bull market ending

At the top of this post you will see the September 23 cover of Time Magazine. Right below it is an image of today's New York Times front page. And below that is an image of the May 17 Economist cover.

I learned from Paul Montgomery, the inventor of the magazine cover indicator,  that the image of a bull on the cover of Time Magazine has bearish implications for the next 12 months (although the market may well rally for 4-8 weeks after the appearance of the cover). In this regard it is also interesting to recall the May 17 cover of The Economist which also depicted a bull, just a week before the May 22 top in the S&P at a level almost equal to last Friday's close.

I think today's New York Times headline reinforces this bearish warning. Why? It tells us that the economist and Obama associate Larry Summers has withdrawn his name as a possible nominee for Fed chairman. Summers has been an enemy of the Fed's quantitative easing program and has no special expertise in monetary economics. Last night when Summers' withdrawal was announced the S&P jumped more than 1% showing how much the market likes the Fed's QE program. But the headline makes me think that the beneficial effects of the Fed's QE program are now pretty much priced into the market. This doesn't mean that the S&P won't go higher - the economy is improving after all. But it does mean than one prop under the market has now been kicked away.

When the S&P reached the 1540 level I took a guess that the market would have a hard time moving above its 2007 top and on this basis suggested that conservative contrarians cut back on their stock market exposure. Such a cut-back normally would require a 2% drop in the 200 day moving average (the red line on the bottom chart). This moving average is currently at 1575. However I think that while this cut-back was early these magazine covers and headlines suggest that it will turn out to be as good an exit point as any subsequent moving average signal.

The bottom line is that the odds now favor a lower S&P 500 index 12 months from now.

bubble in Japan ?

As you may know the Japanese stock market has more than doubled in the last seven months. Last week The Economist featured the Japanese prime minister on its cover as superman. A couple of days later the New York times published a front page, above-the-fold story on the Japanese economic recovery. During the following two days Nikkei average of Japanese stocks dropped 13%.

A bullish magazine cover story right at the top of a big run-up in stock prices makes one reasonably wonder whether or not the Japanese equity party is over. My answer? Not by a long shot.

From the point of view of contrarian theory the cover of The Economist is not as significant a long-term contrarian indicator as it may appear to be at first glance. Tale a look at the top chart which shows the Nikkei stock average on a monthly basis going back to its all time high (red line) in December 1989. As you can see, despite rhe recent run-up, this average is still trading 60% lower than it was at its 1989 high. As I explained in my book it is very unlikely that a bullish investment crowd will grow to bubble-popping size until the market is at all time highs. So I conclude that the bullish cover actually marks the birth of a bullish investment crowd in the Japanese stock market, not the end of the growth of such a crowd.

I have another reason for doubting that this cover marks any sort of important top in the Nikkei or low in the yen. The Bank of Japan has embarked on a massive quantitative easing program which is scheduled to run for two years. I for one think the BOJ now means business and I expect its purchases of Japanese bonds to continue. But given the BOJ's track record many investors doubt that it will continue its QE program. So I think there is a lot of room on the upside in the Nikkei and on the downside in the yen which will be occupied by the charts as skeptical investors start believing in the BOJ's announced intentions.

It is worth mentioning that QE in Japan is bullish for the US stock market too as it is for the rest of the world's markets. The same can be said for the Fed's QE program. So short term fluctuations aside world stock markets are almost certainly headed higher from current levels.

Bull

Here is the latest cover of The Economist. It shows an imagage of a bull breaking through a wall, presumably the wall represented by the previous all time high points the Dow and the S&P had reached in 2007. The top chart is a daily chart of the S&P 500 and the horizontal green line is the 2007 top at 1576.

According to Paul Montgomery's magazine cover theory this bullish cover is a definite negative for the stock market going forward. However, such covers on average preceded bull market tops by 4 months or so. This means that prices are likely to move still higher before anything resembling a bear market begins.

I would add that this cover is less representative of the investing public's mood than a similar cover on a general circulation magazine. I don't think there is anything like a bullish investment crowd operating in the US stock market right now. If fact I would characterize investors' attitudes towards the stock market as skeptical.The low levels of trading volume and volatility also testify in support of my conclusion.

However the rally of nearly 10% during the past month has caught investor's attention. Measured by the five day moving average of the CBOE equity put-call ratio there is more bullishness in the market than has been seen in more than a year.

