• Consumer Sentiment
• Formal Recession
• 20%+ Decline
• Coppock Guide

Here is the fifth: monetary policy. Of course, almost every single central bank around the world has reduced interest rates. Here is a quick summary of a few key ones:

US Fed
The intended Fed funds rate stands at 1% but the problem is that the Federal Reserve took its sweet time in lowering interest rates. Rates topped out in June 2006 at 5.25% and were taken down by the Fed subsequently. But as the bond market repeatedly was warning, the Fed was behind the curve by a very wide margin.

The US is also undertaking a gargantuan multi-trillion dollar fiscal stimulus package with a much more comprehensive one waiting in the wings until January 20th 2009 when Obama takes over.

Canada
Almost one full year ago, the Canadian central bank began its easing cycle and I wrote that since central banks move in packs, this was the beginning of a world-wide trend.

The Canadian central bank has since lowered interest rates continuously. The overnight rate has almost halved from 4.5% to 2.5%. The next meeting in early December is seen by almost all as another opportunity to cut further.

China
The Chinese central bank announced a massive 108 basis point cut in their key interest rate today (to 5.58%). While this is their fourth time cutting rates since September, this recent move shows just how worried the Chinese government is. Usually interest rates are stepped up or down by just a 27 basis points but this move is four times larger in magnitude.

China has also announced a $590 billion fiscal stimulus package as well as lowering the reserve requirements for several banks to pump more money into their economy. Right now, putting money into a bank account is a losing proposition since the latest data has inflation at 4% and banks pay 2.5%. Basically, China is pushing its people to consume, rather than save.

England
The Bank of England is no stranger to large rate cuts. At the beginning of November, it cut 150 basis points off its key lending rate (from 4.5% to 3%). That followed a 50 basis point cut in early October 2008. Most are expecting another cut next week when the monetary policy committee meets. Some are even calling for a further 0.50% cut.

England is also pushing forward a VAT reduction (to 15.0%, from 17.5%), and a $30 billion stimulus package.

European Central Bank
The ECB has been the most sluggish in responding to the current decline in economic activity. They are under pressure in their next meeting of December 4th to take drastic action and lower by 50 basis points. But considering the extremely hawkish tone of the ECB that is very unlikely.

The ECB has already cut 100 basis points since October to bring their rate to 3.25%. But as the Eurozone faces its first recession in 15 years, it may not be enough.

Australia
The Reserve Bank of Australia topped up its rate in March 2008 at 7.25% and ever since has been lowering it. On October, it also cut 100 basis points and more recently, by 75 basis points to bring the target cash rate to 5.25%. This is the steepest cut in rates since the 1991 recession in Australia. And it may just help them to dodge most if not all of the fallout.

The Australian government is also implementing a stimulus package of $6.7 billion - helping first time home buyers and pensioners.

Japan
In its most recent decision, the Bank of Japan held interest rates steady at 0.3% (not a typo). They are reluctant to return to the zero interest rate policy they adopted between 2001 to 2006 because it was not that helpful. But the Japanese central bank is pursuing alternative ways of pumping money into their economy. For example by accepting a wider assortment of assets as collateral.

Warm up the helicopters!
At this point, all central banks are focused on the present battle against the very real danger of a deflationary spiral. Of course, if they overdo it, as they almost always do, then they have to quickly mop up the extra money sloshing around the world financial markets without causing another dramatic downturn.

Don’t you just love central planning comrade?

The chart covers almost 100 years of market history and it has a lot to say. The average 10 year return over this time horizon was +89% - the dotted blue line. The following were the tops:

• August 2000 — +365%
• August 1992 — +281%
• June 1959 — +311%
• September 1929 — +247%

Notice how the tops are all around the summer? I know, four instances is hardly a robust sample size but still. If you recall, last summer, Jeremy Grantham was warning his clients the world was a bubble.

Right now, for November 2008, the rolling 10 year return is -25.57%. That is not the lowest but it is quite low. If we assume the worst for this month and take the lowest level at which the S&P 500 Index closed last week, then the monthly rolling 10 year return is -36.51%.

