Great article to read about market direction. Pretty charts, so u should click below instead of reading my repost.
contraryinvestor.com
MARKET OBSERVATIONS
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MARKET OBSERVATIONS - 5/19
Boo Hoo Hoo.com...It always amazes us that liquidity can shift from too plentiful to non-existent in a very short space of time. This goes for liquidity available for corporate lending, the housing market, stocks purchases, etc. As we have said before, when incremental liquidity isn't really needed, there just seems to be too much around. Too much money chasing too few "opportunities". Alternatively, there are many instances when liquidity truly is needed that it is simply nowhere to be found. Financial market liquidity has been playing its own game of musical chairs over the past few years. Certain sectors of the stock market have been simply cash starved. Recently, many areas of the bond market are being liquidity choked. Over the past year or so, this has been an ironic juxtaposition. Net startups with surely flawed business models have been lavished with waves of liquidity. Simultaneously, common stock investments representing many companies with real earnings and cash flow have been left gasping for drops of liquid sustenance. At the risk of sounding like a broken record, we reiterate that liquidity is a coward. At the first sign of real trouble, it vanishes. For the stock market, we haven't seen real trouble yet.
Many of the so-called professional bullish market pundits and casual observers of the financial landscape, like Alan Greenspan, have marveled at the wonders of technology over the past few years. The new era paradigm thinkers credited the tech revolution for lighting the afterburners under economic growth. We're wondering if all of that is about to change. Hand in hand with a shift in liquidity. As many of you may have seen, net startup Boo.com was forced into liquidation a few days ago. The apparel e-tailer simply ran out of money. No angels to the rescue. No VC cavalry arriving to save the day. The CEO was quoted as saying that he wished he had brought aboard a counterpart to himself that would have focused on cost controls. Another soon to be casualty, Digital Entertainment Network (an experiment in online entertainment), is also shutting down its operations and is contemplating bankruptcy.
These may be isolated incidents for the moment, but point out a much bigger theme to us in terms of inciting perceptual change. What happens when a Boo.com liquidates? People are fired, office rental payments stop, their advertising budget goes to zero, and spending on technology hardware is over. Get the picture? Boo.com may be a microcosm, but says something big about the perceptual virtuous circle that is new paradigm thought. Once the liquidity for startups such as Boo.com exits the playing field, the effect will be felt in the real world economy of ad budgets, office rents, server purchases, etc. The positive virtuous circle of the new era can be thrown into reverse gear. As we see more and more of these type of events, expect broader market liquidity to start shaking in its boots before ultimately running for cover.
Shorting Out...It just may be a bit different this time. Over the last 10 years, public participants in the stock market have been taught that stocks always recover. Greenspan has surely more than done his part in supporting that thesis. The concept of moral hazard has clearly been embraced by the professional investment community. How else could you explain cash levels in equity mutual funds at record lows or the astronomical use of leverage and derivatives in "modern day" investing?
As you know, short interest in a stock or an index is a real indicator of broader sentiment toward that stock or index. Being the contrarians that we are, very high levels of short interest are often an indicator that a lot of bad news and fear is impounded in the price of the security or index being measured. Conversely, low short interest ratios indicate complacency and direct lack of fear. With this in mind, we thought it might be time to take a look at what short interest on the NASDAQ is currently saying about confidence. With the crushing blows many of the NASDAQ superstars have taken over the past few months, one would naturally expect a relatively high level of anxiety. Right? Well, not quite. Have a look:
NASDAQ
Short Interest Ratio At Market Low
Bear Market Low 1990
2.9%
Bear Market Low 1994
3.2
July 1996 correction
3.1
April 1997 correction
3.0
October 1997 correction
2.8
October 1998 correction
2.8
NOW
1.5
The current short interest ratio does not indicate fear at all. It is much lower than at any of the previous NASDAQ market lows of the past 10 years. We keep hearing the bulls pointing to oversold indicators as points of comfort in assessing the potential depths of the current downturn. From our perspective, overbought readings have meant nothing for years on the upside. Shouldn't oversold readings mean nothing if we are truly on the brink of a secular bear market? The shorts have been driven from the NASDAQ. The close to 100% move in the NASDAQ from October of 1999 to the top this year clearly forced the shorts to evacuate in the upward tempest. The short interest ratio indicates confidence, complacency, and belief in the NASDAQ stalwarts. For what it is worth, the quantitatively oriented folks at Ned Davis Research have calculated that since 1990, a short interest ratio for the NASDAQ at a level below 1.7% has historically produced a subsequent negative level of annualized NASDAQ return.
