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Stock Market Top Watch: Recap

by Michael Nystrom
Saturday September 23, 2006
Cambridge, MA

Part I
Part II
Part III


The old adage is that a watched pot never boils also applies quite nicely to the stock market: A watched market never tops, or so it seems. Top picking has been a hazardous occupation for bears such as myself over the past five years, but this didn't stop me from going out on a limb and trying to pick the top last week in Imminent Decline Dead Ahead. In that report I said I thought we were in for a big decline soon and that "...the market should end the day lower than it starts on Wednesday [the day of the Fed meeting announcement], and lower on Friday than it starts the week on Monday."

Well, I got the first part wrong - the market was up big on Wednesday, reaching its highest point of the day - and the week - just before the Fed announcement (Point 1 on the chart below). It sold off immediately following, but still closed the day way higher thanks to Cisco's bullish earnings report, and the good news from the Fed.

The market made another run for new highs at Thursday's open (Point 2), and one more right around lunchtime (Point 3) before running out of gas and collapsing into the rest of the day. Although the range for the week was only about 1%, the week was not without drama and volatility! Business news headlines crowed about the new 5-1/2 year highs for the SPX, but the index only bested these levels by a couple of points (the thick red line on the chart denotes the May 06 highs), and at the end of the week the market couldn't hold its gains. My subscribers were kept abreast of developments as the week progressed in Parts II and III of this series.

It is said that the market climbs a wall of worry, and with all the bad news of the past several months there has been lots to worry about: The Israel-Lebanon war, the Iran situation, the five year anniversary of 9/11, the high price of oil, and the looming FOMC meeting. Now much of that worry is gone. But if the market climbs a wall of worry, it also slides down the slippery "slope of hope" - a clever phrase coined by Robert Prechter.

Much of the preceding month's worry is now gone: The oil crunch is clearly easing, and interest rates are actually coming down. With these worries out of the way, we can start hoping for some things to get this market going higher, right? Next week we've got a slew of economic numbers on the way: home sales, consumer confidence, durable goods orders, the Chicago NAPM survey and more. And what I call market sweeps week - 3Q earnings releases, that is - also start next month. Let's hope we get some indication for a soft landing, because last week's Philly Fed Index (the first negative reading in three years) and the drop in August's leading indicators (slowdown not seen leading to recession, the Boston Globe confidently reports) didn't look so hot. In fact, these were the primary triggers behind last week's market selloff from the highs. (If I recall correctly, Point 2 on the first chart above marked the release of the Leading Indicators, and Point 3 was the release of the Philly Fed Index - the news that really sank the market.)

Bull Not Bull

While we didn't get the big selloff last week that I was expecting, we did get what could be the beginning of it. For some, watching the market like this is like watching the grass grow, but I love it, and it is what I do for a living! The market did close the week lower than it started the week, posting a bearish "key reversal" week - another good sign for the bears. However, weekly key reversals haven't been very good indicators over the past several years - we saw lots of them in the late 90's, but the market powered right on up through them. So take this with a grain of salt.

Many commentators on the open thread for this article believe the government will support stock prices through the election: "...by Rove, we won't be seeing gas prices this low or stocks this high for, uh, let me guess, two years." This may be true, or it may be a sign of investor complacency - there seems to be general agreement that stocks are overvalued, but a belief that they will not fall because they are being protected by the PPT. But is there any way the PPT can hold up prices in the face of a lot of bad news? I doubt it.

My next positive indication that the market has peaked will be an SPX close below 1300, and a low beneath that close. The market is a tricky beast - it might dip down below the upward sloping trend line for a bit, draw some aggressive bears in, then slaughter them with new highs. We've seen lots of that kind of bear busting all through this little rally. To reiterate: My key is to see a close below 1300, and then a low beneath that close. At such a point, I'll feel confident shorting this market, with a protective stop at around 1300. New highs beyond this week's highs of course mean to go long. While I don't think it will happen, I won't argue with the market if it does!

They say that "a man hears what he wants to hear and he disregards the rest (in this case the "they" are Simon & Garfunkel). I'm fully expecting a recession, but Cornhusker, has this to say on the open thread:
By the way...I'm an executive recruiter in the banking industry. Our clients (banks) are expanding at a rate that we have NEVER seen before, not even last year. MONSTER sign-on bonuses for Commercial Loan Officers, Regional Presidents, & Compliance Officers.

Think about it...if the Banking industry even had a whiff of an impending "recession"...why would 75% of our clients be telling us they will be increasing staff size over the next twelve months (and last year was a record year for us)? ...from an employment perspective, the banking industry is more bullish now than I HAVE EVER SEEN IT, and I've been a recruiter for eleven years. I'm long & strong on U.S. equities until the trend tells me otherwise.
If this is true, then are predictions for a recession premature? Do the banks know something the rest of us don't? Do banks stand to "make bank" in foreclosures and repossessions in the great housing bust? Or is it just that participants are always the most bullish at the top? I'd love to hear your comments.

In the meantime, I'm keeping a close eye on the stock market, as I believe this is the best leading indicator of a recession. I'll also be taking a look at the commodity market this week as well. Subscribers are notified immediately of updates, and best of all, subscriptions are free!


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