On the charts, the DOW and S&P 500 are managing to hold above key support levels at 10,000 and 1,040, respectively, but not before closing below these key technical levels in the recent sessions.

The bears appear to be in control, while the bulls are trying to hang on and minimize the losses. The blue-chip DOW closed below 10,000 on August 26 for the first time since July 6, when the index fell to 9,686.48. In the previous decline, the DOW held below 10,000 for five straight days from June 29 to July 6, prior to rebounding. The DOW has broken below 10,000 in five of the last six sessions to August 31. In our view, the breaks are worrisome and could point to a more sustained move below 10,000.

With four months remaining in the year, stock markets are negative and under selling pressure. Stock markets have closed lower in 17 of the last 25 sessions to August 30. The bias is negative, as stocks search for a bottom. Until we see it reach one, the downside risk remains high. The overall bias at this time is down, as reflected by the current level of the indices below key moving averages and chart tops. The key will be the ability of markets to hold as we move forward. I continue to be cautious due to a fragile technical picture.

The near-term technical picture has turned more bearish with weakening Relative Strength as of August 31.

Markets continue to be on fragile ground and this should not be a surprise given that the key stock indices were unable to break or hold above some topping resistance on the charts. The failure to break higher was a red flag and a signal of further potential downside weakness to come. All four of the key stock indices are negative this year and are fighting to find some support. The Relative Strength is weak.

On the charts, the stock indices are trading at a crux, below the key 50-day moving average (MA) and 200-day MA, along with the tops on the charts as follows:

Russell 2000 — 675
NASDAQ – 2,320
DOW — 10,650
S&P 500 — 1,125

The S&P 500 failed to break its key 1,100 level on August 18 and is back below its 50-day and 200-day MAs. The Russell 2000 is below its 50-day and 200-day MAs.

While there is some decent support on the charts, I continue to see a “death cross” on the charts for all four stock indices. This is a situation in which the 50-day MA is below the 200-day MA. This is a dangerous bearish indicator. I’m not trying to scare you off, but just warning you to be on alert.

I continue to be cautious given that markets need to receive some oversold buying support at the lower supports. As I said, the recent failure to break above the chart tops is bearish.

Monday was an impressive day for stocks with the S&P 500 and NASDAQ on a technical level, as both indices rallied back above their respective 200-day moving averages (MA) and the highest level in a month. All four of our key stock indices are now back above their respective 50-day and 200-day MAs and are positive on the year. While the indices continue to be down from their 52-week highs, between 5.61% for the DOW and 11.28% for the Russell 2000, the ability to rally and hold is encouraging. However, you need to be careful, as the 50-day MA remains below the 200-day MA with all four indices. Also watch, as there is some topping on the market charts. A strong break above on rising volume is critical.

The chart tops are as follows:

Russell 2000 — 675

NASDAQ — 2,320

DOW — 10,650

S&P 500 — 1,125

The trend of the NYSE new-high/new-low index had been edging higher, with 17 of the last 18 sessions bullish. The near-term trend is positive. In the technology area, investor sentiment on the NASDAQ is mixed, with only 17 bullish readings since May 6. 

NASDAQ

The near-term technical picture is bullish on above-average Relative Strength (RS), but the index needs to break 2,320 in order to gain ground.

The NASDAQ is above 2,200 and its 50-day MA of 2,225 and 200-day MA of 2,263. Be careful, as the 50-day MA remains below the 200-day MA.

DOW

The near-term technical picture for the DOW is bullish, with above average relative strength (RS), so there could be further upside moves in the near term. The DOW is holding above its 50-day MA and 200-day MA. Be careful, as the 50-day MA is below its 200-day MA. There is a bottom around 9,800 on the chart.

S&P 500

In the broader market, the near-term technical signals for the S&P 500 are bullish, with above average RS, so there could be more gains. The S&P 500 held above the key 1,040 level and rallied above its 50-day of 1,082 and its 200-day MA of 1,114. The upward break is positive. There is key support around 1,040 on the chart. Be careful, as the 50-day MA is below its 200-day MA.

RUSSELL 2000

The near-term picture for the Russell 2000 is moderately bullish on above-average RS, so the index could see upside moves. The index trades with the economy. The index is above its 200-day MA of 640 as well as its 50-day MA of 638. Watch for key support at 600. There is some topping on the chart around 675.

Finally there’s some good news on the corporate revenue front. A lot of big companies reported solid earnings growth in the second quarter, but revenues haven’t been inspirational. The Dow Chemical Company (NYSE/DOW) just reported very solid numbers and this is a good sign for the industrial economy.

The company reported that its revenues in the second quarter this year grew to $13.6 billion, representing a solid 26% increase over the same quarter last year. Dow Chemical experienced a seven-percent increase in sales volume and a 19% increase in prices. This combination of sales and price growth is a good indicator for the industrial economy.

Dow Chemical experienced double-digit sales gains in all geographic areas (31% in North America), and the company expects a sustained global economic recovery led by Asia.

