The last peak in the US stock market was November 25th. While last week saw a lot of down and a lot of up, the net result was a net loss of 0.25% over the period (basis S&P 500). Comparatively, last week our All Season strategy made over 1%. That’s one more reason why we gage the health of the market on a weekly basis. I have been expecting some sort of consolidation as the major stock indexes are now retesting their highs, in some cases all time highs. Furthermore, a number of short term momentum indicators reached an overbought condition where we naturally begin to see various rounds of profit taking. While the current rally could have reached a peak for the year, I believe there is more to this uptrend.
For one, the psychology toward the markets is just now reaching a very bullish state and not yet at extremes that we have seen in the past. I am hearing too much skepticism in the media for this to be a meaningful peak. They are asking questions like, “Is it too late to buy stocks now?”. Alternatively, we need to hear questions like, “Are you rich yet?”. Second, intermediate term price oscillators and other measures similar suggest that there is at least one more strong phase up in the current rally before they even reach an overbought condition. Think of the current situation as a 7 out of 10 condition with 10 being a very rich and risky market. Finally, in my world, once the markets have embarked on a strong uptrend, we look for weekly divergencies between price, volume, breadth and momentum to identify the likely end of a move. So far, I see little in the way of technical problems based again on weekly information. Daily charts and statistics are not so favorable but still positive. So the trend is up until further notice but we want to be careful about chasing big up days on any new purchases.

Now let’s look at the longer term picture. A few weeks ago, I wrote commentary on Quality vs. Quantity and suggested that this rally still looks like a piece, perhaps the final exhaustive piece, of a long term market uptrend that is coming to a close. In other words, the longer term evidence suggests that we are closer to the end of a bull market than the beginning of a sustainable new up trend. What am I looking at? I’m looking at the facts that the advance/ decline lines (a measure of market breadth) have not confirmed the marginal new highs in the broad market indexes made on November 18th. I am also looking at the continued thread of selectivity in the market. While there is certainly new strength in the transportation, technology and financial sectors, the underlying strength within these sector moves is thin and unimpressive. Broad sector participation is still coming from the energy and commodity complex. The future of this advance will depend on continued strength and full participation from the new sector leaders. Today, I just see selectivity which again is the hallmark of an aging bull market.
Furthermore, Buying and Selling pressure is still showing that sellers are in control of this market (see chart of the week) and the Lowry’s intermediate term sell signal on October 10th is still in effect, despite new price highs for the year. From a cycle standpoint, this bull market is 794 market days old. That is roughly 38 months and the average bull market lasts 34 months. We are due for a decline of some magnitude and it should come sooner rather than later. Finally, I am watchful of the yield curve that I spoke of last week which is clearly showing an economy on the verge of recession. I don’t buy the arguments that “this time is different”. There are too many independent forces at work that make up the slope of the yield curve. Unless something drastic happens to avoid an inverted yield curve, we should factually be preparing ourselves and our portfolios for a stock market decline and an economic recession in 2006. Year end seems as likely a place as any for this rally to peak as it did last year, although too many expect that outcome at this point for my comfort. So I’ll amend the date and suggest the markets should put in an intermediate term peak NEAR the end of the year. I plan to sell into this rally as our risk managed models dictate. If you would like to discuss your individual situation or decisions you are considering, please feel free to call me directly. Next week, I will be commenting on how and when we typically make money for our clients. I’ve discovered some interesting trends within our own strategies that I plan to share. Happy shopping.

Sam Jones