As January goes, the year goes?

There is a popular Wall Street saying that as January goes so goes the rest of the year. Alluding to the performance seen in January is typically a precursor to how financial markets may perform the rest of the year. It should be recognized these popular sayings and others like “sell in May and go away” tend to be better talking points than actual money management strategies. After all in January 09 the markets witnessed declines of greater than 6% and found a way to end the year in positive territory.

While this January wasn’t as disheartening as last year’s start the markets did give up ground with the Dow Jones losing 3.46% the S&P500 declining 3.7% and the Nasdaq sliding 5.37% according to MSN Money on 2-1-10. What is of special note in regards to these declines is the majority of the damage was created within 3 days. I find it amazing how the market can lose the gains of 10 weeks in 3 days.

In fact it’s been roughly 10 weeks since the last time I have written about where the markets sit and in those weeks much has happened. Most notably is the change in market behavior on news in regards to the economy and companies earnings.

You may recall a few months back we wrote about expectations and how they influence market behavior. At that time we were speaking on how the market was rising on less than desirable news because the news was at least beating the poor expectations of the time. Now we seem to be seeing the flip side of this behavior.

Throughout this January the economic and earnings news has been fairly decent showing a continued stabilization and possible recovery in the economy. Topping the news at month end was the announcement that 4th quarter GDP increased 5.7%, up from 2.2% the previous quarter, according to Forex Factory on 1-30-10. Most likely this number will be revised lower – does it surprise you that the government often gets the numbers wrong? Regardless the market rewarded this positive news with a 1% decline.

This is a different reaction than the 150 point gain seen in markets when last quarter’s GDP was reported to be positive for the first time since October 2008.

We have said in past writings that it isn’t the news we need to be aware of, it’s the reaction to the news. So far since the beginning of the year the market has had many reasons to move higher and has been reluctant to do so. I can’t underemphasize how important this one simple change in market behavior is. If a market doesn’t go up on good news then there is reason to be alert.

This behavior naturally leads us to wondering why the market may be acting in this way. Back in October we mentioned 3 factors – technical’s, valuations and expectations -that could put a lid on the market’s rally.

It seems those 3 factors are contributing to the markets recent struggles and I offer the chart below as a visual to help explain.

Here we have a 3 year chart of the S&P 500. You’ll see the peak in 2007 towards the left, the bottom of the decline in the middle and the subsequent rebound. The first area to pay attention to is the circle on the right hand side.

Notice the large red candle moving down. This circle marks the 50% retracement.

Which means this circle represents the point the market had recovered 50% of its losses. This tends to be a very well know stopping point for many bear market rally’s of the past as seen by this additional chart compares the bear market rally of 1929 to the rally of 2009.

I am not suggesting that this market is the same market we had in the 1930’s however I am a believer that history has a tendency to repeat itself and it behooves us to be alert.

So what is an investor to do at this time?

Turning our attention back to the 3 year chart of the S&P 500 you will see two horizontal lines with an arrow in the middle of them. This is the low risk entry point we have been waiting many months to see the markets move to.

This area represents the spot the markets broke out after the first bounce out of the March lows and is an area that should act as support for the market.

If the economy is truly starting to recover then markets should hold this level and move higher from there.

However, if the economy has a double dip recession or unemployment continues to rise and housing continues to stumble then this area marked on the chart could be breached and if it is we will most likely see a test of the March lows.

While we hope this will not happen we must be aware of the possibilities and be prepared with a plan that can provide us opportunities to benefit.

For now we keep our eye on that level as our buying opportunity with a strict stop loss if that area should fail to hold any market decline if one should develop.

It is important to remember there are other ways to make money than owning the stock market.

In fact we tend to believe investors will be better rewarded by looking at Absolute Return Strategies as opposed to the traditional buying of mutual funds that need the market to be trending higher to make money.

Absolute Return strategies are willing to look at alternatives such as interest rates and currencies to create potential returns.

As an example we have provided 2 additional graphs of sectors we feel have greater probability for growth in the near term.

Let’s start with the no brainer –
Interest Rates.

The basic idea is with interest rates being at historic lows we can make the assumption the path of least resistance is for rates to move higher and I offer this chart for illustration purposes only.

This is a picture of an exchange traded fund which tracks the yield on the 20 year bond. This is not a specific recommendation but is used to give you a visual of the interest rate markets. You will notice on the left hand side of the chart red bars protruding towards the right. These bars represent volume. You will notice where the bars are longest is where volume has been greatest.

This is also an area on the chart where prices have moved higher giving us evidence that there are more buyers than sellers in that price range.

You will also note a line connecting the low points of the chart.

As long as this line stays firm and price does not move below it we will have additional evidence that our theory is correct and investing in rising rates may be beneficial.

We must also mention that if our belief is correct there could be additional difficulties in the housing market as rising rates increases the cost of borrowing money for mortgages.

Our second graph is from our contrarian picks – the good old U.S. Dollar.

Everyone and their brother have bad talked the dollar over the past few months.

In our past writings we have mentioned our belief the dollar was beginning to form a bottom and this chart seems to add credence to this belief.

You will notice the long red volume line on the left of the chart and how the price of the dollar has bounced higher from that price. In addition you will see a line connecting the recent lows of the dollar’s rally. As long as that line holds its integrity we will be buyers of the dollar.

Now I can hear a lot of you saying, “ But what about all the money we are printing wont that make the dollar worthless?” To that question I offer some conventional thinking that no matter where you go in the world people have and will continue to want to own dollars, there is no other currency that is so easily accepted. In addition, the dollar is where investors run to if greater concerns arise in the world such as what we are seeing in Greece, Spain, Portugal, Dubai and most of the Eastern Block countries.

It is also important to mention that if the dollar is beginning a rally this could cause the stock market to have a tough time as the stock market has seemed to need a weak dollar in order to stay afloat.

It’s time to wrap all this up with a few bottom line notes.

First, the recent decline in the stock market and the impulsiveness of this move increases the probability that we may be witnessing a trend change with the possibility of the market moving lower into March setting up a good buying opportunity.

Second, for the near and intermediate term alternative investments such as interest rates and the dollar appear to have better technical set ups than the stock market.

And lastly if your portfolio is only invested in stocks or traditional mutual funds which need a rising market to appreciate you should look into alternatives such as Absolute Returns to provide greater diversification to your portfolio.

Warmest Regards

Colby McFadden