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Stock Market and Economic Overview

Stock-Markets / Financial Markets 2011 Aug 10, 2011 - 12:25 PM GMT

By: AVA_Research


Best Financial Markets Analysis ArticleAVA Investment Analytics : Approximately three months weeks ago the U.S. markets began to correct. We warned about this first correction in the May issue of our firms paid research publications.

We followed up in June, forecasting additional downside down to the 11,800 level with the highest probability. This level was to be the repurchase area for those who decided to sell positions at the top. The Dow rallied in late June after hitting 11,844.

By the time the July issue was published, the Dow was over 12,600. However, in the July issue we warned that the correction in the Dow and Nasdaq was not finished. Without hesitation, we warned of at least another correction in coming days down to 12,150, with additional downside to the 11,800 and 11,500 levels. We also discussed the 11,200 level as a reasonable possibility. Shortly after the July issue was published, the Dow rose to over 12,700, then began to correct. As it turned out, these two corrections now represent a larger correction period which has shifted the market into a bearish trend.

Over the past week, several events have occurred which have now caused us to place our bias for more downside. Thus, at the present time we view corrections down to more extreme levels as buying opportunities.

On Friday August 5, the Dow closed at 11,444 after testing the 11,200 level, hitting an intraday low of 11,134. Meanwhile, the Nasdaq closed at 2532 after having tested the 2450 level. While both markets staged an impressive late day rally to close significantly off the intraday lows, the rally in the Dow was more impressive.

However, based on our current analysis, it’s apparent that the Dow and Nasdaq will decline lower in coming days. Even the worst-case scenario bottom is possible over the next several weeks/months. Overall, investors should view the correction levels mentioned above less as buying opportunities unless you plan to engage in short-term trading.

On the positive side, we believe these corrections will represent buying opportunities (for select securities), but this could change depending on what happens in the U.S., EU, Japan and elsewhere in coming months; whether or not and when to buy will also depend on your investment horizon.

Regardless, even after factoring in minimal adverse events in the global economy, the bounce back up is likely to be delayed. This means you should be in no rush to buy into the market because a definitive trend reversal (from bearish to bullish) is likely to take several months. During that time, we expect a good deal of volatility, with some nice rallies. 

Because we are entering a psychological transition and investors have not yet fully digested the most recent events over the past week. Separately, each of the recent events probably would not have caused reason for much concern. However, the combined impact and timing of these events is worrisome.

As well, we recently uncovered some very additional concerns I intend to detail in our paid research publications. Let’s discuss the recent events which have caused investors to become worried. First, on July 29th, the latest GDP data was released, and it was very bad. Q1 GDP was revised from 1.9% growth to 0.4%. Meanwhile, Q2 GDP came in at 1.3% (which I am certain will be revised downward in coming quarters).

For several months we have been discussing our view that the reported GDP data was too high and would be revised downward. However, even we did not expect the downward revision to come so fast. The timing of the revision to Q1 GDP data came at the worst possible time. The recent GDP data was followed by declining growth in consumer spending, the slowest in two years. With little doubt, consumers will spend even less in coming months.

Keep in mind that the first half of 2011 is likely to be the strong half of the year. We have been alerting our clients to this forecast for several months. Thus, as you can imagine, the remaining two quarters are going to be pretty bad by the time all revisions have been made. Also keep in mind that the funds from the economic stimulus are nearly exhausted. When the stimulus was passed in early 2009, I insisted that several more stimulus packages would be required over the next several years. 

Next, we had the debt ceiling drama, which caused the world to focus on the state of the U.S. economy. Although this circus show had been ongoing for a few months, its impact rose as the August 2nd deadline approached.

The entire world watched Washington make fools of themselves. More important, it was this charade that actually led in large part to Friday’s downgrade of U.S. debt; another problem (psychological, not economic) is only beginning to be priced into the market. Once the debt ceiling was raised, it added more negativity to the economy and markets due to the ridiculously low level of spending cuts passed, in exchange for agreement to raise the ceiling. 

As I have insisted throughout, the recession which began in December 2007 never ended. Furthermore, the term "double-dip" recession is not possible. In fact, the term is not even valid, as I have discussed in the past. Similar to the structural employment rational used by Washington to account for the chronically high unemployment, the same fools have come up with double-dip so as to imply that real progress has been made in the economy. However, the data paints a different picture. As it stands today, the current recession has now persisted longer than the longest recession from the past 150 years.

While the market had been doing a nice job stomaching the miserable state of the housing and job markets, these recent events, along with an early market sell-off increased the selling pressure. Going forward, negative events and perceptions (problems in the EU, etc.) will be magnified by investors. The same applies to economic data.

If these recent events had not occurred, we believe that the Dow would have likely rallied off of the 11,800 or 11,500 support, even with the latest GDP data. Only later would the Dow have settled to the 11,500 area as economic data rolled in towards the fall. Thereafter, the market would have likely rallied in coming months back to the 12,500 level. In other words, Washington (both parties) shares a good deal of responsibility for the market decline. Remember that when you run out of money during what were supposed to be your Golden Years.

But things are different now. As the markets react in coming days/weeks, we plan to reassess the critical support level in order to determine under what circumstances it could break down.   

After a huge sell-off in the market yesterday, things are looking even more concerning. The Dow closed at 10,809.85 for the day, down a whopping 634.76 points for a one-day loss of 5.55%. The S&P 500 declined to 1119.28, before closing at 1119.46, falling by 79.92 points, for a decline of an eye-popping 6.66%. Even worse, the Nasdaq lost 174.72 points to 2357.69, for a one-day loss of 6.90%.

But the biggest loser for the day was the Russell 2000, down by 63.67 points for a one-day stunning loss of 8.91%. 

