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[TTHQ Staff]

BEING STREET SMART
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Sy Harding

SANTA CLAUS CAME TO TOWN! December 23, 2004.

The traditional Santa Claus rally arrived on schedule this week. The Dow, S&P 500, and Nasdaq were all up for the week, and after the dismal summer have now rallied back and broken out to new highs for the year.

The market remains in its favorable seasonal period. (My newsletter’s Seasonal Timing Strategy triggered its entry signal on October 28, just three days after the Dow hit its low for the year on October 25).

Economic numbers continue to come in mixed, but with enough positive to keep investors confident. This week t

he Conference Board reported that its Leading Economic Indicator Index rose in November. This indicator is designed to forecast the economy six to nine months in advance, and had been down for five months in a row. The American Petroleum Institute reported crude oil inventories unexpectedly rose again in the week ended December 17, this time by a large 2.9 million barrels. That continuing indication that oil supplies are more than enough to meet current demand, drove oil prices still lower. Perhaps that was a factor in the University of Michigan’s report that its Consumer Sentiment Index improved to 97.1 in December from 92.8 in November.

More than enough to produce a jolly holiday season for the market.

However, there was also enough negative news to prevent the market from running away to the upside.

The Commerce Department reported that Durable Goods Orders, which are orders for big ticket items, rose 1.6% in November after declining 0.9% in October. That seemed to be good news until it was realized that aircraft sales, which have volatile up and down months, had risen a huge 64% in November, and without that aberration, Durable Goods Orders actually fell 0.8%.

The week’s most troubling news was that new home sales fell 12% in November. That comes on the back of the previous week’s report that new housing starts plunged 13.1% in November. Both were the largest monthly declines in more than ten years.

My worry about those numbers is that the main supports for the economic recovery of the last three years have been the housing boom, and healthy automobile sales. A few weeks ago Ford and GM reported their November sales were so dismal they would have to cut back production for coming months. And now comes two big declines in housing numbers.

So once again this week there was enough positive news to keep investor confidence high, but more signs of disturbing trends setting in that could signal trouble down the road.

Regarding the market’s technical underpinnings, as I noted last week, market breadth has been impressive, and relative strength and momentum reversal indicators remain positive and have quite a ways to go before they would normally become overbought.

However, there are also a couple of worries showing up in the technical picture. Corporate insiders have again begun to sell their stock to a significant degree. And investor sentiment has reached an extreme of optimism and confidence usually present at important market tops. Investor sentiment is known as a ‘contrary indicator’. That is, investor emotions are usually at an extreme of pessimism and bearishness at important market bottoms, made so by the market decline to that bottom. And usually at an extreme of optimism and bullishness at important market tops, made so by a substantial rally or bull market.

However, both extremes of insider selling, and extremes of investor bullishness, are frequently very early in warning of market tops.

For instance, the warnings in the financial press this week about the dangerous level of investor optimism are primarily based on the Investors Intelligence investor sentiment readings, which reached a level of 62% bullish last week, not only above the danger zone of 55%, but at a level not seen since late January, 1987. That may send shivers down the backs of investors who were caught in the infamous 1987 crash.

However, investor sentiment cannot be used by itself to ‘time’ the market. While the Investors Intelligence sentiment numbers reached 62% bullish in January, 1987, therefore warning of a major market top ahead, the market continued to rise. The Dow gained an additional 30% from late January, 1987 to its August, 1987 high. Only then did the market begin the decline that ended with the October, 1987 crash.

So, as I’ve been saying for awhile, enjoy the rally as long as it lasts. It continues to be the season to be jolly. But realize that trouble may lie ahead sometime next year.

Happy Holidays!

Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.