Trader’s Narrative

Last week we reviewed the latest position of Lowry Research on the stock market: Turbulence Ahead, Uptrend Intact. One of the major reasons that Lowry’s continues to believe in the health of the market and a continuation of the uptrend is the lack of selling pressure.

Lowry measures this through their proprietary metric called (what else?) Selling Pressure. It remains low and falling, helping to support the thesis of a healthy market rally. According to Paul Desmond: “Every major market top in Lowry’s 76-year history has been preceded by a sustained rise in selling pressure. With selling pressure recording a new 12-month low within the past two weeks, no such rise is now evident.”

This has got to be frustrating for the bears. But it is also unbelievable to the large number of participants in the market who continue to look at the current price levels as a mirage. The US retail investor is not venturing out into equities, even after watching the stock market climb a wall of worry inch by inch.

This has been and continues to be the most hated stock market rally that I’ve ever witnessed. In any case, it is comforting to confirm Lowry’s proprietary measure of selling pressure with a similar measure from InvesTech.

Click chart to see larger version:

Source: InvesTech

Jim Stack, the writer of InvesTech has a handy checklist for new bull market conditions. One of them is this metric. And along with the rest of the list, it has been flashing a bright green buy signal for a few months.

As well, the month of November has been historically one of the best months for the S&P 500 since 1950. I’m not sure that another 20% rally by year end will convince the retail investors to risk their money in the stock market again. But we may just see that.

Here is the second installment of the conditions that precede new bull markets, as put forward by Jim Stack of InvesTech:

“Formal” Recession - confirmed (not just feared) by media headlines. Once again, this reveals the importance of being a contrarian investor… buying when no one else wants to. Historically when you see “RECESSION!” in the media headlines, it has often been the time to back up the truck to start loading up on stocks.

According to the data from Google Trends, there was a peak of “recession” headlines or mentions towards the end of January 2008:

I thought there was an increase towards the end of the year in 2007 but that was before the rate again doubled within the first month of the new year. You can see the same chart for mentions of “recession” before the spike in January.

But whether we are or were in a recession depends on who you ask. The most accepted answer comes from the National Bureau of Economic Research (NBER) and they have yet to confirm anything. But they always do so after the fact, which isn’t all that helpful anyways.

According to the Conference Board, the “data certainly reflects a weak economy, but not one in recession”.

The Recession Buy Indicator
The Recession Buy Indicator is an intriguing indicator used the veteran stock market newsletter writer, Norman Fosback. It is made up of four indicators which are “coincident” - that is, neither leading or lagging but a measure that moves at the same time as the economy.

These four are: manufacturing and trade sales, personal income, non-farm payrolls and industrial production. These are the same measures used by the NEBR to pinpoint recessions.

According to Fosback, there is a buy signal when each of the components is below its rolling 6 month high. That is the case right now since the coincident index has not gone up since October 2007.

Coincidentally I wondered out loud back in mid September 2007: Are we in a recession already? That may turn out to be accurate.

This Recession Buy Indicator gives infrequent but very good buy signals. There have only been only 4 in the past 30 years but they provided 30%+ annual returns on average. The validity of this indicator comes from the historic pattern of the stock market hitting a major bottom approximately six months after the economy enters into recession.

Like all historical patterns though, we don’t have a guarantee but a picture from the past that this is what has happened on average. The exceptions are important. For example, this indicator gave a buy signal in February 2001, which if followed, produced a tremendous amount of loss and pain. The stock market bottomed almost two years later in early 2003.

Conclusion
It’s difficult to tick this condition off as being met since the NEBR has not officially labeled a recession. It may or it may not. But going by everything else, it would seem to have been met.

A big question on a lot of minds is whether what we are seeing is just the run-of-the-mill bear market reaction (a bear market rally or “dead cat bounce”) or whether perhaps this is the start of a brand new bull market.

While I do have some ideas, I’m not sure myself. Well, no one really knows. What I mean to say is that I don’t have a strong conviction one way or the other right now. But I’d like to change that. So this week I’m going to cover the 7 prerequisites for a new bull market as set out by Jim Stack, the writer of the InvesTech newsletter.

According to Stack, there are seven major conditions that have historically been present before we’ve launched into a secular bull market. Like most approaches to the market, these seven conditions simply allow for a list that we can check off. The more conditions are present, the better the chances that this rally is the real deal. But as always, never a guarantee in sight!

The first one I want to cover is consumer confidence, or more precisely, a plunge of at least 34 points in the Consumer Confidence Index:

Plunge in Consumer Confidence - Marked by a drop of 35 points or more. This index is reported monthly by The Conference Board and is based on a representative sampling of 5,000 US households. It’s calculated as a weighted average composed of 40% current and 60% future expectations and is commonly used to predict the future health of the US economy. For investors, it can also provide a valuable clue to identifying the “Best Buy” opportunities on Wall Street. Logically, such opportunities seldom occur in the late stages of a bull market when consumer optimism is already frolicking at lofty levels. Instead, the time to start shopping for stock market bargains is after confidence has plummeted and gloom is widespread. In each of the past 5 recessions, the Conference Board’s Consumer Confidence Index has tumbled over 34 points before a new bull market was born. Watch for a similar drop that might help to confirm the next true low-risk buying opportunity.

Here is a chart of this indicator showing a plunge of almost 50 points:

Incidentally, it is almost at the exact same level when the stock market reached its bottom in March 2003.

Here is the other widely followed consumer sentiment survey, Reuters/Michigan:

Its good to see these two surveys agree with each other so much. The Reuters/University of Michigan sentiment survey is even lower than where it was at the March 2003 market bottom. It is plumbing depths not seen since the early 1990’s and 1980’s. Curiously, back in the 1980’s, the unemployment rate was twice as high as it is now.

Anyone familiar with market history will recognize those time periods as excellent times to buy. If you’re not or if you would like a refresher, just pull up a really long term chart from your favorite charting platform.

So we can comfortably check off this condition as being met. The next one tomorrow.

Oh and in the meantime, I highly recommend you give InvesTech a look see - and no, I am not affiliated with it nor do I receive any compensation if you do.