Libya… Like Egypt?

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

For many, many weeks, I have discussed the stock market's need for a pullback. A short-term cleansing to refresh the rally. Unfortunately, far too many others have been talking about it as well, so the market decided not to accommodate, until it wanted to.

Several weeks ago, I offered that the pullback so many were looking for would probably come out of nowhere with some geopolitical event and would quickly lop 4-7% off the major indices. Tuesday was just that day, following more unrest in the Middle East. This time it was Libya with its big supply of oil. Since I have been writing about this pullback since late last year, I certainly deserve zero in the way of credit for it finally happening. I mean, even a broken clock is right twice a day! Call for something long enough and it's bound to happen at some point.

As I've mentioned before, it's still incredible that the Dow has not closed below its 20 day moving average (average price of the last 20 days) since 12/1 as you can see below. That's historic momentum! I am going to go out on a limb and say that the market will not respond the same way as it did with Egypt and this time it will close below the 20 day moving average in the coming week or so.

But at the same time, I also do not believe this is the start of a real correction (10%+ downside). Corrections typically do not start with a bang like we saw on Tuesday, just one day removed from the high. Instead, more significant declines usually start slow and small, building towards the large down days, like snowball rolling downhill and gathering momentum. When is a snowball and market going the fastest downhill? The second before it hits the bottom. In this case, we could (and should) see some more downside, but I don't think it's anything serious, yet.

I'll be watching for signs of sector rotation among leadership, both positive and negative, along with any indication that the emerging markets are ready to percolate again. As the major US indices have steadily marched higher since December, which you see from the above chart, emerging markets, chart below, weighted towards the big countries like China, India and Brazil, have totally lost their leadership role and unable to make upside headway.

Equally as important, the performance of the high yield (junk) bond market must be closely watched after the single most dramatic bull market run in history. For the most part, as long as the high yield market is confirming the rally and outperforming on the downside, the structural bull markets in stocks should continue, for now.


Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz

Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

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Q4 in Review

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

As I reviewed Q4 of 2010, I was shocked to find how many folks had a sudden case of selective amnesia. It’s an affliction that affects people in the investment, usually two years after a bear market.

I think we all know and remember how tough 2008 was. Emotionally, financially, economically, systemically, politically. The very core of capitalism was being threatened, not to mention the very real risk of a modern day depression. Money managers all over the world saw their worst weeks, months, quarters and years of their entire career. The "deer in the headlights" syndrome fell over a good part of the industry.

What I find so "interesting", just three years later, is how many people either predicted the whole financial crisis and bear market or actually had an up year for clients. I cannot remember the last person who told me they got crushed in 2008. All I hear now is "well I knew it was coming" or "we finished in the black". You knew what was coming? You finished in the black what? Hole?

It's really incredible. I don't know if it's revisionist history or selective amnesia, but it sure sounds like a lot of bull to me! While our business really grew in 2008, and none of our programs lost what the market did, I don't think I want to live through a repeat of that scenario any time soon. There was nothing fun about it.

Turning to the highlights of Q4… Lacking during the final three months of 2010 was the theme of non U.S. geopolitical news. On that front, it was nice and quiet! North Korea may have rattled their saber, but that seemed more like a child craving attention than a nation on the verge of war.

The major headline news was two-fold and occurred during the same week in November. First we had the all important mid-term Congressional and Gubernatorial elections where the Republicans achieved an historic victory, more than reversing the tide from 2008. As I've written about before, I believe this will have positive implications for the markets and economy in 2011 by preventing the largest tax increase in history as well as temporarily cutting the payroll tax by two percentage points.

Not to be overshadowed, Bernanke & Co. formally announced the worst kept secret on Wall Street, another round of quantitative easing or QE2 to the tune of another $600B through June 2011. By QE2, the Fed has been buying the Treasury Bonds sold by the Treasury in hopes of keeping interest rates down.

Interestingly, the unintended benefit of QE2 has been the very positive correlation between the Fed's buying and the stock market rising. Almost every single day in December was up for stocks without even a single down day of 0.50%. That is historically remarkable! Given how poorly QE1 ($1.2T) supported the markets, it's astonishing on the surface that QE2 has been a risk investors' home run.

On closer examination, QE1 was attempted while the markets were in a clear downtrend, actually free fall. The government was trying to catch a falling knife. Bernanke & Co. must have learned their lesson as QE2 was initiated during a solid uptrend with much better results so far. Additionally, just like with interest rate cuts, it does take time to have all that money filter through the system. While Q4 was void of bad news, and I certainly hope that continues, the odds don’t favor another long stretch without some shoe falling somewhere.

