Signs of a Top forming ............. Caution!

Below you will find three charts of indicators that tend to provide a reasonable indication that a "CIT - change in trend" is close at hand. The FED will give us an indication of their thinking on the economy on Wednesday. The markets are waiting to hear that  the next installment of easing (QE3) will be coming some time in the 1st quarter of 2012. This news would likely rally the markets for a few days to a few weeks. If the FED does nothing but confuse the markets, its likely, a size-able decline could ensue.

The technical indications from the market seem to be saying that the rally is tired and most of the bulls that wanted to buy stocks have already done so. Any bad news will provide a convenient signal to sell in order to alleviate the complacency that has built up over the last several months.

The chart to the left is day graph of the CPCE or the put/call ratio for equities. It is a very good indicator of when the market is in an overly bullish state or an overly pessimistic state. Each condition is likely to generate a reversal. Note: we are currently on a sell signal for this indicator.

The NYSE advance versus declining issues is another good indicator of when the market is entering extreme conditions. Turns tend to follow the market extremes.

Here's a comparison of the SP500 index shown in grey (area chart) with an overlay of the Banking ETF-BKX. The SP500 has a significant percentage of its shares in the Banking sectors and they are a good indicator of the overall economy and market direction. The stochastic indicator in the lower window is beginning to rollover indicating a change in direction maybe near.

You need to pay particular attention to how the market reacts to news for the rest of the week. We  are setting up for a sizable move lower and protecting your profits would be a good thing to do.

Some Thing is wrong with the market.......?

It would seem that an awful lot of technicians are paying close attention to the markets these days as many of them picked up on some unusual action yesterday. While the market was rising, ever so slightly, the VIX (volatility index) which normally moves inversely to the markets price, actually was rising as well. The other measure of risk that I follow is the yield on the Ten Year Treasury and it tends to be coincident with  prices, but it was falling. Both suggest a divergence may be occurring which might set up a top in the next few days to a week or so. Divergences are normally a good indicator that a change in trend is near.

Given all the geopolitical problems and technical issues with the Market you would think that there is no where to go but down. The 500 lb. gorilla in the room still remains the FED. Right now I suspect that the only reason for the market rallying is the rumor of the imminent roll-out of QE3.  There are all kinds of headwinds for this market but the market will do whatever it has to do to inflict maximum pain.

Here's the SP500 weekly index. Notice the red box in the upper right hand side of the chart. That's were we expect the index to top - close to the 1350 area. Once the top is in place we can expect to see the move towards 600 to begin. If the index is able to push through the 1375 resistance on strength then all bets say we are likely to see 1500. Hold your bets until the Market tells us which way its going.

"Something Evil this way comes........."

Thought it would be interesting to look at the impact that the structural changes now unfolding in the economy and those that will unfold over the next 10 years will have on the Stock Markets. The critical Demographic changes are going to change the face of the retail customer from a credit card junkie to a spend thrift looking for price trade-offs before making a purchase.

• The largest single demographic group of individuals in the economy are the "Baby-Boomers" who were born after WWII. This group had their peak spending spree top out in ~2000 and they are now retiring in mass. (See bottom chart on the Millennials)
• The big ramp up in the 1990's stock market was clearly driven, in good part, by the spending of these individuals as they educated their children, bought larger homes and purchased goods that reflected their growing income status. (See FRBSF chart below)
• Years of Governments trying to spend their way out of every bubble or crisis has generated debt burdens that can no longer be financed by the old adage of raising taxes. Companies and Government entities willingly gave away future entitlement payments to unions and employees figuring they would not be around when the bill came due, surprise, surprise.
• Normally the thing that floated all boats was a growing economy that produced more revenues each year and everybody would see the wisdom in leaving the problems for the next guy to fix. Almost four years later and trillions of dollars thrown at the problems and we have an unemployment rate that is stuck near 8.5% and that is only because statistical games are being played to mask the real number that is closer to 11%. (See second chart below)
• During the recession of 2008-2009 the U.S. economy destroyed  high paying manufacturing jobs at an unprecedented rate. It lost home-building jobs due to the bubble that the government induced and we are still sitting on a "phantom" inventory of unsold and foreclosure bound homes that could last for several more years. Many of the jobs lost here are never going to come back. Some will, but it could take a decade before we see enough to make a dent in the employment problem.
• As if growing unemployment problems weren't enough - even if you are lucky enough to find work it is likely to be a job with lower wages with few if any benefits. In general the workforce is working longer (hours) and getting paid less. (See chart)

Boomer Retirement: Headwinds for U.S. Equity Markets?
By Zheng Liu and Mark M. Spiegel (Federal Reserve Bank of San Francisco)

Historical data indicate a strong relationship between the age distribution of the U.S. population and stock market performance. A key demographic trend is the aging of the baby boom generation. As they reach retirement age, they are likely to shift from buying stocks to selling their equity holdings to finance retirement. Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades.

Lance Roberts StreetTalkLive.com

 "IF", employment was truly improving, we would be seeing these numbers begin to reverse course. They aren't, and the reason is due to population growth. During the last month it is estimated that the number of individuals of working age, 16 years and over, rose by 143,000 with the working age population now residing at 240.6 million. The offset is that, while job gains are modest and primarily located in lower-paying temporary employment for the end-of-year seasonality, the population continues to grow at an unfettered clip. In simple terms, the economy is not creating jobs fast enough to keep up with population growth.

