While my long-term gold and silver and corresponding mining shares are acting well, I’m not mistaking the fact that they are all underperforming Google. I don’t buy the premise for which the market is valuing this internet company at well over $100 billion; but make no mistake, if I felt it could go to $450, with a minimum of risk, I’d be in and cheering like seemingly everyone else.
This trading range stock market is making me weary. With rallies and swoons that have been quick and tradable, no directional trend has developed. Most market technicians seem to believe that the market will drop to significantly lower levels, but the time in which this will happen is too far out to be relevant in any practical sense. That is to say, it will be at least three weeks or more into the future. In the same manner, if the market were to rally to new bull market territory, first it would have to move into new high ground, and this seems unlikely. Yet given the action in the Dow Jones Transportation Index, anything is possible. The people who are bidding up the transports are not doing it for the 0.6% dividend.
I will describe two recent examples of successful bearish positions on my part to illustrate the difficult nature of the current market. I sold short Autozone $97.86, and then saw it move to all time highs over $100 on a Smith Barney upgrade. It then swooned on lousy quarterly earnings and a CFO resignation. When the market appeared bullish, I covered at $82.78.
I sold short PF Chang’s China Bistro at $51.25. Their quarterly release included disappointing sales and earnings, a (another) CFO resignation, and a stock drop of over 10% in a day. At that time, I thought I really had a long term position in an overpriced stock in an overpriced market that was finally getting a sniff of reality. This proved to be a mirage as three days later (last Monday), I was stopped out of my PFCB short at 46 in a stock market rally that included practically all stocks – good, bad, ugly, and extremely ugly. In both cases, a strong market required that the short positions be closed out. As I draft this, AZO is at $85, and PFCB at $47 – both marginally higher than my cover price and both minus their CFOs. They are both good short sales in my view except for one factor – market conditions. At this moment, taking a bearish position would be lagging Investors Business Daily, and for over a decade, this has been a losing proposition. Even though it has been tough, but not impossible to make money on bearish positions, the environment has been similar for the bulls (except for those bidding up stocks such household loved favorites as Apple Computer, Sandisk, and Google).
As I’ve stated here before, there is opportunity in the short side of US consumer related stocks, and I believe we are in a bear market now. But we are in the midst of a sharp and tradable rally and the environment is risky. Now it is just a question of entry point which has not come yet except for an opportunistic and short term trade here and there. The long term monthly candlestick chart of the Retail Holders ETF puts it in perspective. There are a few things I would like to point out about this chart.
As you can see from the chart above, the Retail Holders index has had a decisive engulfing pattern (the tall red candlestick) in August of 2005, which reversed the uptrend. Note how the July white candlestick occurred on low volume and was reversed downward on high volume. It was also in August, that the March 2002 highs in the RTH index (~98), also failed. The 98 level also failed in November of 2004. If the retail index were to break above 98, and remain there for over a month, then this may cast doubt on whether we are in a consumer stock bear market. I’ll believe it when I see it, and if I see it, I will believe it.
Now I would like to chop up what I just said so that the situation may be viewed with an open mind. It is relevant to note that none of the momentum indicators referenced in the chart above is of value except for providing a warning that says “watch out.” Even though various indicators point to momentum divergences, momentum is just that - momentum. As with trends, momentum can be reversed; actually momentum is reversed much more easily than trends. I’ve seen too many letter writers, myself included, fall into the trap of making a fundamental point via reference of momentum indicators only without any confirmation in trendline breaks or pattern reversals. If a fundamental point is to be made using charts, you need to come to me with something more than a loss of momentum. Show me a decisively broken trendline – nothing less – then I may believe your fundamental point made with charts. If you ever catch me doing this, write me and I’ll send you a full refund, no questions asked!
So are we in a bear market in consumer related stocks? A look at the long-term Dow Jones Restaurant and Bars index suggests a trading range is the more appropriate term.