The coupling of the fast, one month rally, a bullish magazine cover, and a relatively low put-call ratio suggests that a temporary interruption of this bull market is imminent. But I don't think it will be a very big interruption. The most likely development would be a drop to the vicinity of the S&P's 50 day moving average (green wavy line) and possibly to the level of the 2007 top at 1576.

The bull market which followed the bursting of the dot.com bubble lasted five full years. By that clock the current bull market could easily last until March of 2014 although I think a top sooner than that, perhaps in the fall of 2013, is more likely.

things can always get worse - but will they?

Here is a daily bar chart of the euro priced in dollars.

The EUR.USD is very much on the markets' mind now with the Cyprus banking system hanging by a thread. But after a downard adjustment to this news last Sunday night the euro has managed to hold its own as mini-waves of optimism and pessimism have washed across the markets.

I think this steadiness in the euro in the face of bad news is interesting for three reasons. First, the market has dropped for nearly 7 weeks from its early February top. Second, this decline has brought it to a point slightly below the midpoint of the rally from the July 2012 low (blue line). Third, the spring equinox is upon us. According to Paul Montgomery of contrarian Time Magazine cover fame this year's equinox is likely to bring the lunatics out in force this week and next, giving us volatile markets and making a dramatic change in market sentiment more likely now than at other times.

And all of this is occurring in a monetary context which suggests to me that the euro is going to  appreciate against the dollar because ECB monetary policy is much tighter than the Fed's. My conservative upside target is 1.40.

So I have a strong suspicion that this chart is going to look a lot different a couple of weeks from now. I think a big rally is about to start. The first sign of an up trend in the euro will be a move above the 20 day moving average which appears in this chart as a wavy red line.

Conservative Contrarians Take Note

The bottom two images are today's front pages from the Chicago Tribune and the New York Times. Both note that yesterday the Dow closed at historical highs. I think the Tribune headline captures the spirit of this market pretty well. I think investors are happy to see the Dow at new highs but that skepticism about economic conditions and US economic prospects remains strong.

The top image appears on page 1 of the Tribune's business section today. It suggests a little more optimism but in my judgement "Dow 20,000" projections are not very common right now.

I don't think we are seeing a bullish information cascade here, at least not yet. Yet the Dow is at historical highs and the S&P is not far behind. In fact the S&P is just below the levels it reached at the 2000 and 2007 bull market tops. And this bull market has already lasted 4 years.

There certainly has not yet been a 200 day moving average sell signal for conservative contrarians. Nonetheless I think it makes sense for conservative contrarians to cut back stock market exposure to below normal levels now. There was no bullish information cascade visible at the 2007 top either, but we still saw a more than 50% drop from that top.

I don't like to deviate from standard operating procedure like I am doing now. But I think it makes sense to substantially lighten long positions at the top of a 13 year trading range after a bull market has lasted four years and newspaper headlines are starting to suggest increasingly bull sentiment.

Hyperinflation ahead? Not.

In this post I explained why I thought that fears of imminent high inflation resulting from the Fed's quantitative easing policy were misplaced.

Here is a post by Mark Perry which reports the latest estimate by the Federal Reserve Bank of Cleveland of expected inflation. Their number is an average of 1.53% annual inflation over the next 10 years. This is what they come up with after examining both bond market data as well as survey data from investors and consumers.

Of course expectations can always change. But this survey tells us that that there is no reason to think inflation will increase in any significant way base on the evidence at hand which includes the Fed's current QE policy.

Buy ? Maybe not.

Thanks to Paul Montgomery and Elliott Wave International for bringing my attention to the latest cover of a special, February 18 issue, of Maclean's magazine. Maclean's is the Canadian equivalent of Time magazine here in the US. But the cover story is all about the US stock market.

The cover story quotes Ralph Acampora, a noted US market technician, as asserting that the current bull market is climbing a classic wall of worry. He further more observes that since the public has yet to return to stocks in any significant way (as measured, say, by mutual fund money net inflows) there is a lot of upside potential even from current levels. To be fair, he also says that a "correction" now would be healthy and help to repair any cracks which have developed in the worry wall.

Frankly I am in more or less agreement with Acampora as far as the long term prospects for the US stock market go. However shorter term cracks (like this cover story) have started to appear. This is another piece of evidence which suggests that the US stock market is vulnerable to a correction which easily could take it below its November 2012 and even below its June 2012 low point.

At this juncture I think it makes sense for aggressive contrarian traders to move their stock market exposure down to below average levels. The plan would be to restore average or above average levels of stock market exposure after a drop of 5-10% (or more) in the averages, a drop which I think is coming sooner rather than later.