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Expect a Rally Attempt This Week if S&P 1358 Holds


If it doesn't, the NYSE McClellan Oscillator will be very oversold.

Toto, I have a feeling we're not in Kansas anymore.
-- Dorothy, The Wizard of Oz

While most people know "The Wizard of Oz" as one of the most popular films ever made, not many people know that the book was based on an economic and political commentary surrounding the debate over "sound money" that occurred in the late 1800s. Indeed, L. Frank Baum's book was penned in 1900 following unrest in the agriculture arena due to the debate between gold, silver, and the dollar standard. The book, therefore, is supposedly an allegory of these historical events, making the events easier to understand. In said book, Dorothy represents traditional American values; the Scarecrow portrays the American farmer; the Tin Man represents the workers; and the Cowardly Lion depicts William Jennings Bryan. Recall that at the time, Mr. Bryan was the official standard bearer for the "silver movement," as well as the unsuccessful Democratic presidential candidate of 1896. Interestingly, in the original story, Dorothy's slippers were made of silver, not ruby, implying that silver was the Populists' solution to the nation's economic woes. Meanwhile, the Yellow Brick Road was the gold standard, and Toto (Dorothy's faithful dog) represented the Prohibitionists, who were an important part of the silverite coalition. The Wicked Witch of the West symbolizes President William McKinley, and the Wizard is Mark Hanna, who was the chairman of the Republican Party and made promises that he could not keep. Obviously, "Oz" is the abbreviation for "ounce."

It should be noted that before 1873, the US dollar was defined as consisting of either 22.5 grains of gold or 371 grains of silver. This set the legal price of silver in terms of gold at a ratio of roughly 16:1 and put the country on a gold/silver bimetallic standard. Since both metals had other uses than just coinage, whenever the ratio got out of whack rational people would buy the cheaper metal and take it to the mint for coinage. That provided a natural stabilizing arbitrage. With the 1873 Coinage Act, however, the silver dollar was omitted, effectively shifting the country from a bimetallic to purely a gold standard. Other countries soon followed, and as tons of silver were unloaded, the market price of silver to gold rose from 16:1 to a ratio of 40:1. The result was that the dollar was now linked to a metal that was getting scarcer. Particularly hurt by these events were the net debtors, among them the farmers because they had to face a rising real value of their dollar/gold denominated debts combined with declining agricultural prices. Now, while there was a bunch of "noise" in between (the Sherman Silver Purchase Act of 1890, the panic and depression of 1893, etc.), the situation hit its zenith in 1896, culminating with William Jennings Bryan's "Cross of Gold" speech at the Democratic National Convention.

Plainly, the turmoil following the 1873 Coinage Act, the Sherman Silver Purchase Act of 1890, and the subsequent panic and depression, of 1893 left the phrase "time for a change" swirling across the country as citizens struggled to correct the numerous wrong-footed schemes that were so hastily conceived by the country's elected leaders. While I have digressed, I find monetary history truly fascinating and would note that the value of our current dollar, measured in 1900 dollars, is worth roughly $0.03. And that is why you want to have your dollars in productive assets that have healthy cash flows, which will hopefully pay dividends, and that will keep up with the inflation that is most certainly coming our way.

I revisit the dollar/gold topic this morning because I think the most important chart in the world may be in the process of breaking down. The chart in question is that of the US dollar. Since January 2012, the US Dollar Index has reversed its pattern of making higher highs and higher lows, as can be seen in the chart below. Interestingly, the last short-term dollar "top out" occurred on last month's bad employment report, so given Friday's poor employment report the dollar's path this week should be watched closely. Moreover, despite the official line from the powers that be, I think Ben Bernanke actually wants a lower dollar. Not only would it bring about the whiff of inflation that is needed, but it also would increase our exports and allow us to pay back our debts with cheaper dollars. A breakdown below February's intraday reaction low of 78.12, which would also break the index below its 200-day moving average (or DMA) at 78.36, would likely confirm the dollar's downside. The quid pro quo is that I think a weaker dollar would be bullish for the equity markets.^

