Updated Technical Outlook for Stocks

“Profit Confidential” Column, by special guest columnist Anthony Jasansky, P. Eng

The flow of financial news has been plentiful and extraordinarily conflicting, as this market attempts to discount an economic recovery from the deepest plunge in the economy and financial markets since the 1930s. The question I still ponder is: do the massive and rapid gains of the stock market of the last eight months discount a comparable V-rebound in the economy, or are they only reflecting the relief at having avoided a global depression?

My guess is that the market, as usual, has overdone either or both scenarios, a discounting of the rebound and the celebrations at having averted a depression. The combination of unprecedented fiscal and monetary stimulus that has done wonders for the financial markets has yet to do the same for the economy. The coming year will be a reality check as to the outcome.

Trading over the latest two months shows a notable loss in upside price momentum and increasing deterioration in market breadth and volume indicators. In contrast to the indices weighted by large U.S. multinationals that benefit from the weakness in the U.S. dollar, the broadly based stock indices such as the NYSE Composite and the Russell 200 failed to make new higher highs last week.

As the widely watched Dow Jones Industrial Average and the S&P 500 hit another 2009 high last week, investor sentiment (subdued by the experience of the 2007-2009 meltdown for much of the rebound from the March 2009 lows) has surged to unhealthy bullish levels. The sell signals from short-term indicators based on option and index futures trading, combined with the already bearish insider trading and the Investors Intelligence Advisory Sentiment, depressed our sentiment group of indicators to twice our minimum bearish limit.

That leaves only our fundamental and monetary group of indicators bullish due to the “zero interest rate” policy of the Fed. Without a doubt, the unprecedented monetary steps taken by the Fed to rescue banks from self-destruction were the primary reason for the recovery in financial markets.

The dilemma investors now face is what the long-term cost will be for this short-term rescue success. Will the outcome be inflation or will the economy plunge back into an even deeper recession accompanied by deflation? If forced to choose between these two dire alternatives, both the central banks and the public at large will go with the devil they know — the inflation.

Putting aside this long-term dilemma, for the short term, Wall Street pundits are touting the well-known year-end bullish pattern. Beyond that, a very marketable bullish case is being made from the trillions of cash stashed in savings, GICs, and MMFs, earning meager interest.

The cynical policy of central bankers to penalize savers and reward reckless risk-takers is expected to eventually compel an avalanche of “dumb cash” to buy overpriced stocks from Wall Street pros.

The review of asset holdings and money flows within the U.S. mutual fund industry (www.ici.org) suggests that this still remains a wishful hypothesis. ICI monthly data shows that the decline in money market funds assets of $460.3 billion (between March 1 and November 1 of this year) was accompanied by a meager $11.2-billion new cash flow into equity funds. In the last two months, equity funds actually suffered outflows of $10.38 billion and $7.08 billion, respectively.

So, we have a stock market rising with net outflows of money. Just imagine what will happen to stock prices if money comes back into the stock market.