The company’s numbers actually fell short of consensus estimates just slightly. But, in this market, who cares? A 26% gain in sales for the largest chemical company in the U.S. is big news as far as I’m concerned.

We are experiencing an uneven economic recovery and not all industries are participating. It won’t be until the housing sector really stabilizes and all the foreclosures are worked through the system that the economy will be on solid footing for growth. The good news is that monetary policy is still onside and that interest rates remain low.

It would seem that investor sentiment has had a change for the better recently. While investors have been more willing to forgive less-than-stellar economic news, we can’t fool ourselves about the trading action. The broader market rallied in June, and then pulled back sharply. Also keep in mind that trading volume isn’t very robust. I don’t know where sentiment is going to take the current equity market but I’ve learned never to cry wolf. 

A company like Dow Chemical is a benchmark stock to follow. E.I. du Pont de Nemours and Company (NYSE/DD), better known as DuPont, also reported very good second-quarter numbers and cited volume growth along with increasing prices as reasons for its improvement. Most economists, however, expect the U.S. economy to slow in the second half and, while economists are usually proven wrong, the consensus seems probable.

If there wasn’t growth in Asia, then I think U.S. corporations wouldn’t be reporting the kind of numbers we’ve seen this second quarter. We’re definitely on the right track, but we’ve got a long way to go before we can say things are back to normal.

One thing you can’t do in the stock market is control the amount of returns you can generate. Dividends from solid companies provide a level of security, but look at what happened to BP. Anything can happen to any big company at any time. If you are invested in stocks, you are taking a big risk.

Risk isn’t only the other side of the equation; it’s also a factor that you can help control by choosing your investments carefully. I know a lot of people with a lot of money and I can tell that, once they accumulate a lot of wealth, risk-avoidance becomes a top priority. The problem is that it’s difficult to beat the rate of inflation without taking on some risk with your investments. And when you have a lot of money, you have a lot of salespeople calling you trying to sell you things.

Probably, the single best wealth-creating opportunity for individual investors in the past has been real estate. The recent housing crisis aside, you likely won’t find a wealthy investor whose portfolio doesn’t include some real estate.

Investing in real estate is a numbers game. You need population growth, an attractive location, and attractive financing. The cost of building and renovating will continue to go up, and building codes will increase. There’s little you can do to control your risk in real
estate, except not being overleveraged and owning the right asset in the right location. Time, of course, is always your greatest asset in this sector. And we may soon be getting to that time when real estate is a good value again.

Getting back to stocks, if you look at the long-term charts of the main index averages, it’s quite apparent that the actual periods of significant capital appreciation in stock prices are short and few. Most of the time, the market is trading in mediocrity. This makes it very difficult to be a consistent winner at speculating in stocks.

We’ve been talking more and more in this column about having some portfolio insurance for your equity holdings. Some exposure to gold is a good start. This should already exist. The way the market is trading lately, I think a short position would be a wise option to
consider. I like the fact that the technology and railroad industries are saying that business is getting better. The problem is that investor sentiment is not.

If the Dow Jones Industrial Average breaks 10,000 in a meaningful way, then I think we’re in for real trouble. Right now, decent earnings are holding the index above this level. I get a sense in the marketplace that investors are anticipating an all-or-nothing type of outcome for the rest of year. Either the market’s going to tank or it’ll recover to Dow 12,000. Michael Lombardi has been writing a lot about the bear market rally still having life left. Combine that with my thoughts and maybe the market can do both: rally close to 12,000 and then come crashing down again.

The bulls are in control, but you have to wonder how long it will last. The DOW recorded its third straight session of triple-digit gains on Monday and, in the process, rallied above 10,500 on a broad market rally. More importantly, the S&P 500 also closed above its 200-day moving average (MA) after recently managing to hold above the critical 1,040 level, which was a key development.

With the gains, all of the four key indices are trading in positive territory on the year, quite a reversal from just recently when the Russell 2000 was in a technical bear market, but is now down only 10.74% from its 52-week high. All four of the key stock indices have rallied above the 50-day and 200-day MAs — a bullish sign. Now we will see if the gains are sustainable. The market will need to see continued strong earnings and economic news to hold and advance higher. I expect some profit-taking given the overbought condition and hesitant Relative Strength, and based on the recent trading pattern.

As far as investor sentiment is determined by the new-high/new-low ratio (NHNL). The trend of the NYSE NHNL had been edging higher, with 13 straight sessions bullish from June 10 to June 28, prior to a dip to neutral, but 12 of the last 13 sessions were bullish. The near-term trend is positive. In the technology area, investor sentiment on the NASDAQ has been edging lower, with only 13 bullish readings since May 6, but the last two sessions were bullish.

NASDAQ

The near-term technical picture is moderately bullish on above average Relative Strength (RS), so there could be additional upside moves in the near term.

The NASDAQ is eyeing 2,300 and is above its 50-day MA of 2,228 and its 200-day MA of 2,260. Be careful, as the 50-day MA remains below the 200-day MA, but it has been edging higher. Watch to see if the index can hold, as the downward channel appears to be in place. The index is overbought, so watch for some near-term selling pressure.

