Value of Perfect Information

With record numbers of dollars coming out of Money Market Funds, mostly into the crowded trade of short term bonds, anyone who has a minimal knowledge of covered call options and/or an interest in hedging stock market exposure might want to check out: brentleonard.com for an alternative strategy that is low-risk as well as highly rewarding. For those of you wanting more details and actual trading results, a new book is available for $14.95 at Amazon.com: Zero (IN)Tolerance

In a recent Barron’s Mailbag letter I bemoaned the fact that in its efforts to “save the financial system” that helped to get us into this economic squall, the Fed and Treasury have trashed the interest rates too far and too long (by Taylor Rule standards) thereby making it impossible for prudent investors, such as tens of millions of seniors and other safety-minded citizens, to subsist above the poverty level. I was happily surprised that they not only printed the letter but used it as a “teaser” heading for the column – an indication of how important an alternate income strategy is these days.

In my quest for the happy medium between adequate return and allowable risk, I came upon a strategy that I have never seriously considered in my 25 years as an option broker and money manager – the In-The-Money Covered Call strategy. By employing this simple plan one can expect to receive double-digit return with more safety than merely owning stocks- versus a 1% return in money markets or CDs!

Since the current wisdom is that Buy-and-Hold no longer works in this casino environment, and we all know that the shorter the investment timeframe, the worse the profitability (except for those with black boxes and flash traders), then the Intermediate Term would seem to be the solution. Hence iProfit: investment Plan, Rebate Options For the Intermediate Term!

There are three major reasons why this strategy is so timely: the recent sharp decline in all stocks cutting their prices in half, pretty much ruled out another such decline, making quality, dividend-paying stocks more of a bargain, although earnings have been reduced by the economy; secondly, the lowering of stock prices have made dividends a higher percentage, except for those who had to cut or eliminate them; thirdly, the volatility or premium in option prices soared – the VIX, or Volatility Index, recently rose to a record 90, although it has quieted down with the recent rally of 2009. That could change.

This is how it works:  with a conservative part of their portfolio an investor buys a high-quality stock (or an ETF) that pays a minimum of 3% dividend per year, preferably in a tax-deferred account such as an IRA, where there are no tax consequences. For example, they buy shares of ABC stock for $27; then they sell a covered call that is lower than that price, say $22.50, 6 to 9 months out. Let us say the price received from the option is $6.90 covering the difference between stock prices of where it was purchased and where it would be “called” away (unless it dropped below the 22 1/2 level by expiry). This “rebate” not only doubles the dividend return alone, but provides a safety net, giving a much needed peace of mind to the investor. Since they have pre-sold the stock they just bought at a lower price, it can drop substantially before one loses any money – not only that, but by virtually buying the stock at $22 1/2 (after the rebate) the dividend percentage is actually HIGHER!

*Note: If your stock is going ex-dividend in the next month after your option expires, it might be wise to roll out for that month, since the deduction of the dividend amount from the stock price will not affect you, since it is being called away lower. The best plan, in lieu of this, is to put on your trade a few days before ex-dividend and go out 4 or even 7 months on the call, in order to get 2 or 3 dividends over those months.

It is best to use technical indicators, such as prior price support and moving averages – areas where one might have placed stop orders previously – to decide which call to sell. One must also analyze the amount of extrinsic (over and above the stock ITM amount) to decide the strike. Other factors include the Bid-Ask spread, Volume and Open Interest of the option.

One example of an ETF (Exchange Traded Fund) that could be used is the DIA, or Diamond Spider, which represents the DJIA. It pays @ a 3% dividend, although it varies monthly, unlike a single stock. With a current price of $96.80 (1% of the Dow 30), if one sold the 90-strike call for next March at $10, the Dow would have to dive to 8680 before one would even lose money (90 Sale price less the option premium received of $3.20). Under that Black Swan scenario, hopefully, one would have hedged or exited the position at some point on the way down. Doing the math, as of this writing one would receive 6 monthly dividends of @ $.25 each (monthly dividend varies as different stocks become ex-D each month), plus $3.20 extrinsic option premium (over and above the rebate amount), for a total of $4.70. That would be a return of 4.85% for 6 month (9.7% annualized if done twice in a year).

After investing for over 25 years, it is a pleasant experience to see the market tank, such as it did by 8% this summer, and know that I haven’t lost a cent! Over the years I have written many covered calls, but the conventional way was to buy a stock and sell a call just above the price – then hope that it rises, which it basically did for the past few decades. For this reason, one does not have to pick the best stock, just a good quality, stable one with a better dividend.

Another possible “danger” of this plan is that the stock is called away by someone holding an option and exercising it just before it goes ex-dividend. This has actually happened in my portfolio and the return was huge, since I was able to keep the entire option premium sold albeit missing the dividend payment. Another plus with this plan is that by selling the “under water” call, the subtraction of the dividend from the stock price does not affect the profit, as it would with the call above the price; also, if the stock does get called away just before the ex-date, one can go back into the stock and get the dividend with the same strategy.

Also, if one does not use a tax-deferred account, the taxes might be higher, since it involves regular income as opposed to capital gains on appreciation, which may change shortly anyway under the current administration.

Having the stock called away at expiry does cause some portfolio turnover, probably less than the usual mutual fund, but it also gives one a chance to reevaluate the current market environment to decide whether to continue, scale down, or rotate sectors.

