Putting the pieces together...

Ground Glass and Guesses

Ground Glass and Guesses

CXO Advisory quotes Ed Fiedler on predictions: "He who lives by the crystal ball soon learns to eat ground glass." However, several times each year I try to guess what the current market may be saying about the intermediate term investment picture. Currently two market analysts I respect come to the same conclusions by quite different methods. Glenn Neely and Carl Futia both think, at least for the moment, that stocks, TNotes (10 year), gold and the Euro are headed for significant drops. Both think SPX 1430 is a probable high: Neely thinks it will be the high for a long time while Futia thinks the market will correct but go higher over the next year or more.

My own feeling (rightly or wrongly) also has been that 1430 is about tops for stocks, and I had been planning to switch more to bonds. The chart shows some of the reasons why I think 1430 SPX is important:

Most of the talk everywhere I've been is about recession and/or inflation. Recession without inflation would normally be a good time for bonds/notes and for dollars. Since gold looks down to me, inflation is going to slow. The only explanation I can see for all four classes (stocks, TNotes, gold and Euro) going down is a mildly inflationary but continued mild slowdown/recession in the US during which short term rates rise (FED sits on hands). At the same time, the rest of the world slows more and the Euro drops.

Putting it all together, we might do best under such a scenario by putting some of our investment money into the currently most hated of all assets: US dollar short term cash or money market assets. I'm not making any radical changes, just adjustments and profit taking in inflation favored investments. I have had 20% of assets in inflation hedges and have 20% in "deflation" hedges(fixed annuity and cash). Half of the inflation assets are in gold which won't be touched, but I have been and am cutting back on the other half. I think natural gas is a long term bullish story so I might cut back only a bit there if at all. Gold and other mining stocks will get another cut and so will energy stocks apart from the gas income trusts. I will also cut back a bit on "generic" stocks and longer term bond funds.

I do think that bond or "income funds" like LSBDX/LSBRX (Loomis Sayles Bond) and RPSIX (T Rowe Price Spectrum Income) have the smarts to keep the income flowing without taking a hit. I think I've got it right, and in response to Ed Fiedler's remark about eating ground glass, I'll quote Peter Cook's proud saying in Good Evening (in New York, with Dudley Moore): "I have learned so well from my mistakes that I can repeat them exactly!"

The 2CS Revisited

The 2CS Revisited

The 2CS Sentimeter is my favorite gauge of the extremes of investor complacency and panic.  The 2CS is quite low at stock market price highs and quite high at important market lows. It is very simply calculated daily by multiplying the daily CBOE combined put/call ratio by the daily CBOE VXO. (You could use the CBOE VIX instead, but I prefer VXO as it allows me to compare with charts and data I have back to 1996.) Add up the daily P/C*VXO of the past five days and you have the 2CS. (Click on chart for larger version.)

The first monthly chart of the SPX shows the extreme 2CS value in red numerals at important highs and lows from 1996 to 2007. 2CS has been at or above 200 at most of the major crash lows since 1996, with the greatest bearish extreme of sentiment coming right after 9/11/01. The market low after the Russian default and LTCM crash of 1998 also had an extreme bearish reading as did the double lows of July and October 2002. At the re-test of the market low in March 2003, 2CS was 165.

The second and weekly chart of SPX since June 2007 shows up 2CS as an accelerated version of the 1998 to 2002 market. After August 2007 the SPX made new all time highs, but 2CS did not go as low as it had in February and March 2007. I call this "sentiment divergence" which was also seen in 2000. WE also sometimes see sentiment divergence on daily charts during smaller period turns. And, of course, the same can happen at lows.

As the market fell from the early October 2007 SPX high, two 2CS readings near 200 were seen at the January and March 2008 SPX lows.

Another 2CS historical finding, not all of which is shown on these charts, is what happens on the rallies between two successive >200 2CS market lows, such as 1998, 2002-2003, and 2008. In all cases the 2CS reached levels between 120-130 on the rallies between the lows, most recently 123 on April 7, 2008.

My judgment is that SPX may have seen "the" low but that another retest may have started this past week which will probably make a higher market low and smaller 2CS reading than at the previous lows of January and March 2008.