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Well, I took the wrong time to take a vacation. A great deal of very important things occurred last week in the stock market and investors should be extremely cautious.  This morning I will take some time to get you caught up on what is occurring with price levels as well as what I believe to be a fundamental shift in the stock market. The stock market has been in a stock market rally from the middle of March at least until June 11. Since June 11, the S&P 500 has declined -7 %.

One of the themes that I have written about since the low in the stock market in March is the overall future direction of the stock market. If you ask most people on Wall Street, they will say the worst is behind us and we have started a period of recovery. I have argued the opposite. I feel that we are in a long-term bear market that started in 2000 and could last as long as 18 to 20 years (based on history).  Concerning out current situation, my analysis would suggest we have been in a bear market rally. This is a period of time where the stock market stops declining and starts what looks like a period of prosperity and recovery for investors.

These are mean periods of time for investors because they fool the vast majority of people into believing that the worst is behind us. When you look at how far up the stock market went in a small amount of time, it certainly would appear that the worst is behind us. At the same time, it also looks just like a typical bear market rally and not the start of a period of recovery.

Since the March low in the stock market, the question has been how long and how far the stock market will go up. It is a little too early to declare that the stock market rally is over. However, the evidence is building. The problems are becoming much too loud to ignore. So, let’s start with the evidence. We always want to look at price levels of the stock market. Price levels are determined by where the stock market closes at the end of each day. They can tell us a great deal about the level of risk that we are facing.

If we manage to stay above certain price levels, then stock market investors should feel comfortable with taking risk by investing in stocks. However, if the market closes below certain price levels, then the probability increases that stock investors will lose substantial amounts of money. On June 11th, the S&P 500 reached its highest price level since the March low. That closing price level for June 11th was 944 on the S&P 500.

As of last Friday, we were at a price level of 879. The price level of 878 is the first level of risk for the stock market. Last week the S&P 500 fell below that level but has not closed below that level. Remember that the closing level is the most important one to watch. Once that level is broken, the next danger zone lies between 814 and 779. If you are heavily invested in stock, you do not want to see the S&P 500 fall below 779. In that event, I would think that the next price level down could be as low as 719 all the way down to 666.

The price level of 666 is extremely important because that was the March low of the stock market. In the event that would happen, that would be a considerable low and loss to stock market investors. For now, let’s not get ahead of ourselves. Keep in mind that investing in stocks is all about monitoring your risk. One of the best ways to do so is by monitoring price levels.

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Forget about what the Government, Wall Street, or the economists say about the probabilities for the stock market and the economy.  Instead, look at what the people in the day to day trenches are doing with their money.  A key indicator is the actions of the corporate insiders and whether they are buying or selling their company stock.  Think about it for a moment.  If the corporate insiders, the individuals who are seeing the actual numbers and projections for the future, are selling their company stock, then there is obviously something that concerns them. 

According to Wall Street, this is intended to be the buying opportunity of a lifetime.  If so, then why would you sell?  Let’s take a look at the latest statistics that show whether corporate insiders are positive or negative about the future.

In the last few weeks, corporate insiders sold over $335 million in stock versus the buying of only $12 million  (www.financialarmageddon.com).  This begs another question. Is it more concerning that insiders are selling or that insiders are just not buying?

The reality is that the economy is not in good shape and the fundamentals do not suggest that we are remotely close to being out of the woods.  Let’s take a look at a few other variables.

Unemployment

I wrote last Friday about the huge discrepancy in the unemployment report that the Government gives and the unemployment problem that is really facing America.  However, the numbers get even more distorted when you consider other variables.  The temporary workers distort those numbers.  This is the classification of workers who are jumping from temp job to temp job just to make ends meet.  They will count as employed.  The latest shadowstats.com repoprt shows the unemployment number around 20.5%.  That is a far cry from the reported 9.4% unemployment and suggests that a huge headwind faces this economy.

Interest rates

The Government is going to have a tough time getting this economy jump-started if interest rates continue to increase.  This is going to be a key risk factor for the stock market.  This week the Government will be holding another significant bond auction in order to raise money to fund our enormous spending appetite and deficits.  Buyers are demanding higher rates of interest for the bonds thus increasing the interest rates of the government bond markets.  Interest rates were up again last week.  Of course, this affects the interest rates of the consumer markets.  The last thing that a debt crisis needs is rising interest rates.

Price Levels

Let’s not forget the price levels that we watch to determine if the market is making headway and still a good investment or if the risk level has become too high.  The price level of 943 is a huge price level that the S&P 500 has had a tough time getting over.  The longer that the S&P 500 stays below that price level, the larger the chance that the bear market declines will return.  Thus far, this has been a real challenge for the market.

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Please leave a comment and let me know if this is useful or what you would like for me to write about – this is to help educate you on how risk works.  Also let me know how I can simplify this so that it is easier to understand.

Yesterday’s stock market really didn’t tell us much about where we are heading in the near-term.  When looking at the stock market and evaluating risk, it is important to look at 3 different timeframes – short-term, med-term, and long-term.  You could define those time-frames as being bullish (positive), negative (bearish), or neutral (neither bearish or bullish) 

I come to those conclusions by watching the price levels of the S&P 500.  Let me give a real quick definition of price levels. 

Each day the stock market has a value.  When things were great in the stock market back in October 2007, the S&P 500 had a value of  1565.  Now the value of the S&P 500 (referred to as the stock market) of 775 – YIKES!!!  The value of the S&P 500 has declined by over 50%.  So the price level or value of the S&P 500 rises or declines everyday.  If you are invested in stocks or stock type mutual funds (of any kind) chances are the value of your account is rising or declining with the stock market. 

Wouldn’t it be helpful to know when the S&P 500 is at a good value which makes sense to invest and when the S&P 500 is at a value where it doesn’t?  Well, we cannot ever know for sure.  However, we can get an idea. 

Understanding how price levels determine risk, will greatly help you know how much risk to take at any given time.  Also for first-time readers, I only focus on the S&P 500.

Long-term Bearish – For this to change, the S&P 500 wiould have to go above the price level of 1083.  Currently, we are at a price level of 775 (39% away from that price level)

Intermediate Bearish – For that to change the price level would need to rise above and stay above 875.

Short-term Neutral – As long as we staybetween 775 and 741, we are in a waiting mode to see which way the market is heading. 

The most dangerous position for investors is when all three time periods are bearish.  That was the case through last Monday.  So how do you apply this to your investments?  Well when risk is this high, you really want to limit the percentage that you invest into ANY type of stock or stock fund. 

To give you a good idea, the long-term trend for the stock market turned bearish December 26, 2007 (49% ago).  At that point it really paid to be cautious and start greatly reducing risk (removing money from stock and stock funds)

It works the other way as well.  As the timeframes start to change to bullish (positive), then investors should start increasing positions. 

They say that you cannot time the market and that no one can perfectly make all of the right decisions.  There is an element of truth to that statement. This is not a perfect system and sometimes you will make the right decisions and sometimes you will not make the wrong decisions.  However, if you apply some discipline to your investments and follow the direction (positive or negative) of the stock market during these timeframes, I would argue you can save yourself a lot of pain and loss.  Doing nothing at all is ridiculous advice.

Please leave a comment and let me know if this is useful or what you would like for me to write about  – this is to help educate you on how risk works.

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