Dow In A Bull Market? Are Bank Stocks A Buy? We Dont Think So!

By: David Chapman | Fri, Apr 11, 2008
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We are reviving the Technical Scoop series. This will replace the WeekEnd Commentary. It will free up a bit of extra time on weekends, which we found were being given over almost entirely to writing and editing.

We will still be offering some commentary on global economic and geopolitical events and their impact on investments and the markets. But we will be returning a bit to our roots with this resurrection of the Technical Scoop, where we used to comment on companies, their charts, and their relationship to what was being said in the markets or the news. So this will be more chart-oriented than was the WeekEnd Commentary. We hope to publish at least two issues a month.

We are inundated with information these days. Not only do we have financial publications and business sections in the newspapers, including the Globe & Mail, the Financial Post, the Wall Street Journal, the Investor's Business Daily and more, but there are others such as the Economist. There are many financial websites offering articles written by a number of fine analysts and covering a wide range of financial and geopolitical subjects. It's not hard to feel overwhelmed by it all and to miss more of it then we actually read. As a writer we constantly have the fear of sounding like every other writer covering the same topics, and that our analysis may not be as incisive as that of the next guy. It is a crowded field.

So we try to find a niche, do it a little differently, but still provide the perspective on the markets that is needed in today's volatile information world.


A recent missive from Richard Russell said that he believed the stock market was still in a primary bull market. The lows of October 2002 and January 2008 were nothing more than "important secondary or cyclical correction bottoms".

For those of you who don't know, Richard Russell is a veteran market guru and author of the Dow Theory Letters, published since 1958. The Hulbert Financial Digest has rated him as one of the best market timers after tracking him for over 30 years.

Mr Russell is well known for his bearish views, so for him to say that the markets were still in the long-term bull market that began in 1982 caught us by surprise. Naturally we checked to see if his Letter was dated April 1. Or was it possible he was drinking from the same Kool Aid reservoir as Ben Bernanke? (Bernanke, like a drunken sailor, has been handing out money as if it were candy. Or was it helicopter drops, bailing out his buddies on Wall Street and saving them from their own greed?)

Either way, the recent loans to Wall Street ($200 billion) or the taking-on of spurious securities ($30 billion of Bear Stearns structured finance securities) was unprecedented, certainly since the days of the Great Depression. You could call it the "nationalization of Wall Street" as market analyst John Ing of Maison Placements recently did (Gold: The Nationalization of Wall Street - March 27).

Meanwhile the US housing crisis rolls on as the administration and the Fed try to figure out another bailout plan. The IMF says that Wall Street losses could approach one trillion dollars, which is quite a ways away from the current write-offs scoreboard of about $250 billion. Either way the losses dwarf anything seen during the Savings & Loans crisis which sent us tumbling into the recession of the early 1990s. Or for that matter any of the other major crises seen since the Great Depression.

There has even been speculation about a hyperinflationary depression (the Hyperinflation Special Report of April 8 by John Williams of Shadow Government Statistics, Not only are we having the helicopter drops (ultimately very inflationary) with M3 money supply growing at a rate exceeding 16 per cent according to Mr Williams, but even the reported M2 is now growing at over 10 per cent a year. We have food and energy price inflation, food riots in some countries, and blockages of US highways by truckers angry about the cost of gasoline, although the US by any measurement still has some of the cheapest gas in the world. Still at current prices around $3.25/gallon the US is fast approaching the inflation adjusted highs of 1980.

Top this off with the US debt that clearly can't be paid back in anyone's lifetime current or future. The administrators of the United States of America have bankrupted the country. Never discussed are the unfunded liabilities of Medicare and Social Security. Currently that unfunded liability is estimated to be about $45 trillion. Yes that is trillion as in $45,000,000,000,000 (did we get enough 0's?). Add in the current Federal debt (growing rapidly thanks to colonial wars and the worlds largest military to pay for ) plus the debt related to the trade deficit (that grows at roughly $800 billion annually) and you have a total debt of about $62 trillion. And all this against a GDP of roughly $13 trillion. While the US may have the world's largest economy it also has the world's largest debt. The GDP of the rest of the world exceeds their debt.

Note: Canada by comparison has funded its social security and funds its health care as well even though our taxes are higher. So the US will eventually be forced to either slash benefits hugely or raise taxes to pay for it. Of course there is one more solution and that is getting the printing presses going even more than they currently are. That of course would trigger the hyperinflationary scenario. Since they won't raise taxes the current generation and future generations are facing a increasingly bleak future more akin to life in a third world country. But shortfalls in social security (think pensions) are not unusual as most pension funds in North America are facing shortfalls. Think the recent announcement by the Canadian giant Teachers Pension Fund that announced a shortfall or an underfunding of over $12 billion.

