Technicals versus Economics

Friday, January 27, 2006 | 12:45 PM

I got involved in a debate earlier at RealMoney - Columnist Conversation, and wanted to pass it along here.

Pre-GDP (1/27/2006 7:31 AM EST), I wrote :

1) Technicals remain strong, and continue to be the driving force short term. But economics look weak, and continue to be source of concern long term.

2) Last Friday's market actions was the market's early warning sign. Very heavy volume to the downside on a big selloff is never a good thing. I interpret that day as a foundational crack of the cyclical Bull market. Again, we are not looking for a 1987 situation, but rather a Q1 topping out, and an ugly rest of the year.

3) Gold also looks toppy -- it's well overdue for a 10% correction. We are short here, but would re-establish a long position in the 480-510 range.

4) A 500 point day in Japan is too exuberant -- it's a sign of very emotional trading. Historically, these sort of buying frenzies tend to end badly. As such, we are lowering our multiyear price target on the Nikkei down from 21,000 to 18,000. I would not be surprised to see this lowered again before year's end. And the Korean Topix, which I have liked for some time, is geting crazed. Still plenty of upside, but getting frothy...

Norm Conley raised a legitimate question about this:

"It seems as if you are taking two outlier one-day moves in markets (one "up" move, and one "down" move), and extrapolating that although they are contradirectional, they both carry ominous portents."

My response was:

I wrote:

You raise some fair points; Let's see if I can -- briefly -- explain further:

1) I was specifically referring to market internals (as opposed to chart patterns) when I said the technicals were strong: The Up/down ratio, advance/decline line, new 52 week highs, % of stocks over their 50 and 200 day moving average -- none of these are in a danger zone yet, and if anything, are positive.

2) Last Friday was down 2% on heavy volume; That's not a sign of excessive emotion or panic -- rather, its a sign of significant distribution by institutional sellers. That's rarely a one-day event. I interpret that as a warning sign of more trouble to come, as it reveals that big holders are willing to bail at early signs of trouble.

3) Japan up that huge is simply a buying frenzy. Clients of ours in Korea are telling me all the foreign cash flowing into the Kospi has engendered a giddy mayhem. (500 points! Geez!)

4) As I have mentioned previously, crowds are right -- don't fight the tape -- until they become an emotional mob. We are seeing early signs of that in Asia. Again, it doesn't mean it rolls over tomorrow, but as someone who has been Bullish on Japan for 2 years and Korea for 1, and most recently Malaysia, I fear we could be later in the investment cycle than I originally believed. (Facts change, and I am compelled to adjust to them).

5) Lastly, the single most common emailed question I recieved after the Cult of the Bears series was this: How on Earth can you be Bullish short term but so Bearish long term? The answer is that I use both techncials for the short term and the macro top down economics work for the longer term.

Shorter term internals / Technicals are positive; Longer term, the Macro is negative.

I do not worry about the day-to-day, focusing instead on trading 30-90 days out, and investing 1 to 2 years. In fact, as to the day-to-day, I'm surprised the response to GDP wasn't more Bullish, along the lines of "Hey, this is proof positve the Fed can now stop!" But that's not my forte, and I never try to guess the day gyrations.

Norm then noted:

Your year-end target on the S&P represents a 31%+ decline from today's prices. An 11-month decline of that magnitude in the S&P is nearly unprecedented and certainly represents a bold call.

My response was: 

Actually, 25% corrections are more common than most investors realize -- especially in secular bear markets. They are hardly the black swan events many make them out to be.

From 1966-1982, the market saw 5 sell offs of ~25% or more. The chart here shows corrections of 25%, 36%, 45%, 27% and 24% over the course of 16 years. That's one every 38 months or so. Our last 25% correction was July 2002 -- 42 months ago.

So a 31% correction will hardly be an earth shattering event, and if it comes to pass, it will likely be a response to many issues.

When the Business Week predictions came out, and I saw I was the low man, I was, quite frankly, aghast. I assumed I'd be in the bottom quartile or even decile -- but not low man on the totem pole. Remember, we had Bill Gross calling for Dow 5000 and even more Bearish guys saying much worse. I suspect the more Bearish participants just chickened out -- but that's probably because they are smarter than I.

Given that Lions pick off the gazelles that stray from the herd, I would have much preferred to be near the bottom, rather than the outlier . . .



1/27/2006 9:46 AM EST
RealMoney - Columnist Conversation

A few quick comments
1/27/2006 7:31 AM EST
RealMoney - Columnist Conversation

Hardly unprecendented
1/27/2006 10:37 AM EST
RealMoney - Columnist Conversation

Friday, January 27, 2006 | 12:45 PM | Permalink | Comments (5) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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Shorting gold? Check out the Big Balls on Barry! Too volatile for my taste but it has nowhere to go but
down when equities fall. I can't recall a shakedown
in equities that didn't also impact gold. The correction
that began in March of 2000 is a perfect example.

I've also felt that Japan is topping out. According to my
charts I see trouble after the Nikkei crosses 16,500.
I always read your blog and found you bullish on Japan still and that gave me some pause.

It's nice too see a chart reader confirm this though.

What do you think of Taiwan? The index is still below
the 1990 high of 12,000. Marc Faber has been playing
it up also.

Posted by: Mike | Jan 27, 2006 1:07:36 PM

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