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Jeff Saut Presents: Richard's Lament


Unfortunately, it continues to leave us in the trading "twilight zone".....


Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

"The stock market picture just doesn't look good to me. Consider the following – on February 1, 2006, my PTI (Primary Trend Index) stood at a high of 5708. That matched its all-time high. On the same day the Dow stood at 10953. Yesterday with the Dow at 11235, my PTI was at 5699, actually lower than it was on February 1. I'd call that a decided lack of progress on the part of my PTI.

OK, now let's check the Lowry's statistics. On February 1 with the Dow at 10953, Lowry's Buying Power Index (demand) stood at 446 and Lowry's Selling Pressure Index (supply) was at 485. Selling Pressure was dominating Buying Power and the spread between the two was 39 points in favor of Selling Pressure. Yesterday the Dow closed at 11235, which was 282 higher than its February 1 close. But yesterday Lowry's Buying Power was at 411, which was 35 points lower than it was on February 1, and yesterday Lowry's Selling Pressure was at 515, which was 30 points higher than it was on February 1. Yesterday the spread between the two had increased to 104 points in favor of Selling Pressure.

My conclusion is that investors have been selling into all the rallies, and that what we have seen during most of this year has been deterioration in the market's internals or the market's under-structure. If a house's base is built of bricks, and one-by-one you remove the bricks – at some point the house is going to cave in. The same situation applies in the stock market.

That's the real story of the stock market here in 2006. Oh, one more item – I haven't forgotten those new highs in the Transports that have not been confirmed by the Industrials. Yeah, that action is still on my mind, and as yet nothing "bad" has come of it. But those are primary non-confirmations, and as a life-long student of Dow Theory I have to say that those non-confirmations make me wary. I think those non-confirmations have been telling us something – and it isn't something good.

In this business, there are always foolers, things that don't fit into what we consider normal. For instance, last week my advance-decline ratio of operating-companies only rose to a new high. Normally, the advance-decline ratio tops out well ahead of the major averages. So the fact that the A-D ratio hit a high last week should give this advance more time before there's any major trouble. Will that progression work this time? Do we have more time before any real trouble? We "'should" have more time, and it looks as though we will.

So dear subscribers, I'm suggesting that we be careful right now. This is an overvalued market that is not acting well from a technical standpoint. Let me put it this way – if the bear market was to resume this week – then in July or August or September we might look back and say, 'Well, all the warnings were there, why did we ignore them – and how is it that we didn't act on them?'"

Richard Russell – "The Dow Theory Letters"

Greetings from Dana Point, California, where we are participating in Pimco's investment conference. In attendance are such noteworthy folks as Bill Gross, Colin Powell, and Alan Greenspan; yet, we reserve their comments for next week's letter and like last week, began this morning's missive with another quote from the lesser known Dick Russell. Why have we quoted Mr. Russell for the past two weeks? Because we concur with his cautious stance, and we respect the wisdom he has accumulated over the past 60 years of observing and writing about the markets. Verily, just like we were aggressively bullish back in mid-October 2005, we are currently aggressively cautious on the equity markets, for while the DJIA (11279.97) tagged another new reaction high last week, only four of the Dow's 30 components made concurrent new reaction highs. Those four components were: Boeing (BA); Caterpillar (CAT); J.P. Morgan (JPM); and United Technologies (UTX). Interestingly, three of these four stocks are in keeping with one of our main investment tenants, which goes "invest in things that China and India need." Also worth noting is that the DJIA is a price-weighted index and as such the performance, year-to-date, of three of these Dow "heavyweights" has gone a long way in lifting the senior index while most of the Dow's other components are in downtrends.

Consequently, we remain suspicious of the DJIA's outperformance for the year, with the DJIA better by 5.25% (YTD) while the much higher beta NASDAQ 100 (NDX/1679.81) has improved only 2.10%. Typically, if a rally is to have "legs," the higher beta stocks tend to outperform. We have seen this action before over the years and it has always made us cautious. We have come to dub said action "the solitary dance of the Dow." What we think causes it is when portfolio managers (PMs) get nervous about a potential stock market correction they tend to reduce their holdings in the higher beta stocks (read: sell them). Since many of the PMs cannot hold cash, they tend to buy the "safer" Dow stocks where they are not betting their jobs. Lost in the recent Dow Delight, however, is the fact that the market internals are deteriorating, with Lowry's Buying Power Index continuing to weaken, the number of new daily highs not expanding, our proprietary indicators becoming pretty overbought, and our sense that everybody's bullish and complacent on everything, and the list goes on.

Meanwhile, there is outrageous leverage in almost every corner of the country, interest rates are rising, stock market valuation is optimistic, there are tough earnings comparisons in the back-half of this year, commodity prices are increasing, the "bull run" in stocks is long-of-tooth (3½-years), the dollar looks to have peaked, and real estate prices/sales appear to be softening right when TRILLIONS of dollars worth of variable rate mortgages are set to re-price at higher interest rates over the next few years. Indeed, last week's Investors Business Daily newspaper noted that 29% of mortgages taken out in 2005 have zero or negative equity. If home prices fell 10% that percentage would jump to 47.7%. Unsurprisingly, at least to us, is that Friday's housing figures showed a 10.5% decline in new home sales (the biggest drop in nine years) with prices falling from $234,200 to $230,400 per unit. And, as the good folks at ISI Group note, "the number of unsold houses is up 28% y/y, and prices are up 11%, putting the dollar value of unsold houses up a staggering and unsustainable 42% y/y (to $578 billion)."

So where does all of this leave us? Unfortunately, it continues to leave us in the trading "twilight zone," which is why we remain mainly in CASH on a trading basis despite the various indices' upside breakouts. For the investment account, our best guess is that what occurs from here is that the Fed will continue to raise interest rates until there is a financial accident. From there, we think the Fed will lower rates, causing a surge in the inflationary readings, which is why we have begun to recommend the gradual re-accumulation of "stuff stocks" over the next few months. And almost on command, last week gold (at $560/ounce) closed back above its 50-day moving average ($555.51), ditto for crude oil (@$64.26 with its 50-DMA at $63.78), natural gas appears to be bottoming, and don't look now but gasoline is up roughly 30% since mid-February. We are particularly intrigued with natural gas after its nearly 60% decline. For ideas we suggest contacting our retail liaison desk (x72520), or our Houston and Canada-based energy analysts. Additionally, we would offer Apache (APA) in the large cap universe and Ultra Petroleum (UPL) in the small/mid-cap universe for your consideration as the best allocators of capital as measured by the metric of "reserve growth per debt adjusted share."

The call for this week: In last Monday's missive we suggested there would likely be more information as to the stock market's direction gleaned from last week's action rather than from the previous week's witch witch expiration. What we learned is that so far there has not been much follow-through to the upside breakout of two weeks ago. Further, the S & P 500 "tagged" the upper Bollinger Band (BB) and retreated, causing the BB to roll over and turn down (read: a negative). As the insightful service "" notes, "If the reverse analog pattern of time cycles is still working, we should be putting in a TOP right here. Time cycle Low 5 projects to late June. We remain cautious."


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