To put things in perspective, we’d have to go back to the summer of 1941 to find lower numbers. The lowest point, within the 100 year time frame used, is August 1939 which provided a soul crushing 10 year return of -62%. Not at all surprising since it is the 10 year anniversary of the great bubble top of the 1920’s.

The other low point occurred in June 1932 with a 10 year return of -43.55%.

Can things get worse? Of course. But at this point, if you have a long term time horizon, a cast iron stomach for risk, the data suggests you should be taking small positions and slowly adding to them cautiously, even if the market continues to tank. That may sound crazy, but where we are right now in market history, only comes about very rarely.

Getting back to Grantham, right now, he is warming up to the equity markets, not just in the US but around the world. In this recent interview, he outlines why he is cautiously bullish and how he is trying to balance two kinds of regrets: getting in too early (more losses) and missing the boat on a rally.

You can also read his most recent quarterly letter in which he goes into much more detail (look in the Reports and Articles folder).

For similar news and articles, check out news.tradersnarrative.com

According to InsiderScore, “insiders are more bullish now than at any time since the two weeks immediately following the Black Monday market crash of October 1987“:

Source: InsiderScore.com and SentimenTrader.com

I checked with a similar service that tracks Canadian stocks: Canadian Insider and not surprisingly, the Canadian market is showing a similar pattern of insider buying.

The pattern was especially noticeable for Canadian REITs. And I’m not referring to ESOP where there is a preset schedule. REIT insiders are going out into the market and buying of their own volition. RioCan REIT, which I mentioned a few days ago, had 11,440 units purchased just on November 19th and November 20th, as an example.

The same can’t be said about precious metal stocks. For example, Barrick (ABX) and NovaGold (NG) do not show any buying interest from corporate insiders. If anything, there is a slight bias of selling. Which means that while insiders as a group are very bullish, they are still being selective. The k-ratio fell to 0.23 and has rebounded with Friday’s move in gold. That’s getting close to an attractive level for gold stocks, but if we are headed for a deflationary spiral, gold doesn’t stand a chance. But so far, the Philadelphia Gold Bugs Index (HUI) has bounced off the 175 level which I mentioned would act as support.

There’s Always a But…
A caveat to consider: in September 2007 insiders were enthusiastic buyers. Although not nearly as now. That uptick in buying was, of course, not very profitable since most stocks topped out shortly afterward. The question now is, does today’s frenzy mean that insiders see real value or will we simply see the market fall more and insiders get even more excited about buying?

Whatever the answer to that, the solace that the current buying pattern does provide is that insiders are not selling. The worst possible scenario after all, would be to see the “smart money” insiders bail out after the market’s face melting 50%+ decline.

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Bears are cute and cuddly, until they tear off your head and feast on your carcass. The bear rampaging through Wall Street has taken the poor S&P 500 index down 52% at its deepest level. In case anyone is still keeping track of these sort of things, that’s off the charts.

It is a deeper loss than the bear market we last saw in 2002 in the aftermath of the technology bubble, and it is deeper than the “oil shock” induced bear market of the 1970’s, mercifully ending in less than 2 years from the top in October 1974.

The only bear market that lasted longer and created more devastation was the 1929 aftermath which sliced off 90% off the market’s valuation from its top by the time it was over.

It is the weekend and time to lick your wounds and get ready for duck the swats of this ferocious bear. Don’t forget to check out news.tradersnarrative.com for continous links to articles, breaking stores and analysis. Here are a few examples:

Buffett seems to have been taken off guard like many investors. Way back in 2007, well before the market topped, Berkshire Hathaway (BRK.A) wrote European style put options on the S&P 500 index and 3 other international indices for the next 15+ years. Does that mean that now, more than ever, the market is “cheap”? or did he make a massive blunder?

Fairfax’s Prem Watsa, who many liken to Buffett, recently removed protective hedges and for all intents and purposes went long the stock market after many years of forecasting doom and gloom.

Obama is reported to have tapped Hillary Clinton to be Secretary of State. Hmm…. that strikes a bell. Who was it that mentioned Hillary as the next Secretary of State two months ago?

