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December 23, 2006

Don't Worry, Be Happy!
by Tim Wood

The market escaped the fall decline, the summer rally has stretched right over into the Santa Claus rally, we are now in the "best six months of the year" for the stock market, the Wall Street analysts are all rabidly bullish and the market is at new highs. So, why worry?

The advance out of the 2002 low has created an environment in which there is basically no fear in the market place whatsoever. Yes, I know the arguments as to why. I guess the number one reason I hear is that we are now in a new paradigm and that the markets are perfectly controlled by the invisible hand. I will admit that I have been surprised by the markets resilience. I will admit that I do believe in market manipulation, but I do not believe that such manipulation can continue indefinitely or that "they" have perfect control of the market. No, the market is just too big for anyone to have "complete control." I do however believe that as a result of the massive liquidity infusion that took place in the wake of the 2001 and 2002 declines that the stock market was literally resurrecting from the grip of what was then the beginning of a very nasty bear market. Obviously, "they" have a great interest in trying to control the markets on an ongoing basis. But, at some point I believe that the weight of the market will become great enough that whatever the degree of control over the market really exists will be lost.

The following text on Manipulation was taken from Robert Rhea's book, The Dow Theory.

"Manipulation is possible in the day to day movement of the averages, and secondary reactions are subject to such an influence to a more limited degree, but, the primary trend can never be manipulated.

Hamilton frequently discussed the subject of stock market manipulation. There are many who will disagree with his belief that manipulation is a negligible factor in primary movements, but it should always be remembered that he had, as a background for his opinions, a most intimate acquaintance with the veterans of Wall Street, and the advantage of having spent his life in accumulating facts pertaining to financial matters.

The following comment, taken at random from his many editorials, affords convincing proof that his views on the subject of manipulation did not vary and I will add that even today I feel that these views are not too far from the truth.

'The average amateur trader believes the stock market is guided in its trends by a certain mysterious 'power,' this belief being the one factor, next to impatience, most responsible for his losses. He reads tipster sheets avidly; he scans the newspapers industriously for news likely, in his opinion, to change the trend of the market. He does not seem to realize that by the time the news of real importance is printed, its effect, so far as the basic trend of the market is concerned, has long ago been discounted.'

'A limited number of stocks may be manipulated at one time, and may give an entirely false view of the situation. It is impossible, however, to manipulate the whole list so that the average price of 20 active stocks will show changes sufficiently important to draw market deductions from them.' (Nov. 29, 1908)

'Anybody will admit that while manipulation is possible in the day-to-day market movement, and the short swing is subject to such an influence in a more limited degree, the great market movement must be beyond the manipulation of the combined financial interests of the world.' (Feb.26, 1909)

'...the market itself is bigger than all the 'pools' and 'insiders' put together.' (May 8, 1922)

'One of the greatest of misconceptions, that which has militated most against the usefulness of the stock market barometer, is the belief that manipulation can falsify stock market movements otherwise authoritative and instructive. The writer claims no more authority than may come from twenty-two years of stark intimacy with Wall Street, preceded by practical acquaintance with the London Stock Exchange, the Paris Bourse and even that wildly speculative market in gold shares, 'Between the Chains,' in Johannesburg in 1895. But in all that experience, for what it may be worth, it is impossible to recall a single instance of a major market movement which depended for its impetus, or even for its genesis, upon manipulation. These discussions have been made in vain if they have failed to show that all the primary bull markets and every primary bear market have been vindicated, in the course of their development and before their close, by the facts of general business, however much over-speculations or over-liquidation may have tended to excess, as they always do, in the last stage of the primary swing.' (The Stock Market Barometer) '...no power, not the U. S. Treasury and the Federal Reserve System combined, could usefully manipulate forty active stocks or deflect their record to any but a negligible extent.' (April 27, 1923)

'It is true that a flurry in the price of wheat or cotton may influence the day to day movement of stock prices. Moreover, sometimes newspaper headlines contain news which is construed as bullish or bearish by market dabblers, who collectively rush in to buy or sell, thus influencing or 'manipulating' the market for a short period. The professional speculator is always ready to help the movement along by 'placing his line' while the little fellow timidly 'lays out' a few shares; then, when the little fellow decides to increase his commitments, the professional begins to unload and the reaction ends, and the primary movement is again resumed. It is doubtful if many of these reactions would ever be caused by newspaper headlines alone unless the market was either overbought or oversold at the time---the 'technical situation' so dear to the hearts of financial news reporters.'

'Those who believe the primary trend can be manipulated could, no doubt, study the subject for a few days and be convinced that such a thing is impossible. For instance, on September 1, 1929, the total market value of all stocks listed on the New York Stock Exchange was reported to have amounted to more than $89,000,000,000. Imagine the money which would have been involved in depressing such a mass of values even 10 per cent!'

Friday was a light volume day, so in using this past Thursday's volume I want to make a point. The volume for Thursday on the NYSE, the Nasdaq, the NDX, the S&P 100, the S&P 400, the S&P 500, the S&P 600, the Industrials, the Transports and the Utilities totaled some 7.53 billion shares from around the planet. If the thickness of one sheet of printer paper was equivalent to one share traded or one unit of volume, then Thursday's volume would equate to a stack of printer paper over 424 miles high. As I hope you can see from this example, for the market to be controlled in a significant and continuous way it would require unimaginable volume and money. Now this is not to say that it can't be done under the right circumstances. But, what I am saying is that once the tide really does turn, I believe that whatever the degree of "control" over the market may exist will be lost by the shear volume or weight of the market.