DOW

The near-term technical picture for the DOW is moderately bullish with above average RS, so there could be additional upside moves in the near term. The DOW is above both its 50-day MA of 10,181 and 200-day MA of 10,402. Be careful, as the 50-day MA is below its 200-day MA. The index is overbought. There is a bottom at around 9,800 on the chart.

S&P 500

In the broader market, the near-term technical signal for the S&P 500 is moderately bullish, with above average RS, so there could be additional upside moves in the near term. The S&P 500 held above the key 1,040 level, and it has rallied above its 50-day and 200-day MAs of 1,083 and 1,113, respectively. There is key support around 1,040 on the chart. Be careful, as the 50-day MA is below its 200-day MA. The index is overbought.

RUSSELL 2000

The near-term picture for the Russell 2000 is moderately bullish on above-average RS, so the index could see more upside moves. The index trades with the economy. The index is above its 200-day MA of 639 as well as its 50-day MA of 639. The index is overbought. Watch for key support at 600.

Yet it’s not clear sailing by any means. Be careful, as the price trends on the indices are down and, unless there is a steady upside move, the trend will remain intact with additional downside moves going forward.

It’s a tough stock market to make any money from. With sentiment changing almost every day, one might as well just trade index futures. In this market, the likelihood of owning a runaway winner is so small that it would really come down to blind luck.

The timing isn’t right yet to be making any bold moves in equities. You can trade around earnings news, but the returns are small. We’re likely to get more of the same from the broader market — a wide trading range around Dow 10,000. Once earnings season is over, however, the market will only have economic data to trade on and, so far, this news hasn’t been good enough.

I do feel that some sort of portfolio insurance is a useful strategy to consider over the next couple of quarters. The fact is that investor sentiment remains locked in a bearish mindset. Companies are generally saying that business is getting better, but investors don’t believe that they can outpace the economy. Revenue growth needs to be more robust for any stock market rally to sustain itself.

Right now, there are a number of attractive large-cap stocks that offer high dividends to shareholders. These stocks are the most attractive in this market on a relative basis. For speculators, you can trade the index and you can trade precious metal producers. You probably would be better off investing in real estate.

I’m not hugely bearish on stocks, but I see mediocrity in the numbers. No growth equals no growth, and this applies to revenues, earnings, and stock prices. Sitting with money in equities in a no-growth environment only works if you collect big dividends. In the absence of a bull market, equities don’t really make a lot of sense. Mind you, there isn’t a lot else to consider if you have money to put to work. Cash and bonds certainly don’t pay much.

A lot of investors are sitting on the sidelines waiting for a catalyst to take action. While there are always big risks out there, I don’t think we’re going to get a big catalyst anytime soon. Both the economy and the stock market need more time to balance themselves out.

07/19/10 — The general uneasiness of the stock market is blatantly apparent and even good earnings news can’t seem to sustain any lasting interest from buyers. Clearly, the bear market reigns.

So far, corporate earnings are holding up well, but the numbers are padded by extreme cost control. Top-line growth just isn’t happening, and this is worrisome for the next 12 months. Unless we get more robust revenue growth, the earnings picture will slowly deteriorate.

There continues to be a lot of talk about two very real scenarios for the economy — a double-dip recession or a lost decade. I’m in the camp that feels that a decade of very slow growth is more probable given the situation. We have a lot of issues to work through before we can even find a new equilibrium to start from.

For individuals, the two main issues to be dealt with are housing and employment. For governments, the two main issues are spending and debt. Really, these issues are the same for both governments and individuals. They’re just on different scales.

As we all know, the housing market doesn’t operate like the stock market. Housing booms and busts take a lot of time to work things out. And, so do debts and deficits. If governments decide that they want to be more prudent with their finances (as they should), then this will have an impact on the economy. We can’t have it both ways. In my view, the housing market has only just begun to right itself after the initial shock of the subprime mortgage meltdown. We’ve got a long way to go before inventories, foreclosures and prices find the right balance, before another upturn in the housing market develops.

Low and slow. That’s a reasonable expectation given the current state of things.

There are also a lot of potential shocks out there that could contribute to a slow growth decade. The sovereign debt issue in Europe is not over. The numbers really aren’t getting any better. The politicians have only begun thinking about the issue. It’s a great first step, but investor sentiment can still easily turn on the euro. This currency risk has enormous ramifications for you and your daily life. In addition, the world’s second largest economy (China) is in the process of deleveraging itself both in terms of monetary and fiscal policy. You can see this reflected in Chinese equity markets. In a bid to keep a lid on inflation, China’s economic growth is likely to come under pressure over the next several years. Whether we like it or not, this affects our economy.

It really doesn’t matter what the prediction is. An individual’s best strategy in these economic times is the elimination of debt if possible. After that, you can trade the market’s action, but don’t expect any major new trends to develop.

