Smart money tracker premium

Stocks:

The fact that the market refused to give back any of yesterdays big rally is a huge plus. (The 123 million of positive money flows on the slight pullback is another.) At the close yesterday most of the short term indicators had reached extreme overbought levels. The only time those kind of conditions don’t lead to a pullback is when the market is coming out of an intermediate cycle low. At times like that pent up buying pressure is strong enough to roll over any overbought conditions. I think today confirmed that we have indeed seen the bottom and that we are now in the initial stages of the next intermediate cycle.

The next level of resistance will come in around 1150. I expect this initial thrust will probably stall out at that point as the market contemplates a possible head and shoulders top. 1150 would mark the top of the right shoulder if this pattern were in play. I seriously doubt it is. I think a more realistic projection is still the megaphone pattern of expanding volatility (and it could easily overshoot on the top side). I’ll explain why in a minute.

As many of you probably recall, I’ve pointed out before that spiking energy prices have always preceded a recession. $147 oil was the final straw that broke the economy in `08 and sent the world spiraling down into the worst recession since the 30’s.  I’ve also pointed out that we have those conditions present again as oil has surged from $35 a barrel to over $80 in less than a year. In theory that should damage the economy enough to send us back down into a double dip recession. Now hold that thought for a second.

Here is what I see from most of the blogosphere. There is now a large group of technicians pontificating on this or that technical level that will mark the top of the bear market rally (yes this is a bear market rally, but then so was the last cyclical bull from `02-`07). Retail investors tend to limit their analysis to charts. Hey it doesn’t require much work and most really have convinced themselves they can get an edge in the market by doing nothing other than spending a few minutes a day looking at lines on a graph. But here’s the thing, bear markets don’t begin because of lines on a chart. They begin because the fundamental underpinnings of the market are broken. A real bear market begins because the economy is heading into a recession and earnings are going to be contracting.

Now going back to our discussion on energy, we should in theory be heading down into another recession. Oil has spiked enough to crush consumer demand, especially since the economy is still fundamentally damaged what with unemployment holding at almost 10%. (15+% if one takes the true employment figures instead of the governments phony manipulated numbers.) However there is a big mitigating factor that I think quite a few people are overlooking. The government in their misguided efforts to contain the real estate collapse have virtually halted foreclosures. The mark to market rule has been changed so banks are free to hold on to bad loans and avoid the necessary write downs. As one should expect it hasn’t taken too long for most of the borrowers that are underwater on their mortgage to figure out they can just stop paying. As long as the banks are not being pressured to foreclose people can just stay in their homes indefinitely, and all that money that would under normal conditions be used to service mortgage loans is now being used for consumption.

This is just an observation and it’s limited to Las Vegas, which does have one of the highest unemployment rates in the country, but every time I go into any of my favorite restaurants they are packed. If the economy was sliding back into recession this would be the first area of discretionary spending that would be cut. So far the restaurant indicator is showing no sign of an impending recession.

So yes we do still have high unemployment, and yes those people are not consuming. But that percentage of the population is being made up for by a huge wave of mortgage money that is being diverted into the economy. As long as that remains the case then I think it’s going to take much higher energy prices to destroy the economy and let’s face it until that happens we aren’t going to get another leg down in the secular bear market.

Personally I expect it to happen next year as the dollar drops into the next 3 year cycle low and begins to have structural problems. At a time when the rest of the world is coming to their senses and initiating austerity measures to shrink debt the US is operating under the misguided notion that we can somehow borrow and spend our way out of a problem caused by too much debt and too much consumption.

So while the rest of the world is taking the first steps toward fixing their problems we are just digging a deeper hole. Trust me it is going to come back and bite us in the ass. Ultimately we are going to delay a true recovery by years if not decades and that is if we don’t completely destroy the country in the process.

Short term indicators:

Most of the short term indicators have cycled back into neutral after today’s choppy trade. I don’t think it will be long before the market moves up to test the 1150 level. I did mention yesterday that the market averages 6-10% during the initial thrust out of an intermediate cycle bottom. A move to 1150 before we drift down into the half-cycle low (usually occurs somewhere around day 15-20 of a daily cycle) would be roughly 10%. That sounds about right to me.

Gary