Next, I want to address the complacency in the market place. Below I have included a weekly chart of the Industrials, along with the Investors Intelligence percentage of bulls verses bulls and bears in the upper window. The blue line at the 50 percent line represents the same number of bulls as bears. In other words, at that level market sentiment is such that there are just as many bulls as there are bears. We have just completed the 217th consecutive week with this reading at or above the 50% level. This indicator moved above the 50% level the week of October 25, 2002. The week of June 23, 2006 this indicator did move to the 50% level. But, nonetheless is has been either at or above the 50% level now for an unprecedented 217 consecutive weeks. If we look at this data from a slightly different point of view and look at the ratio of bulls verses bears we find that there are currently 2.85 bulls to each bear. So, these numbers are telling us that the market place simply is fearless and complacent about a market decline.

Another example, of this extreme complacency was seen recently with by the second lowest reading ever seen on the VXO, which is the old VIX. The VIX and the VXO are often referred to as the "investor fear gauge". A high complacency rate equates to a low VXO reading, while fear relates to a high VXO reading. If you are unfamiliar with the VIX please see www.investopedia.com/terms/v/vix.asp. Anyway, the 1993 reading was the lowest reading ever, so this leaves the recent low, two weeks ago, as the second lowest reading on record.

Now, I want to show you a chart of lumber, which from its 2004 high down into the November low has dropped 50%. In December lumber prices have bounced and at present lumber is down approximately 42% from the 2004 high.

In the next chart below I have included a long-term chart of copper. I don't think anyone will argue that the advance out of the 2001 low up into the 2006 high was a parabolic move that was associated with the housing bubble. Since the May high copper is now down nearly 30%. So, let me make a couple of points here. One, as is always the case, parabolic moves never last! Two, the boom in copper prices should now be over as both the housing market has cooled and the air is now out of this parabolic advance. Plus, we have lumber prices that are way off their highs, which was also obviously associated with the housing bubble.

Now, in the next chart below we have the Dow Jones Home Construction Index from 2000 into the manic top that took place in 2005. It is interesting to note that lumber prices peaked a full year ahead of the housing market. In other words, lumber anticipated the topping of the housing market in that there was a non-confirmation between the two.

However, with copper, the speculative mania overshot the top in housing and continued pushing it up well after the top in both lumber and housing. But, here too, there was a non-confirmation by the housing market and we can see that non-confirmation was real.

So, now let me connect the dots. Here we sit with a Fed that certainly has an interest in keeping things afloat and quite honestly has done a very good job of it. We also have a public with virtually no fear or worry whatsoever. As the market was deflating into 2001 and 2002 the Fed began to flood the system with liquidity. In doing so, they ignited the housing boom, saved the stock market from what began as the initial leg down of a much nastier bear market and instilled a complete sense of complacency onto the public. As a result, everything floated higher on the back of the excessive liquidity that was pumped into the system and now here we sit fat, dumb and happy.

More recently, as we all know, the housing and commodity dominos fell. Now, here we sit with the stock market still holding up at this point and everybody seems to be oblivious to the fact that it is among the very next if not the domino to fall. Well, as I have been explaining, we continue to see the warnings from the ongoing Dow theory non-confirmations. This non-confirmation is telling us that something is wrong just as it did in 2000 and just as the non-confirmation between lumber, the housing indexes and copper did more recently. Also, my statistical data surrounding the 4-year cycle continues to suggest, contrary to popular belief, that the 4-year cycle did not bottom this past summer. On top of that, we are now beginning to see the poor economic data continuing to stream out with the latest example of this being the Philadelphia Fed Survey and Industrial Production on Thursday.

Yes, at this time the advance out of the summer low is still intact according to Dow theory. But, two of the previous reinflation bubbles have already begun deflating and we are seeing technical cracks appearing in the stock market. Thus, things are not as rosy as they appear. All the while the public is numb. Personally, I have my doubts about the "powers that be" being able to pump the economy enough to save it again. After all, we are still seeing the deflating of the bubbles in housing and commodities from the last, or really the ongoing, reinflation effort. All the while, stock market is still hanging on from these reinflation efforts but is increasingly moving onto thinner and thinner ice. I believe that the housing and commodity markets were the first dominos to topple and that the stock market will likely be the next. We are certainly seeing indications of this anyway. Also, the sentiment data tells me that the public is fearlessly complacent and obliviously numb to the real danger here. So, in light of these warnings and in spite of the fact that the stock market is at all time highs I don't like what I see and the overall picture here makes me nervous.

My analysis tells me that there is far more risk in the market than people realize. If you would like to see more detailed analysis on specifically what the statistical data is telling us about this risk, then I strongly urge you to consider a subscription to Cycles News & Views. I first presented this detailed analysis on the 4-year cycle at the New Orleans Investor Conference in November. In this presentation I reveal the quantified market risk using statistical analysis that exist in the market today. This slide presentation is now available to subscribers. It not only gives us the quantified risks, but also tells us where we are, what should follow, when and why. I also provide turn points for stock market, gold, the dollar and bonds using both statistical probability and my unique set of turn indicators as well. A subscription also includes short-term updates three nights a week. Get the technical and statistical facts. Please see www.cyclesman.com/testimonials.htm.

Tim W. Wood
Cyclesman.com

Copyright © 2004-2008 by Tim W. Wood. All rights reserved.

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