Now that the market isn’t free falling every single day, we can get back to selecting what looks good to buy, technical analysis, etc.  We have various charts that are starting to look constructive.  Now, before we all get too excited that we could be setting up to have our first back to back up day this whole month, caution is still warranted.  There are not green flags just yet.  But, things are definitely getting better.

One positive I’m seeing is a potential pattern developing in the Dow Jones (and probably other indexes as well) that could be bullish for the medium term.  You’ve all heard of a head and shoulders pattern.  This is typically negative.  It’s when a stock or index makes a high, pulls back (that’s the left shoulder), goes to an even higher high, pulls back (that’s the head), and then makes a lower high (that’s the right shoulder).  That pattern typically precedes a fall in the particular investment you’re watching.

Well, I’m noticing the making of an upside down head and shoulders pattern which is bullish.  As you can see from the chart below, we made a low on October 10th.  Then we made a lower closing low on October 27th.  If we came back and went down but didn’t close lower than 8451 (the October 10th close), we could be off to the races.

I think this rally can take us to Dow 10,000 fairly easily.  But, it may not be straight up.  We’re starting to get 2 steps forward and 1 back which is ok compared to 10 steps backwards and 0 forward as we’ve been most of October.

I will caution you that today had very light volume.  We need to be rallying on heavier volume.  If you have large positions that are highly correlated to the stock market and you don’t want to ride them back down, put stops underneath them.  As the market moves up, continue to move your stops up as well.  Not a bad week though.

Have a nice weekend.

I’ve been mentioning that we’ve had major improvement in the credit markets over the past week or so.  Spreads are loosening up and LIBOR continues to come down.  All of the intervention worldwide is helping the credit markets.  I believe the panic is behind us.  There is still some fear but the panic is gone.  As far as the equity markets, the panic also seems to be subsiding.  There is still plenty of fear but not as much.

The pattern the last three days has been very constructive.  Up 900 points, down 70, then up 200.  We basically had a pretty strong day Tuesday, a mild profit taking pullback yesterday, and a pretty strong day today.  I nibbled today and made a couple of purchases.  The first purchases I’ve made in a very long time.  I have stops on major holdings that are general to the market not wanting to give up gains made in the past few days.  But, certain stocks and sectors are looking good for the first time in a while.

We can’t dive in but we can buy on the way up.  I have not yet bought extremely high beta ETFs just yet, but I am nibbling here and there.  The market is in the process of improving but it’s not THERE yet.  I think the selling pressure is easing up but the demand for stocks isn’t there just yet.  It’s like holding something under water in a pool.  If you let it go, it bounces to the surface.  That’s where we are right now.  The pressure has been released for the short-term which is giving equity prices a boost but the really strong demand isn’t there yet.  But, every up day causes those with 100% cash to question their sales they made and jump on board at some point.

Today was a big improvement and the fact that we’re building on the 900 point up day from two days ago is very constructive.  In addition, the market tried to sell off in the last hour but when we were only up 50 or so, the buyers stepped back in pushing the Dow up 189.  That’s another positive sign.

One main concern I have and it may benefit us in the short run is we are getting better than expected economic reports.  This is fooling everyone into thinking things are improving.  They are not.  They will get worse and as the months go on, people that read these reports will have sticker shock when they see those bad numbers.  But, for now, let’s hope they are good in the short run and it causes equity prices to rise.

So far so good.

What made the market go up yesterday almost 900 points?  The second biggest point gain on the Dow Jones ever.  Here are a few reasons for it and why it could go on a little longer:

• The stock market was oversold with almost every stock trading below its 200-day moving average.  This isn’t typically the case.
• Credit markets aren’t panicking anymore, just fearful.  In other words, spreads are tightening showing the credit markets are thawing out.
• My Crazy Investor Indicator has shown great fear for some time.  This usually produces some type of rally.
• Volatility is at record highs so volatility comes not just in the form of downside but also upside.
• Many people are bearish and have sold out and those that haven’t are wanting to sell the rallies.  Putting on our contrarian hats we would say that the rally could go further than we think.
• Asset allocation funds and pensions, etc. are now out of whack.  Because stocks have fallen so much, these asset allocation model accounts need to be re-allocated by selling bonds and buying stocks.  I’ve heard most are out of whack by 4% or more.  That could produce some demand for stocks for a while.
• Investors are pricing in a .5% cut by the Federal Reserve.
• Some of my oscillators have been making higher lows even though the market was making new lows.  This is a positive divergence.

