In the past week we have received some of the worst economic news we have ever seen yet the markets are holding up very well. For your convenience here is a short breakdown of some of the most recent news.
-Official news that the recession started in December 07-Outlooks slashed at At&t, Merck and Dupont to name just a few-Worst holiday shopping start in 35years
-533,000 jobs lost in November (worst since 1974)
-Home foreclosures at a record high
-GM and Chrysler on the brink of failure
Why All This Doom And Gloom?
Despite all this bad news the markets held up extremely well and in fact look like they may have a fairly healthy rally coming in the next week. Why are the markets holding up so well despite all the bad news in the market place? My only answer is to point to the Dow peak in October 2007. Volatility increased in July 2007 when the subprime crisis hit the headlines, but the Dow continued to rise for another 3 months before it crashed. The market may be manipulated in the short to medium term, but is too powerful to resist in the long term. Sucker rallies, as in early 1930 and in late 2001, are a recurring feature in bear markets.
Our natural instinct tells us that if price has halved it must now be cheap. Experience, however, has taught us not to trust our natural instincts. Value investors are salivating over forward and historic price earnings ratios which lead them to believe that they are looking at a bargain. Unfortunately, forward earnings are unlikely to resemble past earnings for quite some time. Forward earnings are also unlikely to resemble forecast earnings for some time: analysts are notoriously poor at forecasting earnings in a down-turn. As are management, to whom they listen closely. Management are eternal optimists — accepting that there will be a down-turn, but seldom believing that they will be seriously affected.
Below I have cut and pasted a piece of research I receive each week. It suggests that we should see some buyers come into the markets based on a technical trade. However, the fundamentals of our economy and financial markets remain subpar. In the past we have seen these market rallies end abruptly which means all investors should continue to approach the markets with caution.
Dow Jones Industrial Average The Dow found short-term support at 8000, with Twiggs Money Flow (21-day) rising above zero for the first time in a month. Breakout above medium-term resistance at 9000 would signal another test of 10000. Reversal below 8000 would indicate a test of 7300.
Long Term: The primary trend is down and any rally is likely to be of the sucker variety. Penetration of the 2002 low of 7300 would offer a long-term target of 6000; calculated as 8000 – ( 10000 – 8000 ). Twiggs Money Flow (13-Week) shows a bullish divergence, but is yet to be confirmed by breakout from the downward trend channel. It is important not to approach the market with any preconceived ideas, but I cannot see a primary trend change in the short or medium term. I would treat any bear market rally with suspicion. If it had to break through primary resistance at 9600, a large correction, it would be prudent to wait for confirmation from a higher trough followed by a new high.
Based on this information we have moved a portion of our money market funds into the market in the hopes to see some gain before the end of the year and will monitor very closely as we are suspect of the longer term prospects in the markets. We will update you again around December 19th.
We will update you again near the 15th of December, until then I hope you and your family have a great beginning to the holiday season.
*The opinions expressed are those of Colby Mcfadden as of 12/8/08 and are subject to change due to market and other conditions.