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“Market Meltdown” or “Market Meltup”

Edward Yardeni, president and chief investment strategist at Yardeni Research was quoted in a Wall Street Journal Article over the weekend stating that he sent a note to clients on Friday: “Stock prices are on the verge of either a market meltdown or a market meltup,” Mr. Yardeni said. “ I know that’s not very helpful, but it is what it is.” But Mr. Yardeni’s message is helpful once we know the forces driving this conflicting message.

The meltdown scenario is pretty obvious. It all hinges on what happens in the coming week(s) with the government shutdown and the debt ceiling. The stock market began its’ free fall on September 19th until it abruptly did an about face on October 10th driven by a mere whisper of a deal coming out of Washington. Of course that deal didn’t materialize so we should expect the market to reverse course again on Monday.

The meltup scenario is a result of President Obama’s selection of Dr. Janet Yellen on October 9th to replace Dr. Ben Bernanke as the new Chairperson of the Federal Reserve. Her confirmation will reinforce the Fed’s evolution from an institution run by market-wise bureaucrats focused on controlling inflation to an institution run by academics committed to a mission of steady growth and minimum unemployment at the expense of higher inflation.

Head & Shoulders Head Fake

On Wednesday of last week the DOW closed on the cusp of a classic Head & Shoulders pattern hovering just above the 14,800 neckline only to give us a “Head Fake” by Thursday morning.

Head & Shoulders

Wednesday night President Obama announced Dr. Yellen as his selection to replace Dr. Ben Bernanke as Fed Chairperson.

On Thursday morning the market opened up nearly 200 points. Then rumors began to swirl that Washington was close to a deal on the debt ceiling and the government shutdown. By the closing bell on Friday the market was up 434 points in two days.

The following chart is a classic example of the importance of waiting for a pattern to completely form. The market had twice before shown strong resistance at this level so all it needed was a little good news to reverse the trend.

Head & Shoulders Head Fake

Fool’s Gold

What is gold really worth? Not Fool’s Gold, but real gold but you would be foolish to buy gold if you didn’t understand what really drives it’s price.

You can’t eat gold, it won’t keep you warm at night, it produces no income, and it has limited industrial use. Sure it looks pretty and it’s considered precious but it has little practical use other than an alternative currency. But how useful is it even as an alternative currency if very few people have physical possession of it.

Gold is a commodity that is traded no different than oil, corn, wheat, or pork bellies and all commodity prices are driven by supply and demand. Unlike other commodities, very little gold is consumed. It may change shape and change ownership but most gold will remain on this earth forever.

It is estimated that all the gold ever mined totals 174,000 short tons and new gold mined is approximately 2,000 tons a year. Subtract the small amount of gold that is consumed and the global supply of gold increases only about 1% per year. So the supply side of the equation is very stable.

Global Market Uncertainty

We find ourselves faced with Global Market Uncertainty as long term trends begin to show signs of weakness. Changes in the direction of long term trends can and will change the investment landscape for decades to come.

As I pointed out in last month’s article, the long term downward trend in interest rates may be nearing a turning point. While markets appear to zigzag up and down randomly they generally follow a predictable pattern. In a strong uptrend we typically see each new “zig” up to be higher than the previous “zig” up and each new “zag” down higher than the previous “zag” down. In a strong down trend we see the opposite, lower high points and lower low points.

The first indication that we may be nearing a trend reversal is when we see the zigzag pattern violate the direction of the larger trend.
If you follow the chart below from its low point in 1949 you can see that each new high point is higher than the previous high and each new low point is higher than the previous low. In 1961 you can see that the zigzag pattern was violated when interest rates failed to rise above the 1958 high point before turning lower. But the low point in 1962 did not drop below the low point of 1960 so the trend reversal was averted.

Bursting Bond Bubble?

Wall Street pundits have been warning of a potential Bursting Bond Bubble for well over a year but these warnings have largely been ignored as the Federal Reserve continued to prime the pump.

Bonds have been touted as a safe investment for over 3 decades. So how can they be risky now?

Bonds are debt securities or loans. Interest rates tied to bonds move down as bond prices are bid up by investors. But unlike stocks, bond prices can’t climb higher forever. As interest rates tied to bonds get closer and closer to 0%, investors turn to other places to put their money. After all, who wants to invest for nothing in return?

Contrary to popular belief the Federal Reserve does not set interest rates on government bonds. The free market determines the price of bonds. If there are more buyers than sellers bond prices rise and interest rates fall and vice- versa. But the Federal Reserve can influence market prices by the amount of buying or selling they themselves are doing within the market.