You put all this together and you get a rally that is very large and bigger than we’re used to.  But, given the volatility we’ve been seeing, we shouldn’t be surprised to see more 500+ point up AND down days on the Dow going forward.

I discussed on the air that the volatility works both ways.  We’ve mainly been seeing volatility to the downside lately.  But, with the Dow up almost 900 points, this is the 2nd 900 point up day on the Dow during this crash.  This is why I’ve been mentioning moving slowly.  Imagine if you sold yesterday afternoon and capitulated after riding this all the way down.  You know as big as this country is that somebody did just that.  You’d be kicking yourself.  So, you have to move slowly in here.  It was dangerous to not own any stocks going into today being that we were oversold but it was more dangerous to own too many stocks for obvious reasons.

There are a few things I need to check off on my list before I commit new capital.  Today was check one.  We had a very strong up day.  Heavier volume, 900 points, and broad participation.  Now, here’s what we need to see next.  Follow through.  Remember, we have not had two consecutive up days all month.  It’s so easy to think the train is leaving the station on a day like today.  But, let’s think about the last time we had a 900 point up day.  Had you sold or shorted the next morning, you would have saved a ton of money.  Also, remember I told you in the past that 300+ up days on the Dow occur in bear markets, not bull markets.  Since 1995, there have not been any 300+ up days on the Dow during a bull market. 

Now, this doesn’t mean we can’t make money even if we’re still in a bear market.  But, navigating in a market that moves this fast is near impossible.  The best thing we can hope for is a weak pull back.  We had about a 70 point drop the Tuesday after we jumped 900 on the Dow a couple of weeks ago.  That was ok.  It was the next day when the Dow dropped over 300 points.  That’s how we knew it was just a short covering rally.  So, the bottom line is that it’s just too early to analyze the rally after one day.  I have been seeing some of my oscillators making higher bottoms even though the market had closed at lower levels.  So, that’s a positive divergence.  Also, many are saying we’ve successfully tested the intraday low of October 14th.  Perhaps.  But, I caution you as I have in the past that successful double bottoms typically don’t come this close together.  So, let’s breathe and see if we get some follow through tomorrow.

By the way, consumer confidence hit a low of 38.  It’s an index that was at 110 about a year ago.  The estimate for was around 51.  This is very correlated with the stock market and I’ve never seen this low of a number.  But, it’s more of a lagging indicator as people feel sour after the market has gone down.  But, still something to keep an eye on.

When we see the Dow even on the day until 2:50 p.m. CST and then finish down 200 points, that tells you there’s some serious liquidation going on.  Here’s the way it works.  Joe Investor calls his mutual fund company and says ”sell me out”.  The fund is required to sell him out that day.  Now multiply that by hundreds or thousands of phone calls saying the same thing.  The fund manager who is heavily invested in stocks and very light on cash because he has to be per the prospectus needs to sell a lot of shares to raise cash to send to Joe Investor.  So, he starts selling positions in companies he wants to hold but can’t.  The mutual fund manager can sell anytime during the day to raise cash and naturally wants to get the best price for those stocks he/she is selling.  So, he/she waits until the end of the day to see if we’ll get one of those big rallies like we did a couple of Monday’s ago (up 900 points on the Dow). 

At 2:50 p.m. CST, the market’s flat and not going anywhere.  The manager realizes we’re not going up, so they start selling.  The snowball starts and program trading kicks in.  Computer A sees shares falling and it starts selling triggering Computer B to sell.  Then stop losses are hit and we go lower.  That’s how we drop 200 points in 10 minutes.  That’s how the 1987 crash happened.  Now add to that hedge funds who are leveraged to the hilt and to reduce that leverage must sell stocks.  Add to that 401-K investors selling their funds and moving to money market accounts.  All of this is forced selling and what we call selling pressure.  Until the selling pressure subsides, it’s hard to rally for a sustained period of time.  But, it will come.  It’s called capitulation.  We’re obviously not there yet.  Today was lighter volume but the downside volume was 86% of total volume.  So, it was still a strong day as far as the negative internals.

Continue to exercise patience.  It’s tough out there and things are still very dicey.  The two silver linings are lower oil prices which are translating into cheaper gasoline and credit markets are easing up so the greasing of the wheels is starting to work.  Also, the markets are pricing in a .50% rate cut on Wednesday and eventually going to 0% when it’s all said and done.  We’ll see.

[polldaddy poll=1039365]

The pennant is officially broken that I wrote about a few days ago.  I said it was forming and I thought it more than likely would resolve itself to the downside.  It has this morning as I write.  Now, the next logical thing traders are looking for is to hold the intraday lows we had recently.  So far, so good.  I will caution you though that successful double bottom tests usually don’t come this close together so even if we hold and move a little higher I’m still skeptical.

