An Agnostic View of the Financial Markets

The stock market rallied throughout most of yesterday’s trading session, then stumbled into the close. This pattern has become unnervingly familiar of late. It’s true that the Dow has only dipped 2% since closing a notch above 10,000 on October 19, but the decline feels a bit worse than that. Maybe that’s because so many midday rallies have turned into late-day selloffs.

Or maybe the market feels so weak because it IS so weak. Most of the broad indices like the S&P 500 and the NASDAQ Composite are down more than 5% from their recent highs. Meanwhile, former market leaders like the BKX Index of financial stocks have tumbled more than 10% from their recent highs. These corrections aren’t devastating, just discomforting.

Every rational investor knows that the market recovered much more ground from its March lows than economic fundamentals warranted. But that doesn’t automatically mean that the market is a “sell.” Maybe it is just a “do nothing for a while.” Your editors are agnostic on this topic. But almost no one else seems to be. When the stock market becomes as volatile as it has been lately, every stock market commentator from Pensacola to Pismo Beach trots out a forecast – usually based upon stock charts that show trendlines, resistance levels, Fibonacci retracement points, stochastic indicators etc.

Unfortunately, the identical price charts can yield completely opposite forecasts. Show us a trendline, and we’ll show you two emphatic forecasts – one bullish, one bearish. Both forecasts will be honest and informed by experience, but only one of them will be correct.

That said, our friends over at “Penny Trends” delivered a very persuasive (and bearish) forecast yesterday, based on a very clever technical indicator:

“The market is rolling over… The transformation is amazing… Our list of exchange-traded funds (ETFs) is one of the best tools we’ve ever developed for determining the trends in the markets. By distilling the investment universe into just 87 ‘baskets’ of stocks, and then ranking them by three-month performance, we get a fantastic sense of the big picture. We can tell immediately if investors are building optimism or sinking into pessimism. And we can see which individual sectors and markets are strong and which are weak by the way they react relative to one another. For example…

“A month ago, the five best-performing ETFs in the world were showing an average three-month gain of 34%, while the five worst-performing ETFs in the world were showing an average loss of just 8%. Now, the five best-performing ETFs are up an average of just 17%. The bottom five are down an average 15%. In other words, uptrends are getting weaker and downtrends are getting stronger. It means the market is probably rolling over.

“Here’s another way of looking at the same thing: The 87 ETFs we monitor represent every major currency, stock market, sector, and commodity. A month ago, only eight of the ETFs on our list were showing a three-month loss. That means 79 were showing a three-month gain. Now, 22 ETFs are in negative territory and only 55 are in positive territory…another strong sign the market is rolling over.”

But don’t let this forecast bring you down, dear investor. Things could be worse. The stock market could be just as bad as the housing market.

“But wait just a minute!” some readers may protest. “Isn’t the housing market recovering?”

Well, sort of. Prices are no longer in freefall. But a sustainable recovery still seems like a delusional hope…especially when one considers that there’s a lot more pain to come in the mortgage market.

The Daily Reckoning