This morning after the homes sales data was released, the Dow Jones once again went below that magical 10,000 number.  Yes, the same number we first talked about in 1999.  Here we are over 10 years later and we’re still talking about Dow 10,000.

According to my calculations, the Dow Jones has crossed above or below 10,000 18 times in 2010.  That’s just in 2010.  When I talk to the average Joe on the street about the market, they constantly discuss the Dow Jones and is it above or below 10,000.  They also make comments about the fact that if the Dow Jones is above 10,000, it is a good market.  This is one of the least reliable indicators you can use.  It’s similar to buying or selling stocks based on one moving average.  The fact that the Dow has crossed the 10,000 mark so many times just this year reiterates the need for income and shows that despite the emotional swings, the market has really gone nowhere in 2010.  I think what we’ve experienced in 2010 is in microcosm what we’ll experience on a bigger scale for the next several years.  The bands may be bigger but I believe the results will show that it was a grind it out, essentially flat market, with a lot of bumps and a market that saw 10,000 come and go many times on the Dow Jones Industrial Average.

Use periods of excessive optimism to sell and excessive pessimism to buy and continue to generate income any way you can.  For the short-term, I think we’re very oversold and due for a bounce.  We may not be done correcting overall but I think the stock market will work its way higher into the mid-term elections.  For now, there is neither excessive optimism or pessimism but the pessimism is certainly winning out which makes me a net buyer of stocks, not a net seller.

In early 2010 as the stock market rally was approaching a year old, the concern became rising rates.  At that time, I argued that perhaps interest rates would stay lower longer than most thought.  Although the economy was starting to grow again, it wasn’t growing at such a fast clip that rates would go up.  In addition, investors were so scared from two bear markets in just ten years that treasuries would have a bid underneath them for some time (investors would continue to buy bonds) keeping interest rates low.  Lastly, there was evidence (and there still is) that for every $1 the Fed creates in stimulus, there is a negative multiplier effect and only $.86 is actually going into the economy.

Since the spring, not only have rates not gone up, they’ve fallen even more.  Interest rates on 10-year treasuries have fallen from 4% to under 3% pushing bond prices up.    Is there another bubble about to pop?  Many of you think so.  I think so.  I just think there are a lot of people who may have the timing wrong.  Bubbles can get bigger and last longer than we originally think.  But, eventually, they do pop.  So, just how expensive are treasury bonds?

Below is a picture of the “P/E ratio” on 10-year treasuries.  Assuming the interest you receive on treasuries are your earnings, the P/E ratio on treasuries is currently 35.  In comparison, the P/E ratio on the S&P 500 currently is around 15.

The picture above I created shows the “P/E ratio” on bonds from 1962 to present.  In 1982, bonds were very cheap as were stocks at that time.  Now, bonds are very expensive while stocks I think are not.  This is one main reason why stocks can rally further.  It’s not that stocks are dirt cheap.  But, asset allocators and managers out there are comparing bonds versus stocks using the above metric to determine where there is value.

I’m not calling for an immediate rise in rates but you better have a plan for when they do start to rise whether it’s selling treasuries short or some other tool.  It will happen eventually.

This morning GDP QOQ (Annualized) was released at 2.4% vs. the estimate of 2.6%.  At first glance, you think uh oh.  Then, there was the revision to last month’s number.  It was a big revision UP.  You put it all together, and it shows a economy that slowed down very fast last month.  As you know, I watch this number carefully because it correlates so well with the S&P 500.  (Below is the picture including today’s data).

As you can see, really what we need right now is some stabilization.  I believe that if the economic data that continues to be released over the next few months is mediocre, the stock market can rally further.  What the market has been reacting to over the past 3 months has been the sharp drop in all the leading economic indicators.  Some stabilization in the Europe & the U.S. combined with continued growth in the emerging markets could be just what the bulls want.

