Outlook: Turning Negative

The market closed down last week (ending June 19), breaking a four-week winning streak. We are still up a huge amount from the March 9 lows. The NASDAQ Composite was 1265 on that date and 1827 last Friday, and is now up 15.9% for the year and 44.4% from that low. It is still miles below its all-time high of over 5,000 in March 2000. As we have noted, percentages can be funny in that a stock that drops 50% needs a 100% gain to get back to where it started. The S&P 500 is now up 2.0% for the year, while the NYSE Composite is ahead 3.1% and the Dow is slightly down. All of these have also shown huge gains from their lows. What a difference three months has made. We still don’t know for sure whether this is the early stage of a new bull market or a tremendous rally in a bear market. Our bet would be on the first premise, but we would also hedge a bit by saying there are now some negatives out there.

The first is investor sentiment. A broker friend of mine told me that a bunch of his customers who had dumped at the bottom were starting to jump in again, not wanting to miss the boat. This is also reflected in the Investors Intelligence sentiment readings of newsletter writers, a sharp slowdown in insider buying, seasonality (the bad six months of the year), an overbought market condition, and short-term market indicators going negative. We have also seen a huge rise in the price of crude oil. Looking at these things in order, we see the following.

People do get more positive when the market is rising and more negative when the market is falling. As a columnist in the New York Post put it, “Our emotions are our biggest enemy. They often lead us to do the exact opposite of what we should be doing. They lead us to buy high and sell low, make us excited when we should be scared and scared when we should be excited. Our emotions make us slaves to the stock market and allow it to become our master.” He also said that they don’t ring a bell when bull or bear markets end.

Investors Intelligence sentiment numbers show that at the bottom in March, there were only 26.4% of newsletter writers that were bullish, compared to 47.2% that were bearish. The Dow Jones Industrial Average was at 6626. Now, there are 47.3% that are bullish compared to 23.3% bearish and the DJIA is at 8763. This is a contrary indicator. When there is a big majority of bulls, it is usually not good. When there is a big majority of bears it usually turns out to be good. At the market high in October 2007, there were 62.0% bulls and only 19.6% bears. The DJIA was at 14,093. That turned out to be the high for the bulls and the low for the bears, as well as the high for market. We have had three major bottoms so far. They were October and November last year and March this year. What is interesting is that at the first bottom, the bulls were 22.2% and the bears were 54.4%. The Dow was at 8451. Those figures actually showed less bulls and more bears than we saw at the March low. There were a record number of stocks back in October that made new 12-month lows. That prompted one famous newsletter writer, Joe Granville, to proclaim that this was THE bottom. Everyone looks at the averages, but Joe has a case and we are now above that level.

Insiders bought very heavily all the way from August 2008 until very recently. They were betting they would make money on the stocks of their companies in spite of the bear market. We follow 94 different industries on an insider basis and 54 of those industries are showing the best insider buying in the last five years. Only one group, Precious Metals, has the worst buying in five years. Insiders tend to be right, but they are usually early. The current readings are now neutral and still a good way from becoming bearish. Some stocks we have seen insiders switch to the buy side in the last four weeks are *Chevron, *National Fuel Gas, *ONEOK, *Nicor, *Arch Coal, *Spectra Energy, Continental Airlines, Heartland Express, Cheesecake Factory, O’Charley’s, *Tim Hortons, Avis Budget Group, Republic Service, Stericycles, Corporate Executive Board, *Federal Signal, *Woodward Governor, *Pepco Holdings, *TECO Energy, *JPMorgan Chase, *American Express, and Mentor Graphics. We find it a good sign a lot of time when insiders shift from no activity or selling on balance to buying.

We are now in the very negative six-month period of the year from May 1-October 31. Every single big market gain since 1950 has been in the November 1-April 30 time frame. An investor who only had his money in the market in the bad period actually lost money. That is after 58 years. This suggests more sloppy action for the next few months, but the gains in the next November-April period could be very substantial. Markets often make bottoms in October (the “Bear Killer Month”) and we could see the market be pretty sloppy for a few months as the big gains since March are digested and the economy takes some time to improve. The substantial government actions and outlays should be coming into play pretty soon. Unemployment is still rising, but the rate is slowing and we are also starting to see that economic news is getting better in several areas. It is now entirely possible that the economy will make its bottom in the next three quarters. Some banks have started to repay their TARP loans.

Market indicators have now become overbought. Market conditions go from overbought to oversold and back. When markets are oversold, for instance, the percentage of stocks above their own 10-week and 30-week moving averages goes below 30%. When things are overbought, the same indicators go above 70%. The same thing is true for the percentage of stocks making new highs compared with those making new lows. Stocks can stay overbought for long periods of time, but it usually is a good idea to become more cautious and do some selling when things are overbought, and to be doing a bit of buying when things get oversold. When indicators like these are above 70% and then fall below, it is not a good sign. But when they are below 30% and then move up above that mark, it usually is good. They are now above 70%, but starting to move down. Another technical negative is the fact that at the recent market high, trading volume was at its lowest level of the year. Generally, rising prices and rising volume indicate that the market strength will continue.

Three issues ago, we said the best news all year was the 1,010 stocks with selling climaxes that we saw in the week ended March 13. This was a big technical event and probably one of the reasons the market has done so well. With very few stocks now making either highs or lows, the climax numbers have also been very low.

In the last few years, we saw a huge rise in the price of crude oil, from under $30 a barrel to $148 a barrel in the summer of last year. Gasoline was over $4 a gallon at the pump and that was like a huge tax on just about everyone. The falling stock market and economy put the brakes on that up move and crude was down below $40 a barrel a few months ago. It has now moved up over $70 and gas is now getting close to $3. While nowhere near where it was at the high, it now is a bit of a drag from the low prices that we saw just a few months ago and is starting to become worrisome. This may also have a negative near-term effect on stocks.

Dollar-cost averaging, diversification, and dividend reinvesting are all good things to do. They are a solid basis for long-term investing and take away some of the emotions, like the fear of buying when stocks are low. Nothing is really sure about the market except for those three things and the fact that the future in this country is always good (and that stocks will be higher down the road). Another thing that is certain is that time goes by very quickly.

It is also good to “double up” here on some of your losing holdings and then sell the original holdings after thirty-one days. That lets you get a favorable tax loss, but also keep your position. We have been doing that in recent months and will continue to do so while stocks are low. Price/Earnings Ratios are low and yields are now much more attractive than they had been.

Michael Burkes Outlook is featured in The Moneypaper. To receive a special price of $97 for 12 issues, click here.