Capital Gains Holiday

The cause of all this was housing prices peaked and started coming down.  This has cause an unraveling.  Don’t get me wrong, I don’t mean the cause of the problem was housing.  I mean the crash that’s happening right now was triggered by housing prices falling.  The real cause of this was too much borrowing, too much lending, and too much leverage.

I believe they (the U.S. government) needs to enact immediately a capital gains holiday that may extend for 3 months to 6 months.  You can buy stocks and/or investment real estate with no capital gains.  Only those securities and real estate from this point forward.  If you eliminated capital gains right now, you get more selling pressure.  So, it has to be on new purchases of securities.  But, especially investment real estate.  I believe if they did that, people like you and I would go in and buy some of this excess inventory and potentially stop home prices from continuing to fall.

Let me know your thoughts.

Was this the reversal we’ve been waiting for?  Afterall, key reverslas typically come in the middle of the day on light news.  But I don’t think this was it.  We’ve seen midday reversals during this horrible market.  All were selling opportunities unfortunately.  Eventually though, one will hold.  Today’s reversal was strange because there were two reversals in one day.  First, we opened up strongly only to reverse and head down, then we reversed and ended up.  It’s hard to analyze a day like this but I did notice that the volume was heavier on the way up than it was on the way down.  That’s a positive.  But, at the end of the day taking everything into consideration, we had more downside than upside volume and many other internals weren’t that strong. 

The market is basically moving sideways right now as it congests the big declines earlier in the month.  It’s risky to be short and it’s risky to be long.  So, how do you play it?  They same way we’ve been playing it.  I’m playing it with about 15% equities overall (the rest in cash & bonds).  That gives me some exposure but I sleep a little (just a little) easier when the Dow falls 500, 600, or 700 points.  You have to continue to be patient and wait for the market to prove itself.  We still haven’t had two up days in a row this whole month.  That’s the key.  Once we have two up days in a row, then we can start to think about buying.  Until then, continue to exercise caution.

I’m on my way home from Nashville, Tennessee.  Just a day trip.  I’ll be back on the air tomorrow morning at 7:00 a.m. CST.  (actually 7:15 a.m. CST until mid November)

I don’t like to get too technical on here.  But, I’ve been noticing a pattern forming over the last few days.  I’ve tried to explain it but it’s easier to show it.  Below is a picture of the S&P 500 SPDRS (SPY).  A pennant is when the market starts becoming narrower.  It typically resumes the same trend as before the pennant.  You can see from the picture below that the market had been falling in June, then we got this pennant through July and August.  Then came the big fall in September & October.  Now, we are forming another pennant.  This one is much more volatile but the results could be the same.  If this pattern holds, we should get a big rally in the next day or two.  If the market doesn’t break out to the upside, we could be looking for new lows in all the indexes. 

The selling has been persistent just like the buying was persistent in the late 1990s.  Selling pressure is simply too high right now with fear elevated, margin calls, & mutual fund redemptions.  I’ve been very tempted to purchase a few stocks that look really cheap.  But, it’s not about fundamentals right now.  It’s about fear and the fear is still very present.  The bright spot in all of this is the fact that credit spreads and the shear panic we’ve seen in the credit markets continues to subside.  Some positive news and we could see equity markets rebound sharply.  Make sure if you’re trading in here, play small.

I’ve been talking and writing lately about letting the market prove itself to me before I start investing hard earned money.  That strategy and patience has been rewarded.  Everytime the market has tried to rally, within a day or two we get a sell off and a reversal.  Monday we rallied 400 points.  Today we gave back more than half.  It’s a pattern we saw last week after last Monday’s 900 point rally.  Wednesday the market lost 700 points. 

The credit markets are stabilizing and credit spreads are tightening which is a positive development.  I believe if that trend continues, the panic will continue to subside which may help prevent severe drops in the equity markets.  If this happens and we see the markets stabilize and just move sideways, then we may be able to put some pairs trades on where we short weak areas that should be going down and go long strong areas like healthcare that are starting to perform well.  That could be very soon.

For now, the pennant is forming in the markets.  This is where the market fell and now the moves are becoming smaller and smaller.  Picture a triangle laying on its side.  These typically will break down and continue the pattern before.  Since the pattern before this consolidation was down, it’s wouldn’t be surprising to see the next leg be down.  In other words, we need a rally soon or even the bulls will toss in the towel.