Although the Federal Reserve has slashed interest rates 1.25% in the past couple of weeks, the markets so far have shown little positive reaction. Although there is plenty of reason to be pessimistic about the economy right now, watch for the markets to rally over the next month or so.

Fluctuation and volatility are inherent in the financial markets. Recently, the majority of the movement has been downward. On a technical and cyclical basis, major stock market indices are in an oversold condition. That means chances are increasing for a swing back to the positive side.

With all of the problems facing the economy (more on that to follow), I am not forecasting a return to a bull market situation. Instead, I think stocks will probably regain about half of what they have given up since peaking a little over three months ago.

I’ve included a chart showing the price activity of the Nasdaq (black line) over the past two years. The S&P 500 (blue line) and the Dow (gold line) are included for comparison. Notice that as of today, the Nasdaq is essentially right where it was two years ago. The gains of 2006 and 2007 have disappeared. The horizontal red line is about the peak level where I think the Nasdaq could recover to if we see a short-term rally. That would represent a 10% gain–not insignificant in the midst of a major downturn.

The middle and bottom sections of the chart provide some of the reasons why I believe an upturn is immanent. The middle section is a moving average convergence divergence (MACD). This indicator is at its lowest level in many years. It appears to have bottomed and started to turn upward. And the divergence–signified by the black portion in the middle–is on the verge of turning positive.

The bottom section is simply a momentum indicator. While it remains in negative territory, it has also been rising after reaching a multi-year low point.

The Fed’s interest rate cuts and continued congressional support for a economic stimulus plan should help provide some emotional support for investors. In addition we have seen oil prices moderate somewhat and there is speculation that the January jobs report is going to be better than expected. The combined effect is likely to be enough to give the markets a boost.

Over the longer term, the situation is still grim. Here is the assessment of the Federal Open Market Committee when it released its announcement on this week’s rate cut:

“Financial markets remain under considerable stress, and credit has tightened further for some businesses and households.  Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.

“The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

“Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity.  However, downside risks to growth remain.  The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.”

In other words, right now FOMC members are so worried about the prospect of a recession that they are willing to forgo their primary objective of controlling inflation.In a preliminary estimate, the Commerce Department this week reported that gross domestic product rose by a 0.6 percent rate in the last quarter of 2007. This was the lowest rate of growth since the first quarter of 2007. For all of 2007 the Commerce Department estimated that GDP rose 2.2 percent.

Because this is a preliminary report, it is possible that it could be revised downward and that GDP growth could virtually disappear. The commonly accepted definition of a recession is two consecutive quarters of negative GDP. That means one can’t actually identify a recession until it is well underway. By their recent actions, I suspect that some members of the Federal Reserve believe that the recession they hope to avoid is already underway.

In that case, we will continue to get dismal economic reports and it won’t take long for the financial markets to resume their downward movement.
F.S.

Last week I wrote that most market and economic fundamentals looked weak. In the meantime, the president announced an economic stimulus plan and the Federal Reserve made a surprise announcement of a 3/4% interest rate cut. Unfortunately the reaction from Wall Street and from investors was not overwhelmingly supportive. Instead of rallying on this news, the markets actually saw a couple days of sharp declines.

The reason for this drop is undoubtedly because Wall Street is worried that the situation could be much worse than anticipated if the Fed and the president are willing to take such actions before a recession has officially been declared. Wednesday the market staged a dramatic turnaround and finished on the positive side. There was additional follow through on Thursday. But technical indicators are still showing that weakness is dominant.

The chart below shows performance of the Nasdaq over the past three months. I’ve used a method called “candlestick charting” because I think it gives a quick visual understanding of this negative market period.

Candlestick charts reflect the open, high, low, and close market prices over a certain period. Candlesticks are composed of the body (red or white) and an upper and a lower shadow (wick). The wick illustrates the highest and lowest traded prices and the body the opening and closing trades. If the stock or index went up, the body is white, with the opening price at the bottom of the body and the closing price at the top. If the stock or index went down, the body is red, with the opening price at the top and the closing price at the bottom. A candlestick need not always have either a body or a wick.