The embedded videos don’t seem to be working so here are the links to them: Hillary Clinton and Recession Watch.

It was not surprising then that the market broke through the October and November lows. This week’s AAII numbers show an increase in fear (finally!). It is important to note that they came in on Wednesday - before the elevator drop through previous support levels - so it is curious to guesstimate where sentiment would be if the survey was administered afterwards.

AAII bulls came in at 24.37% and the bears at 57.14%. While this is a good development, as I’ve said for the Nth time, what we really need to see is the market recover and a commensurate increase (or plateau) in bearish sentiment. That would give me confidence in any ensuing rally. But if once again people start clinging to every uptick as a hopeful recovery, it will be short lived.

ChartCraft’s Investor’s Intelligence sentiment measure was mostly unchanged with 31% bulls (a tiny decrease) and 43.6% bears (slight bump up from last week). This survey came out on November 18th and it continues the slow trending decrease in bearishness from October.

Of course, the completely useless Citigroup Panic Euphoria model continued to impersonate a dead parrot’s heartbeat monitor. If Vikram wants to cut costs at Citigroup (C), he could start at worse places.

Market Vane’s bullish consensus sentiment dropped slightly to 40%. During this downturn this measure of sentiment has also stubbornly remained above previous panic levels. The lowest it reached was 32%, a far cry from the 20% range we saw in the darkest hour of the previous bear market.

Options Market
The options market continues to confound. While the CBOE equity only put call ratio increased to 1.16 as a result of Wednesday’s 6.12% plunge in the S&P 500, the next day’s carnage which took the index down 6.7% actually saw the put call ratio fall to 1.05.

The same pattern was noticeable in the ISE Sentiment index. The ISE call put ratio fell to 78 on November 19th - low but not extreme - but then it rebounded the next day even as the market took a more intense drubbing.

The options market continues to act crazy. Although put call ratios don’t walk hand in hand with the market every day, this is just bonkers. It is almost as if we’ve entered an alternative universe where previous market indicators and measures mean nothing.

Volatility
Volatility hasn’t imploded (yet). In fact, the VIX is back at previous highs last seen in late October. The thin layer of good news may be that while the market has broken to new lows, volatility hasn’t.

It wasn’t long ago when 45 was considered “extreme”. Since mid October the VIX has stayed above “extreme” and redefined it. Beforehand, we had broken above 45 on only four occasions. So yes, this is an absolutely unprecedented market.

Value Investors Peek Out
The ever cautious head of Fairfax Holdings (FFH), Prem Watsa, has peeked from under the covers and decided to remove the protective hedges for the firm’s equity portfolio. While Fairfax still holds the bulk of their assets in fixed income, it is another sign of valuations coming to attractive levels. Watsa is compared by some to Buffett because of his cautious nature and his strict adherence to a value oriented investment philosophy.

Watsa wrote to Fairfax shareholders: “While we believe the recession may be long and deep, we also believe that stock prices may have already discounted the worst of the economic decline. As value investors, we are finding an incredible number of investment opportunities across the world. That said, in the short term we recognize that stock markets can continue to fall significantly.”

To get similar news, watch news.tradersnarrative.com - that’s where I put links to interesting articles, breaking news, reports, etc.

In case you’re not familiar with them, Lowry is one of the most respected technical research firms. Their prestige flows not only from their longevity (they are the oldest continuously published letter on the US markets) but also due to the quality of their analysis. Their principal, Paul Desmond, won the Charles H. Dow award in 2002 for his research into 90-90 days and their role in market bottoms. They have mostly institutional clients with some retail clients paying $1000 a year for regular access to what you’re about to glimpse.

This also has some poignancy today since we have now fallen appx. 55% from the 2007 top as Paul Desmond opined: How brutal can this bear market get? We are now below the S&P 500 2002 bear market level. Is that enough? has the bear extracted its pound of flesh? Read on to find out what Desmond’s firm thinks.

