Invest Intelligence When It Realy Matters

A Lesson in Market Forecasting

Before I begin, I would like to say that most of you will need to actually study this article. You will need to read it and reread it.

You will need to look at your own charts of the Dow and think back what was happening at the time in order to extract the most from this piece.

The reason I say this is because first, it is a bit involved.

Second, I am not so sure I was able to explain things as clearly as I would have liked. It is extremely difficult to explain rational for things that rely largely on instinct and know-how. But I have tried to do so.

While you might disagree, I can assure you that I have made every effort to simply this analysis as much as possible.

That is why you won't see all kinds of lines flying all over the place on my charts.

The fact is that if you really understand technical analysis, you should be able to illustrate and detect things using a simple analysis.

I have found that technicians who get carried away with numerous indicators and lines drawn all over the place really don't know their craft as well as they may think.

I can tell you that I have even seen CMTs (Chartered Market Technician) that don't really know what they are talking about, illustrating that this designation does not necessary mean anything beyond a basic understanding. The same is true of the CFA designation in my opinion. 

I don't know about the CMT requirements, but I do know the requirements for the CFA are quite demanding. Regardless, the best training in my opinion is practical experience.

 

There is no specific formula that ensures success in the investment process other than hard work, commitment, the ability to learn from your mistakes, and many doses of humility. 

 

Before you begin, always remember that is something that is complex is has been made easy to understand or not difficult to get through, than it is most likely not accurate.

 

As well, if it is too easy for you to understand, then you aren’t being pushed enough. And if you aren’t pushed, you will never improve your skills and understanding.

 

Either before or after you begin this piece, I recommend you spend some time studying my 3-part market forecasting tutorial article. This article was originally published on July 18, 2008, prior to the launch of this site. Therefore, it was on other sites that have since banned me and removed my content so as to try to erase my track record.

 

I just ran across this piece and have posted it on this site in the archives.

 

When you read it, you might notice that the first part is similar to the tutorial I presented in my SEC complaint on WaMu. I included this in my complaint knowing that the SEC investigators are clueless, so I want to guide them through my analysis.

 

Okay now, let's begin.

Those who have been following me for some time will recall that I first discussed the possibility of Dow ~6000 in my 2006 book, America's Financial Apocalypse.

Since that time, I released numerous articles into the public domain warning of a market collapse.
 
Two warnings that stand out in my mind were in May 2008 (my first article into the public domain) and in August 2008
 
The first article, Stay Clear of Traditional US Assets, provided a big picture as to what has happened in the US over the past several years.
 
The overall message was to stay out of traditional US assets, as the title states. The only exceptions I made was for healthcare and oil. Let's have a look at some excerpts of this article:
 
"With rare exception, investors should stay clear of traditional asset classes. If you haven’t already done so, you’d be wise to invest in commodities, gold, oil trusts, and foreign currencies (Yen and Swiss Franc). In addition, investors without short investment horizons should have some exposure in China and Latin America. Keeping cash on hand is also advised. When the market sells off, you may choose to buy in.
 
But don’t expect it to last. Buying the U.S. market after sell offs and moving to cash after rebounds is the best way to navigate this storm. A buy-and-hold strategy will crush most investors. Once rates begin to soar, Washington will no longer be able to suppress inflation data. At that point TIPS will be a good investment.
 
Over the next decade, I expect gold, select foreign currencies, oil trusts, TIPS, Chinese and Latin American equities to significantly outperform the U.S. stock market. Watch out though, because if things get really bad, the entire world will be affected. But that will represent a buying opportunity in Chinese and Brazilian equities.
Finally, I would advise investors to consider taking some type of short position in financials pretty soon, preferably with an ETF, such as UltraShort Financials ProShares (SKF)."
 
You'll notice I also stated that gold would perform well. You should not confuse that with my criticism of gold in my 3-part article, Fool's Gold.
 
I hope you understand the point I was making with this later article.  
 
The August 2008 article, Get Ready for the Earnings Meltdown, warned investors about a collapse in earnings.
 
At the time, everyone else was focused on the banks. I had already warned about the banking collapse, so I was focused in the next phase; a collapse in earnings which would lead to a collapse in the market.  Here are some excerpts:
 
"You Can Run But You Can’t Hide
Standard & Poor’s earnings estimates for Q2, Q3, and Q4 of 2008 are -11%, 40%, and 60% respectively. Remember, this the same S&P that rated the mortgage junk AAA. It will also be the same S&P that will end up issuing drastic revisions in earnings once the bottom falls out. But that won’t help investors after the fact.
 