Speaking to gold, I have been bullish on gold and stuff stocks in general (energy, cement, timber, agriculture, water, electricity, precious metals, etc.) ever since China joined the World Trade Organization (or WTO) in 2001 on the assumption that when per capita incomes rise people consume more "stuff." My firm rode that theme to large profits until the Dow Theory "sell signal" of November 2007 where said investments had grown into such large "bets" that we recommended selling 30% - 40% of our stuff stocks to re-balance portfolios. The strategy was to allow long-term capital gains to accrue to portfolios, and raise some cash, going into what we thought was going to be a difficult 2008. Since the stock market's bottoming process began in October 2008 (actually on October 10, 2008 when 92.6% of all stocks traded made new annual lows, a statistic I have not seen in more than 40 years in this business), gold has been on a tear, having rallied from $681 into last summer's closing reaction high of $1891.90. At that time, I warned investors I was putting "in" gold's short/intermediate high, and recommended adjusting precious metals positions accordingly, when I bought six of our son's gold coins to help fund his summer excursion to Europe. The result was that I paid slightly over $1900 per coin; so far, that has proven to be the peak price. While I think gold is in a consolidation pattern that will eventually be resolved with higher prices, I don't think that will happen for a while.

Turning to the stock market, the S&P 500 (^GSPC) and the Nasdaq Composite (^IXIC) suffered their worst week of the year, falling 2.44% and 3.68%, respectively. The weekly wilt left both indices near their lows for the week, as well as below their 50-DMAs. Such action brings into view the intraday April reaction lows of 1357.38 for the S&P 500 and 2946.04 for the Nasdaq Composite. A confirmed close below those levels would represent a break below what a technical analyst would term a "spread triple bottom" with short-term negative implications. That caused one old Wall Street wag to exclaim, "Triple bottoms rarely hold!" This week should hold the key for that statement. Last week's consternations centered around economic and earnings reports. As my firm have been warning since the beginning of April, the economic reports have taken a decided turn towards the softer side. Last week that skein worsened since of the 21 reports released only seven came in better than expected. Likewise, the 1Q12 earning report "beat rate" has been softening over the past three weeks, having fallen from a 73% reading to last week's 61% level for the S&P 1500. Even worse is the decline in companies giving positive forward earnings guidance. Of course, that is causing analysts to reduce their expectations. Accordingly, of the 10 S&P macro sectors the best upward earnings revision ratios are in consumer discretionary (+19.1%), financials (+18.6%), and industrial (+17.7%). Meanwhile, energy has the worst ratio (-36.3%), likely driven by falling energy prices and bulging inventories.

The call for this week: If the spread triple bottom around S&P 500 1358 holds this week, there should be another rally attempt, albeit still within the range-bound environment we have seen for the past eight weeks. If the 1358 level fails to hold, then we might just get what I have been looking for since the beginning of February: A quick dip into the 1320 - 1340 support zone. If that occurs, it would most certainly leave the NYSE McClellan Oscillator very oversold, as well as finally raise my daily and weekly stock market internal energy indicators back to levels that would register a full load of energy, something I have been waiting for these past eight weeks. And this morning, given the "throw the bums out" election results in the EU, it looks like the S&P 500's 1358 is at least going to be tested if not violated. Personally, I would like to see a plunge into the 1320 - 1340 zone, but they don't run Wall Street for my benefit. As for vehicles under consideration for your "buy list," in addition to the index exchange-traded product of your choice, in last week's verbal strategy comment my firm listed three companies that are favorably rated by our fundamental analysts and are "triple plays." Triple plays are companies that have beaten earnings/revenue estimates and have raised forward earnings guidance. Those names were: Abbott Labs (ABT); Equinix (EQIX); and Intuitive Surgical (ISRG).

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No positions in stocks mentioned.
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