The presentation was given by one of their junior analysts, Tracy Knudson CMT. First she review what happened from the market top in 2007 and then moved forward to today and Lowry Research’s view on where we are headed from here. Then a brief overview of sectors and the changing role of 90-90 days:

• Lowry is now known for Paul Desmond’s research into 90-90 days but they primarily use proprietary indexes: buying power and selling pressure
• use these two metrics to gauge health of the market and the underlying momentum to measure who has upper hand
• important to look at both components of 90-90 days: total price points gain/lost and total volume of advancers/decliners
• buying power & selling pressure calculated from public information released by NYSE for that exchange
• Lowry is working on beta versions of same for NASDAQ and international markets (still private)
• mid-July 2007 first warning sign that bull market losing strength
• new high on index not confirmed by adv/dec breadth of NYSE (OCO) operating companies only, S&P 500 or NASDAQ
• this was a sign that rally was becoming selective rather than continuing as broad-based

• Lowry’s % of OCO above 30 day moving average in early June 2007 80%, in mid-July 2007, 64%
• July 23rd 2007 brought about dramatic change in tone of market
• within 3 trading sessions we saw two 90-90 down days: sign of intense selling, not seen in a while
• this moved selling pressure metric above buying power [blue circle CHART 5]
• beginning of August 2007 brought 3rd 90-90 down day
• when this happens w/o an intervening 90-90 up day, it is a very negative sign for the market
• at this point Lowry started to advise clients to sell into rallies and to pare positions
• tops are a gradual process, in contrast to bottoms, so clients should have time to exit market orderly
• in August selling pressure accelerated: Aug 16th dramatic hammer candlestick bottom, Aug 17th 90-90 up day
• monitored rally started in mid-August to gauge health of bull market and quality of rally
• selling pressure fell but buying power rose little: rally powered by sellers leaving, rather than by new buying [CHART 7]
• as recovery extended into Oct 2007, buying power continued slow slide lower
• market breadth also played important role in gauging health of ensuing rally
• % of stocks at least 25% from last rally high started to increase, going from 9.8% to 20.6%
• Lowry also looks at unweighted indices to remove capitalization skew: Rydex S&P Equal Weight ETF (RSP)
• mid-Sept Fed cut interest rate but internal market measures were weak
• adv/dec was below June peak - only large multinationals were carrying index higher
• by end of Sept 2007, buying power fell to lowest level in 6 months [CHART 8]
• negative divergence between market indices and Lowry’s buying power measure
• Lowry’s conclusion: prices not low enough to attract significant investor money, will need to go lower in order to do so
• early Oct 2007, as Dow made new high only 5 of 30 components rose to new all time high & only 10 to new 52 week highs
• Lowry’s OCO new high/new low indicator continued to show internal weakness of market
• Lowry Research told clients: market would retest recent lows
• in aftermath market has had 5 counter trend rallies ranging from 6.4% to 17.7% lasting 8 days to 2 months
• Lowry’s watched each one by looking at similar measures to gauge health of rally and probability of new bull market
• lasting bottoms need two conditions: exhausted sellers and strong demand from buyers
• good example from recent market history: 2002 bear market bottom
• Lowry told clients to buy on March 17th, 2003 - three days after market made its year lows
• reasoning was the two conditions not met in October 2002 low and until then
• in October 2002 proprietary selling pressure measure hit previous high hit in mid-July 2002
• in March 2003 selling pressure was significantly lower as it had continued to fall from double top in July/Oct 2002 [CHART 18]
• difference between characteristics of short term rally and new bull market are these
• selling pressure failed to contract in March 2008, May 2008 and mid July 2008
• in each instance, buying was met with heavy selling, causing Lowry to conclude market would have to move lower to attract sustained demand from buyers
• recent market environment has been extremely volatile, due to credit and real estate bubble as well as no uptick rule
• market has traded within a small range - is accumulation taking place?
• during highly volatile days Oct 15, 16, 21, 22 and Nov 5, 6, selling pressure continued to rise
• buyers not using trading range or volatility to step up and accumulate shares while sellers remain active
• Nov 19th 2008 took buying power -10 to 127 and selling pressure +12 to 906, an all time high
• very rare to see market bottom when selling pressure is at all time high
• only happened once - 1974’s V-bottom where selling pressure and market both rose in tandem
• in 1974 both market and selling pressure were trending and suddenly shifted
• Lowry Research believes we’ll have to fall below Oct/Nov lows to attract strong demand [CHART 22]
• do not use targets but instead monitor market daily and use measures mentioned to gauge health
• advance decline lines would need to rise sharply
• sectors with least selling pressure: utilities which Lowry’s believes is seeing accumulation
• selective strength in telecom also
• financial sector is seeing heavy selling pressure as well as information/technology, consumer cyclicals
• consumer non-cyclicals are moderate to ok
• energy/oil sector is seeing a withdrawal of selling pressure but no sustained rise in buying power
• gold or basic materials sector is similar - since Oct low, a reduction in supply but no demand has come in
• health sector: minor accumulation since October low
• Wed Nov 19th 2008 was a 90-90 day
• so far we’ve seen 6 of them while in this range
• Nov 12th was a 90-90 down day followed by Nov 13th a 90-90 up day
• normally a bullish sign but have to be cautious in current market environment
• elimination of the uptick rule allowed more volatility and as a result seeing more 90-90 days
• 90-90 days are still important but because they are not as rare as before, need to take with grain of salt
• their appearance should not be interpreted outside of proper context or lose some forecast ability
• key factor of 90-90 days is follow through, must be followed by rise which we have yet to see
• market not required to have a 90-90 down/up day to bottom - can do so perfectly without
• two ways: either scared out of this market or bored out of the market
• intensity of this bear market is ferocious, as measures by number of 90-90 days
• Lowry believes it could last quite a while and be one of the more pronounced bear markets we’ve seen
• reason this because of the lack of demand and intensity of selling as seen through their proprietary indicators