You have to realize what lies ahead and react accordingly. With about 65% of the S&P 500 companies having reported Q2 earnings, the results have not been so bad, with about 70% having beat the 2007 mark. In fact, as the pundits love pointing out, “if you remove the problem child – the financials, S&P earnings have increased by 10%.”  
 
"Regardless of the estimates or hype, a double-digit gain from non-financials is impressive — in any economy," said Howard Silverblatt, S&P's senior index analyst.
 
Sure it’s impressive when the Fed has been in a printing frenzy. Well guess what? You can’t remove the financials from S&P earnings. With about 92 financials in this index of 500, we are talking about 16.7%. Also consider that earnings were aggressively revised downward so as not to disappoint.
 
More important, how well do you think earnings will be down the road with the heart of the economy – the financial system - collapsing?
 
Distance Yourself from the Herd
Please do not forget that Washington through its rebate checks, and the Fed through its endless printing of money, have made their most desperate attempts to delay a recession. While they have failed in my opinion, the real severity is coming soon. Make no mistake about it, S&P earning estimates for Q4 won’t even come close to estimates. By the time Washington reports the required (and laughable) “two consecutive quarters of negative GDP” it uses to officially acknowledge a recession, it will be too late for investors who followed this herd mentality.
 
Continued problems in the credit markets combined inflation will create a drag on earnings. This will accelerate corporate bankruptcies by late 2008, only to soar thereafter. Perhaps the only force that will help earnings will also be the force that ultimately takes them down - inflation. You can’t inflate your way out of a recession, nor can you consume your way out of one either. And Washington is about to learn this first hand.   
 
Sure, it’s possible that we will see the market rally over the next couple of months. If so, you would be wise to sell. More aggressive traders might consider shorting it entirely once it tops out based on the 1-year resistance trend line. It’s also possible that the Dow will break down below the 10,731 lows it made a couple of weeks ago.
 
Only time will tell. It all depends on when the consumers fall and companies start to revise downward. Throughout this difficult period, you would be wise to keep in mind where the slope of the DJIA lies. Eventually, the Dow will follow this slope. It’s just that simple. Don’t try to make it more difficult than it really is. 
 
 
 
 
Now that you know the other side of the picture, you should be better positioned to navigate the market through 2008. As I have been advising for several months, you should sell on rallies and only buy after sell-offs if you’re a really good trader because the market is trending downward. The few investors who had the luck or insight to liquidate their portfolios many months ago might be better off waiting for more clarity. The correction in oil will most likely continue, but that will represent a buying opportunity. I will continue to buy more oil and healthcare. Everything else in the U.S. market is a lost cause for now."   
 
 
Now I want you to focus on the statement I made at the end of this excerpt regarding the slope of the Dow.
 
I did not specifically state what I meant by this because I had discussed it in at least one or two previous articles. I also discussed it in detail in America’s Financial Apocalypse.
 
Looking back now, it was probably a poor judgment call to assume everyone understood what I meant, but hey, what can I say, I’m certainly not perfect. You should have read the book.  
 
In fact, given how accurate the book has been as well as the fact that it will remain valuable for years to come, you’d have to be crazy to not have read it.
 
Of course, that’s just MY opinion for whatever that’s worth.
 
I suppose investors are too busy reading all of the new books that dramatize the collapse but do nothing to arm you with the insights they need to navigate this storm.  
 
That's usually the type of behavior to expect from investors who have been brainwashed by the media.
 
Here’s a chart from America’s Financial Apocalypse, showing a (rough) slope of the Dow.
 
 
 
 
As you can see from the chart, the slope passes through the 5500-6000 region (adjusted for 2008).
 
Over the next seven months since the August 2008 article, the Dow imploded by about 45%, from about 11,500 to 6400.
 
Then in March 2009, when the Dow was 6500, I released another article into the public domain that advised investors to begin buying. 
 
While I felt there was a good possibility of the market to go lower, I emphasized the need to start buying now.
 
This was the first all out market buy signal I had ever given. Here are some excerpts of this article:
 
"What should you do? If you are a long-term investor, you should gradually start buying into the market in small increments. Only the best names, companies with little or no debt and market leadership; companies that pay cash dividends; dividends that are relatively safe (check free cash flows, debt levels for starters).  
 
If I think it’s going lower, why am I telling you to start buying? If you try to pinpoint the bottom, you will miss everything.
 
