Trader’s Narrative

Usually I have trouble parsing Cramer’s advice. But just a while ago he was surprisingly lucid. I’m referring to Cramer’s call for people to take out money that they would need in 5 years’ time. Remember that? Here it is again, in case you missed it:

Well, it turns out a very reliable indicator is now flashing buy. The funny thing about this indicator is that it isn’t a short term buy signal. But whenever it has indicated a buy point, as it is now, the market has been higher four years in the future.

VLMAP
The indicator is the Value Line’s Median Appreciation Potential which is the median measure of how much higher or lower a large sampling of stocks will be trading as indicated by Value Line’s analysts. VL itself frowns on using it as an indicator but according to a market timing system devised by others, VLMAP signals a buy when it rises above 100 - meaning that in 4 year’s time, stocks will be trading higher by 100%.

As Mark Hulbert reports (link above) the last two times that VLMAP has given a buy signal were after the tragic events of 9/11 and at the bear market bottom in 2002. It also gave a signal in mid-July when the markets spiked lower.

Hulbert was kind enough to send me the in depth study he cites in his article. It concludes:

While it is clear from the above regressions and analysis that VLMAP is not a perfect predictor of the market, it is also true that VLMAP does have strong statistically significant forecasting powers. …The Value Line Composite Indexes, especially the geometric version, have the best track record in comparison to VLMAP. During the decade of the 1990s, the Russell 2000 is the best market measure as predicted by VLMAP.

While VLMAP may not represent the long sought after Holy Grail for predicting the market, it nonetheless proves to be beneficial and worthy of investors’ attention.

You can download & read the whole report in my Free Trading Resources section (under Reports & Articles). But be careful you don’t get stuck there rummaging through all the other free stuff there.

I don’t have a crystal ball and this indicator is, like everything else, far from an iron-clad guarantee that the market will indeed be higher… but watching Cramer put in that sober performance, I couldn’t help but think that he will regret it. It was a gut feeling but now there is quantifiable data to back it up.

But of course, considering the short term memory of the average “Cramerican” within four years, even if the market is higher, they won’t bother to remember it. Just like they ignore his call at the top of the tech bubble cheerleading bloated stocks even higher or his most recent disasterous calls:

In March, he said Bear Stearns “is not in trouble.” After Bear Stearns tipped over, he wrote in his New York magazine column that the bottom had finally come. “I feel the bear has been tamed, and the worst of the clawing is over,” he said. And on Sept. 15, he hosted his friend Robert Steel, chief executive of Wachovia, and suggested that its $10.71 share price was a bargain. Two weeks later, it was at $1.84.
Source: Cramer Retreats Along With The Dow

Booya?

Here’s a chart of +50 years of the intended Federal Funds rate:

Now is an appropriate time to take a step back and look at the bigger picture because what the Fed has just done is extremely rare.

It has reduced the interest rate by more than 43% in less than 6 months. To find such a frantic slashing of rates we’d have to go back to the Volcker years in the early 1980’s.

The only other time in recent history that is remotely similar is the aftermath of the 9/11 tragedy in late 2001.

What makes it intriguing is that unlike the 1980’s and 2001 when everyone knew something horrible had gone wrong, we don’t really have that now. I think it will take some time for us to understand just what happened.

It seems surreal now as we are going through it. Perhaps the only way to understand it is through the perspective of time. Who would have believed that the current credit crunch makes the 1998 crisis pale in comparison?

Last week I talked about how the breadth numbers for NYSE and Nasdaq can diverge quite a bit. Which means that if you’re watching just one of them, you don’t get the whole picture.

This can be especially problematic when we have the bond market making a strong trending move, which we’ve had recently. On June 7th 2007, just one day after I wrote about this, the NYSE advance decline numbers dipped into an extreme oversold reading of -2784. To show you have extreme this was, we didn’t see this sort of breadth even after the September 11th terrorist attacks.

The last time the NYSE advance decline approached such an extreme in recent history was May 7th 2004, when it hit -2926. So what was special about May 2004? After all, the summer intermediate bottom of 2004 didn’t happen until a few months after in mid August.

Well, as you can guess, May 2004 was another time when bonds were being dumped left, right and center and the yield was shooting higher. Then, the 10 year bond yield breached 4.87% and panicked everyone, just like it is doing now.

So, not surprisingly, all those bond-like securities trading on the NYSE got dumped. And that created the lopsided breadth numbers. Anyway, back to present day.

On June 7th 2007 the NYSE breadth was -2784. But the Nasdaq breadth was only -1725. Fairly low but not extremely so. To put that into perspective, the March 2007 bottom saw a reading of -2579 (for the Nasdaq advance decline).

Anyone watching just the NYSE numbers would have thought that we had arrived at a historically oversold level. And perhaps may have charged ahead and bought “the dip”. But the oversold reading was a mirage created by the changing nature of the securities traded on the NYSE.

I looked back only a few years and it seems that when the Nasdaq and NYSE breadth numbers both reach an extremely low level, it is much more probable that the market has reached a bottom. This is just a “back of the envelope” calculation, so don’t take it as gospel. To me though, it just makes sense. I’m going to take a deeper look and go back a few more years to see if this holds under different market conditions.

To see instances where both the Nasdaq and the NYSE’s advance decline numbers hit extremes, click to enlarge graph:

I remember exactly where I was on this day 5 years ago.

I accompanied my Mom to go see a heart specialist. Her appointment was in the morning and as we waited I remember flipping through a Reader’s Digest halfheartedly looking for an interesting article. The doctor saw her and did some tests. Everything checked out. I was very happy to hear him say that she had a very strong and healthy heart. We left the medical building soon after, she heading out to do some shopping, while I went back to my place.

I stopped by a Tim Horton’s to satisfy a craving for a Boston Cream. One of the girls behind the counter told me that on the radio she had heard a plane had just crashed into a building in New York. I asked her, are you sure? She said, I don’t know, I think so… that’s what I heard.

I shrugged it off and thought, That’s the silliest thing I’ve heard. There is no way an airplane would crash into a building. Not with the modern technology they have onboard.

When I got home, I turned on CNBC and for the next few hours I watched with absolute horror as the tragedy unfolded. I felt numb but my brain processed one thing: everything had changed. The world I knew had just been rolled up and replaced with another.

Here’s a never before seen video captured on that day: