Volume I, Issue 44

BASEBULDING CONTINUES AS MARKETS DECLINED UNTIL OCT. 10 AND HAVE BOUNCED OFF OF THOSE LOWS FOR TWO WEEKS NOW. INTERBANK LENDING RATES CONTINUE TO MAKE PROGRESS TOWARDS LOWER LEVELS BUT RECESSION FEARS HAVE NOW TAKEN CENTER STAGE. HISTORY IS THE BEST GUIDE AT A TIME LIKE THIS.

The Oct. 14 update stated that we had likely seen the worst of the declines due to the capitulation style selling that occurred on Oct. 10. I explained that the next stage before a rise should be a base-building stage for seven weeks or so. That is exactly what is happening so far. In the last two weeks there have been some major declines, but there have also been huge advances. The net effect is that decline of the major North American market averages has been halted since Oct. 10. The base-building stage is the process of shifting the ownership of stocks from weak hands to strong hands -- from individuals and institutional investors who borrow too much money to invest, to those who can afford to hold them. Remember, for every seller there is a buyer. It is encouraging to see that corporate insiders, who know the companies they work for better than anyone else, are buying shares in their own companies at the highest rate in 10 years. While they are not usually accurate to the day or the week of the market low, this type of buying typically happens near a low point. Insiders can sell for many reasons, but they only buy for one reason -- to make money. Their action shows that they have a lot of confidence in their futures of their firms and believe that share prices are a real bargain now.

This current chart shows that the lows in the DJIA occurred on Oct. 10. It also shows that the markets have been base-building since then. Each line is one week.

The positive developments of interbank lending rates falling almost 50% from their highs and sharply lower oil prices have been overshadowed by concerns of a global recession. There was a very severe recession in the US during 1973 and 1974 during which the DJIA declined 45%. US equity markets have already declined 45% from their peak since last October. Therefore, even if there will be a major economic slowdown, it has likely already been factored into current equity prices.

Almost every decline in US markets has been less than 50%. The only exception occurred during 1930 to 1932. Even after the crash of 1929 (when there was a stock market bubble) when stocks declined 45% over several months, prices rose 50% in four months after before declining further. Keep in mind that this is a credit crisis where real estate is overvalued. This is different than in 1929 when all stocks were very overvalued and 2000 when technology stocks were overvalued.

The last time there was a credit or liquidity crisis was in 1907. (It is interesting to note that the Egyptian and Japanese stock markets crashed in 1907. Therefore, this is not the first time that global markets and economies have moved together -- it has been common place for over a century.) The DJIA declined by 45% over one year and bottomed in November 1907. If you look at the chart below, you can see that the DJIA traded in a range for 3 weeks after that, exactly like it had now. Charts merely document how the masses react to a certain situation. If is very interesting to see that a similar pattern of human behavior seems to be taking place during this liquidity crisis and the crisis in 1907. Time will tell if the bottoming process and rise will follow the same pattern too.

In summary, the current decline is very close to the maximum decline that markets experience. The average bear market lasts 13 months and this is twelve months since the Oct. 2007 high in US markets. The base-building process could continue until late November. A major longer-term advance should follow if history is any guide.

This shows that the DJIA followed a similar pattern of decline during the liquidity crisis in 1907 compared to the current liquidity crisis. Will the bottoming process and rise after follow now too? Time will tell.

Bonds - The long term oscillators issued a buy signal for Canadian bonds last week by turning up just before a big rise in price and decline in yield. The oscillator turned up for US bonds this week, also issuing a buy signal. Bonds should do well if there will be an economic slowdown. This could indicate that confidence is returning as investors are now willing to buy more than just short term Treasury Bills.

Commodities - The sharp rise in the US dollar, prospects of slowing growth, lack of liquidity and extreme aversion to risk has caused free-fall declines in many commodity prices and currencies. Selling by leveraged institutions is likely responsible for much of this volatility. Nonetheless, prices are extremely oversold and should rise significantly when things start returning a little bit closer to normal. See the indicators for gold and oil below. Resource stocks are also extremely oversold. Many of these stocks are now base building. When the long-term oscillators turn up from these deeply oversold levels and the short-term trend charts turn green, it will indicate that the sell off is over. See gold and oil charts below.