Will we see a rally? Of course. When? I would say a rally could come soon. But once again, no one knows. Anyone who claims to know is a fool. You have to take things day by day. I’d expect such a rally to be triggered by some relatively trivial news or data set. Wall Street will make a big deal over it looking for an excuse to rally. The forces in play are setting up for a rally. Focus on market psychology and don’t waste time on this VXN and VIX rubbish…..they are coincident indicators. Technical analysis is fairly useless right now.
 
What happens if you start making money soon after you buy, say if a rally occurs? Sell, sit back and be patient. Let more bad news come in and see how the market reacts."
 
You should check that I was not recommending investors to buy in at 9000 or 8000 or 7000 like many others.  If you keep telling investors to buy over and over as the market falls over and over, without then you really missed the call, right?
 
Of course several others kept warning investors to stay out of the stock market because it would go lower and lower. And the same guys have insisted that the market will collapse throughout 2009, missing a 65% surge. 
 
Now, we come across a more difficult period of market forecasting.  Here, I want to show you some things hoping you will add to your skills, rather than relying on the Wall Street hacks and gold bugs. If you listen to either of these extremists, you will fail miserably. 
 
What prompted this article?
 
I recently received an email from one of the newsletter subscribers and I wanted to respond here because it was their question that made me realize many people might be looking at the stock market the wrong way.
 
The individual asked if I was going to issue a special report to update subscribers on the potential of a market collapse (note that this person was not asking me to respond to a question via email because I do not respond to such questions). 
 
Granted, this individual had not yet received the latest newsletter. And as subscribers know, in February, I warned of the potential of a technical breakdown in the market.
 
At the time, the problems in Greece were of big concern. 
 
However, I concluded that I did not see any definitive signs (at that time) of a break down, although I stated the need to remain cautious, as you will soon see.
 
But, since that time (early February), the stock market rallied from around 9900 to 10,750 since that time; in about five weeks time.
 
That should have been a signal to investors that a market collapse is now a virtual impossibility at this time, unless some type of crisis occurs, or a string of very bad data.
 
As many of you realize, the issues in Greece have since subsided a bit. However, the situation in Greece and other European nations is likely to be far from over.
 
So it struck me that this individual, like everyone else, has most likely been reading articles scattered throughout the Internet that keep talking about a market collapse.
 
Let me be clear. These individuals have NO IDEA what is going on. 
 
They have no idea how to forecast the market.
 
They have no idea about anything as far as I’m concerned.
  
They are following the doomer crowd which has the intention of pumping gold and smashing the dollar.
 
Understand that these are the same individuals who keep saying the market is going lower ever since the he rally that began in mid-March 2009.
 
And they kept scaring investors every day for every month in 2009 that the market would collapse to new lows.
 
This caused many individuals to miss out on the biggest market rally in several decades. 
 
You need to remember that the next time you decide to pay attention to what they say. In the end, you determine who to listen to. 
 
You are putting your assets at risk if you pay attention to what they say. 
 
Take a look at their track record and you will see they have no idea what they are talking about. 
 
They are all over the Internet on virtually every financial site and blog you run across.
 
They are only qualified to rehash the financial news of the day, so you might want to remind them of that. Doing so will send them the message that their attempts to alter investor sentiment are not only futile, but have been noted.
 
You should understand that the stock market does not fall for a reason.
 
And it certainly does not crash without a very good and very big reason. 
 
Just because the market is overvalued, or because it rallied by 65% in less than a few months does not mean it will collapse back down.
 
Certainly there will be retracements, as they are normal. We have had several retracements over the past eight months. 
 
As a matter of fact, while the market does not fall for a reason, it can rise for no particular reason.
 
In order to understand that, you need to realize that there is always an inherent upward pressure on the stock market that is much stronger than the downward pressure.
 
Why might this be? 
 
First, the amount of cash that can only take long positions is much larger than the amount of cash that CAN take short positions. Notice I said “can.” That means that the shorts can also go long.
 
In addition, there is a much larger amount of cash that MUST remain primarily invested in the markets at all times, so this adds to the upward pressure in the market. Over the past couple of weeks, the gradual rise in the market has been due to no real news in my opinion.
 
Instead, what has caused this rise has been the inherent upward pressure funds have placed on the market. 
 
Alternatively, one could argue that it has been the easing of the crisis in Greece that has been responsible for the gradual and sustained rise in the stock market. 
 
So now, let me show you some excerpts of my discussion of the stock market since late January so you can understand this better.
 