07/14/10 — My husband travels a lot, mostly to the U.S. and Europe, which means his wallet is often stuffed with both U.S. dollars and euros. This can also mean that — in his case, that is, being an academic and all — on more than one occasion, he’s tried to pay for his coffee and bagel with wrong currency. The other day, packing for a two-week conference at Penn State, he opened his wallet to check the stash, then looked at me, seeming lost for a moment.

“Honey, I have monsters in my wallet,” he said.

It took me a while to stop laughing, but when I finally did, I told him, “Thanks, you just gave me a great heading for my next PROFIT CONFIDENTIAL article.” And not only that; my husband’s
exasperated statement was spot on, although unintentional and uttered in a completely different context. Regardless, these days it seems there really are monsters in our wallets.
For months now, the world has come to perceive the euro as bordering on apocalyptic. The headlines have swelled with words like “crisis,” “sinking ship,” “chaos,” “perfect storm,” “horror,”"panic,” “failure,” “Armageddon,” etc. The moment that Greece’s sovereign debt debacle started unraveling, the euro experienced one of the more violent instances of dethroning. The currency that unified an entire region and was one of the greatest economic experiments in recent history nearly disintegrated in a matter of months.

I don’t know if the euro will survive the eurozone’s sovereign debt crisis. It may or it may not. But, in comparison to the U.S. dollar, I still think the euro may be a lesser monster. Broken, bloodied and battered, there may still be healthy tissue underneath all that mess.

For example, comparing the regulatory push towards fiscal and structural reform in Europe to that in the U.S., it is clear that the latter’s efforts resemble those of an impressionable child imitating an adult. Perhaps the eurozone has been pushed against the wall and perhaps this is why the EU regulators are coming up with constructive decisions, not just promises. Then again, perhaps it is not. Still, the U.S. should wield a much bigger bat and should try not to strike out as much.

Additionally, look at what Europe has done to support its currency. April was a black month forthe euro. Greece’s finances were in disarray and the country was dealing with frequent occurrences of citizen unrest. As things went from bad to worse, bond prices plunged, sending yields and costs of borrowing into the stratosphere. Everything in Europe smelled of decay, not just the ruins of Pantheon.

Understanding that a second credit crisis could be only days away, the eurozone finance ministers knew they had to do something and they knew it had to be something big. So, they came out with a rescue package valued at 750 billion euros. It was more than anyone had anticipated and it was designed to help not just Greece, but other PIIGS countries as well. However, unlike the U.S. bailouts, which were mostly about saving Wall Street, the European bailout was first and foremost about the euro.

The EU bailout came with huge strings attached. Greece, Portugal, Spain, Italy, Britain, Ireland, etc., had to agree on harsh austerity programs. That meant severely limiting public spending, increasing taxes, increasing retirement ages, and infusing new life into the labor market. It also meant those accepting the bailout had to agree to reduce deficit to about three percent of their respective GDPs within the next few years.

Recently, I wrote about what fiscal austerity happens to mean in the U.S. From the day that Congress passed the TARP Program in the fall of 2008 to the G20 Toronto Consensus in June of 2010, all I have seen from the U.S. government were ineffective attempts to placate voters, calm investors and please everyone else. To accomplish all that, the U.S. government would have had to have supermen on its payroll. Of course, there are no supermen. Instead,
we seem to be saddled with a government paralyzed with indecisiveness and lacking initiative, but having plenty of “short-sighted” long-term vision.

07/14/10 — Things are looking up in the technology industry, and one of the best companies to follow in the semiconductor industry isn’t Intel; it’s Novellus Systems, Inc. (NASDAQ/NVLS).

Novellus isn’t the biggest company in the world, but it does belong to the S&P 500 Index. Based in San Jose, CA, this company sells specialized equipment that is used in the fabrication of integrated circuits or semiconductors. These products are the brains of electronic devices. Novellus sells its products all over the world. What it says about its business reveals a telling sign about the health of the technology sector in general. One of the company’s principal competitors is Applied Materials, Inc. (NASDAQ/AMAT).

The company just reported revenues and earnings for the second quarter of 2010 that beat consensus estimates. It also made a solid forecast for the bottom half of the year.
According to Novellus, its second-quarter revenues grew 16% to 321.4 million dollars, up 45.1 million dollars from the first quarter of 2010 and up a whopping 170% from the comparable second quarter of 2009. Net income for the second quarter of 2010 was 63.3 million dollars, or $0.66 per diluted share, up substantially from the first quarter of 2010 and up from a net loss of 50.0 million dollars, or ($0.52) per diluted share, in the comparable quarter last year.

Bookings in the second quarter of 2010 were 384.9 million dollars, up 63.5 million dollars, or 20%, from the first quarter. Company management reported that the current upturn in semiconductor demand is being fueled by growth in worldwide communications. No doubt, all those smartphones are making a difference in the semiconductor industry.

Novellus expects that its third-quarter revenues will increase sequentially to between 335 million dollars and 365 million dollars with an improvement in gross margin and earnings per share.

We’re in the very early days, but a financial report like this is a definite positive sign, particularly as the company expects business to improve through the third and fourth quarters.