As you can clearly see, over the past three months, the red candlesticks occur much more often than the white. And except for the past couple of days, volatility has been much greater on the down sessions. You can also see that the Nasdaq declined more than 20% from the high it reached in October. I’ve included the Dow (gold line) and the S&P 500 (blue line) for comparison. These indices have also seen significant losses over the past 12 weeks.

On the bottom portion of the chart, I’ve included three separate indicators. Each of the three shows me that although the market has turned up, momentum remains negative. The first of the three indicators is a stochastic oscillator. It crossed over and turned positive on Jan. 22. That indicates we are likely to see four or five days of upward market movement.

The middle indicator is a moving average convergence divergence (MACD). This indicator is still showing that weakness is predominant. When the blue and brown lines cross and turn upward, that will be an indication that market momentum is shifting toward the positive again.

The bottom indicator is a Relative Strength Index (RSI). In order to have enough strength to sustain an uptrend, the RSI needs to trend above the 50 level. Right now it is at about 30.

So each of these indicators is showing a slight upturn in the market, but not enough to provide incentive to jump back in. Combined with the weak economic fundamentals, the prudent course for investors right now would seem to be to remain on the sidelines.

Of course, no one can predict the future and it is possible that the market might stage an impressive rally from this point. But if the indicators are correct, there will be more down days in the near future.
F.S.

If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group.  This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call me, Flint, at 800-279-3377.

You requested this MarketOwl free e-newsletter. Please add support@marketowl.com to your e-mail address book to ensure prompt delivery.

The honeymoon is over for Federal Reserve Chairman Ben Bernanke. The Fed chairman is facing the toughest test since he took over for Alan Greenspan. As if the real estate problems weren’t bad enough, a report this week showed that the Fed’s chief enemy–inflation–is at its highest level in nearly two decades. Wednesday the Labor Department reported that inflation rose 4.1% in 2007, the worst number in 17 years.

Normally the Fed controls inflation by raising interest rates and tightening up on the money supply. But in a major speech last week Bernanke promised to aggressively cut interest rates to prevent the economy from plunging into a recession. Many economists now predict the Fed will lower rates by a half-percentage point at the end of a two-day meeting on Jan. 30. 

There was another economic warning bell last week when it was reported that the nation’s unemployment rate leaped from 4.7 percent in November to 5 percent in December, a two-year high. That raised concerns that consumers, whose spending is vital to a healthy economy, would clamp down and send the economy into a tailspin.

And if anyone needed more evidence that the economy is in serious trouble, it came today when Bernanke, in testimony prepared for the House Budget Committee, addressed the need for an economic rescue package. He said the action should occur sooner rather than later and that the White House and congress can do more than the Federal Reserve alone in providing support for the economy. There was also confirmation from presidential spokesman Tony Fratto that the president believes that some sort of short-term boost is necessary to deal with the softening economy. In the past, economic stimulus has generally included some form of tax cuts.Of course all these negative reports are taking a toll on equity markets–and not just in the U.S. Emerging market funds dropped about 3% Wednesday over concerns about a U.S. recession. After all, U.S. consumers are the major buyers of world goods. If they quit buying, it isn’t just our economy that will take a dive.

The chart below shows the Nasdaq over the past three years. Notice that the current correction is the steepest during that entire time. The Nasdaq is currently about 15% below the peak it reached in October 2007. It is resting right on a key support line shown on the chart by the red line at about the 2380 level. Right now the Nasdaq is back to same level as in early 2006. If it breaks below this area the next support is about 2000.  

