Sunday, December 14, 2008

Reversal Signals emerging !!

Stock market crashes always leave a staggering amount of traders, speculators and others which take vow of never to return to this markets. Bear markets often make stocks speculative and the art of investing, a gamble. History gives us great insight into the mind of 'the crowd' which shows the various points of market indecisiveness.

There has been many instance where firms which were too big to fail, failed and left investors in lurch. It happened with the telephone stocks, railroads, over-leveraged arbitrageurs of 1980s, technology stocks, real estate and now the auto manufacturer. There is a very important lesson in all of the failures that they have something common. All market participants knew that the physical growth in volumes of there business is a given. It was in fact true. Just see the numbers for the aviation sector by clicking here .

However the aviation sector worldwide has lagged the market for decades and has given very poor return. Real estate boom and bust cycle is far more prevalent and pervasive. In the bull market the expectation of growth is taken as a proxy for growth in profitability and gives fuel to the bullish argument. When traders and investors realize that the profitability is very low, there is a rush to sell stocks at any given price. The age old fashion of asking 'how much' to pay for the stock can be of great help in finding correct sectors to enter.

The Dow Jones Industrial Average has been in a bear market since the begining of the 21st century priced in terms of gold. Take a look -

The real test of the current bear market would be at the Dow Gold Ratio of 9. It has not traded below it after the gold window was taken out by Nixon. So if the conditions become worse than they are, this is the indicator to look forward for an early warning. The high yield bonds have been falling in prices and the spread on High Yields have gone out of proportion rising a staggering 770% in one year. But it has bounced of quite substantially in the last few days. Take a look at the High Yield Select Bond Index of 10.

Any rebound in this index will arguer well for the stocks in general. Now there is an important development that has taken place simultaneously in two different markets.

A - The USD has broken down forming a head and shoulders pattern and a failure of the fifth wave.

B - The commodity index is very near to a breakout.

Take a look at the CRB index divided by the USD index -

If this reversal holds than it would put the deflationary theory to rest and will give some respite to the continues asset devaluation taking place. The USD has broken down from a head and shoulder pattern and is falling steadily.

As I have already pointed out that crude oil has bottomed out for the short term and heading higher for some time, it is important to be cautious of the USD index as a reversal in USD may lead to a fall in all commodities to new lows.

USD has been acting as a gauge of the sentiment and a higher USD was showing risk aversion and stock fell in line with it. In the short term the correlation of a stronger USD and stronger equity market is broken. Risk aversion sentiment is ruling the markets. A stronger USD is important for US equities and will lead to stronger growth in world equity markets also. This correlation can give early leads into the markets.

These factors are giving some clues about the strength of current bear market. The economic conditions will worsen even more and more bad news comes in bunches. The stocks however look forward and a fruitful recovery will take some more time.

Indian stock markets have given a small rally of about 7.4% in the last one week. I mentioned in my previous post that this rally can last for about 1000 points. But there are signs that this rally lacks strength as the upmove are not showing impulsive behaviour. S&P CNX Nifty will face strong resistance at 3250 and the inflection support now stands at 2810. A close below this level would take markets lower.

The next two quarters would be the best time to accumulate high value, high dividend yield stocks. Markets would stretched to the downside and give investors the real time to buy which is the best thing about bear markets.

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