A few days ago, I posted a picture of initial jobless claims on top of the S&P 500 to show you the correlation of jobs and stock prices.  You’ll hear from some “pundits” that jobs don’t matter.  We’re a service economy now and manufacturing here in the states is never coming back.  And while I believe that, my job is to figure out what makes stock prices go up or down.  Job growth is one of the many components that affect stock prices.  Today, we got another confirmation that jobs do matter. The change in non-farm payrolls figure came out at 7:30 a.m. CST.  The number (which will be revised) came out at a -125,000.  This was a little better than estimates, but once again this number is going in the wrong direction.

I know it’s hard to believe government numbers and we know they change over time but the point is this:  If you believe we’ll have more jobs and a robust economy, you buy stocks.  If you believe we’ll have stabilization like we did in the mid 2000s where jobs were created even at a slow pace, you buy stocks.  If you think unemployment is going to stay over 10% and increase, then you avoid stocks.  This is a longer-term indicator and while things look very bearish based on the above graph, I think we are setting up for a tradable rally in the next few days.  As always, we have to monitor the strength to determine whether or not it should be shorted or not.  We often get rallies into holidays that are somewhat patriotic.  This year, it may be the opposite.  I think the rally comes after the holiday.

Short-term (starting in the next few days) – Bullish
Medium-term – Bullish
Long-term – Bearish

Some people will say technical analysis is hocus pocus and voodoo.  I think just the opposite.  I think sometimes fundamentals don’t make any sense.  All you have to do is plot the news on top of the price of any security and you’ll often see that the technicals lead the fundamentals.  But, as many of you know, I’m not an all or none investor.  I combine the fundmanetals with the technicals.  In addition, I know that a lot of people that are controlling money DO watch the technicals so it becomes a self-fulfilling prophecy.

Given that, right now I’m focusing on the fact that technicians are watching the 50-day moving average and the 200-day moving average and how they interact and where they cross.  The last time the 50-day moving average crossed below the 200-day moving average was early 2008 (highlighted in yellow circle).  In June of 2009, the 50-day moving average of the S&P 500 went above the 200-day.  Now, we’re very close to getting the bearish crossover once again.  With that said, I am expecting a rally that will keep the 50-day above the 200-day based on some other technical indicators I watch.

The fundamentals continue to deteriorate and are conflicting with the technicals.  Therefore, I’m still approaching this market very cautiously.  I expect a few more weeks or months of upside.  However, this market will eventually need to be shorted but I don’t believe it’s yet.

I’ve commented before about jobs.  You’ll hear some say jobs don’t matter.  In this global economy, that may be partially true given the U.S. is a service based economy.  However, our job is to figure out what correlates with stock prices going up or down.  This morning, the initial jobless claims were released.  The number came in at 472,000 vs. the estimate of 450,000.  The last reading was 456,000.  Below is a picture of the initial jobless claims going back to year 2000 (inverted) versus the S&P 500.  You can see there is a very tight correlation.  Therefore, if you believe more and more people are going to be looking for work in the months ahead, you can’t be extremely bullish on stocks.  On the other hand, if you think the economy is recovering and jobs are coming back, you should be bullish.

With the market bouncing up and down on a daily basis, nerves are high.  The question I get more than any other is whether or not this is a new bear market or just a bump in the road.  I’m going to lay out some historical characteristics of bear markets vs. corrections in a bull market.  In 2007, there were several signs that the market was beginning to deteriorate.  It’s not just about looking at the level of the Dow Jones Industrials.  During 2007, in addition to the economy beginning to slow down, the internals of the stock market were getting weaker.  Anytime I analyze the NYSE, filtering through the various types of securities traded takes some time.  Closed-end bond funds, REITS, preferred stocks, etc. are traded on the NYSE.  Stripping those out and looking just at the operating companies gives an investor a much better sense of actual buying/selling and the future direction of the markets.  In 2007, the number of companies making new highs began to fall while the ones making new lows started rising.  In addition, the amount of volume (shares traded) was increasing on down days and falling on up days.  Various stocks began to enter their own private bear market.  Then, various sectors did the same.  Eventually by 2008, the entire market was in a downturn that eventually snowballed into what amounted to a stock market crash.  This progression that led to a new bear market was typical even though the drop in 2008 and the intensity were not.  Bear markets such as this one tend to look like a lower case “n” where they roll over.