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Every single index out there was created by someone or by some committee and it is regularly updated and managed to keep pace with the changes in the real world.

That goes for the Standard & Poor’s 500 Index, the behemoth out there that has more money following it than any other index out there. The composition of the list of 500 stocks is presided over by the S&P Index Committee, a group of employees of McGraw-Hill Companies.

They follow a few guidelines:

• U.S. Company
• Market Capitalization: min. $4 billion
• Public Float at least 50%
• Adequate Liquidity and Reasonable Price.
• Sector Representation
• Company Type: operating, not CEF, REIT or BDC

But, in the end, these are just guidelines and the committee has full discretion to include any company and to exclude another, even if it technically meets all the criteria.

Every once in a while the committee faces a rare situation where a large portion of the S&P 500 Index does not meet one or more requirement they have outlined. Usually the simply ignore it and hope that it just goes away on its own.

In October 1987 there were 35 S&P 500 Index stocks that traded for less than $10 a share. In the aftermath of the September 11th terrorist attack, 59 S&P 500 Index companies traded for less than $10 a share. Right now we are going through a similar situation.

Currently there are about 101 S&P 500 Index stocks trading at sub $10 a share. Unbelievably, one S&P 500 component, E*Trade (ETFC), closed below $1 a share. And there are 36 stocks trading below $5 a share. These are levels at which stocks are called “penny stocks”. You can find a table of the constituents, ordered by share price here:

This isn’t just embarrassing for the companies and the index committee. More importantly, it presents a real problem for mutual fund managers who are restrained by covenants from buying shares trading at less than $10 or a low capitalization level. Although somewhat arbitrary, these restrictions are there to define a mandate for the manager and to protect the fund’s investors from “penny stocks” which are seen as more risky.

What is happening now is that many funds simply can not buy more shares of certain companies, even if the manager feels it is a good idea to do so for the investors. Usually they can keep the shares already in the fund but thanks to the covenant, the market can not look forward to demand coming in to prop up these shares. At least not from the usual domestic fund market.

Also, 186 S&P 500 Index stocks have less than $4 billion market capitalization. With 25 companies failing to even meet the $1 billion capitalization level. This creates problems when mutual fund managers are bound by covenants to only purchase large capitalization stocks. The only bright side is that a few medium and small capitalization mutual funds can now buy former stalwarts of Wall Street.

