An increasing number of vocal onlookers believe that the Federal Reserve is determined to use any power within their means, to hold the system together until at least after the approaching presidential elections. Alan Greenspan and other Fed governors are talking up the economy, and are filling the airwaves with statements attesting to its increasing strength.
Additionally, along with their likely market intervention, Fed and government officials are pulling all stops in their attempt to bolster the stock market with similar rosy forecasts. To this end, the Fed has flooded the banking system with liquidity. Witness the 11% increase in M3 alone during the past twelve weeks.
Also, they grudgingly only raised the Federal Funds rate by 0.25% from its multi-decades low. If they truly believe their own indicators that inflation is beginning to appear, they should be aggressively increasing interest rates to ward off future price rises.
In contrast, there are others who feel that the Fed is acting in this fashion for another reason. They view the same data and opine that their true motive is to prevent a return to recession. The last thing that the Fed now needs is for stock prices to collapse!
They fear that this would drive consumers into a state of withdrawal, and cause them to reduce their spending which is needed to sustain the economy.
Further, the latter contingent points to something of which they believe the Fed is well aware. It is the lack of real, concrete data that the economy is indeed on the road to recovery.
Yet, no matter what are the reasons for the Fed’s present posture, and despite all of their efforts, it appears that recent evidence indicates that they are losing the battle to maintain a strong economy.
The past few months has seen an increasing flood of data that suggests that the economy is again slowing. Newly issued reports indicate that not only is the housing market beginning to weaken, with recent housing starts posting a year over year 8.5% decline, but retail sales are slowing, and capital spending is on the decline as companies instead repair their balance sheets by paying down their debt.
Further, the stock market, which acts to foretell the future direction of our economy, is being inundated with negative data and signs indicating lower stock prices are potentially looming on the horizon.
All of the major stock market indices have now fallen below their respective 200 day moving averages! This has enormous significance because it forebodes the likely resumption of the full force of the Bear Market. Also, Lowry’s buying power index completed and broke down from a head and shoulders top while their selling pressure index, after having posted a multi-year low, appears to have completed its bottom and has begun to move higher.
A continued fall in buying power combined with what is likely the beginning of a sustained increase in selling pressure, has the potential to create havoc in the stock markets! To cap this off, following five consecutive weeks of decline, the Industrials again closed below the important psychological 10,000 level.
To me, it feels like the economy and stock market have absorbed everything that the Fed and government could throw at them in order to keep them afloat.
Unfortunately, the bearish forces are now beginning to gather and threaten all of their efforts. If this assessment is correct the end result will be sharply lower stock prices, and a following weakening economy.
Fortunately, a stock market trading pattern exists whose resolution may prove invaluable in predicting the stock market’s future long-term direction. Historically, periods of low stock market price volatility have typically given birth to great price movements.
We are presently in the midst of an unusual time when U.S. common stocks have been held within an abnormally small trading range. For nearly eight months common stocks as measured by the Dow Industrials, have been trading in a band which is bordered by about 9,800 on the low side and 10,800 at its upper limit.
The last time that a similar relatively narrow price range transpired was in 1996. Then, common stocks backed and filled across an eight month time-frame, when the Dow Industrials were held between about 5200 and 5850.
When the Industrials finally broke above the upper trading limit it rapidly moved higher. Its first stop was above 7,000 before a short correction occurred, and the rest is history. It posted its ultimate Bull Market peak at 11,722.98. This was little more than three years after breaking out from that narrow trading range.
Periods of low market volatility appear to represent times when the various market players are in great conflict. They are periods when either accumulation or distribution of shares are occurring. Those who believe that a Bull Market exists are accumulating shares.
Conversely, those who are certain that the bear is in charge are divesting themselves of stock and are distributing their shareholdings into the market. The tug of war between the bulls and bears is ultimately resolved in favor of those who are correctly attuned to the market’s major secular direction.
If the common stock trend is in a bullish mode the buyers will eventually overwhelm the sellers, and the market will move significantly higher over time. Conversely, if a Bear Market is in force, the buyers will finally give way after they virtually drown in a sea of offered stock.
It is as if those who are betting in the wrong direction will throw everything that they can at their correctly attuned opposition, until finally they are forced to run for cover to limit their further financial damage.
When the final capitulation occurs by those who are on the wrong side of the market, the stage is set for a sustained move in the market’s fundamental direction. In essence, break-outs from important periods of low price volatility have time and again correctly forecasted the market’s long-term direction.
This observation not only holds true when dealing with common stocks, but it can be applied to virtually all other trading markets! Like all technical formations it is not 100% accurate.
Further, if common stocks are in an accumulation phase, which would truly surprise me, a break above 10,800 would indicate substantially higher equity prices. In either event, when the resolution of the Dow Industrial’s present trading range occurs, betting against the market’s verdict will likely prove quite costly.
The Dow Industrials closed last week at 9,962.22. This places it only about 150 points above the 9,815 intra-day lower limit of this trading range. Complacency reigns among today’s investing public! If 9,815 is appreciably violated it will announce the great potential for far lower across the board stock prices.
Additionally, given the fact that the important psychological10,000 level has similarly been breached, it is possible that our complacent investors will become concerned, if not frightened. This, combined with the obvious headline grabbing deterioration of an increasing number of economic indicators, and a weakening investor sentiment, may combine to turn the reigning complacency into abject fear.
If this results it will not only bode poorly for stock prices, but also for the fate of our economy. Be aware and act accordingly.
