"An Orangey Sky"
By Frank Barbera CMT. April 17, 2007
“Substitution-Mass Confusion, Clouds inside your head, -- I can’t feel this way much longer, expecting to survive,---With all these hidden innuendoes, just waiting to arrive” go some of the psychedelic lyrics from the song Bye — Bye Love off the self titled 1978 hit album by The Cars. Well, for anyone looking at the stock market in 2007, it has been a case of “Substitution-Mass Confusion” as yesterday’s trading saw the S&P 500, Russell 2000, and NASDAQ Composite either recording or flirting with new multi-year highs.
Gone are the fears of Sub-Prime defaults, Evaporated the concerns of a slowing Housing market, Transmutated any worries about slowing consumer spending. Substituted instead are ‘happy’ thoughts of a Fed easing and lower interest rates leading to another round of (you guessed it…) Fed credit creation.
As the song continues, “It's such a wavy midnight, and you slip into insane.” Are you feeling confused? Are you feeling bedazzled? Do you know which way is up? Such is the nature of a major market engaged in a primary trend ‘topping process.’ The idea is to create confusion and to keep investors off balance. For the large cap institutional monies that are exiting long positions and raising cash, the distribution process is an example of the classic merchandising exercise of creating panic, picking up stock on the cheap, and then selling it out into strength later on. Odds are high that we are in a Distribution Top, meaning the latest round of new highs simply provides enough psychological confidence to create the right backdrop for retail investors ‘to feel good’ about buying back in, in the process facilitating a repositioning of investment portfolios for larger institutional investors. Ah, the poor unsuspecting and confused ‘retail investor’ always trying to find the peanut under the wrong shell.
A quick scan of the Wall Street headlines shows us the ravenous institutional LBO pools scooping up Sallie Mae, the great liquidity driven game continuing afoot, with God knows what form of financial ‘scrip’ used in under-writing most of these ‘deals.’ More headlines shows us talk of Internet stocks and Google, -- Ah, yes, one of the leading horseman for the ‘creatures of confidence’ -- being hyped into the earnings release — oone m-o-o-r-e time! Any time we hear ‘bubbly-bullish-babble’ on Internet stocks, well, it's one of those ‘creepy hair on the back of your neck standing up moments,’ and then of course, there is Citicorp, whose earnings were down 11% year-over-year, BUT, fear not, were ‘better-than-analysts’ estimates, hence, more bullish-babble and more B.S. Speaking of Google (GOOG), we wouldn’t be all that shocked to discover in the wake of 20/20 hindsight, perhaps a few months down the road, that the high at $513 on 11/22/06 was THE final high for the stock. Of course, we admit we could be mistaken and we have no interest in shorting Google. Yet, when viewed on an Elliott Wave basis, there was a very nice five wave advancing pattern that peaked out into the Thanksgiving Day high. Since then, the ‘Mother of All Bubbles’ has had a difficult time besting the $510 resistance zone, and while it could “pop” toward that area again in the wake of its forth coming E/R, I strongly suspect that a triple top, ‘failing’ right shoulder rally is amiss, ultimately portending that the stock is heading for another type of E/R -- more likely the ‘Emergency Room’ in the wake of a break down below key support at $455.00 in the months ahead.
As can be seen, I am not a GOOGLE believer, even though I love the search engine. The law of big numbers and high analyst growth estimates suggests much froth, and much downside risk, which after-all, with a market cap at 150 Billion GOOG is up there with the big boys. Let’s see a quick compare and contrast with Chevron Corp, for example. At about the same market cap, we see Total Revenues CVX $195.34Bln vs. GOOG $10.6 Bln, Gross Profits CVX $65.98Bln vs. GOOG $6.38bln, Net Income CVX $17.14Bln vs. GOOG $3.08bln — what’s wrong with this picture? A few years ago, when Yahoo was all the rage, I remember a similar market cap comparison right at the high with Exxon Mobil, with the same better than then 10X multiples at hand.
OK, I know. I can hear the cacophony of GOOG bulls roaring above the crowd about the GOOG growth rate, but really… I think Barron’s had it fundamentally right all along. For now, we’ll let the MACD do the talking, wherein MACD is currently near neutral — that’s right, NEUTRAL, EVEN as the stock is NEAR all time highs. This is a chart with the smell of a big, bad, bearish divergence in the air, as the 50 day average rolls over toward the 200, suggesting GOOGLE bulls beware!
Above: Google and the Medium Term MACD. Note prices are not far from former highs, but this time, MACD is lagging noticeably. Note also that the current rally is taking place against the backdrop of a declining 50 day average which is descending on an intercept course with the 200 day average, technically -- a big red flag.
And what about those Banks? As we all know, this cycle has been far more a ‘credit cycle’ than a ‘business cycle,' and far more an excess liquidity driven story then anything else. A few weeks back, with prices plunging out of control, we wrote about the prospects for an extensive S&P recovery, reaching back up to 1440-1450, which at the time seemed like we had imbibed one too many tequilas. Well, not only has the S&P recovered all of its losses, but we have also seen but the much-depressed brokers and large cap banks largely in recovery mode. The inevitable surprises along the way: (1) the S&P excess strength to new highs -- in our view, was powered ahead by big gains in Energy stocks, (to which we are eternally grateful as they remain large core holdings, especially the drillers), and (2) the actual less than expected rally in the Money-Center Banks where to date, the BKX has still NOT closed its 2/23/07 gap at 118.93. Perhaps that additional rally still lies ahead, which is another reason that, for now, we would hold back from any intense bearish uttering on the S&P re: the next few weeks.