Currencies - Americans have now been selling foreign assets that they purchased as the US dollar declined in value for years. Bringing this money home for safekeeping is one of the reasons for the spectacular rise in the US dollar and the precipitous decline in most other currencies expect the yen. Rightly or wrongly, when the going gets tough, the US dollar is still the preferred choice during a flight to quality. The long-term oscillators for the Canadian dollar and the euro are now where major long-term moves to the upside have started in recent years. This can happen at anytime. The long-term oscillators can often turn up one or two weeks after the low.

This current chart of the Canadian TSX Index also shows the base-building that has occurred since Oct. 10. The Canadian market usually follows the US markets, which usually lead global stock market.

The long-term oscillator for the SP 500 is now very oversold and back to the level it reached on July 15 when the financials bottomed for the first time. It is so low that it can turn up anytime now.

This short term trend indicator turned red (indicating a downtrend) for the SP 500 Index in September. When it turns green (uptrend) it will be the first indication that the sell off is over.

The oscillator for the Canadian TSX Index is also very oversold and can turn up anytime to indicate that a rise is beginning.

Last week the oscillator for Canadian bonds turned up giving a buy signal just a day before a major spike to the upside. This week the same oscillator for US bonds turned up issuing a buy signal.

The long-term oscillator for gold is higher than it was a few months ago even though the price of gold is lower. This is a positive divergence.

This short term trend chart turned red for oil on July 17 when the price of oil was at $130. On that day I sent out a special update stating that oil was peaking. Now the price is in the mid sixties. When this turns green it will be the initial sign that oil and perhaps most other commodity prices will rise again.

The euro and most other currencies have fallen sharply against the US dollar. You can see that the oscillator is now as oversold as it was in 2005 before an historic three year rally began. Hang on to your hats!

When this short term trend chart for the euro vs. the yen turns green, it will be the first indication that the unwinding of the carry trade is over. You can see that this turned red in early August and has stayed red ever since.

Note from the Communications Coordinator

On Wednesday, Oct. 22, the Chart-of-the-Day was unintentionally delivered to all Bulls Zen Bears email subscribers. We apologize for the confusion.
If you enjoyed reading the Chart-of-the-Day, please visit the daily blog.

Volume I, Issue 43

MARKET ACTION CONFIRMING THAT THE DECLINING TREND HAS TRANSITIONED TO A BASEBUILDING STAGE. LACK OF LIQUIDITY MEANS PRICES DO NOT REPRESENT TRUE VALUE. SHARP DROP IN OIL IS THE BIGGEST STIMULUS PACKAGE WITHOUT COSTING TAXPAYERS A PENNY.

The Oct. 3 and Oct. 10 updates explained that when markets bottom in October, history shows us that the average day is Oct. 10. History seems to have repeated itself very accurately as it seems more and more likely that investor capitulation exhausted the heavy selling pressure on Oct. 9 in the US and Oct. 10 in Canada. Last week, I mentioned that the worst of the decline was likely over. By the end of last week, several prominent US analysts were echoing my conclusions. In spite of some sharp declines on Wednesday and Thursday, US markets experienced the biggest weekly gain since the previous bull market began in March 2003 with a gain of 4.6%. The TSX Index rose 5.5% for the week. While the markets obviously need to rise a lot more to recover their losses, it was a major change in the declining trend seen since August.

Markets that turn around and go straight back up (a V bottom) usually happen during a long-term downtrend such as 2000 to 2002. A double bottom (W bottom over seven weeks or so) usually happen at the end of a decline before a major long term rise. Therefore, if Oct. 9 was the initial low, market prices should go up and down within a range until late November. At that time a powerful new long-term rise could begin. Do not be too surprised if there is some scary market action in late November when the final low point could be probed. It could be close to the Oct. 10 low. Below, please see the chart of the SP 500 during the the October 1987 crash showing the double bottoming action between the Oct. 19, 1987 initial low and the Dec. 4 final low market by the arrows. The next chart shows the most recent market action for comparison purposes. The Canadian markets followed this trend very closely.

