Transports, Utilities, & Iran

     From April 8 through April 23 2010  the DJ Transports powered up another 351 points. At the point of strongest acceleration the RSI reached a peak of 83.14, a remarkably high reading for a major index. This astounding display of leadership and strength is puzzling to me on a fundamental basis because it is difficult to  conceive of the improvement in the volume of physical commerce that this juggernaut of an index seems to be foretelling. I am construing its meaning to be that the economic recovery will be stronger and more persistent than had been expected, though I still can't believe it presages some sort of explosion in the quantity of goods being shipped. I emphasized in my previous letter that the leader ship of the Transports was the key to the durability of this primary bull market. It is hard to believe that the index won't take a rest very soon, but it is not yet acting exhausted. It seemed to be working off the extreme overbought level of its RSI through sideways action of its relative strength versus the S and P 500 during the week of April 19-23. 
     If the Transports do move into a prolonged correction/ consolidation, I will be scrutinizing the action of the dormant DJ Utilities Average to see if it comes to back life and starts moving upwards towards and beyond its Dec. 14, 2009 high of 406.72  The Utilities are considered a bellweather index for a number of reasons. This fact would make an assault on their old highs if it should occur, a very meaningful event. The exception to the bellweather attribute of the Utilities is that they can be a haven for safety and yield in bear markets and recessions, such as they were in 2001-2004. But they did help lead the first major upsurge of this bull market, along with the Transports, to its mid December 2009 highs. Therefore I would looked upon their renewed strength as a manifestation of their bellweather nature rather than of merely a flight to safety in a environment of crumbling financial assets.

     On the question of market sponsership, I still don't believe that this market is being primarily driven by the public. Such members of the non-professional public as are participating are mostly doing so from the long side, but they are not the driving force behind this bull. This market thus far is more of a quiet, Paul Dysart type market with big money sponsership accumulating slowly and inconspicuously. We undoubtedly are into the Dow Theory 2nd psychological phase where the market rises in response to visible improvement in business (in today's case, more of an improvement in profits than in business) and the public participates in moderate but increasing  numbers. As Dow Theorist Robert Rhea wrote, the second phase is usually the most deceptive, stretched out, and difficult to interpret of the 3 primary market phases. Russell's Big Money Breadth Index tells the tale of what the large interests are doing, and its story is that they are accumulating, although the week of April 19-23 did reveal a deceleration in the index's rate of increase. 
    Both the McClellan Oscillator and the McClellan 5% Index declined enough to relieve their overbought condition but not become very oversold. The 5% indicator, in particular, really only declined to a less overbought status. If these two can again move towards the strongly overbought region, it will mean that the breadth of the market is going to surge up noticeably before any appreciable decline from the present price levels. Strong markets can remain neutral to overbought for a long time, but we do like to see an oversold reading once in a while to squeeze out some of the excesses and reduce risk.
     The end result for the week of April 19-23 2010 is that the DJ Industrials and Transports, the cumulative A-D line, the S and P 500 and most other indexes and Averages closed at post March 9, 2009 recovery highs. The DJ Utilities did not
even make a serious attempt at new highs, but remain in a trading range currently bounded by 375 on the bottom and just below 390 at the top. Their sensitivity to interest rates may be the major factor in their hesitation. Since many investors buy them for yield, they have some of the trading characteristics of bonds. And bonds at this time are under suspicion of being in the early stages of a bear market. But the Utilities also have the properties of an industrial index as well since they produce products such as energy and water supply. In particular, demand for energy increases in proportion to increased production and transport of goods.
Thus it is also very sensitive to economic expansion. Which of these two attributes is now dominant in determining its price action is hard to say, but it would be a definite harbinger of a continuing bull market if the Utility Index were to reassert its strength and rally to new recovery highs.
      The following is my reaction to speculation about Israel possibly attacking Iran's nuclear processing plants without cooperation or participation by the US:
      Of course Israel has contingency plans to attack Iran's nuclear facilities, but Obama will not give Israel permission to fly over Iraq, regardless of pressure from McCain. Furthermore, McCain's base among conservatives is rapidly eroding because he is a foreign military adventurist but weak on internal American security (open borders advocate). George W. Bush put us in too a weak financial position and too overextended a military position to carry out major action against Iran. It's true that we now have huge bases in Iraq but the Iraqi Shiites will oppose our use of them against Iran and, where the US is involved, the Iraqi Sunnis don't believe that the enemy of their enemy is their friend . So we would probably be throwing Iraq into violent turmoil if we tried to use our bases in Iraq to attack Iran. The Stratfor article of 2009 clearly outlines why the task is beyond Israel's ability to successfully accomplish on its own, even if it could overfly Iraq.  In actuality, because of the dispersal and hardening of the nuclear sites, it would not be an easy task even for US air power.