The technology industry is certainly one that’s going to be leading the economy. As soon as individuals have more income, they spend more on consumer electronics. As soon as corporations have more cash flow, they upgrade their information technology infrastructure.

What we need from the technology sector is confirmation of improved business conditions in other sub-sectors like software and services. So far, I’d say we’re off to a decent start. I hope it stays this way.

07/12/10 — Here’s the most common question that arises whenever I bump into a PROFIT CONFIDENTIAL reader: “Michael, how close are we to really having another Great Depression?”

This is a question best answered by the facts:

During the 1930s, approximately 9,000 banks in the U.S. failed and there was no FDIC insurance for depositors. Comparatively, after the FDIC shut down four banks last week, the total number of banks to fail in the U.S. this year has now hit 90.

The most pessimistic predictions are for 1,000 total bank failures in the U.S. because of the recession that started in 2007. The FDIC covers up to $250,000 per depositor per institution if a bank fails. Again this protection was not present during the Great Depression.

Unemployment in the U.S. hit 25% during the Great Depression. Today, unemployment sits around 10% and worst-case predictions are for that rate to go to 12%.

In the 1930s, in a huge government mistake, the “Smoot-Hawley Tariff Act” was passed to restrict trade with foreign countries. Today, the U.S. is a heavy promoter of international trade.

Leading up to the stock market crash of 1929, stock brokerage houses would lend you $9.00 for every $1.00 you had invested with the stock brokerage house in stocks, or a 90% margin. Of course, today margin accounts can only give you a 50% margin; for every $1.00 you have invested in a stock, you can get another $1.00 as a loan. And not all stocks are marginal.

Finally, there are mixed views on how the Federal Reserve acted during the Great Depression years. Economist Milton Friedman believed that the government was contracting the money supply at a time it should have been expanding the money supply. Of course, today, we have a very expansive monetary policy, with interest rates at record lows.

So back to the question:

Can a second Great Depression happen? Sure, anything can happen at any time. But if we look at the points above, we are very far away from Great Depression II. The recession we experienced in 2007 can be solely attributed to the decline in the value of U.S. real estate that
started in 2005.

Falling house prices led to failed mortgages, which led to failed mortgage-backed securities, which led to investment bank failures and mortgage company failures, which led to declining stock prices.

We need to give to give credit to Ben Bernanke and the U.S. Federal Reserve. They have done a masterful job at steering us away from the Great Depression II. We just need to see the long-term effects of how all that debt we accumulated trying to save the economy works out.

Michael’s Personal Notes:

“So where have you been, Michael?” From the e-mails and phone calls, it seems my loyal readers missed me last week. Thank you. It’s nice to be missed.

I’ve been travelling in the U.S., trying to get a handle on how our economy is faring. Reading the right newspapers and economic news stories on the Internet gets you a “feel” for how the economy is doing. But to get a real feel, you need to be in the trenches talking to big and small businesses about how things are going for them.

While I will talk about the findings of my travels in my next few commentaries, I did come back with a more upbeat feeling about the economy and our future. There is no doubt in my mind that the real estate market is dead and will be dead for the next couple of years at
a minimum.

But small and mid-sized businesses, in general, are witnessing an uptick in the demand for their products and services. While banks are still not lending like they used to, innovative American business people are climbing out of their rut. This is great news for our
economy.

At the end of the first quarter of this year, non-financial companies in the U.S. were sitting on $1.84 trillion in cash, according to the Federal Reserve. As a percentage of total assets, cash on corporate balance sheets is at its highest level in about 40 years. Such a high amount of cash on company balance sheets tells me three things: First, corporate America is playing it very cautious. They want to see how the economy fares in the months ahead before investing in plants, equipment, and inventory. Second, corporate America has the cash to spend as the economy improves. Third, if the economy does not improve, corporate America has the cash to work through a double-dip recession.

Cash is king in poor economic times. Corporate American has figured that out this time around.

Where the Market Stands:

The Dow Jones Industrial Average is set to open this morning down 2.2% for 2010. We’ve passed mid-year, and big-cap stocks have gone nowhere in 2010.

If we look at the fundamentals, as I have written above, there is no doubt that the economy has improved since late 2008. The risks are still there (sovereign debt in European countries and at home, the pathetic American real estate market, a slowing Chinese economy), but corporate earnings have been improving and there is nothing that the stock market loves more than rising corporate earnings.

On the technical side, a chart of the S&P 500 looks like a “dog’s breakfast.” A huge top is in for most stock market indices. When the right shoulder of a head and shoulders pattern has been formed, it is the kiss of death.

The most positive thing I think the market has going for it is the great number of pessimists out there. I have failed to see a stock market newsletter or advisory service that has not mentioned the big negative around the head and shoulders formation. You know how I feel about the market. It always does the reverse of what is expected of it. As long as so many advisors and analysts are bearish, the market has support.

What He Said:
“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour wait…people are spending in America today at an unbelievable clip. 1932, 1933…who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi, in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.

— “Ahead of the Street” Column, by Mitchell Clark, B. Comm.