Right before the 1987 crash, stocks were overvalued by 40% and fell 40%. In 2008, stocks were not overvalued and by some measures are now undervalued by more than 30%. The 1987 crash was a stock market problem caused by overvaluation. This is a credit crisis caused overvaluation in real estate and easy credit. After the 1987 crash, some real estate deals were canceled and fears of a depression were widespread, yet there was very little damage to the economy. The same concerns were raised after the 2001 terrorist attacks. American consumers have confounded the pessimists many times. Whatever showdown occurs may already be reflected in current stock prices.

1982 Compared to 2008

While there are man issues to be concerned about right now, I think the economic problems in 1982 were much worse than they are now. In 1982 interest rates were over 15%. Many businesses were losing money and going bankrupt while individuals were losing their homes because they could not afford the payments. Unemployment rates were 12%. North American banks were teetering on edge because of all the money they had loaned to Argentina and Brazil. Now interest rates are at 4%, unemployment rates are closer to 6% and Canadian banks are strong. Iceland has only 300,000 people compared to the millions in Brazil. While this situation is frightening, I think that 1982 was the closest the world economy has been to a collapse in my lifetime. It is important to keep our situation in perspective.

Liquidity is Continuing to Improve

I would say that one lane of alternating traffic is now getting through the massive accident on the six lane highway of global liquidity. Three month Libor rates had the biggest fall in nine months today. The TED Spread (an indicator of the rate that banks charge to lend to each other) has declined from an all time high of 4.63% on Oct. 10 to 3.64% on Oct. 17. Below 1% is getting closer to normal. The lack of liquidity (as shown by the high TED Spread) has resulted in prices that have changed so much that they do not represent true value, even if we are in a recession. For example, recently US investors were paying money to invest in US Government Treasury Bills to keep their money safe instead of earning interest. Even now, the rate on a one-month US T-Bill is only 0.35% while a three-month T-Bill is 1.16%. There should be little difference in those rates. This is concrete evidence that the pricing for some assets is out of line with reality. However, credit conditions are improving. As they get closer to normal, there could be a major adjustment to higher prices of currencies, commodities and stocks, together with a move to lower prices for the US dollar and short-term T-Bills. Using the analogy mentioned in previous updates, prices now can be compared to what a convertible can be sold for an instant during a January snowstorm. It is not snowing as hard any more compared to a week ago. Many despise the stock markets for their volatility. It is important to realize that stocks trade at a price for which they can be sold at every day in light of current market conditions. I would venture to say that every house, vehicle, property, and business would experience similar volatility if they were appraised every day for their cash value in light of current economic conditions.

Oil Price Decline is a Huge Stimulus Package

There is talk of another stimulus package for US consumers. The free fall in oil prices from $145 per barrel to $70 is an economic stimulus that is many times greater than any government can put together. It also does not cost taxpayers a penny.

Overall Picture

Corporate insiders are now very heavy buyers of shares in their own companies. Stock prices are very undervalued and cheap. There is more cash on the sidelines compared to the value of the SP 500 than at anytime in the last 30 years. This includes 1982, when 15% interest rates provided a very attractive risk-free alternative to other investments. Pessimism and fear is at levels rarely seen (see VIX chart), but always seen at a market bottom. Interest rates are low and declining. Markets fall before the economy deteriorates, and rises well before it improves. The markets appear to have made the transition to a base-building stage. In conclusion, all the pieces of the puzzle for a major market low are falling into place!

Bonds - Long-term oscillators give a buy signal for Canadian bonds.

Commodities - No clear signals for gold and oil yet.

Currencies - The US$ is still king of the currency castle but how long will that last? No change so far.

The long-term oscillator for the SP 500 has not turned up yet but than can take another week or so.

The SP 500 and this US Banking Index long-term oscillator are much higher than they were in July even though the Banking Index tested the July low and the SP 500 declined well below the July low. This is a positive divergence. These need to turn up to confirm an uptrend.

