The Morning Call--A new trading range but no incentive to buy

The Morning Call

11/2/12

The Market

           

    Technical

            The indices (DJIA 13232, S&P 1427) had a gangbusters day.  Given the magnitude of the rise, I think that we can establish the interim support level (12973/1395) as the new lower boundary of a short term trading range---the upper boundaries being 13661/1474.  As I noted previously, the aforementioned lower boundaries have additional support coming from the 200 day moving averages (12986/1378).  Additional resistance also exists at the 50 day moving averages (13328/1433).

            Both of the Averages are well within their intermediate term uptrends (12673-17673, 1337-1933)

            Volume was flat; breadth improved.  The VIX dropped about 10%, putting it right in the middle of the zone between the upper boundary of its short term downtrend and the lower boundary of its intermediate term trading range.  It also remains above its 50 day moving average.

            GLD fell.  Since the upper boundary of the new very short term downtrend also declined, GLD again closed right on this boundary.  It remains above the lower boundaries of its short term uptrend and the intermediate term trading range.

Bottom line:  indices appear have set the lower boundaries of new short term trading ranges. However, given that these lower boundaries are above our Year end Fair Values, I have little technical incentive to Buy stocks at the bottom of this trading range. 

In addition, yesterday’s bounce had a number of the characteristics of ‘dead cat bounce’.  Whether that proves to be the case will clearly depend on follow through.

In any case, the next important technical occurrence is a test of either/both of the boundaries of these new short term trading ranges in order to judge their strength.  As you know, I don’t think that the lower boundaries will hold; but for the moment that judgment is wrong.

            The AAII sentiment survey (medium):

            http://pragcap.com/aaii-sentiment-neutral-sentiment-plunges

            Doug Short takes a look at where we are in the market cycle (medium):

            http://advisorperspectives.com/dshort/updates/Secular-Bull-and-Bear-Markets.php

            Is the Shanghai Composite giving a bullish signal (short):

            http://advisorperspectives.com/dshort/guest/Chris-Kimble-121101-Shangai-Update.php

    Fundamental

    

     Headlines

            Reasonably strong economic datapoints was the fuel for yesterday’s rally.  They included weekly jobless claims, the ADP private employment report, the October ISM manufacturing index, unit labor costs along with a solid PMI number out of China.  There were some slightly disappointing stats (second quarter nonfarm productivity and October consumer confidence); however, the jobless claims, ISM numbers and Chinese PMI carried the most weight.  So overall,  (1) I would agree with investors in judging the data positively and (2) the data keep the data flow pointing to a continued recovery and away from a ‘double dip’.

            That said, we need those positive stats to keep our forecast on track.  Certainly they do; but that simply means that the assumptions in our Valuation Model are still operative which in turn keeps S&P Fair Value at 1395-1400---in other words, below current prices.

            That says nothing about the ultimate economic consequences of either Hurricane Sandy or the elections/fiscal cliff.  Since those consequences will start impacting us sooner rather than later, I think a little extra dry powder (something over 15%) makes sense until we get a little clarity on both.

More on Sandy from Café Hayek (short):

            http://cafehayek.com/2012/11/tim-worstall-on-measuring-economic-activity.html

            David Rosenberg on Sandy (medium):

            http://www.zerohedge.com/news/2012-11-01/rosie-sandy-one-economists-realistic-hurricane-post-mortem

            And none of this says anything about the eurozone which seems to have disappeared from the lexicon of most of the financial media.  It is like they are taking the Alfred E Newman ‘what me worry’ approach.  Well, they may be correct.  But I remain sufficiently concerned about possible multiple bankruptcies and the damage that they would do to the US economy that I just can’t be that sanguine.  So my thought is that our Portfolios need even more cash reserves than would otherwise be necessitated by the hurricane/fiscal cliff problem.

            The Greek tragedy continues (medium):

            http://www.zerohedge.com/news/2012-11-01/more-greek-drama-coalition-member-pasok-turmoil-it-seeks-quell-rebellion

            And (medium):

            http://www.zerohedge.com/news/2012-11-01/not-exactly-greek-orthodox

            Here is a decent description of how the ‘muddle through’ scenario will work (medium):

            http://www.telegraph.co.uk/finance/comment/jeremy-warner/9647248/The-euro-is-heading-for-a-permanent-state-of-depression.html

            If, indeed, the euros are that lucky (medium):

            http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100021059/the-german-bloc-will-have-to-take-its-bitter-medicine-in-greece/

Bottom line:  stocks, as defined by the S&P, are overvalued, as defined by our Model.  The problem is that I haven’t yet factored into our Model the economic consequences of either Sandy (not enough time) or the elections (too uncertain)---both of which will almost surely impact the economy and likely to the negative.  I am less concerned about the effects of Sandy but the elections could have profound results. 

Hence, I see little incentive to chase stock prices in an overvalued but highly uncertain economic environment.

           

            Update on market valuation:

            http://advisorperspectives.com/dshort/updates/Q-Ratio-and-Market-Valuation.php

            http://advisorperspectives.com/dshort/updates/Crestmont-PE-Ratio.php