While the broader market has been ticking higher, I still get an uneasy feeling about the market’s general trading action. I think the best word to describe the state of the equity market is fragile. No doubt, the recent rally was due to the Fed’s unwavering support for the status quo and that’s what the market wanted to hear. There remains, however, a lot of investment risk out there and that’s why a lot of individual investors aren’t participating.

It’s a tough environment in which to be a buyer right now. There’s not a lot of compelling evidence for taking on new risks. The broader market might keep ticking higher, but I wouldn’t be surprised if we get a pullback shortly. That’s the way the trading action’s been for quite a while.

The price of a barrel of oil still is the best near-term indicator for the stock market. Gold’s been holding its own, but it seems to be suffering from a lack of new investor interest. The spot price of gold looks to be waiting for a breakout, but won’t likely form a new trend unless there’s some major geopolitical event and/or major new weakness in the dollar.

It’s really a wait-and-see kind of market, but the outlook for corporate profits is still strong. This is why we will likely continue to experience what I call a “stealth rally” in stocks this year: choppy trading action with an overall upward trend on light trading volume. That’s my outlook right now.

As a speculator in stocks, the two most attractive sectors of the market include U.S.-listed Chinese companies and precious metal producers. As a new buyer, I’d lean more towards the mining industry as a theme. While there continue to be more and more U.S.-listed Chinese stocks in the marketplace, only a select few are really doing well. In fact, from my analysis, you can count the select few great companies on one hand only. The opportunities in Chinese enterprise are plentiful, but investors in those businesses are a fickle bunch and will jump ship on a moment’s notice. These kinds of stocks are much more suited to real-time traders, while you can be more of a longer-term investor in mining shares.

I can’t think of a better play on economic recovery than global precious metals and, to a lesser extent, the agricultural sector. These are two investment themes that encompass all the best stories there are to tell in China, India and at home.

— “Calling the Trend” Column, by George Leong, B. Comm.

There is no debating the fact that stock markets are on a nice uptrend at this time on strong market breadth and bullish investor sentiment. Yet, as we have seen, you need to watch the extremely overbought technical condition and selling resistance, as stock markets edge higher. The reality is that, after the gains in 2009 and in the first quarter of this year, we need to see reasons for markets to trend higher.

The DOW touched a new 52-week high of 10,869.55 on March 19, and it is trading at its highest level since October 2008. The steady gains over the past three weeks have been impressive. The ability of the major stock indices to hold above key support levels has been positive.

As we move forward, here is my near-term technical view.

Investor sentiment continues to be bullish and this will offer buying support to stocks. Investor sentiment as reflected in the new-high/new-low ratio on the NYSE has been bullish in 233 of the last 236 sessions (98% during this time) back to April 9. In the technology area, the NASDAQ had been bullish in 195 of 236 sessions, or 81% of the time.

NASDAQ

The near-term technical picture is bullish with strong Relative Strength, so we could see more near-term upside moves.

Market breadth as indicated by the advance-decline line has been mixed, with six of the last 10 sessions above 1.0. The overall trend is bullish.

The NASDAQ is above its 20-day moving average (MA) of 2,321 and 100-day MA of 2,223. The index is also above its 200-day MA of 2,102.

The index is extremely overbought, so watch for selling pressure. The near-term upper targets are 2,400 and 2,458.

The CBOE NASDAQ Volatility Index is stable at below 20, an indication of reduced market fear. Some contrarians view this as a selling signal.

DOW

On the blue-chip side, the DOW has been steady over the past three weeks, and it is trading at its highest level since October 2008.

The near-term technical picture for the DOW is bullish, with strong Relative Strength. The DOW is above its 20-day MA of 10,540 and its 100-day MA of 10,359. The near-term targets are 10,878, 11,000, and 11,060. You should watch this, as the index is extremely overbought.

S&P 500

In the broader market, the near-term technical signal for the S&P 500 is bullish, with relatively strong Relative Strength. The S&P 500 is above its 20-day MA of 1,135 and its 50-day MA of 1,116. Lower support is at key support of 1,060 to 1,080. Upper resistance is at 1,185 and 1,200. Watch the index, as it is extremely overbought.

The CBOE S&P 500 Volatility Index is holding below 20, indicating reduced fear.

RUSSELL 2000

The market leader has been the small-cap area, as the Russell 2000 is up nine percent this year. The near-term picture for the Russell 2000 is bullish, with relatively strong Relative Strength. The index is above its 20-day MA of 660. Lower support is at the 50-day MA of 636. In the near term, watch for resistance at 696. Watch the index, as it is overbought.

The key is to ride the rally, but, at the same time, take some profits off the table, especially on some of the big winners. If you are up over 100%, take profits on half of the position and let the other half ride.

— “Calling the Trend” Column, by George Leong, B. Comm.

The benchmark Shanghai Composite Index (SCI) continues to hover around 3,000, but is down about eight percent this year. The recent correction was driven by concerns of a real estate and credit bubble forming in China and the decision of the Chinese government to halt lending by banks. The action is feared to hurt economic growth in China, but, at the same time, it may be the right move to avoid a financial collapse in the country. I feel that the fact the SCI is holding at 3,000 reflects the support for the move.  