Bear market, may be. The charts of many key consumer stocks appear to be damaged, yet they have surged back recently with sharp rallies. Yet, you cannot ignore that the level of technical damage done to these charts cast doubts on the sustainability of the recent rally. Homebuilders serve as an excellent example. Following is a three year weekly chart of Toll Brothers. While the chart appeared to be damaged with a deep and sharp sell off of its high at about 58, the damage was at least temporarily halted at the “4” marked on the chart. It would appear that the likely scenario would be the formation of the right shoulder of a head-and-shoulders reversal pattern. While this may be plausible, the pattern would not be validated until 36 was decisively taken out to the downside. (Maybe there is no housing bubble after all!) A decisive break of the proposed neckline would do a lot of talking about whether the housing bubble was bursting. But until that happens, there is not a bear market yet.
The Dow Jones Transportation Index serves as an example of how difficult this market can be, and why patterns need to be completed before they may be considered meaningful.
There are some lessons to be learned on this chart. Remember the head-and-shoulders pattern proposed? Having proposed this pattern in a market wrap up (twice), I surely remember it. The proposed pattern could not be validated until the proposed shoulder was broken to the downside. All the bearishness suggested by the plunging neckline was not to be until the neckline was broken. In retrospect, the proposed right shoulder may have been a 3rd Elliot Wave (as indicated by the momentum at the top and extension). Such a formation would have indicated more significant upward movement in wave 5, which did not occur in the proposed head (H), or proposed right shoulder (Sh). Whether this is a proper Elliot Wave count is pretty much immaterial for practical purposes. The important point is that the bearish pattern was not validated by a break of the neckline, and therefore any suggestion that the transports were in trouble would have been (and is) premature.
There will be opportunity to make money with bearish positions in consumer stocks, but not until the market turns bearish. We don’t yet have a support break in PFCB, but once (and if) we do, there will be a profitable intermediate term trade as can be seen in the long-term weekly chart. Forty ($40) is a key support/resistance area for PFCB. Once 40 is broken decisively to the downside, the stock should travel downward to 22 (where there is some support) or lower.
All major averages were up again today led by the Dow Transportation Index which moved into new high ground and the Nasdaq 100 (QQQQ) which was up about 1.5% today and approached its resistance point of 40. On the individual stock front it appears that the stocks showing the most momentum were up the most today. Sandisk and Apple Computer were up over 3% and GOOG was up over 1.5%. The stock market indices are heading up, and so are long-term interest rates. In the long-term (say, 3 weeks) this is not important. Yet longer term higher interest rates will douse the flames feeding the US consumer frenzy. Before this happens, we will get the convergence of lower oil (assuming the short term trend stays in place), and a stock market that reaches high ground and makes the news. And as it stands, it appears that this will all happen during the Christmas shopping season. It’s one more party for the consumer feeling wealthy, while the real economy continues to languish.
The bond market sits at a critical juncture as shown in the 3-year weekly chart below. While a downtrend has been broken, it is just below where you could call it a decisive break. If the 10-year note rate goes above 4.85%, that would be a multi-year high, and if it reaches 5.0%, this would be a number that would make the news and wake up the average citizen as to the upward trend in interest rates. In previous instances such as April of '04, and early Spring of '05, upward trending rates produced a stock market swoon. This time around, interest rates are heading higher while the stock market rallies. If interest rates head higher still, it will eventually hurt stocks; that is, if history is any indicator. It is notable that 10-year interest rates have continued a trend of higher lows since June of '03, almost 30-months which is the longest duration since the secular bull market in bond prices began.
The chart below adds a long-term perspective.
Finally, that brings me to gold. After a bold advance, gold is consolidating at about $460 per ounce. If gold approaches $500 an ounce, this will also awaken the general public to the obvious fact that there is serious inflation in the pipeline and this will shed a negative light upon those officials who site official statistics as evidence that inflation is benign. There is credibility at stake, and if credibility is lost, that would have a negative effect upon the financial system, and the economy propping wealth effect. For that reason, I would think that whatever can be done to keep prices of gold down, will. It will probably remain in a base until after Christmas. After that, gold would likely head upward in my view.
Enjoy the stock market party while it lasts and have a great evening.
James J. Puplava Financial Sense™ is a Registered Trademark
P. O. Box 503147 San Diego, CA 92150-3147 USA 858.487.3939