Market Correction

    As of the April 1,  2010 the market has been in a correction/consolidation mode for about 3 weeks and in a slow rise mode for a few months. According to my application of the 50% principle of  the late renowned Dow Theorist E. George Schaeffer, the Dow Jones Industrials, Transports, as well as the S and P 500, all  must  stay above their respective 50% levels on any decline to create a favorable probability that they will challenge or exceed their previous all-time high. The half way point of the decline from the high of Oct. 9, 2007 to the low of March 9, 2009 is the measure that is my reference. For the DJ Industrials the 50% level would be 10,355.50, for the DJ Transports 3820.74,  S and P 500 the 50% level would be1120.84. All the above indices haves done this, but  I am using daily closing prices of the  high and low points in these Averages to calculate the 50% levels The S and P 500 was not used by Schaeffer but I am extending the principle he used for the Dow Jones Averages to the Standard and Poors 500 Index.
     Indeed, as Richard Russell of DowTheoryLetters.com has repeatedly observed the Transports have climbed to new recovery highs while the Industrials have taken their time confirming,  so under the Dow Theory we had a belated confirmation. Personally, I feel that because of the weakness in the economy, the Transports are the Index which would tell us the most about whether this recovery can continue to expand. Now that the Industrials have followed the direction of the Transports, we might expect to see Transports take a rest and cool off from their torrid rally. If they can resume their strong leadership after their period of consolidation, that would be a strong bullish omen for the overall market. That is because the activity of the Transportation companies is in direct proportion to the volume of business activity, goods which are being shipped across the nation.
    In today's context, I would view the advent of weakness in the DJ Jones Transports as the most worriesome of  harbingers. By weakness, I mean not only a severe decline in the DJT, but also a failure by them to rally strongly from whatever level they eventually decline to from here. The overall market cannot sustain a strong advance from whatever point it eventually declines to without strong leadership from the Transports, again, the reason being that the strength and duration of this cyclical business recovery is very tenuous and susceptible to collapse. The Industrials are a somewhat less direct reflection of the quantitative level of commerce in the US, because most of them are multinationals that make sales in areas of the world where business and incomes are more buoyant and because they have become so lean and efficient that they can make profits even in a weak economic environment. However, we definitely do need to see them at least confirm the strength of the Transports for a continuation of the broad market rally to sustain itself. If the Industrials should degenerate from merely lagging the Transports to outright weakness it would be an indication of impending problems in the world economy as a whole.
      Even though many technical market letter writers are bullish, and various governmental and private agencies are trying to put the most positive possible spin on statistics that they can (like the National Association of Realtors on changes in home prices or volume of home sales), it still seems to me that this stock market is climbing a wall of every imaginable kind of worry. Poor household balance sheet problems for so many Americans, caused by indebtedness and low incomes are rendering most people unable to invest in financial assets, even if they weren't highly skeptical of the idea that there could be a bull market in stocks taking place. The term "The Great Recession" is a subconscious mockery of the application of the label "recession" to present business and employment conditions. By the standards of business cycle categorization  in use before the Great Depression of the 1930's, this is undoubtedly a depression.
     It really does defy conventional wisdom and common sense that corporations could make profits in a climate of such weak consumer demand. And if companies can't make money, why should stock prices rise? The Boeckh Investment Letter stresses that nonfinancial corporations have excellent balance sheets. In the 4th quarter of 2009, corporate profits were still 4 times their levels at the profitability nadir of  2002. This is a fair basis of comparison because the last quarter of 2009 will probably prove to be the period of minimum corporate profitability for this downturn.  If business and employment conditions worsen significantly from this point, then a new basis of comparison would have to be determined. As many have stated, the obverse side of unemployment is that  corporations have become able to increase earnings by becoming more productive with fewer people.
      I have echoed the prevailing wisdom that this upswing in the business cycle can"t be sustained without improved income for consumers. However, I think that consumer spending must in the future shrink to a smaller proportion of our GDP. I think Americans have the right idea in increasing their savings, both for their own personal good and the long-term benefit of the American economy as well. This country's economy can not continue to be based on consumption that is unsupported by a strong productive base, with the necessary investment for that coming from increased savings by those presently fortunate enough to have income.