There is no question that we are going some truly extraordinary times right now. Almost every single measure or method to look at the stock market is off the charts. The market unequivocally broke through support today. Even slicing through Weinstein’s support level. The only consolation that longs can take home is that this is an unprecedented market environment, dwarfing previous bear markets in intensity and in its uniqueness.

You already know how to use bullish percent indices to time the stock market. Although they are usually shown in point and figure charts (those X’s and O’s), I prefer to look at a line chart because it moves in tandem with time and the market proxies like the NYSE index, Dow Jones and S&P 500.

But the original way that bullish percent charts were interpreted was to gauge where we were along a continuum of bull or bear market. The short version is that when the NYSE bullish percent index moves up above the 70% line and closed below it, the market is on notice. Similarly, when the NYSE bullish percent index moves lower than 30% and then breaks above it, there is an indication of underlying health, and a portent of a nascent bullish rally.

Looking at a very long term chart of the NYSE bullish percent index, it is easy to see the efficacy of this measure of market internal health:

Recently though, the NYSE bullish percent index has been breaking down through the 30% level not only often but to such a degree that it has fallen lower than it did after the Black Monday crash of 1987.

Here’s a chart zooming into the past two years to show more detail:

Each successive piercing of the 30% “maginot line” brings about a weaker and weaker counter rally from the market. Until in July, the market barely manages to plateau before falling again. So what’s up? Why is this once solid indicator start to sputter and fail so badly?

My hunch is that what changed over time was the inclusion of non-equity securities on the big board. Right now half of the securities traded on the NYSE are closed-end funds, ETFs, ADRs, municipal bond funds and other funny pieces of paper that do not represent fractional ownership of a public company as it used to when traders started pushing paper under the Buttonwood tree.

This is why Lowry Research service started to keep “operating company only” NYSE data. Speaking of Lowry’s, I went to a presentation by one of their analysts last night and will share the details with you tomorrow.

It is only visible on a very long term chart and boy, it doesn’t look good at all. Double top formations are among the most reliable, which makes this ominous. The sheer size of it is also not good news for the market because a measured move would take the S&P 500 Index (SPX) to … well, let’s just say no one, not even a bear would like to think of a world with the index at that level.

The only consolation I can give myself is that it is reminiscent of the very large head and shoulder formation everyone saw towards the bottom of the last bear market. If you look at the chart you can make it out.

The left shoulder occurred in 1998, the large head from 1999 to 2001 and the right shoulder in 2002. The measured move for that technical formation was also hair raising. But it never actually happened even when it broke below the neckline. It did however, give a lot of doomsday scenario fodder for the perma-bears.

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Of course, we did break through that level and we are in a bear market. So what about now?

Weinstein thinks that we are going through a bottoming process but it isn’t finished yet. He is still bearish, long term, but thinks that we may have hit a low short term. If the market can close above 9,800 he expects a rally. If it closes below 7,800 he expects it go even lower:

Moving Averages
A few readers asked me about the difference between 150 and 200 day moving averages. Weinstein mentions in the interview that he uses the 50 and 200 day moving averages, with the first for short term trading. There really isn’t a magical number. A long term moving average should represent the long term trend. Since there are approximately 200 trading days in a year, it makes sense to follow the 200 day moving average. But anything close to that level is fine as long as you stick to it.

Basing Sectors
If you are familiar with the stage analysis that Weinstein applies, he thinks that “select regional banks”, airlines and a few healthcare stocks are in stage 1 or basing. That doesn’t make them automatic buys, yet. They have to finish basing and break above with a volume burst. The financial sector has gotten clobered but the regional banks are different than the investment banks like Goldman Sachs (GS) and JP Morgan (JPM).

Worldwide Bear Market
Stan also mentions that this is a global bear market with stock markets across the world being mauled. I would go beyond that and say this is beyond a bear market like the one we saw in 1970 because everything is under forced liquidation, gold, oil, commodities, bonds, REITs, etc.

Watch the whole video for more details. And for up to the minute links to videos and articles like this, watch news.tradersnarrative.com