How does one identify the underlying trend of the market for optimizing profits?

As of May 9, 2008, the market as measured by the S&P 500 (SPX) is currently in a major correction or bear market. In determining the market trend, the relationship between the 15-week and 40-week EMAs (Exponential Moving Averages) is a very useful investment tool. If the 15-week EMA is above the 40-week EMA, the market trend is up. Conversely, if the 15-week EMA is below the 40-week EMA, the market trend is down. Take a look at the following ten-year chart that illustrates the significance of the relationship between the 15- and 40-week EMAs:

Clearly, the 15-week EMA lies below the 40-week EMA. Therefore, from a market trend perspective, the market is in a major correction. Over the past ten years, this investment approach has been excellent. If the investor would have sold his/her S&P 500 investment in late 2000 at approximately 1,450 and then purchase it back in early 2003 at approximately 925, that investor would have eliminated a 36% lost. Purchasing at 925, early 2003, and holding the investment until January 2008, you investment return would have been 57%.

Currently, investors would be out of the market and in a money market fund or an inverse ETF, such as DOG, DXD, SDS, or QID.

It's Not Over Until It's Over

As promised from Thursday’s post, the identification of the graphs is as follows (Contrary Investor and StockCharts:

Over the twelve plus year period the 50- and 200-day EMA lines have crossed four times. Once in 1998, the 50-day EMA briefly pierced the 200-day EMA to the downside, suggesting a move into bear territory. The next cross to the downside was seen in late 2000 (dot.com debacle), warning of an equity market plunging into its largest and most extended bearish episode in many years. It was not until May of 2003 that the 50-day EMA crossed back up through the 200-day EMA. And, in January 2008, we have seen a cross to the downside. Until the 50-day EMA moves back up above the 200-day EMA, my position is to assume a defense investment position, such as being invested in a money market fund and/or inverse ETFs like DOG, SDS, DXD, and QID. Also, had one followed this very simple indicator over time, one’s financial health could have been greatly enhanced.

Double Your Pleasure or Double Your Pain

Since January 2008, my position has been that the market is either in a major correction or the start of a "Bear Market."  Therefore, I thought it was about time to revisit that position.

When it comes to the stock market, I am a trend follower, or momentum trader.  I adhere to moving averages as a technical tool to determine and identify the trend of the market, i.e., Bull Market and Bear Market.  Overtime, the 50-day EMA and 200-day EMA has been very useful in identifying the underlying trend of the market.  That is, when the 50-day EMA is above the 200-day EMA, the market trend is up.  Conversely, when the 50-day EMA is below the 200-day EMA, the trend is down.  (You may want to read some of my previous posts on the subject of moving averages.  You may find them very educational and profitable to your financial well-being.)

Referring to the above two charts, I have left off the time in terms of when the two charts were created.  Both charts are depicting that the 50-day EMA has turned up, even though it still lies beneath its 200-day EMA.  Is this a foreshadowing event of the start of a new "Bull Market?"  The market, as depicted by the S&P 500, has rallied over the past month, as indicated by one of the two above charts.

Tomorrow, I will reveal the dates and the results of the above charts.

Assurance from President Bush

Bush gives assurance that the U.S. is "on top" of the financial situation. Wow! Isn't that reassuring as the dollar plummets against the EURO and the price of gold exceeds $1,000. Thank you, President Bush. This is the same type of rhetoric that we heard a year ago about the "sub-prime mortgage" problem. Let's put the blame where it directly belongs. That is squarely on the shoulders of the Federal Reserve System.

The Impudent Boldness of Greenspan

Former Federal Reserve Chairman, Alan Greenspan, warns that we face the worst financial crisis since 1945. This is the same man whose tenure at the Fed gave us the dot.com debacle and the sub-prime debacle through his expansionary monetary policy of excess liquidity. So much for accountability, Mr. Greenspan.

Market Update

The market as measured by the 15-week EMA in relation to the 40-week EMA continues to correct. As long as the 15-week EMA lies beneath the 40-week EMA, this market correction or bear market will continue. Therefore, investors must continue to take a defensive posture during this time. Either stay very liquid (Money Market Fund), short selective securities, or purchase inverse ETFs, such as DOG, SDS, SIJ, and/or DXD.

Double Jeopardy

What you are looking at in the chart below is the 50 and 200 day moving averages of the very same S&P over two different cycles or time horizons. Focus especially on the relationship of the 50-day MA to the 200-day MA along with the directional movement of the 200-day MA. Does this chart along with the moving averages provide you with any clues about the direction of the market? Tomorrow, we will identify the time horizons.

Source: Contrary Investor

Çredit Crisis: Precursor of Great Inflation

An excellent article on the causes of economic "booms and busts" is not only thought provoking but just might make you mad. After you read the article, ponder the following questions: What is the Fed's explanation for economic booms and busts? Who is the Fed accountable to? Why does the Fed appear to get a "free pass" from the media and politicians?

