Because of the Thanksgiving holiday, I am not doing a market commentary this week. Please enjoy this time with your family and friends and forget about the world’s economic troubles for a few days.

F.S.

Back in mid-October, one expert after another was quoted in the financial media as saying that the worst was over and the best move for investors was just to hang on. In my weekly commentary, I wrote that from all the indicators I know of, there was no evidence that the markets had reached bottom.

In October, major indices never reached the lows set back in the 2000-2002 bear market. The last week of October the indices rallied and many of the experts who earlier said the bottom was in started saying “I told you so.”

Now it is my turn. So far in November, the market bias has been decidedly negative. And this week major indices surpassed the lows set during the 2002 bear market. I wrote a month ago that every technical indicator that I knew about was negative. That remains the case today.

Below is a chart of the price activity of the S&P 500 so far this year. I added a red line to show the technical support that the index failed to break through on prior attempts. The first time it reached that support in November, a strong one-day rally pushed it back above 900. But a week later the index has easily broken through that support and could freefall from here.

Normally I am not an advocate of short positions. Somehow it makes me uncomfortable and even a little unpatriotic to place a bet against American industry. Normally my short positions are reserved for hedging. But early in November I took a position in a fund that shorts the S&P 500.

It was the indicator in the middle section of this chart that convinced me. That section shows a moving average convergence divergence (MACD). I think the MACD is a pretty good tool for forecasting near-term market behavior. Notice the red arrow I added to the MACD. See how it only made it about halfway back to the zero level before it rolled over? That is a very negative sign.

The bottom section of the chart is a relative strength index (RSI). It faltered early in November when it reached the 50 level and could not break above it. That is also a negative sign.

By every technical, fundamental and cyclical indicator, this is a very powerful bear market that wants to go lower. The fact that Congress and Wall Street and virtually every investor in the world want it to reach a bottom and turn back up is meaningless right now.

Once again today on the radio I heard a commentator telling investors there is no need to panic they should remain invested in the stock market. He said that U.S. stocks historically average a return of 10% a year and that as long as investors stay in the market, they will quickly recoup their losses.

My three horses produce less manure than he was throwing around. Major indices are already approaching 50% losses for the year. So if his 10% figure is correct, it will take investors 10 years to recoup what has already been lost. (Do the math. It takes a 100% gain to make up for a 50% loss.)

But there are no signs that the markets aren’t going to keep dropping. How low can they go? A month ago I wrote that 600 on the S&P 500 seemed very possible. At the time the index was at 950. Today it closed at 752. Now I am thinking that there is a distinct possibility that it could fall as low as 500 before this bear market ends.

Rod Jackson is the chief architect of our managed investment strategies. A few days ago someone asked him about the next level of strong technical support for the Dow. He said he thinks 4,000 is possible.

Until we see dramatic increases in consumer spending and confidence and until corporations return to profitability, the only direction the market can easily go is down.

F.S.

So far this year the S&P 500 is down more than 41%. The Dow Jones Industrial Average has lost about 37% and the Nasdaq is off more than 43%. One result of this serious correction is that a huge group of Americans between 45 and 65 are wondering what their retirement is going to look like. I happen to fall into that group, as do most of my colleagues.

Over the past three decades, retirees have enjoyed the benefits of an economic boom unrivaled in any recent period. Many retirees have more disposable income than at any period in their lives. Instead of downsizing homes and lifestyles at retirement, many I am aware of do exactly the opposite. While these folks worked undoubtedly worked hard and are deserving of their reward, they are also beneficiaries of good timing.

According to the U.S. Census Bureau, more than 80 million baby boomers were born between 1946 and 1964. The first of this group began collecting Social Security benefits in late 2007 (coincidently, about the same time the market started its downward spiral). With problems in the housing markets and the overall downturn in the economy, discussion about the inevitable shortfall in Social Security has been pushed aside. Yet shortfalls in Social Security and Medicare have the potential to create an even greater disruption in the future economy.

According to numbers from the Old-Age, Survivors, and Disability Insurance (OASDI)– more commonly known as Social Security–the program is the largest government program in the world and the single greatest expenditure in the federal budget. It currently constitutes 37% of government spending. Medicare accounts for an additional 20%+.

