Where is The Stock Market Headed? 200 Day SMA

Since there really is no daily update for real estate, I want to discuss the equity markets today. So the stock market took a shellacking from its high in October 2007 to its recent lows, with the Dow losing 18.1%, the Nasdaq composite falling 23% and the S&P 500 falling 19.4%. Many are beginning to entertain the idea that this 20% or so decline constituted a "bear market" and that the climatic sell-off overseas and slashing of rates by the Fed constituted a capitulation, ending this nasty period and setting up the next bull market.

It should be so easy! In 1998 when Long-Term Capital almost brought the financial system to a grinding halt after more than a year of the "Asian contagion", the market got slammed for 2 months or so and the sell-off was replete with rumors of Wall Street firms about to go tapioca. The relentless bout of panic selling was met with a fed rate cut and boom, stocks were off to the races through 1999 and 2000. People would like to analogize today's market with that one....but I think they are dead wrong.

The reason for this is the action of one powerful indicator, which was flashing an all-clear sign in 1998.....but is not doing so today. As a portfolio manager I found this one simple indicator to be the most valuable in establishing a market mind set. Before I share this elementary concept with you, a couple of explanations. First why should you care? As Noah and I have been saying for at least 6 months, while the Manhattan real estate market is a special case versus the rest of the country, it is not immune to a recession, particularly one that is centered in Wall Street. We have cited lots of statistics and information to back up our belief that this is true and I think so far we have had a pretty good track record of being in front of financial market developments that have stunned and amazed many.

Whether we have just made it through a bear market in stocks or are beginning a period of lower stock market returns is likely to be very significant to the Manhattan real estate market. Second, Noah says "don't try to time the market", as you respond..."but isn't this just another example of you guys being closet market timers"? To this I would say that as a mutual fund portfolio manager, I never had the opportunity of trying to time the market, because my job was to be at least 90% invested in stocks at all times, and even when I was with a hedge fund, the risk of being wrong (fatal) prevented us from making significant directional bets on the market. Despite this, I always tried to pay attention to the technical side of the market and have a mindset regarding the overall direction of the market, which told me whether to be more aggressive or more conservative with my investments given the constraints I worked under. Noah has essentially been telling real estate investors the same thing. If you are raising a family and need more space, if you have a 4 year plus view, if you have ample funds, don't avoid buying because the real estate market looks like it may be dicey in the short-term. But have a mindset about what the future could be like and adjust your degree of aggressiveness if there looks to be significant signs of an acceleration or deceleration in the market.

Okay, lets get down to business. If you take a look at the chart above,which is from CBS Marketwatch, you will see a great example of a top in a stock or market. Charts work for both charts and markets, because they are just records of the trading patterns of the human market participants....who act the same over and over year to year, century to century, market to market. This chart shows how the market got creamed over the summer, made a nominal new high in October, got slammed back to the same level in late November, then tried to get back to its old high. The action over 6 months' time created a large overhead supply of stock people were holding at a loss, and would be tempted to sell on any rally that got them back to break-even. When this rally attempt "failed", in the same area where stocks spent most of their time going all the way back to May, people decided to dump their losers and the market got drilled to a new low. It has recently popped back up some, but even an optimistic article on CBS Marketwatch, which suggests that sector rotation is laying the groundwork for a new bull market notes: "Given the severe January breakdown, rallies to the S&P's neckline - the 1,400 area - will likely draw sellers." This selling probably started yesterday.

Now before I talk about my simple indicator, let me say that I don't like being bearish and it's been a drag cataloging all the negative complications of the residential real estate bubble popping lo these many weeks. I am looking forward to the day I will write a piece entitled "Buy Anything with a Symbol" or "Buy the Condo You are Standing Closest to..... NOW!!!!" But now isn't that time.

I have not really commented on the stock market since my "Black Monday 20 Years Later" piece back in June. I was amazed at the positive market action this summer, despite the very negative implications of the emerging credit mess.....and I have been waiting for the primary market trend indicator to turn negative, as it did recently, before uttering a negative word about this volatile and crazy market. I also decided to catch up with an old friend of mine for a sanity check before I wrote this piece.