Is the Stock Market Overpriced?

To answer the question “Is the Stock Market Overpriced” we need to compare the market price to it’s relative value.

The stock market is driven by 3 factors: Fear, Greed, and Earnings. While fear and greed are the primary driver’s earnings are the root cause and ultimately sets the course.

As corporate earnings rise, the underlying value of the stock rises. This attracts more buyers than sellers, which drives the stock price higher. As earnings decline stock prices decline as sellers outnumber buyers. If earnings were the only factor we probably would never see market bubbles or crashes.

Greed rears its’ ugly head when buyers push prices higher than the rate of earnings growth. This trend can continue as long as new money continues to enter the market.

As the gap between earnings and prices widen stocks become more and more expensive relative to their underlying value. When earnings growth stalls fear begins to grow and investors will start cashing in. As long as sellers outnumber buyers prices will fall.

You may be Over Insured!

If you’re not reviewing your insurance policies at least every 5 years you may be over insured. Having too much insurance can be as detrimental to your finances as being under insured.

All insurance is designed to do two things. Reduce your exposure to risk and make a profit for the insurance company. But your insurance company isn’t actually absorbing any risk at all. The premiums you are charged are designed specifically to cover all future claims while still producing a profit for the company. It’s really not much different than the odds set by a casino where “The House” never loses.

InsuranceWe all know we must have insurance to protect ourselves from financial catastrophe. The key word is catastrophe. At the time you buy a policy you factor in your risk exposure and your ability to absorb that risk and buy the policy that meets your needs. But these two factors change over time.

Take for instance your car insurance. When you bought your first new car you probably put little or no money down and the lien holder required you to maintain full coverage and a low deductible. After all it’s their money at risk at this point not yours.

3 Unexpected Benefits of an Emergency Fund

Originally published by John Frainee on February 26, 2013

You already know that having an emergency fund helps you in times of financial desperation. It covers you, for example, if you have a large medical bill, your car’s radiator needs replacing, or if you lose your job. After having an emergency fund for several years, I’ve noticed a few unexpected benefits. These are just a few more reasons to start your emergency fund as soon as possible!

1. You’ll make better career decisions.

If you’re stuck at a job you don’t care for (to say the least), perhaps it’s time to move on. Having an emergency fund up and running will give you the confidence to take appropriate risks.

Making the jump from your day job to your dream job is scary, but it’s even scarier if you don’t have a cushion of dollars in the bank. Should you fail, you’ll want to have some money saved up that you can use for the essentials.

Without an emergency fund, I would have never taken the plunge into full time blogging. There would have just been too much at stake otherwise.

Is the Cyclical Bull Market Over?

Is the Cyclical Bull Market, which began in March of 2009, almost over?

In my January post I presented a “Market Psychology” perspective of the current market where I pointed out that individual investors were finally beginning to re-enter the stock market in measurable numbers. Unfortunately “John Q. Public” is normally the last to arrive before a significant correction.

In my February post I focused on the “Technical” aspects of the current market. The long term chart I presented suggested that the Secular Bear Market which began in 2001 may not be over yet. If true, the current cyclical bull market will not continue much higher without changing the long term thesis.

In this post I want to present a “Fundamental” analysis of the current market. Fundamentalists want to know if the market is expensive, priced right, or too cheap. Their focus is on corporate earnings relative to price. To measure this relationship they calculate the “price earnings” ratio by dividing price by earnings.

The thing to remember is that the larger the PE ratio the more expensive the stock or market at large and vice versa.

The Big Picture

The chart below confirms that we are still firmly entrenched in the Secular Bear Market which began with the “DOT COM” Crash of 2000/2001. This chart portrays the big picture view of the current state of the market representing the Dow Jones Industrial Average from January 1, 1900 to today.

We are currently suffering through the 4th Secular Bear Market of the past 112 years. The previous 3 Secular Bear Markets have lasted an average of 18 years. If the current Bear is going into hibernation this will be the shortest Secular Bear Market in history.

It should be painfully obvious that these long term Secular Bear Markets can wreak havoc on your retirement portfolio and should not be taken lightly.

So how will we know when this Big Bad Bear has finally drifted off to sleep? The wave pattern you see in the upper quadrant of the chart below is a Coppock Curve momentum indicator. Notice how the Coppock Curve is either cresting or in the early stages of a downturn at the start of each Secular Bear Market. Conversely, the Coppock Curve is either forming a trough or is in the early stages of an upturn at the start of each new Secular Bull Market. Notice also that the Coppock Curve has historically been at or near the 0 line before it flattens and begins to turn up.