First, I want to post the conclusion I made from last month’s (February) issue from the market forecasting section. Note, at that time the market was flirting with a breakdown in a somewhat important technical support area. Let’s have a look….
 
“CONCLUSION: Based upon what I see today, there is no clear evidence indicating that this correction is the beginning of one that will cause a reversal in trend. However, I feel that the chances of this are quite good.
 
The market could certainly rebound next week and we could even see new highs in a few weeks, although I do not see this as a likely event (a rebound is possible, but new highs are not likely, at least right now).
 
However, ask yourself what the upside is from here. It is not much. At most, we are looking at maybe 10% or 11% from the year based on current levels, BUT ONLY BASED ON the absolute best of scenarios (which I cannot see happening). In contrast, the downside risk is significant, although has a much wider range at anywhere from 15% to 30% over the next 12 months.
 
As well, the upside since my 10,800 forecast (reached on Jan 19) from here is much less, at around 3-4%. So, unless you are a short-term trader you might want to consider setting this one out, even if the market mounts a strong rebound next week. If you have been a subscriber for at least a couple of months, you should not have been exposed in the market by much.
 
One final note. Due to the rapid sell-off, it is entirely possible that the market will rebound on Monday, even if the downward trend is forming (i.e. selling pressure continues next week after Monday). This is a normal reaction based on the selling that occurred late this past week.
 
But you should not necessarily interpret that as an escape from downward pressure. It could represent an exit for selected positions. If we do see continued selling on Monday similar to what we saw on Friday, it could be a big problem.”
 
 
Now let’s have a look at what has happened since that time to see if I anything has happened causing me to change my analysis.
 
I’d like you to review the charts below, also taken from the February issue. Note that these are just excerpts. The full analysis is contained in the three reports I released for subscribers of the newsletter.
 
First, I begin with some excerpts from the January 24th Risk Management report.
 
“It should be quite clear that the market was looking for any reason to sell off after mounting a massive ~65% rally in 10 months. As you can see from the chart below, while there were a few corrections during this period, each was countered with a stronger rebound, sending the DJIA to new highs.
 
So a correction was bound to happen at some point, right? 
 
In fact, the correction could continue and still would not necessarily signal a reversal in trend. 
 
If anything, the recent sell-off is healthy for a market that is way ahead of itself. A continued sell-off would be even healthier.
 
The only problem is that the bears have been waiting on the sidelines for several months, so they could pile in on the short side to escalate the downward momentum.
 
Also, note that while each previous correction was by about the same amount, the current one has occurred over a shorter time frame. This is something to pay attention to because it hints at the POSSIBILITY that this time things MIGHT be different.
 
Furthermore, there are negative stimuli in the air triggering the sell-off; mostly the thought that the market is ahead of itself and the economy is NOT really in recovery mode. These are all very valid points to consider.
 
Note also that earnings thus far have been quite good from several companies (GOOG, AMD, JPM, INTC, etc.) while forward guidance has been generally quite optimistic, especially from some of the big banks.
 
On the other hand, earnings from companies that are on the leading edge of the economic cycle have not been so good (AA).
 
You should keep in mind that during periods of uncertainty, when the stock market does well, investors undermine the problems, choosing to focus on GREED. But when the stock market does poorly, they often PANIC.
 
Based upon the run the market has had over the past 10 months, combined with no real improvements to the economy, investors with a significant percentage of their portfolio invested in the stock market (which hopefully does not include you) should consider reducing their exposure considerably.
 
By now, you should realize that deciphering market direction is not so simple.
 
There is no way to determine what will happen in the future.
 
The best we can do is lay out the most relevant data and go with probabilities.
 
And of course, things can change on a daily basis, which makes the analysis even more complicated. So, let’s continue.
 
Below is the same chart as above, updated since January 24th.
 
What do you see?
 
 
 
 
I’ll show you what I see in the next chart.
 
First, I show a chart from a special report I released on January 24, 2010. Then I will show you my analysis since then.
 
As you can see from the first chart below, I have denoted several selloff-rebound areas since June 2009.
 
Notice that each selloff occurred over about the same duration and by the same amount.
 
 
 
 
But shortly thereafter each selloff the market made new highs (if you count the June and July selloff-rebound periods as one). In other words, the bullish trend remained intact because no critical support areas had been violated.
 
In the same chart above, I showed the selloff made in mid-January 2010, to around 9900. This was a critical selloff. You will recall it occurred as pressure was mounting in Greece.
 