With that as our background, we were surprised by Richard's missive. Grant you he did offer the premise that the current correction cycle should bottom for good some time in 2008-10, and then it would be onward and upward to new highs. We don't have much argument with that although we believe it could be as late as 2012 before we see the final bottom of this current crisis. We are just not sure at what level we will make our lows.

Our problem with the "bull market that we have never left" thesis is that even though we may go to higher prices in the stock markets, it will not necessarily mean much. If John Williams' hyperinflation premise is correct, we have no doubt that the DJI would soar to new highs. Just take a look at Zimbabwe. The stock market there was the best performer in the world during 2007 - up 12,000 per cent. Sounds impressive, until you put it up against the 100,000 per cent inflation over the same period. Then it looks pretty paltry. On the Zimbabwe Stock Exchange, prices move in millions of Zimbabwe currency. One would have to be a fool to be involved in that market, irrespective of whether Mugabe stays or goes.

Not that we are suggesting we will soon see IBM stock trading at $118 million rather than the current $118, but you get the picture. We want to show you three pictures of the DJI that say to us we are definitely in a bear market. The bull market ended between January and March 2000.

Chart #1 - Dow Jones Industrials, 1920-2008, adjusted for inflation. This shows the DJI has been in a wonderful long-term up trend. That is what one would expect to occur over a long period of time as we make gains on an inflation-adjusted basis. But it also shows long periods of bull and bear markets. In 1929 we reached a high of 2,010; in 1932 we hit rock bottom at 314 a loss of 84%. The next major bull market got underway and we topped out in 1966 at 3,048. The ensuing bear market didn't bottom until 1982, at 837 for a lesser loss of 73%.

We now have our channel (a line parallel to the connecting of the 1932 and 1982 lows). Lo, the highs of 2000 came in at around 6,660 to hit the top of the channel. In 2007, while we made higher highs, it was merely a double top when adjusted for inflation. We are now starting to break down from that double top. If past history of bear markets are any measurement then the bottom on this market won't come until we hit lows of anywhere from 1798 to 999. That's ugly.

While we are not saying we will collapse to the lower line (currently near 1,700), we expect a serious move towards it over the next several years on an inflation adjusted basis. If we were to show this same chart using John Williams' CPI data (calculated based on the old method of calculating CPI), the current level would be even lower.

People tend to focus almost exclusively on the absolute moves and levels in the market forgetting that what is really important is the real return after inflation. Once inflation is taken into consideration the picture is not nearly as pleasant. Given the helicopter drops of Bernanke & Co. it is possible that we will not go as low as the levels suggest. But then again it is very possible as rapidly growing money supply is ultimately very inflationary. In absolute terms we may make new highs. On an inflation adjusted basis we might actually be losing and falling further behind.

Chart #2 - Dow/Gold ratio. This chart shows that the ratio topped out in 1999, when one unit of the DJI would buy about 45 ounces of gold. Today that DJI unit buys only 13.4 ounces.

We all know that the Dow/Gold ratio has a long history. In 1980 the ratio was 1:1 and in 1932 it was 2:1. At the important market tops in 1929 and 1966 it was about 29:1. In gold terms the DJI has been falling for years. Whether we will make it back to the 1:1 level seen in 1980, we don't know. But with a falling US dollar and a Fed willing to drop money from helicopters, the Dow/Gold ratio will continue its downward trend and will continue to favour gold over stocks.

While the DJI has made new highs in absolute terms in gold terms it has been in a bear market for years. Yet strangely enough the bulk of the investment world still spurns gold and when you compare all the gold in the world which is worth about $4 trillion it is paltry against a paper world of stocks and bonds of about $180 trillion.

Chart #3 - Dow/Euro. Europeans looking at the DJI in terms of their own currency see a bear market in progress. The DJI topped in 2001 in euro terms and the collapse into 2002-03 was quite severe, taking us back to 1995 levels. The recovery into 2007 was extremely feeble and has now collapsed again, with minimum targets down to about 3,000 in euro terms. That's quite a drop.

On an inflation-adjusted basis, a gold basis and a euro basis, the Dow Jones Industrials has been in a bear market since 2000. Like Richard Russell says, we could see even higher prices down the road. But what inflation adjusted, gold and the Euro is telling us is that it will be merely an illusion.


We are amazed at the number of buy recommendations we are seeing on financial stocks these days, particularly on the Canadian chartered banks. On the other side we continue to hear and read that the commodity market in general and the gold market in particular has been in a bubble and that its demise is just around the corner. So we are going to examine two companies' charts from a technical perspective, to see if it makes sense to jump back into bank stocks and jump out of gold stocks.