Bear Market Rallies

Alan Abelson, who writes a column for Barron’s, states in last week’s edition that during the 2000-02 bear market, there were no fewer than 16 rallies of at least 5% in the S&P 500, each lasting on average about a month, and no fewer than 35 bounces of 5% or more in the NASDAQ, which still managed to wind up losing nearly 80% of its value. In other words, this bear market is not over yet. Therefore, your investment mentality should be the mirror image of what it was during the bull ride from 2003-08. That is, sell the rallies.

Dollar as the International Reserve Asset

What are the implications for the value of the dollar, given the following chart?

The Great Fiscal Stimulus Package of 1929

Does the title sound familiar, with the exception of 1929? Read the article and see if you can substitute 2008 into the title. Article is located at Mises.org. Make sure that you follow the link to the original article that was published in Times Magazine.

Need One Say More

The Market Has Spoken!

The weekly 1387 level on the S&P 500 was taken out this week (See chart below). Given this penetration, we are now either in a "major correction or bear market." Therefore, our focus will be on sell signals rather than buy signals. Sell signals are the mirror image of buy signals. Our primary bear market instrument is the SDS, which is an inverse ETS of the S&P 500. As an inverse ETS, its price rises when the market (S&P 500) sells off.

Since the market is extremely oversold, we should expect the market to rally short-term. Keep-in-mind that this is not a time to me looking for a major bottom. Don't get sucked in by those pundits who will be screaming that this is a golden opportunity to buy. Prepare yourself mentally to either short the market or purchase inverse ETFs, like SDS. The best chance for the market to make some kind of a bottom, based on market cycles, is around March 27, 2008.

Source: Jack Chan's "Simply Profits"

Inflation Jumps in 2007

Inflation rose to 4.1% in 2007 from 2.5% in 2006, which is the largest increase in 17 years! Take a look at the following chart of the growth of money. That just might help explain a good part of the reason for the increase in inflation.

Market: Critical Junction

As indicated in my post of January 15, 2008, all four long-term indicators have now turned "bearish." From a short-term perspective, this market is very "over sold," which should generate a price reaction back to resistance near term. If this is a start of a new bear market, similar to 2001-2002, the SPX must take out 1387 on a weekly basis. See the following chart from Jack Chan at Simply Profits. I will monitor very closely this critical level.

Investment Trend

As we head into 2008, the market is giving very negative (bearish) signals. If you have followed this blog over the course of the past semester, you would have been keep abreast of the key turning points to the market trend, especially the SPX's weekly 17-and 43-EMA's, which has been refined to a weekly 15 and 40 EMA's. Over this semester, I will continue monitor this long-term indicator along with three others, which are from the "Contrary Investor." These three indicators are the SPX Trend Line from 2000, SPX's 80-week MA, and SPX's 10- and 40-week MA. All four indicators are currently negative.

S&P 500 Index: Home Building vs. Department Stores

The following chart does not bode well for overall consumer confidence and the economy, especially for retail sales as we enter the Christmas shopping season. Keep-in-mind that consumers constitute approximately 71% of GDP.

Source: The Big Picture

Today's FOMC Meeting

On September 17, the Fed cut the Fed Funds rate by 50 basis points to 4.75%. This was the first rate cut by the Fed in 18 months. The rationale given by the Fed was because of the precarious situation of the credit markets, which really means the subprime mortgage mess.

Today, the Fed will cut the Fed Funds rate by 25 basis points. At least this is the betting line over at the Chicago Board of Trade. 98% of the traders are pricing in a 25 basis point cut, while only 8% are pricing in a 50 basis point cut. I am firmly in the camp of another rate cut, because our credit problems (subprime mortgages and SIV's) are still with us.

The importance today is not the Fed's action but the reaction of the markets, currency and equity. Rates cuts are generally considered bullish for the equity market, except when a recession is looming on the economic horizon. Thanks to the Contrary Investor for providing the following insight on the rates cuts that preceded the previous recession.

On January 3, 2001, the Fed cut the Fed Funds rate by 50 basis points; and the S&P 500 responded with a gain of 5%. Interesting the rate cut a month ago resulted in a 2.9% increase in the S&P 500.

Learning point is that not all rate cuts are bullish, but rather the key is the reaction of the financial markets to any change in monetary policy.

Washington Mutual's Earnings To Suffer From Mortgage Woes

The "Wall Street Journal" has just reported that Washington Mutual, one of the nation's largest mortgage originators, expects to set aside nearly $1 billion on a pretax basis in the third quarter to cover potential future mortgage losses and record a $150 million writedown on mortgage loans it planned to sell. Chairman and Chief Executive Kerry Killinger said, "While we're disappointed with our anticipated third-quarter results, we look forward to an improved fourth quarter as we continue to see good operating performance in our retail banking, card services and commercial group businesses." Did you noticed that he did not mention any improved performance for the mortgage side of the business for the fourth quarter.

Technical Analysis: Would You Purchase this Stock?

Question: Refer to the following "Point & Figure Chart" that goes back to 2003 and decide if you would purchase this stock. Point & Figure Charts provide a long-term perspective of price action. The X's indicate the price is rising and O's indicate the price is declining.

Answer: In your response, indicate the reason for your decision. [There is neither a right or wrong answer.]