Next, I show some charts from the market forecasting section of the February newsletter, released two week later. As you can appreciate, the selloff at that time was certainly cause for concern.
 
 
 
The next chart shows some similarities in the most recent selloff with that which occurred back in the June-July period of 2009.
 
While the short-term trend had reversed, a critical support region had not been violated.
 
This implied that the longer-term bullish trend was intact.
 
 
 
 
In the next chart, I provide a closer look at the most recent selloff in the first week of February. Notice that it is trending upwards.
 
 
 
 
 
In the March newsletter, I continued with this analysis.
 
In the first chart of this series, I have circled three important regions. This chart is the same as the ones on the previous page, except it is current.
 
Notice that each encircled area shows the market sell-off, followed by a rebound.
 
In the first two areas, you can see the rebound led to higher highs not long after making the short-term low.
 
In the last and most recent area, you can see that a new high has not been made even after several trading days.
 
 
 
 
 
In the second chart in this series, the red arrows show the approximate deceleration of the market sell-off. The green arrows show the approximate acceleration of the market rebound.
 
 
 
 
 
The third chart shows the same data, except the important areas are now encircled in green.
 
As well, you can see that I have drawn support/resistance lines (in brown).
 
 
 
 
 
The important take away from this chart is that it would appear that even a sell-off down to the 9500 region would NOT necessarily signal a reversal in trend.
 
However, we really need to look at a shorter time-frame.
 
The following chart shows this. As you can see, the 9800 region is fairly important.
 
 
 
 
 
 
  
 The next chart shows the DJIA over the past three months. I wanted to show you this chart so you can appreciate that this critical index has just about filled the gap since selling off fairly hard from mid-January to early February 2010. 
 
 
 
You might note that the February newsletter was released on February 9th, precisely when the DJIA made recent lows.
 
In that issue, I warned investors to be very careful due to what looked like COULD be EARLY signs of a trend reversal, although I concluded there were NO signs of a reversal at that time (recall the "conclusions" I posted above). 
 
I also stated that due to the recent sell-off, there could be a rebound but I did not feel we would see new highs anytime soon. 
 
Have I changed my mind? 
 
No.
 
However, I am not as bearish (for the short– to intermediate-term) due to the current issues in Europe, but only for that reason.
 
But that only matters for short- to intermediate-term traders.
 
The situation in Europe can change in a heartbeat.
 
Will the DJIA rebound fully, leading to a new high?
 
It is impossible to make such a prediction at this time.
 
I would say that much of the near-term drivers determining whether or not this will happen will come from what happens in Europe because that is currently (and likely to remain for some time) the biggest momentum driver.
 
Some of you may have wondered how I chose to draw some of the support/resistance lines since there are many possibilities.
 
Understand that I do NOT go strictly by technical analysis. I adjust for other variables to help in the selection of the best trend and support/resistance lines.
 
Anyone who uses technicals strictly as a tool (even for short-term trading) is making a very big mistake.
 
Finally, understand that market risk for the DJIA influences the market risk for China and Brazil’s stock markets. 
 
 
You can see the final analysis of my market forecast, as well as much more – an average of 60 pages of unique analysis every month - by signing up for the newsletter.
 
As subscribers know, I have called every single major market move with 100% accuracy since the newsletter was released. Prior to that time, my market forecasting record was virtually flawless as can be verified by reviewing the articles released into the public domain. 
 
Who else do you know of has this track record?  
 
 
Those who read America's Financial Apocalypse and Cashing in on the Real Estate Bubble (2007) were not only alerted to the catastrophe we see today, but were provided with SPECIFIC ways to profit that have yielded over 100% gains since then. 
 
See here for some examples.
 
I can guarantee you the chapter on the real estate bubble alone (chapter 10) serves as the most detailed and comprehensive analysis presented from any book solely dedicated to this bubble.
 
If you want access to institutional-level research, analysis and investment guidance, subscribe to the AVA Investment Analytics newsletter today.
 
If you want a chance to make $100,000, check this offer.
 
 
Mike Stathis is the ONLY investment expert who has no vested interests in his insights. Unlike others, he does not sell gold or promote gold vendors to benefit in some way, nor are his insights serving as a marketing piece to generate investment clients from the retail public. Moreover, he does not sell advertisements. No source that provides credible content sells advertisements.
Finally, he is NOT a perma-bear. Therefore, he is the only expert who has both predicted all that we see today and whose insights are pure and detached from vested interests.  
 
 
 
 
 

 

 

 

 


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