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Jeff Saut: What Goes Down Must Come Up


Smart traders should prepare for a near-term bounce in equity markets.

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.

"It was always the ubiquitous THEY, those indefinable conspirators who would inevitably force the market to go the opposite you were playing it. THEY were the rumormongers who forced stock and commodity prices to fluctuate wildly regardless of the economic climate. THEY were the ones who toyed with the military-industrial complex of the fifties and the sixties and then with the oil powers of the seventies. THEY profited from those long lines of gas-hungry cars and the shortages of everything from aluminum to wheat. THEY were the brains, the real insiders with all the money to manipulate the markets to make even more. THEY were the immovable forces that gave you that lonely feeling that you were up against it, the ones that always profited by your mistakes. THEY were the ones who used pit gossip to create doubts about your stature as a shrewd trader. THEY were the enemy; heartless; calculating; always on the offensive; forever elusive. THEY were everything you weren't."

"Paul has become obsessed with the THEY factor to the point where he would rather rationalize away his own trading blunders. THEY, of course, were always around to take the blame for his poor judgment. Damn, were THEY cunning. Sometimes THEY would suck you into the market by letting you win first; then, like a shifty hustler, THEY would wipe you out. THEY would always see you as just a small-time Charlie Potatoes, a FAST Eddie Felson squeezed between Minnesota Fats and Willie Mosconi in a game of cutthroat nine ball. It always worked. You could never learn your lesson. THEY knew just how greedy you were and that small profits would never satisfy you. And just when you were raking it in, inevitably THEY would lower the boom."

--The New Gatsbys, by Bob Tamarkin

Recently the word "they" has surfaced again on The Street of Dreams: As in, "They are manipulating the markets for their own benefit." Back in the 1970s, my firm often substituted "Arabs" for the word "they," when we couldn't explain the markets' movements. Since nobody ever knew what the Arabs were doing with their oil-induced riches, anytime the stock market went down or gold went up and we couldn't explain it, we said, "It was the Arabs."

Over the past few months, this explanation has also seemed appropriate given the inexplicably schizophrenic nature of the equity markets, which has saddled participants with the longest "up one day and down the next" skein in the history of our market notes. And the last two weeks have been no exception.

Indeed, just look at the daily trading pattern of the Dow Jones Industrial Average (DJIA) over the last 10 sessions: -29; +135; +29; -283; +21; -239; +266; +186; -205; -52. No wonder participants are frozen like deer in the headlights!

And yet, out of confusion often comes opportunity. I thought opportunity had come the week of July 14th. Since the end of June, my firm's been saying that the "selling stampede" was almost over, setting equity markets up for a slingshot rally. While it lasted longer than the typical downside stampede, opportunity finally arrived the week of July 14th, when the DJIA bottomed on day 39 from the mid-May "high."

To be sure, the first rally off of the DJIA's July 15th "low" of 10828 was explosive, lifting the senior index 7.5% and my firm's recommendation on the financial index 75% in just 6 trading sessions. From there, stocks peaked and once again probed the downside in what looked to us like a retest attempt of those mid-July "lows." That probing appeared to end on July 28 at DJIA 11125, leaving the markets in what looks to me like a back-and-forth consolidation of their recent gains.

The pricing action leaves us with two "marks of the bear": The first at the July 15th low of 10828 for the Dow and 1200 for the S&P 500 (SPX), the second at the July 28th lows of 11125 and 1234, respectively. A downside violation of the latter should be viewed as a "warning flag," while a violation of the July 15th "lows" should be viewed as dangerous.

As my firm has repeatedly stated, we don't think those "lows" will be penetrated in the short/intermediate-term. We believe that the markets are attempting to stage an upside 17- to 25-session "buying stampede" with a minimum target for the S&P of 1320 to 1330.

From a seasonality standpoint, this also makes sense. It's the right time of the year to extend the summer rally. Consequently, I "sit" with my remaining trading recommendations in the exchange-traded funds (ETFs), having already "banked" some of the profits into the July 23rd "highs."

Recall that my firm's ETFs of choice centered on the financials, real estate, and the major market indices. Importantly, if those July 23rd highs can be bettered (1291 for the S&P; 11698 for the DJIA), it would go a long way toward reinforcing our "call" of an
upside stampede into the S&P's 1320 – 1330 zone.

Meanwhile, economist Dr. Scott Brown poses the "real" question:

"A downward revision to the estimate of 4Q07 GDP growth (which the markets would normally consider 'ancient history') has renewed talk of whether we've entered a recession. However, such talk is pointless - we already know that the economy has weakened. The (real) question is, where do we go from here?"

Scott goes on to note, "The overall economy has not fallen off a cliff." Obviously, my firm agrees with him, since we've steadfastly maintained since the beginning of the year that there would be no recession in 2008, as defined as 2 negative quarters for the GDP.

Clearly, the economy has been and is weakening. But so far, strong capital goods orders, both for domestic and export customers, have kept the economy out of recessionary territory. However, with the world's economies slowing, and the government's stimulus checks running out, something needs to "ride" to the rescue of the overspent/undersaved American consumer.

For the past few months, my firm has repeatedly suggested that crude oil prices were going to move lower, which would certainly help the consumer. In last week's report, I opined that stabilization in housing prices could also help and noted that the median price of existing home sales had been rising over the past 4 months.

Still, while this is what appears to be happening on the surface, all is not as it seems. Unfortunately, the median price numbers are monthly statistics that aren't seasonally adjusted, as reported by the National Association of Realtors (NAR). Moreover, the NAR's median price numbers always exhibit the same seasonal price trend, meaning that prices appear to rise from January and peak in either June or July every year before tapering off in the winter months.

This has something to do with when people put their higher priced homes on the market and the home-shopping habits of those higher income buyers. For example, the 10-year average seasonal price increase from the January/February annual trough to the June/July annual peak is 11%. This year's rise stands at 10%. Similarly, the average drop in median prices over the past 10 years from the seasonal peak to the seasonal trough has averaged 5.2%. Last year's seasonal drop-off was the highest on record, at -14.6%.

That said, I think it's more important to look at overall year-over-year trends and TTM averages in analyzing this data. On this point, many have pointed out that the year-over-year rate of decline has slowed for the past 2 months, from -8.5% to -6.2%. My counter to that is that you have to understand the changing mix in transaction volumes. With record numbers of foreclosure sales coming back to the market, we're seeing sharp increases in activity in the most distressed markets - the majority of which happen to be out west in California, Phoenix, and Las Vegas. So when you weight the mix more heavily toward West Coast properties, you tend to bring up the overall median price (or in this case, cause it to go down more slowly) because even with the recent price declines, Western region median
prices are still much higher than the rest of the country ($288,000 vs. $205,000).

Regrettably, the year-over-year rate of decline in West Coast properties specifically is accelerating to the downside - just what you'd expect with rising foreclosures. In June, West Coast median prices fell 17% year-over-year. Over the last 6 months, the average year-over-year decline has been about 13% out west.

The call for this week: I keep worrying that what we're experiencing is a "W"-shaped economic pattern; and that after we quit riding the middle part of the "W," which causes participants to believe the worst is over, we'll enter the right side of the "W" for an economic double-dip. Adding to the near-term feelgood sense has been the second largest monthly decline in commodities ever, a collapse in the price of crude oil and a firming of the dollar.

And all of this should allow the equity markets to travel higher in the short/intermediate term.
No positions in stocks mentioned.
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