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CrossCurrents Update

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#1 TTHQ Staff

TTHQ Staff


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Posted 10 November 2011 - 03:41 PM

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The huge rise in stock prices during Octoberhasratcheted up bullish prognostications significantly.  Last month’s10.8% gain is now in the record books in the category of the largest 25monthly gains ever for the S&P 500 and there is nothing like agreatmonth to push optimism.  Meanwhile, as technician and chartistextraordinaireRon Griess (www.thechartstore.com)has recently divulged, the subsequent month and year is down as oftenasit is up (actually 13 to 12 in the Bear’s favor).

Background fundamentals are not just poor, theyborder on catastrophic.  The problems in Europe not only have thepotential to affect the U.S. significantly, they will not be solvedanytimesoon.  From what we can glean regarding our highly leveragedworld,the most sought after solution appears to be more leverage, preciselywhatbrought us to the precipice to begin with.  Sanity has takenleave,not just on vacation but vanished.  The fixes are allillusory. You can’t wash away debt with more debt.  We’re still looking forlower stock prices this month and again, much lower next year.  

More InstabilityAhead 

Given an industry that cannot even regulateitselfwith any reliability or accountability towards the public, moreinstabilityshould be ahead for stocks.  One glance at the story regardingFINRA’salteration of documents (see http://wapo.st/uf0bbY)should be sufficient to turn your stomach.  Check this out, fromFINRA’shome page (see http://www.finra.org/). “FINRA is the largest independent regulator for all securities firmsdoingbusiness in the United States…..Our chief role is to protect investorsby maintaining the fairness of the U.S. capital markets.”  Don’tyoufeel better now? 

And then of course, there is the recentlyexposedscandal behind MF Global’s failure (see http://on.wsj.com/tP2QFband http://on.wsj.com/uLCwrr)whichshould add acid to whatever is currently churning in yourstomach. The company is alleged to have used customer money for its own horriblywrong bets on derivatives.  Oversight?  Are youkidding? Just two more reasons why we expect more instability ahead. Seriously,folks.  Nothing has changed. 

A Bottom?  Are YouKidding?!

Below, perhaps the greatest argument againstthebull proclamation that the shortest bear market in stock market historyended the day it arrived.  Well, not quite.  The “official”standardis a 20% decline on a closing basis and we only got as far as19.2%. However, we have always favored print basis, rather than closingprices,and on that score, the Dow lost as much as 21.6%, albeit briefly. While proclamations of new highs arrived quite recently on a dailybasis,we doubt that outcome about as forcefully as we doubted the notion of a“new era” for technology that presupposed a 250 P/E was sustainable forNasdaq.  In that case, we predicted a 35% crash would occur in aspanof six weeks from February 28, 2000 and we were only off by 2%. Inthis case, the picture we present remains startling evidence of a majortop, rather than a major bottom.  Clearly, the previous couplingofhigh margin debt and low cash-to-assets ratios for mutual funds was anindication of an overexposed stock market.  Each of the priorhighlightedoccasions were followed by a 50% haircut in prices and it is entirelypossiblethat something resembling the past will again occur, perhaps nextyear. 

While the mutual fund cash-to-asset ratio roseto 3.9% in September, this is not a true reduction in exposure. Theselevels rose primarily because prices were down.  The numerator(theS&P 500) fell by 7.2% while the denominator (actual cash) was upinconsequentially. Cash reserves rose by about $1.6 billion to roughly $188 billion, lessthan 0.9% from August.  Fund assets plunged by almost 9.5% to $4.8trillion.  Worse yet, evidence continues to pile up thatthe public is not only leaving this arena, the public is hastening itsdeparture.  Monthly cumulative flows for domestic mutual fundshavebeen sliding precipitously since the 2007 peak and the downturncertainlyseems to be accelerating [Ed note: we estimate another $14 billiondepartedin September].  Given the horrendous background of highunemployment,45 million Americans using food stamps, a virtually worthless SECincapableof fulfilling its mission statement, and various and sundry tawdryaffairslike insider trading scandals and the many, many instances in whichsettlementsare made “without admitting or denying wrongdoing,” it is no wonderthatinflows have turned to outflows.  However, despite the continuingrecord ebb tide, prices somehow managed to not only regain theirfootingbut nearly doubled in little more than two years.  What was thatallabout?!  In our view, it had to have been the very same hedgefundspiling on to capture momentum, the very same hedge funds that are nowexperiencingone of their worst years ever.  The ferocity of momentum can causewild shifts in behavior and as a result of a rally off the March 2009lows,hedge fund assets reached $2 trillion by the first quarter of thisyear. However, there is always a flip side to the coin and momentum can bringabout valuations that only a dreamer could love.  Eventually, thelove affair must come to an end.  And so, we feel constrained toreportthat the benchmark HFRI Hedge Fund Weighted Composite Index was down5.3%through September. 

While inflows have historically picked upsubstantiallyfor the months of November through April as we have shown with our“DeadZone” charts for many years, there has been a pronounced change sincethetech bubble was popped in 2000.  Despite the fact that the stockmarketis a much larger entity now than it was during many of the years from1984-2000,average monthly inflows during the good seasonal period have beensmallerover the last 11 years than they were for the period from1984-2000. This is a stunning development and again, a reflection of publicinterest,or should we say growing discontent.  The Dead Zone is nowaccompaniedby outflows and the only months now worth their salt are January andApril. The two months used to represent 34% of all annual inflows but since2001represent an incredible 82% of all annual inflows.  Favorableseasonalityis not what it used to be.  January’s bonus money buys stocks andApril’s IRA contributions have a similar impact and they will likelyremainthe best bet for bulls.  But January is another eight weeks awayandas our chart shows, we are probably correct not to expect too muchuntilthen.  Unfortunately, two months do not make a year.  Notevenclose.

[Two other charts are showninthis issue of Crosscurrents]

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Alan M. Newman has been the Editor ofCROSSCURRENTSsince the first issue was published in May of 1990. Mr. Newman is alsoa member of the Market Technician's Associationand has been widely quoted for years by the financial press, media, andother newsletters and has written articles for BARRON'S.

The newsletter is published roughly every threeweeks and focuses on economic and stock market commentary, oftencoveringcontroversial subjects. Several proprietary technical indicators areusuallyfeatured in every issue accompanied by current interpretation. Broadsamples of our work can be viewed at http://www.cross-currents.net/. 

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