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Jeff Saut: Monkey See, Monkey Do


Market to confirm lows or fall farther.

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.

This is how the stock market works:

"Once upon a time in a village, a man appeared and announced to the villagers that he would buy monkeys for $10 each. The villagers, seeing that there were many monkeys around, went out to the forest, and started catching them. The man bought thousands at $10 and as supply started to diminish, the villagers stopped their effort. He further announced that he would now buy at $20.

This renewed the efforts of the villagers and they started catching monkeys again. Soon the supply diminished even further and people started going back to their farms. The offer increased to $25 each and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!

The man now announced that he would buy monkeys at $50! However, since he had to go to the city on some business, his assistant would now buy on his behalf. In the absence of the man, the assistant told the villagers, 'Look at all these monkeys in the big cage that the man has collected. I will sell them to you at $35 and when the man returns from the city, you can sell them to him for $50 each.'

The villagers rounded up all their savings and bought all the monkeys. Then they never saw the man nor his assistant, only monkeys everywhere! Now you have a better understanding of how the stock market works."

- Author unknown

Last week the "momentum monkeys" roamed the canyons of Wall Street, emboldened by softening economic statistics and screeches of recession, even though some of the recent economic reports have actually strengthened.

I do find it interesting that said momentum had been trending toward the upside until February 28th, when Ben Bernanke uttered those ill-timed words about "bank failures." At the time (2/28/08) the DJIA was changing hands around 12,700; just six sessions later the Dow is 6.3% lower (11,894), causing one market maven to suggest, "Maybe the Fed needs to be a little less transparent!"

Plainly, last week was pretty ugly with the senior index shedding some 3% and in the process violating its January 22nd closing low of 11,971.19. As of yet, however, the Dow Jones Transportation Average (DJTA) has not confirmed the Dow's breakdown with a similar violation of its January 22nd closing low at 4,170.89. The Dow Jones Composite Average (COMP/4,052.31) has also not confirmed the downside by breaking below its respective January closing low of 3,989.65. Since the Dow Jones Composite is indeed a "composite" of the DJIA, DJTA, and the Dow Jones Utility Average (DJUA), this index is worth watching closely this week.

Indeed, with all these downside non-confirmations what could be setting up is a successful retest of the January lows, which would be typified by numerous non-confirmations on the downside. The quid pro quo is that if all these indices end up confirming the Dow's breakdown, the investing environment will turn decidedly worse.

Given the aforementioned analysis, obviously one of my stock market guideposts is Dow Theory. To that point, readers of my missives should not have been surprised by this year's market machinations. Indeed, I wrote about the Dow Theory "sell signal" that occurred on November 21, 2007, the same week it happened. That bearish signal purported that a bear market began on July 19, 2007, which was the last time the DJIA and DJTA recorded simultaneous highs.

Consequently, ever since that November signal I have proceeded in a pretty cautious mode. In fact, I even used that bear signal to re-balance (read: sell partial
positions) all of the long-term holdings in my beloved "stuff stocks" (energy, timber, cement, precious/base-metals, etc.), which is how I got to a 40% cash position as I entered the new year.

Moreover, I stayed defensively postured until those January 22/23rd lows that I deemed to be the end of the envisioned "selling stampede." Subsequently, I committed some of my cash to trading and investment positions. Having bought at the January "lows," the risk/reward ratio was tipped decidedly in my favor. And, while I had hoped those lows would not be retested, I never gave up on the possibility that they would.

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No positions in stocks mentioned.
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