      The PE ratio for the S and P 500 is 22.16  (Robert Shiller numbers) as of April 14, 2010, well into overvalued territory, and is 12.9% above its 200-day simple moving average. If earnings are destined to keep rising, the PE number would come down and allow room for prices to rise some more before they became overvalued again. This occurred in the 2002-2007 bull market, but economic fundamentals seem even more challenging now than they were then.  Richard Russell feels that there is widespread bullish sentiment among non-professional investors. William Schmidt of Tigersoft.com says that his indicators have thus far shown positive buying by professionals as well as by the public and have done so since the inception of this rally in March of 2010. I must admit that Russell has a contrary view to my own and Schmidt's, in particular,  is perplexing because public buying and professional buying usually don't go together, especially in the early stages of a bull market. I don't really follow any specific sentiment indicators but my sense is that the public has been and still is afraid of this market because of the huge employment and income problems of the ordinary people as well as the trauma from the recent bear market. Although there has apparently been some improving GDP data, it has not translated into a very meaningful increase in jobs. As mentioned above this bull market has truly been climbing a wall of macroeconomic and financial worry
     The McClellan Oscillator 5% (intermediate trend)  Index has not not fallen below -40 since March 9, 2009 and the McClellan Summation Index has not fallen below  +150  since that time. These charts are  created by DecisionPoint.com but can most easily be found daily on StockCharts.com in the Market Breadth section near the bottom of the Market Summary page. Of course, you must use all lower case letters when typing in the names of the sites on your browser address line.What those numbers tell us is that the stock market has not undergone a significant intermediate term correction for about a year. Since the Jan. 19, 2010 highs we surely have been in an intermediate scale retracement, but it has so far not sold off intensely enough to be considered by me to be severe. The maximum price decline (on a closing basis) during this pullback for the S and P 500 so far is 8.13%. The cumulative advance-decline line has been making new post Mar. 9, 2009 recovery highs since Feb.24 on up days during this moderate retracement. It seems to me that it is an impressive show of strength for for the cumulative A-D line to be making new recovery highs a month and a half into a secondary counter-trend decline. Of course, if the decline accelerates and the S and P 500 falls through the 50% level to its Feb. 23 2010 low at 1094.60, which should provide support, that would still only amount to an 8.35% correction. Although then the Average would have to reprove that it intended to rise and remain above the 50% level. Although the DJ Utilities don't formally play a part in the Dow Theory, they have lagged very significantly  in the rally from the Feb.16 minor trend lows. 
     I have written this post over a period of about 3 weeks, but since I wrote the above paragraphs the DJ Transports are once again leading the market up with strong rallies on April 8th and April 9th pushing them decisively above their March 18 high of 4422.50. On April 14th they exploded upward 108.37 points, or 2.39%.. The A-D ratio and Russell 2K, which had already been stronger than the Industrials or S and P, have zoomed  above their March 23 highs convincingly. The S and P 500 has discernibly exceeded its March 23 high of 1174.17 and now stands at 1210.65 on April 14. Schmidt's Tigersoft professional buying index is pointing upwards and Russell's PTI is not only at new highs, but at a perhaps record 73 points above its 89-day moving average, which Russell refers to as "the primary trend line". The sideways to slightly higher price action which went on in most the the major averages for about the last 3 weeks of March turned out to be a  high level consolidation rather than a topping pattern.
    This market is now even more overbought by many standards than it has been , including the distance of major averages above their 200-day moving averages. The large distance of Russell's PTI above its 89 day moving average is a highly overbought condition. Referring to a Stockcharts.com featured indicator, the RSI  for the Transports is 80.03, for the S and P 500 78.29, for the Industrials 75.41, the Russell 2K 79.02,
S and P Midcaps 76.07. A number above 70 is in the overbought range and over 80 is rare for a major index. The DJ Utilities are the major exception with an RSI rating of only 54.94. These are all April 14 figures. Although strong bull market can stay overbought for a long time and merely correct to the neutral range, as this one has done, one would think that a period of correction would appear in the near future to relieve the overbought condition. If this again took the form of a "flat-top" pattern, as William Schmidt likes to call it, otherwise known as a high-level or sideways consolidation, with the McClellan Oscillators only declin- ing to the neutral area, that would be a sign of extraordinary strength. Of course, these kind of "line" formations near the highs of an average must be carefully studied for signs of at least an intermediate level top. I define an intermediate correction which follows an intermediate top as a decline of up to 15% in the S and P 500 lasting a few weeks to 3 months. Of course, a long bottoming period can stretch out the time length considerably and thus provide a solid foundation for the next advance.