The Brink or The Breakout?

Bill Fleckenstein wrote this morning:

For the longest time, I suggested that the economy was going to hit the wall at some point. I believe that’s what is now happening. To give you an example of what that might look like (though I don’t often pay much attention to all those Fed surveys), this month’s Philadelphia Fed business-outlook survey literally collapsed. It had registered 3.8 in September, but the October reading came in at minus 37.5, versus expectations of minus 10. I’m afraid we will see plenty of that ahead for the economy.

Many folks would like to think that given the size of the wipeout we’ve seen, stocks must have discounted a lot of economic damage. I don’t believe that, because for the longest time the stock market basically discounted nothing and especially went off a cliff here in the past couple of months.

I wrote to Kelly Letter subscribers yesterday morning:

Since we adopted a cautious stance in mid-August, we’ve been eyeing October as a time for the market to find a bottom and for us to put money to work. I don’t see any developments so far that are inconsistent with that plan. Events are falling in place along those lines.

Now, if the Oct. 10 lows don’t hold, we don’t find support until all the way back down at the dot com bust lows of 2002 and 2003, which are a heck of a long drop from here. Let’s call that the worst case scenario with hope in our hearts, because if THOSE levels don’t hold we’re strapping on the rappelling gear for a drop back to the early 1990s.

Worst case scenario dot com bust support awaits at:

Russell 2000: 345 (34% down from here)
S&P; Midcap 400: 389 (30% down from here)
S&P; 500: 800 (15% down from here)

According to MACD and RSI, we are already much more oversold than we were at the dot com bust lows, indeed than we’ve ever been before, so the chances of dropping another 15% or 30% look unlikely. Hence I’m calling it the worst case scenario.

Here’s the comparison:

Russell 2000 dot com low: -12 MACD, 40 RSI (now -49 and 36)
S&P; Midcap 400 dot com low: -9 MACD, 33 RSI (now -58 and 33)
S&P; 500 dot com low: -21 MACD, 36 RSI (now -76 and 36)

Unless everything has come unglued and all measurements that worked before are broken, technical analysis says we should get a rising market soon.

At this point in the discussion, somebody is bound to raise the specter of the Great Depression. All comparisons go back to it because we’re supposedly facing an economy that’s the worst we’ve seen since the 1930s. Maybe, but there’s quite a gap between that economy and ours today.

In the Great Depression, unemployment exceeded 25% in 1933. We still haven’t hit 7% now. Bank runs were a chief concern during the Great Depression, but they’ve been kept at bay now by government guarantees and increased FDIC insurance coverage. People of the Great Depression lost faith in the financial system. People today have not.

However, even if things get as bad as they were in the Great Depression, we can still make money in stocks. From its 1932 bottom to its 1937 high, the Dow gained 333%. It then fell 47% over the next year, gained 57% in the next nine months, dropped 35% over the next three years to January 1942 when it finally embarked on the multi-decade bull that saw it rise 869% by 1965. Buying through the depression was the right move.

So, to recap, we expected a bottom in October and we look to be getting it:

  • The market is more oversold now than it has ever been.

  • The charts are drawing a young W-shaped bottom.

  • The economy, while bad, is nowhere near that of the 1930s.

  • The stock market turns up before the economy.

We planned to buy near the October bottom, which leads nicely into the next section.

The next section is titled “What We Want To Buy” and shows just that, with both individual stocks and which indexes look best for riding a recovery. If you’d like to read the entire report, please get yourself on the Kelly Letter list. We’ll email you the report and the current site password for access to the entire archives.

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