to decline -40% into a bottom April 1942.

September 1973 – The Dow Jones saw a top the following October and proceeded to decline -36% to a bottom in December 1974.

The only exception to the rule was in 1954 which was in the middle of a long-term bull market. It continued to increase in value.

With everyone pulling out the party hats, as an investor, you might want to start looking for the valet ticket. The police are on the way and this party might just be getting ready to get busted up.

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When mutual fund managers are very positive on the market, historically they have kept lower levels of cash on hand in their portfolios. Watching these levels has been a very good predictor of where the stock market might be heading. Consider these statistics that date back to 1961.

Throughout the 60’s, mutual funds held on average 5 to 6% of their portfolios in cash. In some instances, it was as high as 9% to 10%. Cash levels of 4% or lower was a precursor to a market decline. In other words, when mutual fund managers held around 4% of cash, it was a signal that the stock market was about to go into a bear market or at least go through some type of a decline.

The following is from a newsletter I wrote to my clients back in 2007 right before the start of the greatest bear market since the Great Depression.

In 1971, these cash levels went as low as 4% and a -9% decline followed.
In 1972, these cash levels went as low as 3.9% and a -42% decline followed.

Then the cash levels went back up to the average of 8 to 10% again for a very long time until April 98. At that point they went back under 5% for the first time in 21 years. Following that dip down to 4.8% of cash, the market dropped -19%.

Then between 1998 and March 2000, the cash levels stayed in the mid to upper 4% ranges. March 2000, saw the first dip down to 4% cash level in almost 30 years. Of course, that occurred at the top of the great bull market run that led to a -47% decline in the stock market.

In September 2005, we set another record low in cash levels of 3.8%. That led to a mild decline of -5.2%.

In March 2007, we are now at a new record of 3.7%. Does that mean we have a bear market in our future? History would suggest that we have some type of stock market trouble in our near future. The irony is that we are at an all-time in the Dow just like we were in March of 2000.

Fast Forward to Today

So, wonder where we are today? We are currently at a record low level of cash in mutual funds at 3.6%.

NEW BULL MARKETS DON’T START UNTIL CASH LEVELS IN MUTUAL FUNDS ARE CLOSER TO 10%.

That is not an opinion. That is what history has shown. With that said, I would be careful with the risk that you are taking. Things can change very quickly.

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The jobs number came out on Friday and the market loved it. The Saturday Edition of the Wall Street Journal proclaimed:

Jobs Data Provide Hope

I have always been a little gun-shy about the word “hope” given its link to our commander-in-chief. I honestly think that the markets are a joke sometimes. The market celebrated that 67,000 private-sector jobs were added last month. Of course, the total number of jobs for the month of August showed a loss of 54,000 jobs. Then there is my favorite number of all – the birth/death ratio.

This is the number of jobs that they “estimate” were created or were lost. I wonder what the jobs number looks like if you take out the 115,000 jobs that were created out of thin air? That is how many jobs they added back into the total. Now it wouldn’t be any fun if we didn’t look at how many jobs the Government estimated were created in the leisure and hospitality sector. After all, Americans have so much money to spend on these types of things. These companies must be hiring like crazy. (Please note the sarcasm.)

This past month 23,000 jobs were added to the leisure and hospitality sector. Thus far this year, the birth/death formula has added 421,000 jobs to the numbers. Of those, 78% were in the leisure and hospitality sector. I seriously cannot make this stuff up.

Are you starting to see what a joke Government accounting is? Let’s switch over to what Barron’s wrote this weekend about the jobs numbers and you will see a much more dire situation. From the article:

• All of the employment gains were part-time—full-time employment, according to the Household Survey, plunged 254,000.

• Those working part-time did so pretty much because they had no choice, and their numbers surged by 331,000—the biggest increase in six months.

• Of the 67,000 rise in private-sector jobs, 10,000 reflected returning construction workers who had been on strike.

• The 27,000 shrinkage in manufacturing slots and flat total goods-producing employment are hardly evidence of a vibrant economy.

I don’t need to tell you that this is a serious problem that isn’t getting the attention of the truth. It is just a bunch of politicians crunching numbers to create the fantasy and illusion that serves them best.

Needless to say, risk is very high in the markets. This is especially the case as we enter into the Bear’s favorite month of September.

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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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OK, call me a conspiracy theorist. It is tough not to be one these days. In fact, the Obama administration is a conspiracy theorist”s dream. These days it doesn’t take much digging to come up with a theory. The politicians are blatantly doing everything out in the open.

On March 16th, I had the opportunity to speak at a conference at Christ for the Nations. I spoke about God’s provision during a financial crisis, where we are now, and how we got here. During that talk, I made the statement that Goldman Sachs was so intertwined with the Federal Government that nothing would ever happen to them (as a reference to companies that might fail). I said that they would always be protected by the government because of all of their ties.

I got in the car after the presentation and the breaking news on CNBC was that the Federal Government was filing charges against Goldman Sachs for securities violations. Wow, I didn’t see that coming. Initially, it didn’t make sense to me at all. Why would the Government go after its own partner in crime? It didn’t take long to figure it out. Within hours, Barack Obama was telling the American people that this is why we need financial reform and this is why the politicians need to pass his financial reform regulatory bill (aka huge Washington power grab/control bill).

In a May 3rd client newsletter, I wrote the following:

The timing of this is very convenient for the politicians. They are trying to pass financial regulation and reform legislation (read: power grab for the politicians). So vilifying Wall Street helps create the reasons why we need financial reform. The Republicans will get a lot of backlash for not supporting financial reform when Goldman Sachs looks so bad. Once again, this is most likely a PR nightmare for Goldman Sachs and probably nothing else.

Last week the politicians passed the financial reform package. Within hours, the SEC and Goldman Sachs reached a settlement with Goldman Sachs not admitting any wrongdoing. What’s even better, they had to pay a settlement of 550 million dollars. In 2009, they had over 13 billion dollars in earnings. Do you think that they are going to miss a measly little $550 million?

Vilify the biggest investment house/bank on Wall Street. However, make sure that you don’t hurt them too much. Make the acquisitions strong. Push the need for financial reform using that bank as the reason we need it. Pass financial regulation. Then let them off of the hook with a slap on the wrist. You scratch my back and I continue to scratch yours.

There are tons of ties between Goldman Sachs and the Government. Just read this article and you will get the idea.

What no confidence?

The market took a tumble at the end of last week the consumer sentiment numbers released. Personally I think that these surveys are somewhat of a joke. However, Wall Street pays attention to them. I don’t think that we need a survey to tell us the consumer isn’t really positive. The indexed showed a decline to an 11 month low. Barrons reported over the weekend that this type of drop has only occurred 6 times in the last 32 years that this survey has been around. Risk is still high in this market. Check your risk levels!

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