A correction, on the other hand, happens very rapidly, is news driven and very scary.  As an trader and advisor, I tend to remember each year based on what the stock market does.  I remember 1998 as though it was yesterday.   In 1998, the stock market had started off the year very strong with 20% gains (based on the S&P 500) in just the first four months of the year.  That was followed by a mild correction (5%).  From the spring to midsummer, the S&P had gained another 10% and was at new highs.  Just as quickly as the rally had started, it came to a violent end.  What caused this abrupt turnaround?  In August of 1998, Russia defaulted on its debt and the financial markets went into a tailspin.  Long Term Capital Management (LTCM), a hedge fund collapsed.  The Federal Reserve sponsored a bailout of LTCM by its creditor banks. The Fed intervened and said they were trying to prevent a financial crisis.  Sound familiar?  LTCM eventually liquidated in year 2000.  In one month, the market had fallen 10%.  For a month it bounced around these low levels until it eventually fell another 10% bringing the correction to 20% from peak to trough.  It bounced 10% and eventually re-tested the lows.  That was the end of the correction, not the beginning of a bear market.

I believe Russia in 1998 is today’s Greece.  The stock market was in a well defined bull market and a 20% correction came virtually out of nowhere.  However, it ended and the stock market went on to make new highs before eventually peaking in March of 2000.

Below, I’ve overlaid the 1998 stock market on top of our current stock market.  There is a very similar pattern.  But notice in August 1998 (blue line) how the market took an initial drop (10%), paused and took another leg down.  I’m not necessarily predicting another 10% fall from these levels in the stock market, but it did happen in 1998 and that was a correction in a bull market, not the start of a bear market.

There are several instances over the past several decades of corrections that look very similar to what we’re experiencing in the markets in 2010.  With that said, there are several headwinds today that are different from 1998.  In 1998, we were dealing with taxes heading down, corporate profits rising, interest rates in a long-term downtrend, and a more peaceful geopolitical environment.  Therefore, there are more doubters of the recent rally than in 1998 and justifiably so.  It’s important to constantly monitor the overall strength of demand & supply of equities rather than try to predict how investors will feel a few months from now.  Over the next few days, I’ll be monitoring that demand & supply to see if any bounces are just the dead cat variety.

I’m getting a few e-mails regarding the Economic Cycle Research Institute’s Weekly Leading Index Growth Rate continuing to fall.  The folks at this great research firm have said repeatedly that for the economy to be weak or strong, the trend must be sustainable and persistent in a particular direction.  The growth rate peaked in October 2009 at 28.5 and is currently 9.  So, the growth rate has definitely slowed but this is still showing that there is growth.  What’s disturbing about the picture below is the fact that it doesn’t look like it’s bottomed.  So, is this the definition of a persistent move?  Given all the headline risk regarding the global economy, I’d say so.  I discussed about a month ago that the GDP Growth rate in the U.S. has probably peaked.  That doesn’t mean we’re not growing but the rate of growth is slowing.  The car isn’t accelerating but rather on cruise control.

It’s not the fact that the economy is still growing.  Investors key off of the rate of change.  Remember, above is the rate of change, not the absolute number (see correlation between the two lines).  As the economic decline began to slow in mid to late 2008, that was a sign that a change in the S&P 500 and stocks in general was coming (many stocks bottomed in November of 2008).  The ECRI peaked in October 2009.  This is 6 months prior to the S&P 500 peaking (at least for now).

While this is something I’m watching very closely, I’m more concerned about the internals of the market and the attitude of investors.  In the short-term, there is a tremendous amount of fear and a bounce is very likely.  The quality of that bounce will be key.  Are sellers pausing or do institutions step in with a high amount of volume and intensity?  We’ll know next week probably.

I still don’t believe this is the end of the bull market.  While I’m not a raging bull, I have gone back and looked at history.  And history suggests that stock markets don’t go from bull market to bear market over night.  Long strong bull markets tend to have violent and quick sell offs that make you believe it’s over.  And while we should trade that, protect capital, and sell some, I would not become overly bearish at these levels.   Bear markets usually develop over time with deterioration in the internals.