Our two stocks are Canadian Imperial Bank of Commerce (CM-TSX) to represent the banks and Agnico-Eagle Mines Ltd. (AEM-TSX) to represent gold stocks. It is open to argument whether they are the best choices. But they have some "opposite similarities". CIBC has been one of the weakest of the bank stocks and Agnico Eagle one of the strongest of the gold stocks. So in that respect they are good representatives.

Technical analysts will look at stocks, indices, commodities and anything else from the outside in - starting with the big picture (monthly charts) and then moving down the scale to weekly and daily charts and then to intraday charts. Monthly charts give us a good sense of the long-term or primary trend; weekly charts give us our sense of the intermediate trend; the dailies tell us about the short-term. So we will follow this process.


The uptrend in CIBC dates from the lows seen in October 1998 and the secondary higher lows in October 2002. Those lows were respectively the Asian/Russian panic of 1998 that culminated with the collapse of the Long Term Capital Management (LTCM) hedge fund. The 2002 lows coincided with the bottom of the dot-com bubble collapse.

If using a 23-month moving average, we would have been long CIBC from June 2003 and would have exited profitably in November 2007. The collapse almost took us back to the up trend line from the 1998 lows that connected to the 2002 lows. For a much longer bull market in CIBC it will become important that that level holds.

But we are currently well below the 23-month MA, which tells us there is no reason from the primary trend to get back into CIBC. A successful test of the up trend line from the 1998 lows coupled with a rebound would have us watching for potential entry points as we would be starting from some sort of bottom.

Agnico has also been in an uptrend since its lows in 1998. From roughly 2002 to 2005 it went through a consolidation correction and very long-term traders would probably have wished to have moved to the sidelines. They would have re-entered in late 2005, when Agnico broke out of the long consolidation pattern. Since then we have been in a solid uptrend, and although we have pulled back of late we remain well above our key 23-month MA.

From the monthly charts, would we buy CIBC or bank stocks? We don't think so. But if we are long Agnico and gold stocks, we would stay put.


The weekly charts tell much the same story. Our key 40-week moving average was taken out a few times over the past few years. However, the break under the key level was usually short-lived and we soon resumed the uptrend.

But another key element of weekly charts never occurred during any of those breaks. We never once took out any previous major weekly low (seen in 2004, 2005 and 2006) until we broke under the weekly August 2007 lows in November 2007. For the first time since the 2002 lows we failed to make any new highs following the recovery period after the key weekly low.

Investors should remember this. For our uptrend to remain in place we need to hold our key weekly uptrend moving average (40 weeks) and we must never take out any prior major weekly low. The same holds true on the monthly charts, only it pertains to monthly and yearly lows. In the case of CIBC, the breakdown from November 2007 not only took out the 2006 lows, it also broke under the 2005 and 2004 lows, signalling to us that CIBC had entered a primary/intermediate bear market. Note as well the huge double top on CIBC's chart. The double top target was to at least $65. The actual low was near $56, telling us this was a very weak market.

Returning to the weekly charts, CIBC has rebounded off its lows but remains well away from the 40-week MA which is way up near $80. It is also below the last weekly high, near $73.60. That zone should act as resistance on any rebound. No reason from the intermediate perspective to buy this stock.

Agnico Eagle on the other hand took off after the long consolidation from 2002 to 2005. There has been some penetration of the 40-week MA but again it always held the previous weekly low. A nice up trend line has now developed. We see no reason to exit Agnico Eagle.

Our conclusion is the same. Would we buy CIBC and the bank stocks now? We don't think so.


The daily charts are telling us a slightly different story than the monthly and weekly charts. For CIBC, there are still no major buy signals. Short-term, though, it broke a downtrend line when it gapped up strongly on March 24. While we have no significant bottoming pattern forming (unless you count the possibility of a spike bottom), we admit it may be forming a bottoming pattern.

But we have learned the hard way that trying to guess what pattern may be forming is a dangerous game. In other words you may get burnt. But with no major bottoming pattern in place, all that is clear right now is that we have started what may be a short-term uptrend. But we are very early in this uptrend and there has been no major test of the lows, so it is difficult to speculate on where we might go next.

Same with Agnico Eagle. We did break under a short-term uptrend - indeed, it topped the same day that CIBC bottomed. But once again, while we have started what may be a short-term downtrend, there are no major signs that it is anything more than just another short-term correction. A gentler uptrend and the 200-day moving average are well below current levels. (The 200-day MA for CIBC is well above current levels.) Agnico has support just below here near $65, again at $60, and down to the 200-day MA near $54.

So, even working from the daily charts, would we buy CIBC and the bank stocks? Yet again, we don't think so.

Charts created using Omega TradeStation. Chart data supplied by Dial Data.



David Chapman

Author: David Chapman
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
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David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

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