China is continuing to grow well beyond the growth rates in North America and Europe. Yet with the growth comes inflation. The Chinese government knows this and is staging its own battle to combat uncontrollable growth. 

China wants to see its economic engine surge forward, but at the same time we must understand that, without control, it can become sort of like a runaway train. Government officials may force the People’s Bank of China to increase interest rates there in order to curb the growth.

The country is targeting GDP growth of eight percent for this year, which is below some estimates that peg GDP growth at over nine percent. The key is to maintain growth without causing problems with inflation and surging property values. “Improving people’s well-being is the fundamental goal of economic development,” said Wen Jiabao in a report to the National People’s Congress.

The country’s manufacturing sector remains strong and will continue to drive China’s economy forward over the next decade. China’s Purchasing Managers’ Index (PMI) came in at a seasonally-adjusted 52.0 in February, below the estimate and the reading in January, but continuing to point to expansion.

The problem in China remains the threat of an asset bubble, but it is only a threat. The International Monetary Fund recently suggested that there is no serious risk of asset bubbles and that China could see GDP growth of 10% in 2010, according to The Wall Street Journal. 

China does not want to risk major impact to its growth and would rather slow it down a bit to avoid a potential meltdown. But with consumer prices surging 2.7% in February from a 1.5% increase in January, there is a fear of inflation and uncontrollable growth. On the producer side, the producer price index increased 5.4% in February from 4.3% in January. The readings are somewhat high, but the CPI is still within the target of three percent set by the Chinese government. We could see higher interest rates if inflation continues to grow. The People’s Bank of China said that it would “…gradually guide monetary conditions back to normal levels from the counter-crisis mode” in its quarterly monetary policy report, according to Bloomberg.

And, unlike in the United States, property prices are surging in China, up 10.7% year-over-year in February, according to the National Bureau of Statistics. On a positive note, to avoid a housing bubble, the sales volume of residential properties fell to 37% in January and February, down from the 50% growth rates at the end of 2009.

The bottom line is that playing the Chinese capital markets involves excessive political and economic risk. Yet, as I have said, you need to be well-diversified, so this would enable you to play some Chinese growth stocks, especially those of the small-cap variety.

By George Leong, CFP, MBA — The Leong Side of the Market column

— “Calling the Trend” Column, by George Leong, B. Comm.

The technical picture looks pretty good at this time, after we hit the one-year anniversary of the March lows in 2009. Small-cap stocks are leading the broader market, with the Russell 2000 up seven percent at a new 52-week high and 57% from its March 2009 low. The NASDAQ and S&P 500 are up 3.12% and 2.23%, respectively, for this year, and up 85% and 71% from its March low. Unlike the last several years, U.S. markets are outperforming Chinese stocks, as the benchmark Shanghai Composite Index is down seven percent.

The overall market is edging higher, with 84% of U.S. stocks above the 200-day moving average (MA) as of March 10, versus 80% a week earlier and 69% a month ago. The rally in stocks in February and March has been a turnaround from the negative January.

The momentum has been driven by excellent market breadth and bullish investor sentiment. Breadth on March 5 was the strongest reading since July 15, 2009. Investor sentiment is extremely bullish. The S&P 500 VIX is low at 17, an indication of market calm and lower volatility.

Now let’s take a more in-depth look at the markets from a technical perspective.

On a positive note, investor sentiment continues to be bullish and this will offer buying support to stocks. Investor sentiment as reflected in the new-high/new-low (NHNL) ratio on the NYSE has been bullish in 224 of the last 229 sessions (98% during this time) back to April 9, 2009. The readings have been extremely bullish at over 90% since July 14, 2009, when the DOW was trading at 8,359 and NASDAQ at 1,799. In the technology area, the NASDAQ had been bullish in 186 of 229 sessions, or 79% of the time.

NASDAQ

In technology, the NASDAQ is holding above 2,200 in a “V” shape formation. I expect to see some cautious and perhaps sideways trading in the near term, as the index moves towards 2,400. 

The near-term technical picture is moderately bullish with above-average Relative Strength, so we could see more near-term upside moves.

Market breadth as indicated by the advance-decline line (A/D) has strengthened, with eight of the last 10 sessions above 1.0. The chart is near-term bullish. 

The NASDAQ is above its 20-day MA of 2,188 and 100-day MA of 2,187. The index is holding above its 200-day MA of 2,049. The index is overbought. The near-term upper target is 2,400.

DOW

On the blue-chip side, the DOW is holding above 10,000 and looking at extending higher towards the previous high, as it is within 1.89%.

The near-term technical picture for the DOW is moderately bullish with above-average Relative Strength. The DOW is above its 20-day MA of 10,192 and its 100-day MA of 10,233. The near-term target is the four-week high of 10,719. Watch, as the index is overbought.