If the economic backdrop continues to deteriorate (i.e. the above picture) and the internals (long-term) suggest deterioration, then a bear strategy will be implemented. Until then, I’m treating this as a correction and holding lots of cash looking for the buying opportunity.

In the last month, we’ve seen the dollar race up over 10%, 10-year government bonds’ yield drop from 3.8% to 3.2%.  We know Europe is in big trouble, emerging markets such as China are putting on the brakes and raising interest rates.  Money is flowing INTO the United States at a feverish pace because investors want safety and they want to invest in companies that don’t sell products to foreigners (at least for now).

Let me be clear that I don’t want to build a long-term portfolio based on a rising dollar and betting against emerging market consumers.  But, for the time being, it’s working.   This led me to run a screen for the biggest U.S. companies that have 85% or more of their revenue coming from inside the borders.  See below.

As the economy recovered in 2009, Australia was the first country to start tapping on the brakes to prevent further inflation by raising interest rates.  They haven’t stopped.  Now, we see China is tapping on the brakes as well.  For the last several years, all we heard was if you’re going to invest, it better be in “global growth”.  While this is certainly true in the long run, what about now?

The argument has been our country is driving dollars offshore.  There are billions of people industrializing.  The U.S. dollar is going to zero.  Interest rates are going to the moon and inflation is right around the corner.  But, let’s review the last few months.  Earlier this year, I discussed on a podcast that perhaps we should maybe prepare for lower interest rates in the near term, not higher.  I thought of this because literally every person I talked to then (and even now) believes inflation is here and we better prepare.  So, I first examined the contrarian view.  Since then, the numbers have proved me correct.  Inflation could be a problem down the road but even though the monetary base has exploded, the multiplier effect has been going down.  Money isn’t circulating as fast as people would have imagined.  So, we’re still in a flat to deflationary environment.  Thus, the Fed hasn’t raised rates and long-term rates have actually come down.

In the last few weeks, the Greece situation has been the hot topic and money has come out of the Euro and into U.S. dollars.  Yes, the dollar has risen.  Now, we all know the government doesn’t want this to happen.  They need a weaker dollar so we can inflate our way out of this.  But, the dollar is going up, interest rates are coming down, and the place to be is the United States of America.  Put on your global hat for a minute.  Let’s say for a minute you’re a billionaire with money and assets that have to be allocated anywhere in the world.  You look at the most exciting places to invest:  China, Latin America, India, etc.  Exciting but risky and they’re growing so fast that their government has started to put the brakes on to slow it down.  That’s typically not the best investing environment.  On top of that, some of the brightest investment minds we have are saying China is another bubble about to burst.  So, that’s out (for now).  Then, you look across the pond to invest your money.  Good ‘ole Europe.  The grandfather (or mother) of the world.  But, they’re falling apart, behind the curve, their currency is falling, and it’s just a mess.  What’s left, the United States of America.  Money is flowing into U.S. treasuries, the U.S. dollar, and stocks with limited international exposure.  Small caps, mid caps, etc. are the place to be.

If you put a gun to my head and said you can only invest in two areas for the rest of your life and you have to stick with it, what’s it going to be?  Emerging markets and materials would be my choice.  But, fortunately, we have a little more freedom than that.  So, we look for rotations and try to track where is the money flowing.  In the last month, Chinese stocks are down over 10%, the S&P is down about 2%, and the Russell 2000 (small cap American stocks) is up slightly.  The dollar is up 4.5% and 10-year treasury rates have fallen from 4% to 3.5% meaning money is coming into U.S. bonds.

I perceive this rotation as America being the hide out and the safe place to be for the short-term.  Again, this isn’t a long-term trend but it could last a while.  The global growth story is out there and has been for some time.  Now that the retail investor is catching on to this, I think we have to put our contrarian hat on for a minute.  The place everybody likes to bash is the place attracting the capital.  The U.S. of A.