Economy's expanding as jobless rate in January fell to the lowest level in 4 years and factory orders rose. No, wait, economy's slowing down as consumer sentiment dropped and the Institute for Supply Management's manufacturing as well as non-manufacturing activities declined... If you're as confused as everyone else about the state of our economy now, then Wall Street has done a good job using the tactics Mr. Shinichi Yano wrote in his book, Sales and Marketing Strategy for The Weak. One of the most effective ways to disguise a company's weakness, or a weak market and economy in this case, is to introduce diversionary tactics to scatter and confuse the enemies, or the investors in our case.
The artifice of diversion and confusion is by no means anything new. It was discussed by Sun Tzu in The Art of War written more than 2,000 years ago. Today, this tactic continues to be highly effective. Judging from recent market volatility, the prevalence of confusion is indeed quite self-evident.
A Gap-Galore 30-minute intraday Nasdaq chart (Chart 1) covering the recent 2 weeks of action (10 trading sessions) displays an "Island Top" reversal technical pattern. I've marked the inter-day big gaps (blue Xs). If you'd look closely, you'd see quite a few smaller intraday gaps on this chart. Of all technical patterns, none manifests a market driven by conflicting news events better than an Island Top formation. In fact, beyond this chart, the entire market action thus far in 2006 had all shown patterns of being driven by contradicting news.
Eventually, a reversion to the means will have to take place. The market jitter, which began on the last trading day of 2005, will have to settle down sometime. When it does, and before a market movement in earnest can begin, it's likely that the market (the Nasdaq Composite Index) could return to square one, or 2200 level, as it did on December 30, 2005. The daily chart of the Nasdaq (Chart 2) shows that the December decline was stopped out as soon as the intraday low on the first trading day of 2006 briefly breached the 2200 support. The 2200 support also happens to be the strong resistance that stopped the market rally in the beginning of August, when I called the end of the summer rally.
It may take a while for the market to sort things out. For now, in the short-term, the decline's likely to continue with a mixture of one or two updays in between.
Jack Hutson's TRIX Index is perhaps one of the best whipsaw-free trend indicators. The interaction of the TRIX Index, a triple 15-day exponential moving average oscillator, and the ATR (Average True Range) pinpoint 2 market bottoms in early March and then in mid October as the TRIX dropped below minus 0.1 and below its 9-day trigger line (red curve) while the ATR rose above 24 and above its 20-day moving average (blue curve). In plain English, this means that while the Nasdaq's declining, the change of the daily closing prices (TRIX) is slowing down to an extremely low level and the accompanying volatility (ATR) is reaching an unsustainably high level that an imminent reversal is statistically probable.
And, this appears to be what's in the making right now (black arrows). The TRIX had just crossed below 0.1 and below its 9-day signal line while the ATR had risen above 23 and its 20-day moving average. However, both indicators still have quite a way to go before reaching their respective extreme low and extreme high levels. Until that reversal happens, the declining trend of the TRIX and the rising trend of the ATR are likely to continue, which means that the market decline is likely to continue.
Incidentally, the baffling July rally after the terrorist bombing in London was marked by blue circle on the TRIX indicator. That was the first time in years TRIX didn't come all the way down to 0 (or close to 0), after crossing below 0.1. Is it likely for that to happen again this time? Not likely. The ATR was falling in July, but it's currently rising while staying above its 20-day moving average. In any case, that July rally must've caught many traders off-guard. It's still a mystery to me.
In any case, one way to counter diversionary tactics is to stay focused on the fundamentals. One unwavering indicator that tells the true story of our economy is the STIR (Sale-To-Inventory Ratio) indicator for the existing housing market. Existing housing market has been the engine that drives the economy in recent years. New home sales volume is less than 20% of the existing home sales. And, most consumer spending has been funded by extracting cash from equities of their existing homes.
The STIR indicator shows whether the sales activities are keeping up with the inventory buildup. When this ratio's at 1, selling activities and listing activities are moving at the same pace. In our case, selling activities have been declining for quite a while now. As of December 2005, the STIR dropped to just 1.36. However, as long as this ratio remains above 1, sales continue to outpace inventory buildup. The real trouble begins when this declining trend carries the ratio all the way down to below 1. That's when price begins to fall in earnest. So far, there have been price fluctuations but not serious decline. According to the National Association of Realtors statistics, the median sales price in December 2005 was still 10.47% higher than the median price in December 2004.
As an aside, please keep in mind what I've repeated in the past that sales statistics are things of the past. Final sales are the results of all the selling activities that took place a month or so ago. The December result that we're looking at right now is actually generated from November or even October's activities.
Finally, we can also choose to not to participate. We keep our cash and wait till the dust settles. That may turn out to be the best counter measure yet.