Lastly, in years gone by, the short community has been a source of demand for stocks in falling markets. Covering shorts at lower levels was not only every short seller's dream, but also clearly provided demand support to stock prices. Given that the short community has been decimated over this decade, it just may be different this time.
The VIX Is In On This One...To possibly corroborate the distinct lack of fear we are witnessing as portrayed by the NASDAQ short interest ratio, it's time to check in on another of our favorite sentiment indicators, the OEX Volatility index. The VIX has had a pretty good track record of spotting true bottoms over the last three to four years when it has reached the 35-40 range. As you can see in the following chart, we were there on the first down leg back in the March-April period. No longer.
Despite deteriorating fundamentals and technicals, along with many individual stocks at or below April low levels, the VIX currently does not say that investors are panicking. The current reading is very neutral in terms of sentiment. It's not total complacency (a reading of approx. 20), but it is nowhere near scared. This corroborates what we are seeing in the short interest ratio. We have not even approached fear, despite some very sloppy market activity lately. As you may already know, the weekly mutual fund cash inflow number for the week ended Wednesday the 17th was a positive $8 billion. One of the biggest numbers in the last two months. There's an old saying in the stock market. "Never average a losing position." Will that adage once again be proven correct? Only time will tell. Clearly, the public has not even flirted with selling so far.
Only Your Hairdresser Knows For Sure...These days this is probably more true than ever given the fact that "everybody" is a day trader. From a simplistic standpoint, the NDX 100 has formed what appears to be a classic head and shoulders chart formation. As usual, Tim's fine chart work leaves no guesswork to the observer.
Down to the Crossroads...Very often, index patterns forming almost perfect right angled triangles experience violent breakouts upon completion. The continual question in each instance is "in which direction?" We suggest you pay particular attention to the following handcrafted beauty from Tim:
Clearly, the ultimate resolution remains a mystery for the moment, but the chart does suggest that the next few weeks ought to be awfully telling. Last week, we graced this page with charts for the likes of CSCO, INTC, ORCL, etc. Let's face it, the charts of the (former?) big cap tech darlings look sick. The key question in our minds is "how much more price damage can the public sustain before they begin to sell?" So far, buying the dip has been a losing exercise.
Def Jam...No, we're not talking about a comedy here (unless you think a $400 billion trade deficit is a laughing matter). We're talking about the trade deficit jamming to what seems like the moon. It's clearly another case of drip, drip, drip. Month by month. Have a look:
Chart source: Dismal Scientist
Year-to-date, the trade deficit is running 59% ahead of last year's first quarter. The consumption binge in the US is simply phenomenal. We were taken aback by CNBC's Mark Hanes wondering out loud today "just what is so wrong with the trade deficit? The negative comments sound like Jimmy Rodgers over the last five years. I want to know what's the big deal about the trade deficit. It helps keep inflation low. Yeah, foreigners may want their money back, but so far they haven't." These shallow comments are what the public hears. There is simply no mention of the potential impact on the US dollar. There is simply no mention of the deteriorating US macro balance sheet as a result of the trade deficit. There is simply no one on CNBC to enlighten Mr. Hanes.
God forbid the dollar starts to fall. Our bet is that consumption of imports would lag the fall in the dollar. If this were to happen, we would immediately start to import inflation. Given the current trade deficit scenario, Greenspan better hope to God the dollar remains stable.
Gradu-AL...It was reported in the Washington Post today that Greenspan's vote was for 25 basis points at this week's Fed meeting. Apparently hawkish Fed governor Larry Meyer had the votes to override the supreme leader and pass the 50 basis point move. You can bet that if the Fed moves in June, Greenspan will be pushing hard to contain the move to 25 basis points. Politic-AL.
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