The Volatility or Fear Index, reached 81 last week and closed today at 54. The peaks during other severe declines have been close to 50 during the 22 year history of this indicator except for the day of the 1987 Crash when it reached 150. It is hard to see, but it appears that the long-term oscillator is close to peaking. All the indicators will likely turn positive together in due course.

The long-term oscillator for the TSX is still very oversold and low. In 2001, the markets bottomed on September 21 and the long-term oscillators turned up two weeks later so they might just take another week or two to move higher if positive action continues.

Lower interest rates and the prospects of a slower economy should be positive for bonds for a while anyway. The long-term oscillator has just turned up to issue a Buy Signal for Canadian bonds but not for US bonds.

Down the road, recession concerns could be replaced with inflation concerns due to all the growth in the money supply.

Gold has declined, as fear seems to have peaked. However, gold could move higher as liquidity improves, confidence returns and the US$ weakens. The oscillator needs to turn up to indicate that another uptrend is underway.

Wouldn’t T. Boone Pickens and other investors who lost a lot of money on oil positions appreciate the signals that this chart for oil has given since summer? The long-term oscillator for oil has not turned up yet either. It will likely turn up along with gold and the stock oscillators.

The US$ skyrocketed as US investors repatriated funds from around the world during this time of crisis. Is the US$ really worth 15% more than the Canadian dollar given the difference in our economies? There will likely be a major adjustment in the future.

The euro also fell sharply against the US$ and the yen as the carry trade was unwound. The oscillator is very oversold and will likely turn up together with the oscillators for most stocks, commodities and bonds.

There will likely be a lot of action and a major turnaround at some time in the future. The indicators shown here should confirm this change soon after it occurs.

Volume I, Issue 42

STATISTICAL AND TECHNICAL INDICATORS REACHED HISTORICAL EXTREMES ON FRIDAY, DURING THE TIME IN OCTOBER WHEN MAJOR MARKET LOWS HAVE OCCURRED BEFORE THERE IS EVIDENCE THAT THE SELLING WAS EXHAUSTED ON FRIDAY AS LEVERAGES AND PANICKED INVESTORS CAPITULATED. IT IS VERY LIKELY THAT THE WORST OF THE DECLINE HAS BEEN SEEN. HOWEVER, MARKETS COULD STILL BE VIOLATED UNTIL DECEMBER BEFORE A MAJOR RISE IS LIKELY TO BEGIN.

The US SP 500 Index has been down 46% from its high, which is very close to the maximum bear market declines of 49.1% in 2002 and 48% in 1974. (The TSX lost 42% from the June 2008 high.) The average bear market lasts 13 months. This is twelve months since the Oct. 9, 2007 high in the SP 500. There are almost no shares making new highs in New York, there are only 3.2% of US stocks which are trading above their 30-week moving average and 1.2% above the 200 day moving average. Cash on the sidelines can now purchase over one third (35%) of the whole SP 500 Index. These are historical extremes that are rarely seen, if ever. When they have been seen in the past, it was been very close to a low point in stock prices and within two months or so from the beginning of a major advance.

Major declines have usually ended in October. When they do, the average day of the month to bottom is on a Thursday on Oct. 10. (Major market lows occurred on Thursday, Oct. 3, 1974, Thursday, Aug. 12, 1982, Monday, Oct. 19, 1987, Thursday, Oct. 11, 1990, Thursday, Oct. 8, 1998, Friday, Sept. 21, 2001, and Thursday, Oct. 11, 2002.) Friday was Oct. 10. I do not know why this occurs, but these are the facts.

If I use the clients in my office as an example , there was very little selling by individual investors during this decline. It was likely professional money managers and investors using borrowed money who were doing the heavy selling. If an investor borrows on the value of the stock positions and prices decline, he is forced to sell some stocks or invest more cash. The more stocks fell, the more that had to be sold until all the stock in weak hands was flushed out. Relentless declines forced individual investors, Russian oligarchs and American Tycoons to sell and realize losses in the billions due to investing with borrowed money.

Part of the reason for the sharp declines was selling when there was a lack of liquidity. There were also declines of historical proportions in commodities and currencies as US investors pulled in assets from all over the globe back into home into US cash. Some of the prices seen were just irrational. Prices should find some sort of reasonable level as time progresses.