The problems in the sub-prime mortgage market supposedly caught everyone off guard. In contrast, every president since Gerald Ford has warned about the developing crisis in Social Security and Medicare.

Baby boomers have been warned that they should not count on Social Security benefits to completely fund their retirement needs. As a result many have invested in the stock market in the hope that growth in U.S. equities will provide a safety net to secure their financial future. Unfortunately, in the past eight years the markets have experienced two major corrections and investors who adhere to a buy-and-hold philosophy may be no better off today than they were in 2000.

The chart below helps to illustrate the problem. The black line is the Dow, going back to 1890. The red line is also the Dow, shown on a logarithmic scale so the up and down moves can be viewed proportionally. I added the green lines to show extended periods (up to 30 years) where the Dow failed to achieve new highs. The purple lines I added to highlight two periods of extended bull markets.

 
By viewing this chart, one can see that periods of long-term sideways movement like we are now experiencing have occurred several times. The powerful bull market that existed through most of the 1980s and 1990s is the exception rather than the rule. Those whose retirement corresponds with such a run are fortunate indeed. But what about those of us whose retirement comes during a period of market consolidation?

Fortunately, you can see by looking at the chart that even during the sideways periods the market makes substantial up and down moves. Our belief is that by actively managing assets in accordance with those internal trends, an investor is not subject to unmanaged market risk. That is why we moved most of our managed assets to a cash position in May. It is a philosophy in direct opposition to many advisors who advocate that the best course of action is merely to ride the market waves because eventually they will rise.

For my grandparents and great-grandparents the concept of a retirement where one did not work but still had plenty of money did not exist. Instead, they were compelled by their financial circumstances to work as long as they were physically able. Once work was no longer possible, one moved into the home of a younger family member. There is a high likelihood that the current economic situation could force many older people back into that model.  

It is my firm belief that the best option for meeting one’s financial and retirement goals is by following an active investment approach that attempts manage overall market risk.
F.S.

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A lot of investors were hoping that once the presidential election was over, the stock market would instantly start to show signs of recovery. We saw evidence of those optimists the day prior to the elections when major indices posted hefty gains. Since then, it appears everyone has realized that a change of presidents does nothing to change market fundamentals.

Although there undoubtedly remain some optimists who believe the market bottomed in October, it appears to be mostly wishful thinking because there is no technical nor fundamental support for such an opinion. Below is a chart of the daily price movement of the S&P 500 over the past two years. 

The gold line is a 50-day simple moving average. I have included it because it is one of the simplest and basic tools of technical analysis. When an investment is trending strongly above its 50-day MA, that is a good indication that risk is fairly low. In general, most investors should never consider purchasing an investment that is trending below its 50-day MA. On this chart we see that the S&P was trending above that mark until October 2007, which we now know was the peak for this index. Since then, the only time the index has stayed above its 50-day MA is during a two-week period highlighted by the pink oval. Currently, the S&P 500 is moving away from its 50-day MA after a sharp climb last week. 

The middle portion of the chart is a moving average convergence divergence (MACD). During periods of market strength, the MACD will trend above the zero level. Like the 50-day MA, the only time that occurred in the past year was a brief span in April and May. Recently the MACD began rising, but now it is curling over and appears to be poised to head down again. Half cycles where the MACD turns back down before approaching the zero line are viewed by many technical analysts as very negative for the market.

The bottom portion of the chart is a volatility indicator. Going back to 1970, it has never been at this level before. In the October 1987 crash, it reached slightly above the 0.03 level. In the fall of 2002 near the end of the last bear market, it peaked at slightly above 0.02. As I have indicated in the past, volatility can be misunderstood. We like volatility when the bias is upward, but that is certainly not the situation now. In a steep downward trend, volatility is a good indicator of market risk. So this indicator is currently showing that risk is probably significantly higher than at any period in the past four decades.

There is a chance that those who believe the market has bottomed are correct, but based in the weakness of economic fundamentals and a wide range of technical indicators, I think there is a good chance that the real bottom is probably still ahead and perhaps significantly lower.

F.S.

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