Today marks the first that we have seen some signs of life from the capital markets. Prior to Tuesday’s close, we saw no let up from this sell-off for 11 to 13 days, depending on which index we are talking about. As of Monday, August 8, 2011, in a period of just under two weeks, the Dow has shed nearly 2000 points for a decline of more than 15.2%. Even worse, the Nasdaq has collapsed by more than 500 points or by more than 17.4% over the same period.  Meanwhile, the S&P 500 has collapsed by more than 16.9%, while the Russell has imploded by nearly 23%.  Fortunately, investors found an excuse to buy into the market on Tuesday, pushing the Dow and Nasdaq up by about 4% and 5%, respectively.

While the indices have been generally closing each trading session right around key support levels, they continue to break down below the previous close each day.  Thus, it would appear that Dow 10,500 and Nasdaq 2150 are right around the corner, with Dow 10,000 and Nasdaq 2000 not far behind. This is very concerning because investors have not allowed time for things to digest.  If they did, we would not be seeing these harsh sell-offs. Panic is leading the way.

Right now, it’s best to sit back and wait for the market to calm a bit. The first stage in the calming process is for the market to mount some decent rallies.

We also expect to see some market rallies similar to what we saw today. The extent and magnitude of rallies will depend in part on how much the Dow and Nasdaq decline per unit time, as well as any potential actions taken by from Washington, the Fed, and the ECB.

The key point is that there should be no rush to buy into corrections unless you are an aggressive trader because we see no catalysts right now that could serve to reverse this bearish trend anytime soon.

Perhaps the most concerning issue is the fact that we have been unable to identify any significant tools that can be utilized by Washington or the Fed, or any possibility of good news that would serve to buoy the market. In fact, with things getting worse in the U.S., Japan and the EU, I dare not think what would happen if China experiences severe economic problems. I have little doubt that China will encounter its fair share of issues, but let’s just hope it can hold up for a couple of years. 

Meanwhile, the situation in the EU is getting worse by the day; much worse than is being discussed in the media. Most banks in Europe are in deep trouble. Although we have discussed this in past research publications, I would have thought that things would have bottomed by now. This explanation for the lack of resolve has been incompetence.

In addition, America’s largest banks continue to have a good deal of exposure to EU banks.  Specifically, there is a very real possibility of certain large U.S. banks having problems disbursing money market funds if EU banks face a more severe crisis. And I will guarantee you the EU banking system is going to face some HUGE problems.

This message is not meant to encourage you will withdrawal your money from the bank, although that would be an ideal way to revolt against the crooks. We are merely pointing this out is because it gives you an idea just how bad things could get. While officials and banking regulators have a much better understanding of the risks and spillover effects than a few years ago, I doubt they realize the full severity of the risks. In short, we do not think we will see a series of events like that in 2008 which resulted in the financial crisis, at least in the U.S. anyway. However, we are likely to see some pretty big shocks to certain banks at some point, mainly in Europe. While the impact is likely to be contained, the problem is that the markets would most likely react in panic.  

Although China’s banks remain well-with high reserves ratios, as a communist nation making the transition into a more market-driven economy, China has very little experience dealing with this experiment in capitalism. Certainly China has some unique advantages that would help it mitigate the effects of soaring defaults say due to the effect of a real estate collapse. However, the fact is that the Yuan is not a freely-floating currency. Although China has received an enormous source of investment capital from around the world, its economy and financial system remain relatively closed to the world.  This could pose as an Achilles heel if a crisis were to strike this nation.

That said, I want to caution you against listening to the various clowns seen and heard in the media, both mainstream and alternative, who have been making stark "predictions" of doomsday and so forth. In my opinion, not a single one of these clowns has a respectable track record, much less any level of credibility. These men are sensationalists and salesmen. 

On the other hand, the perma-bull market extremists are nearly as dangerous and equally as useless - Cramer, Kudlow, and the entire CNBC crew, Wall Street economists and strategists, Washington economists and other officials, the Federal Reserve and the print media. They too are salesmen.

Always remember, extremists are always useless and often dangerous. Most the time, the truth lays somewhere in-between extremes. This comes from someone who actually predicted the precise details of America's Second Great Depression in print and in 2006.

Finally, we at AVA Investment Analytics would like to offer you eight recommendations, as you deal with the current market.

The first recommendation pertains to those who are a bit more active. If you decide to buy into the market prior to seeing a definitive market reversal, you should be ready, willing and able to take the trade when you get it. Otherwise, you might run out of cash while you are forced to sit and watch the market fall much lower.

Second, you should focus only on buying large, strong companies during this period of growing uncertainty. While you may want to buy some smaller names, you should only devote a small portion of these positions to your total investment portfolio.

Third, you should have a general bias for stock that pay nice cash dividends. But this is not enough. You should also look for companies with a long history of dividend growth and stability. You can also look for hybrids, or stocks that offer relatively high dividends companied with relatively nice dividend growth and dividend safety. The key thing here is to understand what you are willing to sacrifice for the benefits you seek. You aren’t going to accomplish this difficult task by using stock screening tools and other investment epiphanies.

Fourth, you need to wait for compelling value.

Fifth, be patient.

Sixth, act with ration and don’t panic.

Seventh, do NOT use margin. In fact, you should never use margin unless you are a very experienced investor because we never know what will happen. If you do decide to use margin, you should use it only for short-term trades.

Eighth, know your limitations and never step outside of these boundaries.

For world-leading research and analysis of the U.S. and global economy, U.S. housing market, market forecasting, securities analysis, IPO research and more, I invite you to join us at AVA Investment Analytics

© 2011 Copyright AVA Investment Analytics - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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