My buddy Stan Weinstein runs a technical forecasting service for institutional investors called Global Trend Alert. His monthly and weekly pieces are found ubiquitously on hedge fund and Wall Street trading desks. Back in the day, Stan literally wrote the book on technical analysis, "Secrets for Profiting in Bull and Bear Markets," and had a widely followed newsletter called "The Professional Tape Reader", which he started back when there was still a ticker tape. I haven't talked to Stan in a long time, but as always he was generous with his time (between grabbing lines from the titans of Wall Street). He sent me his last monthly piece and allowed me to quote him here on UrbanDigs.com. What Stan said went something like this:

"Back in November we turned bearish on the markets primary trend, after the phony rally to new highs, which was not confirmed by the market's advance/decline line, Russell 2000 Index and our proprietary S&P Survey (of the chart patterns of all large cap stocks) among other negative factors. We are now entering a period of bear market rotation where retail, transports and financials, which led the market down, are being cushioned by value buyers and short covering, while new sectors like technology, industrials, cyclicals, machinery and oil related stocks are starting to roll over. The market is never a monolith and some sectors like coals and healthcare services still look like decent places to hide. At a minimum we expect the Dow to get down to 11,000 with a June/July bottom possible, but you could certainly overshoot on the downside."

So how do I add to that? Stan is one of the greats, but it was actually Vince Boening, another graybeard technician who at the time was DLJ's technical guru, who taught me the importance of the key primary trend indicator....the 200 day moving average, when it came not just to individual stocks, but to the market overall. Any stock jockey can tell you that it's bearish when an individual stock falls decisively through the line representing the 200 day moving average of its price on higher than normal volume, and that it takes a lot of technical "work" to fix this damage, so stocks don't usually just turn back around and go straight up after busting the 200 day (although nothing is an "always" in financial markets). However, it wasn't until 1998, with all hell breaking loose in financial markets, and rumors of various Wall Street firms going bust, that I learned how important the direction and incline of the 200 day moving average was for the market overall. I had called Vince Boening to get his take on the market bloodshed, as he was one of the only people around not turning acutely bearish, and he said: "While its obvious that there has been a panic sell off, the 200 day moving average of the market is still moving up strongly, reflecting the robustness of the rally prior to the sudden onset of weakness. There is a natural tension for stocks to rebound when they have sold off so suddenly and traded through a strongly up trending 200 day moving average, because the inertia of the market is still up". Vince was more right than I think even he believed. As it turned out, with the Fed cutting rates to cushion the blow from Long-Term Capital's demise, and then its continued expansion of the money supply in preparation for any Y2K problems, the market rocketed out of the August 1998 lows, (interestingly the Dow itself never made a new high in that cycle), with the Nasdaq and other indices barreling higher until Q1 2001.

I believe that the reason the 200 day moving average is relevant at all for markets or stocks is deeply rooted in human psychology. It's very hard for human beings to suddenly believe that the world has fundamentally changed (excepting maybe a 9/11 type incident) due to an event, we need time to really become convinced that things won't go back to the way they were. As my partner likes to say, it's like sailing away from shore, you keep thinking you can turn around and go back....it takes a long time before you realize you will just have to keep on the same course until you find land again. Thus it really takes about 200 days of continued bad news to shake people's confidence. At the end of my chat with Stan I said "I think this rally looks like a gift to short sellers and those who want to cut back on stocks....the 200 day moving average has only just turned negative (see blue line on the chart)". I could hear Stan typing in the background and pulling up a chart in his system...."Ya know kid, you got a good point." If you look at the market's big plunge back in August it looks hauntingly similar to the late 1998 tape action....and in fact the market did rocket back to a nominal new high this fall as well, but the roll over and plunge to lower lows this fall has put the coup de grace on the bull market, by dispelling all the momentum that was left in the 200 day moving indicator. The market's inertia is now downward.

As far as my compass shows, there is still a long voyage ahead for the market on the downside, and the 200 day moving average says we will just have to ride it out. There's no going back to shore. My only caveat to this view, would be an explosive rally starting....about now, which wiped out a lot of technical damage before the 200 day moving average gets even more negative (as it inevitably will as it starts to factor in less and less of the positive market action of last Spring). Now fundamentally the market isn't historically expensive (if you believe the incredible shrinking earnings estimates), but without the low P/E oil stocks it doesn't look real cheap either. So maybe there isn't that much downside past Stan's 11,000 target, but I wouldn't hold my breath for strong returns from today's level for quite a while. If the market goes to sleep for a spell here, I don't see much in the way of positive events for brokerage firms, hedge funds or Manhattan's economy.

(Premature?) Positive Commentary on Stocks from the Blogosphere:

Positive Energy as Market Struggles

Market Bottom; Insider Buying Exceeds Insider Selling, Signaling Market Bottom

Bear Market May Produce Positive Results For Investors

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