There is evidence that we saw a climax and simultaneous exhaustion of selling on Friday, Oct. 10. This is call capitulation, which means to surrender. Capitulation occurs when there is very heavy volume as panicked investors sell, causing a sharp decline in prices, followed by a sharp rise. On Friday, the SP 500 Index was down 7.6% within the first minutes of trading on the heaviest volume of the year. There was extremely heavy volume on the TSX as well. After rising into positive territory, the SP closed down less than 1% on Friday, which was still up sharply from the low. Then on Monday, Oct. 13, the DJIA had the biggest rise since 1933, rising 937 points or 11%. Today, the TSX played catch up after being closed yesterday by rising 890 points or 9.8%.

If the decline in equity, commodity and currency prices is close to the end, what happens next? Sometimes the markets the rise or stabilize for a few weeks and then retreat close to the previous low four to seven weeks or so after the initial low. After that, a new, strong up trend emerges. That means that we could experience a strong recover for the rest of October and then experience some weakness until the end of November before a strong rise begins. It will be important not to become discouraged and sell during that last and final period of potential weakness just before a rise that we have all been waiting for takes place.

While a double bottom is a very common occurrence, (see a perfect example of a double bottom in the Banking Index chart below), the Canadian and US financial stocks look like they have just completed a double bottom by retreating to or below the July 15 lows on Friday, and then rising sharply above the lows early this week. This throws an interesting curve ball into the normal scenario. Since the prominent financial stocks have already gone through that process, it may mean that there could be more of a consolidation process in the next month or so, and another low could be higher than Friday's low. Resource stocks and other sectors, on the other hand, may have to complete the double bottoming process. I will continue to do my best to keep you informed as new evidence emerges.

Bonds - Canadian and US Bond yields rose some more last week, indicating that money was moving out of the safety of government bonds as mentioned in the special update last week. This was the first sign of a turnaround in equities on Friday. However, bond prices are approaching oversold levels but the indicators have not turned up yet.

Commodities - The long term oscillators for gold and oil are rising. I believe it would be prudent for investors to see evidence that the lending between banks is improving before taking positions.

Currencies - The CAD$ had the biggest drop since 1971 on Friday. When the going gets tough, the US$ cash is still king. I would recommend waiting for improved liquidity and the trend charts to turn positive before making any major currency or commodity moves.

The long-term oscillator for the SP 500 is much higher now than it was in July even though the Index is much lower. This is usually positive. It could turn up with any time.

The July 15 low and last Fridays low (the green bars) for the US Banking Index is a classic example of a double bottom that often occurs at a major low. The oscillator is much higher than it was at the July 15 low which is positive. It can turn up soon with more stability here.

Volatility recently spiked to highs not seen until 1987, yet the oscillator did not reach a new high. This indicates that volatility is peaking which is positive for equities. The calculation for the Volatility Index was reconfigured after 1987 so the high of 150 by the VIX during the 1987 Crash may not be comparable.

The long-term oscillator for the TSX and the TSX Energy Index is on the verge of turning up and has not changed too much recently after bottoming on August 25. When this turns green it will be the first confirmation of turn around.

The long-term oscillator for gold is still positive. If one looks back to 1987, you can see that gold stocks often follow the equity markets more than they follow the price of gold. That is why they could perform better as equities improve.

During the week of the 1987 Crash, US and Canadian bonds rose 10% as interest rates were slashed by 2%. This time they have not performed very well during this crisis as it seems that short-term cash was the asset of choice. However, they are approaching the oversold level now.

The long-term oscillator for gold is still positive. Gold performed better after the Crash of 1987 than it did during the Crash. Perhaps it will follow the same pattern now.

The short term Trend is still negative for oil after it turned negative on July 17. It would seem that the price is poised to rise when things start returning a little closer to normal.

It would be prudent to wait for this short term Trend chart to turn green before becoming positive on the CAD$.

The Euro has not turned green or positive yet.

The euro has been negative vs the yen ever since early August.