Lance Roberts StreetTalkLive.com

    The impact on wages, as other inflationary pressures rise, hits the consumer where it hurts the most. We have discussed the fact that recent declines in wages and salaries combined with the rising costs of food and energy are consuming more of the household income. This bleed on incomes has led to significant slides in the personal savings rate and the ability for the consumer to continue to spend outside of the main necessities to meet their basic standard of living. This pattern is unsustainable, and sharp decreases in personal savings rates have historically been precursors to the onset of recessions.

Another large demographic group is on the rise to replace the "Boomers".  They are the 18-29 year old's or the "Millennials". This demographic group is very unlikely to have the same values as the retiring Boomers  and may not support a lot of the social programs currently in place. They are more likely to seek radical restructuring rather than minor tweaks. A case in point, the article (link below), gives you an interesting look at how this group views driving (a car) and how it will effect Detroit's Automakers for years to come.

http://www.detroitnews.com/article/20120116/AUTO01/201160362/Today’s-youth-a-tough-sell-for-automakers?goog

 


This is just the beginning of a long list of problems that have either been kicked down the road to be resolved later (now) or are outgrowths of the current economic situation that is blowing up in our faces. No matter how we got to this "perfect storm" of events, the only thing that matters is how are we going to financially navigate safely from here forward. I've heard it suggested that if we accomplish anything in 2012, but Armageddon, it will be a success.

Market Trying to Rally

Given the bad news of late (only sounds good due to the TV spin doctor's twisting of the facts) the market is holding its own. The monthly chart of the SP500 below remains on a sell signal generated in April of 2011 at point "E" or 1370. If the market wants to rally for a few weeks or so we could see the area near 1350 as a possible magnet. The indicators on the chart in the second box (Yellow Rectangles) are still rolling over and the longer, slower indicator in the lowest box is approaching the zero line and its flattening trying to move sideways for a bit before it decides whether to go  up or down. The long term outlook still says we should see a move lower in the coming weeks and months ahead. The final target near 600 may take a few years to achieve.



The next chart uses another index to try and foretell the SPX's direction. It's a funny thing about favorite indexes that people use in forecasting as they only seem to be good if they tell the story the forecaster is selling, read CNBC here. The Shanghai Index is not often mentioned unless it is projecting a move higher. The SSEC is shown below and on a weekly basis has been very accurate. Here again we are on a sell signal generated in April.

2012 Outlook - Not a Normal Business Cycle

Before we get too optimistic about the new year, we have to take stock of where we are. All indications seem to point to little progress being made in our effort to crawl out of the last recession of 2008-2009. The following "ECRI" article from Business Insider concern's their call for another probable recession right around the corner. With a recession staring us in the face, Europe still trying to implode, the consumer paying down debt  and the very low GDP forecasts for 2012, it is hard to believe the stock market can rally to new highs unless the FED intervenes and unleashes QE3. Even then it will only be a quick sugar high until the market figures out that things are really much worse than anyone thought they could be.

Read the article (excerpts) that follow and then look very closely at the last chart at the bottom of the page. You need to understand the potential environment you will be investing in going forward. It will help you to decide what kind of risk tolerance you're willing to maintain.

(1)  The Weekly Leading Index (WLI) growth indicator of the Economic Cycle Research Institute (ECRI) posted a -7.6 in its latest reading, data through December 23. On September 30th, ECRI publicly announced that the U.S. is tipping into a recession, a call the Institute had announced to its private clients on September 21st. Here is an excerpt from the announcement:

Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there's nothing that policy makers can do to head it off.

ECRI's recession call isn't based on just one or two leading indexes, but on dozens of specialized leading indexes, including the U.S. Long Leading Index, which was the first to turn down — before the Arab Spring and Japanese earthquake — to be followed by downturns in the Weekly Leading Index and other shorter-leading indexes. In fact, the most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not "soft landings." (Read the report here.)

For a close look at this movement of this index in recent months, here's a snapshot of the data since 2000.

Read more: http://www.businessinsider.com/advisorperspectives.com/dshort/updates/ECRI-Weekly-Leading-Index.php#ixzz1iEDX29oe

ECRI doesn't provide the general public with the analytical details behind its calls, but the latest Hoisington Investment Management quarterly report a similar forecast for negative growth with an interesting analysis that warrants close reading. Here is the opening paragraph and a snippet near from the conclusion:

Negative economic growth will probably be registered in the U.S. during the fourth quarter of 2011, and in subsequent quarters in 2012. Though partially caused by monetary and fiscal actions and excessive indebtedness, this contraction has been further aggravated by three current cyclical developments: a) declining productivity, b) elevated inventory investment, and c) contracting real wage income....

In summary, the case for an impending recession rests not only on cyclical precursors evident in productivity, real wages, and inventory investment, but also on the dysfunctionality of monetary and fiscal policy.

The full report in PDF format is available at the Hoisington website.

More recently Van Hoisington reiterated his view of a coming recession in a Barron's interview:

Our expectation is that we are going to enter another recession next year, when we haven't really fully recovered from the previous one. We think we are in what Niall Ferguson, a Harvard historian, recently termed a slight depression. This isn't a normal business cycle.

(2) Here is a chart of the (SP500) shown before and the details behind it can be found on dshort.com. It's a collaboration of work done by Doug Short and John Carlucci. It suggests the market is likely to retrace from its 2000 highs to the the blue arrow at the lower trend line.  The rate of decent will follow a ~34% (grey) retracement angle. The key points to take away from the analysis is that we are not yet half way done with the move lower and it will take until ~2022 to complete the move to approximately ~500.  Scary eh? That's about 4500 on the Dow.