The bottom portion of the chart is a moving average convergence divergence (MACD) of the Nasdaq. This indicator is at the lowest level of the past three years and is providing no evidence of an immediate turnaround. Fundamentally and technically this is a critical juncture for the markets. Investors holding long equity positions need to be prepared to move to the sidelines if the market continues to drop. At these levels, stocks are on the verge of reversing the long-term uptrend and beginning a new bear market. Normally a 20% drop is considered the level that constitutes a shift to a bear market. So a break below this existing support level would push the Nasdaq very close to that mark.

The markets will be closed Monday for the Human Rights day holiday. For those who get the day off work, enjoy your long weekend.
F.S.

If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group.  This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call me, Flint, at 800-279-3377.

You requested this MarketOwl free e-newsletter. Please add support@marketowl.com to your e-mail address book to ensure prompt delivery.

One of the more common myths perpetuated by Wall Street is that all investors need to do to make money in the stock market is buy. Wall Street pros can produce pretty charts that show that over time, major stock indices like the Dow or the S&P 500 will outperform virtually every other investment.

For an investor with an unlimited time horizon that might be true. But most of us don’t have an indefinite investment period. And what Wall Street pros don’t like to mention is that stocks have a history of producing little or no gains over extended periods.

That is the reason Wall Street pros do exactly the opposite of what they advise ordinary investors to do. These experts tell investors that the best strategy for buying stocks is to purchase index funds and then just hang on to them until they are ready to retire. The rationale is that people will start following this advice in their 20s and their money will accumulate over 45 years or so. This is called “buy and hold” investing.

Unfortunately, most of us either aren’t smart enough to start investing in our 20s or circumstances prevent us from doing so. In fact, I would guess that most Americans really don’t start putting away money for retirement until they are in their 40s. And the bulk of the money they save probably actually accumulates when they are in their 50s.

So what happens when one of those flat market periods coincides with an investor who starts saving the bulk of his retirement when he is in his mid to late 50s?

Let’s look at a chart so you can see exactly what I mean. Below is a chart of the S&P 500 from 1970 until now. I’ve added two red lines to the chart so you can see the type of periods I am referring to.

Notice that an investor who started putting money into the S&P 500 in 1970 would have earned zero return until 1983. We’ve seen a similar situation more recently. An investor who bought the S&P 500 in 1999 did not break even again until 2007. In other words, a 58-year-old who started saving in 1999 hoping to retire in 2007 will instead be working as a Wal-Mart greeter because his investment has not had the type of gains he hoped for.

Wall Street wants investors to focus on that period from 1983 until 1999. Someone who was lucky enough to start their retirement plan in 1983 and then retired in 2000 hit the jackpot. Although there were a couple of blips along the way, that period produced phenomenal market returns. Unfortunately, most of us do not have that kind of perfect timing. And for those of us investing now, economic conditions seem closer to 2000 than to 1983.

To combat these periods of market doldrums, Wall Street pros use a strategy called “active portfolio management.” Instead of buying positions, holding them and hoping they will go up, professional managers move assets from one industry segment to another in an attempt to catch those that are starting an upward move. When the stock market appears to be headed for a correction, active managers will shift assets away from stocks into something safer, such as money market funds or bonds.

So why does Wall Street tell investors to buy and hold rather than to actively manage their investments? Because active management is very difficult to employ successfully. Professional managers are watching the financial markets constantly, using a wide range of sophisticated tools to help them decide when and where to shift assets.

Sometimes it works very well. For example, one of the managers at Strategis Financial Group, Rod Jackson, employs active management for his Focus Growth Strategy. In the early part of 2007, he shifted his allocation from real estate into international funds. In the fall, he shifted again into government bond funds. In contrast to the anemic 2007 return of 4% for the S&P 500, the Focus Growth Strategy returned about 20%. Of course it doesn’t always work that well. Another active management strategy managed by Jackson, Global Tactical Allocation, gained just 6%.

Right now many investors are concerned about the economy. With real estate sagging and the prospect for further market corrections, a professionally managed active management strategy might be a viable option for some investors.

F.S.