S&P 500

In the broader market, the near-term technical signal for the S&P 500 is moderately bullish, with above-average Relative Strength. The S&P 500 is above its 20-day MA of 1,087 and its 50-day MA of 1,108. Lower support is at key support of 1,060 to 1,080. Upper resistance is at a 52-week high of 1,150. Watch, as the index is overbought.

RUSSELL 2000

The market leader has been the small-cap area. The near-term picture for the Russell 2000 is moderately bullish, with above-average Relative Strength. The index is above its 20-day MA of 611. Lower support is at the 200-day MA of 575. In the near term, watch for resistance at 696.

— “Calling the Trend” Column, by George Leong, B. Comm.

In 2009, the small-cap Russell 2000 gained 25.22%, which was ahead of the larger-cap DOW and S&P 500. So far, nearly three months into 2010, small-cap stocks are leading the broader market, with the Russell 2000 up 3.52% versus 0.48% and 0.26% for the NASDAQ and S&P 500, respectively. Blue-chip stocks are down, with the DOW off just under one percent.

The buying in small companies is not a surprise given that this group generally rises with the economy. If the trend of economic renewal continues, we expect small-caps to continue to outperform in 2010.

Yet, you will not see Wall Street cheerleading for small-caps. The reality is that Wall Street typically focuses on larger companies. The rest “fly” under the radar, being largely under-followed and, thus, by extension, largely undervalued.

Why? Simply put, for big Wall Street firms, there is no money in following small- and micro-cap companies. As a result, regardless of how good a story behind a company is — and regardless of how strong its fundamentals are — Wall Street continues to ignore this rather large pool of good investments.

The Street has grown over the years. Big banks have bought out small independent brokerages and small independent brokerages have kept on merging amongst each other to grow into bigger ones. This has left small-caps out in the cold, with no one interested in promoting stories that brought little in fees. These days, brokerages make money only if they promote the most liquid stocks, which are in turn only large-caps. You could call it the catch-22 of 21st century investment banking.

There is one more reason why the Street does not like to research small-caps. That reason is trading margins or, rather, a lack thereof. Namely, as competition among brokerages became more and more cutthroat, trading margins became narrower and narrower. Today, no trading desk has “play money” to spare for speculating on development-stage companies. Plus, only large-caps are liquid enough to keep those trading margins safe.

Luckily, that is also where independent research companies come handily into play. They do not get paid through investment banking fees. They also do not trade the stocks they recommend. Rather, they are driven by the success of their picks. Their only allegiance is to the readers of their reports.

If Wall Street is not interested in small-caps, then why should individual investors be? As with everything else, there are pros and cons when it comes to investing in small-caps. However, one of the biggest “pros” is value. There are so many great little companies that no one has ever heard of before. There are companies with breakthrough science behind them and companies operating in a niche market. Yet, because Wall Street is focusing on larger companies, their stories go undiscovered and their stock prices go undervalued for years on end.

As I said, as the economy picks up, small companies tend to do better than larger companies due to their flexibility to react. I remain long-term positive, as small-cap stocks have proven to be tops over the long run. The key is to maintain diversity within your portfolio.

— “Ahead of the Street” Column, by Mitchell Clark, B. Comm.

It takes a fair amount of expertise to be good at trading junior mining stocks. Along with U.S.-listed Chinese stocks, this sector is going to be hot over the next couple of years. In a way, you really have to approach the mining industry from the prospector’s view. There could be gold in those hills; then again, there might not be enough of it to make it worthwhile. In the end, the prospector’s approach is the same as the speculator’s approach — you have to spread your risk around and be ready to jump ship at any time.

If you find a junior mining stock that’s going up in price on the stock market, take note of it immediately. In my experience, mining stocks can be some of the best momentum trades of all — even more so than a Chinese technology stock.

What you want in a junior mining opportunity for investment is a company with a reputable management team, which has a bunch of money in the bank and owns a great property. For me, I like to see a miner that’s already producing from its property (or properties) and is doing a lot of development work in the surrounding area. A small, existing producer that’s prospecting for more precious metals is a great asset, because if it increases its reserves, the company automatically becomes an attractive takeover target for the big producers. Big miners always have access to a lot of capital and are always looking to expand their production. Even with their financial resources, there’s a lot of competition for good properties in the world. In any given location, there’s only so much gold that can be extracted, so the big players are always looking to buy the small players. It’s the only way they can grow.

Really, it is an exciting time to be in the mining business. Spot prices are strong and the prospects for higher spot prices are good. There isn’t a lot of growth from Main Street businesses these days, so investors are becoming more interested in precious metal producers. Finally, there’s the inflation/weaker dollar/hedge myself against the end of the world scenario that just can’t be denied. So, the fundamentals for the mining industry are pretty solid now.

If you’re prospecting for stocks in this sector, I really think it’s wise to choose a couple that have a track record of success. I’m not just referring to a successful track record of production; I’m talking about a track record of success on the stock market. Like I say, there are no better momentum trades in the stock market than in mining stocks. There aren’t a lot of them out there, but they certainly do exist.