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> CrossCurrents Update, By Alan Newman
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post Nov 10 2011, 03:41 PM
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HOME OF "PICTURES OF A STOCK MARKET MANIA"

The huge rise in stock prices during October has ratcheted up bullish prognostications significantly.  Last month’s 10.8% gain is now in the record books in the category of the largest 25 monthly gains ever for the S&P 500 and there is nothing like a great month to push optimism.  Meanwhile, as technician and chartist extraordinaire Ron Griess (www.thechartstore.com) has recently divulged, the subsequent month and year is down as often as it is up (actually 13 to 12 in the Bear’s favor).

Background fundamentals are not just poor, they border on catastrophic.  The problems in Europe not only have the potential to affect the U.S. significantly, they will not be solved anytime soon.  From what we can glean regarding our highly leveraged world, the most sought after solution appears to be more leverage, precisely what brought us to the precipice to begin with.  Sanity has taken leave, not just on vacation but vanished.  The fixes are all illusory.  You can’t wash away debt with more debt.  We’re still looking for lower stock prices this month and again, much lower next year.   

More Instability Ahead 

Given an industry that cannot even regulate itself with any reliability or accountability towards the public, more instability should be ahead for stocks.  One glance at the story regarding FINRA’s alteration of documents (see http://wapo.st/uf0bbY) should be sufficient to turn your stomach.  Check this out, from FINRA’s home page (see http://www.finra.org/).  “FINRA is the largest independent regulator for all securities firms doing business in the United States…..Our chief role is to protect investors by maintaining the fairness of the U.S. capital markets.”  Don’t you feel better now? 

And then of course, there is the recently exposed scandal behind MF Global’s failure (see http://on.wsj.com/tP2QFb and http://on.wsj.com/uLCwrr) which should add acid to whatever is currently churning in your stomach.  The company is alleged to have used customer money for its own horribly wrong bets on derivatives.  Oversight?  Are you kidding?  Just two more reasons why we expect more instability ahead.  Seriously, folks.  Nothing has changed. 

A Bottom?  Are You Kidding?!

Below, perhaps the greatest argument against the bull proclamation that the shortest bear market in stock market history ended the day it arrived.  Well, not quite.  The “official” standard is a 20% decline on a closing basis and we only got as far as 19.2%.  However, we have always favored print basis, rather than closing prices, and on that score, the Dow lost as much as 21.6%, albeit briefly.  While proclamations of new highs arrived quite recently on a daily basis, 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 for Nasdaq.  In that case, we predicted a 35% crash would occur in a span of six weeks from February 28, 2000 and we were only off by 2%.  In this case, the picture we present remains startling evidence of a major top, rather than a major bottom.  Clearly, the previous coupling of high margin debt and low cash-to-assets ratios for mutual funds was an indication of an overexposed stock market.  Each of the prior highlighted occasions were followed by a 50% haircut in prices and it is entirely possible that something resembling the past will again occur, perhaps next year. 

While the mutual fund cash-to-asset ratio rose to 3.9% in September, this is not a true reduction in exposure.  These levels rose primarily because prices were down.  The numerator (the S&P 500) fell by 7.2% while the denominator (actual cash) was up inconsequentially.  Cash reserves rose by about $1.6 billion to roughly $188 billion, less than 0.9% from August.  Fund assets plunged by almost 9.5% to $4.8 trillion.    Worse yet, evidence continues to pile up that the public is not only leaving this arena, the public is hastening its departure.  Monthly cumulative flows for domestic mutual funds have been sliding precipitously since the 2007 peak and the downturn certainly seems to be accelerating [Ed note: we estimate another $14 billion departed in September].  Given the horrendous background of high unemployment, 45 million Americans using food stamps, a virtually worthless SEC incapable of fulfilling its mission statement, and various and sundry tawdry affairs like insider trading scandals and the many, many instances in which settlements are made “without admitting or denying wrongdoing,” it is no wonder that inflows have turned to outflows.  However, despite the continuing record ebb tide, prices somehow managed to not only regain their footing but nearly doubled in little more than two years.  What was that all about?!  In our view, it had to have been the very same hedge funds piling on to capture momentum, the very same hedge funds that are now experiencing one of their worst years ever.  The ferocity of momentum can cause wild shifts in behavior and as a result of a rally off the March 2009 lows, hedge fund assets reached $2 trillion by the first quarter of this year.  However, there is always a flip side to the coin and momentum can bring about valuations that only a dreamer could love.  Eventually, the love affair must come to an end.  And so, we feel constrained to report that the benchmark HFRI Hedge Fund Weighted Composite Index was down 5.3% through September. 

While inflows have historically picked up substantially for the months of November through April as we have shown with our “Dead Zone” charts for many years, there has been a pronounced change since the tech bubble was popped in 2000.  Despite the fact that the stock market is a much larger entity now than it was during many of the years from 1984-2000, average monthly inflows during the good seasonal period have been smaller over the last 11 years than they were for the period from 1984-2000.  This is a stunning development and again, a reflection of public interest, or should we say growing discontent.  The Dead Zone is now accompanied by outflows and the only months now worth their salt are January and April.  The two months used to represent 34% of all annual inflows but since 2001 represent an incredible 82% of all annual inflows.  Favorable seasonality is not what it used to be.  January’s bonus money buys stocks and April’s IRA contributions have a similar impact and they will likely remain the best bet for bulls.  But January is another eight weeks away and as our chart shows, we are probably correct not to expect too much until then.  Unfortunately, two months do not make a year.  Not even close.

[Two other charts are shown in this issue of Crosscurrents]

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ABOUT ALAN M. NEWMAN

Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.

The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation.  Broad samples of our work can be viewed at http://www.cross-currents.net/

Subscription rates are now $189 for one year and $100 for six months.  A FREE 3 issue trial subscription is available by emailing us (click the "free trial" link above). Please note: trial requests must include name, address and phone number and must originate from the email address the trial is to be delivered.  Trials are only available by Email (.pdf files).  U.S. Mail subscriptions are available but include a nominal surcharge for postage and handling.

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