Above: the Bank Index plunging into the lows back on March 13th in what turned out to be the day of the low, where we sketched in a recovery back toward 118.00, and
Below: the more “ho-hum” rally which has subsequently materialized.
Above: the Amex Broker-Dealer Index has followed our original script quite closely, but could still ‘hold up’ awhile longer in the 240-250 zone as near term momentum levels are still fairly strong.
Yet we cannot help but be concerned by the approach of earnings season and what could be a series of negative reports coming from the heavy weight financial sector. Already, we see many smaller cap regional banks under substantial earnings pressure coming from an inverted, unprofitable yield curve. For the big boys, prop trading desks are alleviating some of the traditional yield curve pain, but not so for the smaller fry. Does this suggest more pipeline pressures in the air for restrained credit growth as we move forward? Perhaps so. At any rate, as we are always in this game to help the little guy, one tool which we believe bares close watching is the MACD shown alongside the Dow Jones Industrials in the chart below. As can be seen, to begin with the Dow is now very near is 100-day UPPER trading bands, a caution sign to not be getting too bullish despite the likely near term new highs on the Dow. In addition, we also show the DJIA MACD, wherein MACD (stands for “moving average convergence-divergence) is a momentum indicator based on two moving averages, a 12-day and a 26-day exponential moving average and the differential between the two. Historically, when the averages are moving apart from one another, with the 12-day pulling away from the 26-day, momentum is expanding, and vise-versa.
As can be seen, at the moment with the Dow within close proximity to its former high of 12,786.64 seen on February 20th, MACD is still rising at a fairly healthy clip over the last few days. This tells us that short-term momentum behind the current rally is still fairly solid. That in turn means that the averages probably have ‘some time’ left before they turn down in earnest, in our view, probably at least a few weeks of ‘hang time.’ Yet, while the averages may manage to “hold up” a little while longer, or may even press a percent or two higher, the bigger picture outcome is likely to be bearish. I say this because, if we look back to the 3rd quarter of last year, MACD advanced to a high at Point A of +144.78 on October 26th, with the DJIA at 12,163.
Since then, we saw an extended period of divergence with the DJIA pressing high in Nov., Dec. 2006, and Jan., Feb. 2007 against lower highs in MACD. Ultimately, those signals of weakening momentum led to the sharp reaction in March of this year. On the bigger picture trend, that reaction forced MACD into deeply negative territory, below zero. Since then, as prices have recovered back to the levels of the late February highs, MACD has lagged, coming back only part way to this point in time. With a close near +80.00 today, MACD is still well below its former Pt. A high of +144.78 and will probably peak in coming weeks near +100 to +100 zone. Once MACD begins to roll over from those levels, the odds will grow stronger that the stock market will have completed, or be in the very final phases of completing a very important long-term top.
Mind you, we do not want to pre-judge the market too strongly, but at this juncture, a MACD ‘Failing High’ appears to be in the cards in the weeks ahead, and that in the end could speak untold volumes about where the DJIA and the market will be headed in the remainder of 2007.
Yet another element to the current equation is sentiment, which as we have already noted, anecdotally appears to be getting back on the bullish bandwagon with the dismissal of bad news, the ongoing presence of deals, and hot money once again chasing go-go momentum stocks (which in addition to Google, has anyone seen the Solar Stocks lately? FSLR, TSL -- red hot…). Yet to this point, neither our Put-Call work, or the VIX Indices have made the full 180 from extreme bearishness to extreme bullishness. Again, we believe that this suggests markets many have a bit more ‘hang time’ before an important, very major top is complete.
Bottom Line: In our view, there is no question that “all the hidden innuendoes are just waiting to arrive,” including among these, an economy that is slowing, a housing market that will be a major on-going concern, and no end in sight for a badly damaged mortgage market. For those unaware, or ‘dazed and confused’ by the see-sawing market averages “plunging through the floor” one month, and recording “new highs” the next, you have our sympathies; it is some ephemeral, psychedelic, liquidity driven nightmare unfolding before our eyes which comes with one strong word of caution -- Do Not Take Your Eyes Off The Big Picture Problems. They are real, and they are coming at us fast.
In the song “Bye -Bye Love,” the chorus reverts back to the phrase, “It's an Orangey Sky, Always some other guy, -- it's just a broken lullaby,” in which Ric Ocasek (leader singer/writer) used the term “Orangey Sky” as a metaphor for “the Sunset,” “the end of the day,” “the demise of a relationship — i.e. a broken lullaby.” For long term investors, we see nothing to tell us that this is not “the Orangey Sky” - “the Sunset” for the great bull market, with the latest round of new highs likely the reverberating echo of the prior trend. In our view, the equity market is topping, and a major and sustained intermediate term decline is still overdue, and therefore still lies ahead for 2007. The current round of new highs should be a siren song to small investors to review their portfolios and use the current strength to either raise some cash, re-position assets into defensive areas like Energy & Precious Metals, or both.
That’s all for now,
© 2007 Frank Barbera