FYI, I will be on CNBC's Worldwide Exchange on January 20 at 5:35am.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.


Until next time…

Paul Schatz

Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

Storms Brewing for the Stock Market

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

With the month of September and third quarter of 2009 just ending, it’s a good time to reflect on the financial markets and take stock of where we are and where we may be headed. As individual investors, it’s important to stay on top of your portfolios and I usually recommend doing this quarterly with more emphasis placed on the annual review. The vast majority of investors do not want or enjoy valuing their holdings daily, weekly or monthly, and frankly, that’s why you hire advisors. It’s our job to get you from day to day, week to week and month to month.

Since the March 6 bottom in the stock market, we’ve seen a truly historic rally across the board. It’s certainly been “the rising tide lifting all ships”. Unlike previous attempts to rally during the bear market, selling into strength has not been rewarded as the pullbacks have been very brief and shallow. That in itself was an indication that the character of the stock market was changing in April and May.

By the time June came, a very important hurdle was overcome. In most bear markets, rallies do not last more than 11 weeks. Once we got past that point, it was further confirmation that the overall tone of the market had changed from down to at least neutral, if not up. And similar to 2003 when we last emerged from a bear market, the early June peak led to some much needed digestion or consolidation over the next month or so.

Since the last decent low in July, we’ve seen the stock market embark on another nearly vertical run to its mid September high. Similar to what we saw coming out of the March bottom, anyone who sold into the rally was not rewarded and forced to either chase the rally higher or sit uncomfortably with cash during a rising market. As someone who made what I felt were good sales at the time and held some cash, I would much rather wish I had more skin in the game than get stuck during a collapse with too much on the line!

Fast forward to today and for the first time since the rally began in earnest, there are some storm clouds brewing on the horizon. To begin with, several sentiment surveys have come full circle, now showing far too many bulls versus the bottom in March when we saw almost all bears. Similarly, small-time option traders, the ones I commonly refer to as mom and pop, have been exhibiting very bullish tendencies of late.

None of the behavior above can be construed as positive for the market since it usually occurs near market peaks, not valleys. Think of it this way, when everyone is sure of a particular outcome, how often do we see the opposite happen. It’s worse in the financial markets. If the masses are very positive, wouldn’t that mean they already invested and have little cash left to propel things higher? If everyone bought a blue Toyota this year because it got 1000 miles to the gallon and all service was free, who would be left to buy next year?

Besides sentiment not being favorable right now, the stock market has lost “the rising tide lifting all ships”. Typically, as rallies get long in the tooth, we see fewer and fewer sectors keeping pace and leading the charge higher. And those that turned early, say in January or February, will likely turn early before the rest of the market begins to correct. That’s certainly the case now with the Chinese market underperforming. Here in the U.S., the housing stocks, transportation, materials, energy, agriculture, metals and mining have all begun to lag the indices, signaling a “tired’ stock market in need of rest. Should the various technology groups begin to follow suit, it won’t be long before a widespread correction sets in.

Finally, the catalyst for the summer rally was based on earnings that were better than expectations and much “less worse”. With earnings season officially starting on the 7th at 4:00 pm with Alcoa, the likelihood of a repeat performance is remote. At best, history says we can expect a neutral period, but most of the time, following such strength, the next period is weak.

Add it all together and I come up with the best opportunity for a correction since the bull market began in March. If I had a crystal ball, it would say that stocks are in the topping process and should be completed by the 16th. If the correction appears, it should be the most significant since March, taking 8-15% off the major indices. In Dow Jones Industrial numbers, that’s a decline of 800-1500 points that should wrap up sometime in late October to mid November.

For those curious as to why I have such a big range in the numbers, it’s because it’s tough to pinpoint the downside target until we begin to see some weakness and how investors behave. If people use the 8% decline to buy and become even more positive, that opens the window for another 8% lower to clean out the weak-handed holders and get folks to worry more that their recent purchases will be losers. If, on the other hand, after an 8% correction, the media is talking about the end of the bull market and much lower prices to come, chances are the correction is over already.

The good news is that if we see a correction in stocks, it should only serve as a much needed and healthy pause to refresh, with higher prices to come later this year and in early 2010. If by some chance, we get to Halloween without any weakness, the window of opportunity for a significant correction will likely close until the New Year.