Monday, August 10, 2009

Long Term Market Buy Signal Approaching… A Sucker Move?

One of my favorite long term indicators is about to generate a buy signal. I’m not the only one who watches it, so as it gets triggered it will surely bring in more market participants along with their money.

The signal I’m referring to is the 20/50 WEEK moving average cross. This is an indicator that is slow to cross, missing the first part of a move, but generally does catch longer term trends as you can see in this 10 year chart of the SPX (red line 20wma & green line 50wma):

This cross produces very few false signals and when the mandatory 1% pad is thrown in is almost perfect over time. It is meant to be very mechanical, to remove emotion and to remove analytics. The tape, as they say, does not care what YOU think the fundamentals are.

At least that’s how it’s supposed to work in theory, and I have used this signal in the past to my advantage, for sure. However, the resonant disconnect between the fundamentals and price make this juncture a very dangerous one in my opinion. I am of the belief that any further rally in the marketplace is purely based on printed money and NOT on fundamental growth. Our debts on all levels are parabolic and completely out of control. The actions to stimulate the economy have made the underlying fundamentals WORSE, not better.

For example, it took $1.50 of debt to generate $1 of GDP in the 1960s, $1.70 to generate $1 of GDP in the '70s, $2.90 in the '80s, $3.20 in the '90s, and an unbelievable $5.40 of debt to generate $1 of GDP in the latest decade. With the velocity of money CRASHING, the debt is rising exponentially in a desperate attempt to keep impossible never ending growth alive. THIS WILL FAIL, and it will fail miserably.

WHEN it will fail is another question… I believe that it already has, and our banking system, and now goverment, are simply living on a zombie debt orgy that will quickly turn into stasis as it becomes clear that the more money pumped into the system to create growth will only lead to more problems that will require even more pumping, and so on. This circle will end in tears – forget about the Fed “getting the exit right.” It has already gone WAY too far, the math of debt already does not work.

So, do you ignore the signal or do you follow it? Let’s look at it a little bit closer. On the SPX weekly, a little closer in, you can see that the cross has already just happened. The rule is, however, that you wait to go long (long term buy and hold investing we’re talking about here) until the 20wma is 1% above the 50. The 50 is currently at 913, so adding 1% would mean that you wait to enter until the 20 is at roughly 922. It’s already at 917 and is DEFINITELY GOING TO PRODUCE THE BUY SIGNAL SOON, even if the market begins to head down today.

The problem I have with this is that this is CLEARLY A BEAR MARKET RALLY AND NOTHING MORE – that’s my opinion, you must decide for yourself. Six month rallies that gain 50% ARE NOT HEALTHY, are way overextended and destined to fail. They do not happen on the back of fundamentals, they happen on the back of extremes in emotion and money printing/manipulation. China and Brazil? I also wouldn’t touch either with your 10 foot pole at this juncture.

In a brilliant dichotomy, one thing I HATE is market callers who tell you they have a mechanical buy or sell signal and THEN IGNORE IT. I always yell at the MORONS for doing so, and did so at the bulls who ignored their sell signals early in 2008. Am I making the opposite error if I ignore this buy signal? Perhaps.

So, I think it’s important to HEDGE if you are going to ignore equities that now have a P/E ratio above 140 like me. Clearly this price to earnings disconnect is out of whack on a historic basis, earnings simply do not support prices here. Thus, there is NO CHANCE THAT NATE IS GOING LONG ON THIS SIGNAL. Instead, I am still waiting patiently for the sign that it’s all about to unravel – I believe that could be soon, but am prepared for it to take months. I do think it’s smart to hedge long to prevent a collapse of the dollar from wiping out your portfolio of wealth. To me that means having a chunk of your portfolio in precious metals. Another way to go is to actually follow the buy signal, and then hedge the risk with long term (leap) put options. If you do, here’s the problem I have with that…

Look at the following MONTHLY non-logarithmic chart of the DOW Industrials that I posted the other day from 1940. As one reader pointed out in a private email, that could easily turn into a massive head and shoulders pattern. In fact, that is exactly what McHugh has been pointing out about several of the world’s largest stock markets. And, when you run the target on those patterns (not yet confirmed) then you will find that the target is zero or below. Nuts? Maybe, but maybe they are telling you something about the debt that is permeating the globe.

Note on that chart that the monthly stochastic is just above the 60 level and does look like it wants to make the journey all the way to overbought. It may do so, but is not likely to do so in a perfectly straight line. McHugh’s E.W. count suggests that this latest rally is wave 1 up of c up of the larger wave B up. Wave c should have 5 full waves and thus we may make the right shoulder on this chart before it rolls. That would be a ways out both in terms of time and in terms of price.

In the very short term, wave 1 up of c up should be completing soon. That should lead to a wave 2 down (probably starting this week), and then be followed by more upside action taking us into later this year – That’s IF McHugh’s E.W. labeling is correct.

Now let’s zoom in a little on the DOW weekly and see what’s going on there. First note that the 20 and the 50 have not crossed, but that cross is imminent. Note, however, the very clear volume pattern that is MASSIVELY DIVERGING from price. Volume confirms price, and this is clearly NOT happening. Instead, volume is decreasing and the oscillators are way overbought on this timeframe.

So, for me, I would just as soon pass on the opportunity. I like my money to be invested when all three things align – the fundamentals, the technicals, and the psychological. I am a human, though, and can be completely wrong - or right, but way early. That’s what mechanical signals are supposed to eliminate.

Still one more reason I think the risk is too great... Go back up and look at the shorter term SPX chart. We are now nearly 100 points above the moving averages, or more than 10%. An entry now followed by a pull back to the moving averages exposes you to a 10% loss - IF you use the moving average as a stop! If you don’t, what is your stop? Sorry, I do not like it here or anywhere near here. If anything I would much prefer a short term short – but will not fight the manipulation here either until I see a clear sign that it is failing – of course I will let you know if I do. The only acceptable play long, from my perspective, would be to combine your long with a hedge. And the truth is that hedges simply diminish your profits if your primary play is correct. To me, this market is not worth risking capital on, in the same exact way that buying rental property was not worth risking capital on in the year 2005.

Hey, maybe in the year 2525!

Zager and Evans - In The Year 2525

*Note – as always, you invest and make YOUR decisions at YOUR own risk. I am simply presenting information about MY decisions – like them or leave them.