Obviously a Black Swan dive would be disastrous to all stockholders, but that harm will be lessened greatly by both the call premium protecting it by decaying and by the dividends received, even below the low, takeaway strike price. One may have time to wait out a V-spike or even sell a lower ITM call.

In the case of a White Swan, such as the recent incredulous rally, that can be funded with other speculative money, closer to the top of the investment pyramid – possibly even the money brought in by the ITM (in-the-money) sold options. Currently this slightly rising market is the optimal condition for this plan – putting the eventual takeaway price farther away, ensuring your buffer. This is not a complex or short term strategy, and obviously, with more sophisticated knowledge and screening research one could optimize performance even more.

Many Happy Returns!

Brent L. Leonard

www.brentleonard.com

Retired options and stockbroker, ROP, RIA

Retired Adjunct Professor of Finance

at Golden Gate Univ.

Editor, TSAASF Review

Private Investor;

P.S.: In the event of a “Gray” Swan, or a slightly declining stock/ETF (or market) it would be advantageous to ROLL DOWN a strike or two. For example, using the DIA as a proxy, if one had bought the ETF at $96 and sold the 90 Call, one would  lock in the extrinsic premium, the $6 difference and any monthly dividends; if the Dow Jones sinks to 9,000 or slightly lower over the next few months, the Call would expire worthless, and one could then sell the 85-strike a few more months out.

All of us seek to determine a “fair value” for whatever investment we typically trade. Although I have studied the S&P 500 at length for many years, I could not find a good “fair value” estimate for the aggregate index. Sure, there are models out there, and one happens to be created by Professor Robert Shiller. He divides a monthly S&P average by 10 years worth of earnings and adjusts for inflation. This has become the Cyclically Adjusted Price to Earnings Ratio (CAPE) model. Prof. Shiller uses S&P earnings and BLS CPI data as inputs to his model. The underlying data is easily found on the internet. The picture below is his popular chart.

I downloaded his data to compare CPI adjustment vs Nominal and here is the result.  I sort of question the rationale in adjusting for CPI.

Additionally, I questioned his method of using 10 years vs longer timeframes.   I tried to improve Shiller’s data, as just having a number such as 21.17 trailing P/E without a corresponding index price in the chart seemed lazy.  Here is Shiller’s data compared to the S&P over the same time period.

Finally, I decided to track both nominal and CAPE for 5, 10, 20, and 30 year timeframes to give someone the option of which time they choose is most important, shown below:

I also included a Combined Fair Market Value that adds differing times and several other indicators together, shown here.

The entire report is located here for your pleasure.

http://www.scribd.com/doc/42399987/CFMV-Q3-10

The AAII data for the week is out and shows still very high % bulls of 48.2 (down 3% from prior week but still above historical average of 39%) versus % bears of 29.8% (up 8.2% and close to the historical average of 30%). In the prior week there were 2.3 bulls for every bear, the current data has 1.62 bulls for every bear. AAII data seems to be highly correlated to SPX as shown on the chart below. The data for AAII as graphed is shifted forward one week to better correlate.

Friday’s internals were weak, in spite of being a mixed market. The NASDAQ 100 had a huge price move up, but a significant chunk of the price gain came from one stock, Google. Google rose $60.52 per share, or 11.10 percent, in one day, Friday. Google is one of those stocks that a market manipulator can buy to move an index in the hopes it starts bandwagon buying. During the 2003 and 2006 rallies, we saw MMM move the Industrials with bizarre isolated rising price days. At the time, it appeared to us a market manipulator was moving the Industrials higher with 3M purchases. From time to time we see concerted efforts to push markets higher. Now is one of those times. But each time this happens, it causes the subsequent decline to be worse than would otherwise have been the case, like stretching a rubber band too far. The snapback is nasty. Deep pockets can only delay the inevitable. They cannot stop it. Quantitative Easing talk is raising expectations for liquidity infusions that people think will seep into stock markets. Hedge funds are buying stocks ahead of the actual Quantitative Easing from the Fed. QE2 is simply a fancy name for the Federal Reserve printing U.S. Dollars and buying fixed income securities from large Wall Street firms, buying junk bonds, corporate bonds, mortgage backed securities or Treasuries. It is essentially a fraud on U.S. Dollar holders, is a fraud on the taxpaying U.S. Consumer and Small Business, a fraud on the working person who has to get his money through hard labor. We will discuss this further later, and why this policy will destroy what is left of this fragile economy, and will eventually help drive stock market values down toward zero, and drive the U.S. Dollar down toward 40ish. QE2 is wonderful for large Wall Street firms’ short-term profits. They love it. Imagine having a business where the Federal Reserve is interested in helping you make as much money as possible at the expense of everyone else? That is QE2.

We learned Friday that the U.S. Federal Deficit for the Fiscal Year Ending September 30th, 2010, was $1.3 trillion. With a total Federal Budget of $3.5 trillion, this means that for every dollar spent by the Federal Government, they had to borrow 37 cents to cover that expense. Can you imagine running your household or small business like that? You would go bankrupt in short order.

Quantitative Easing will some day be looked back upon as we now look at healing the sick through bleeding back in the 1700s. It is terrible economic policy, in fact should be considered criminal activity. Criminal for many reasons, such as debasing the value of the Dollar, but more importantly because it will be the final nail that destroys our economy. Wall Street is the key beneficiary. Households (consumers) which account for 70 percent of GDP, and small businesses, which account for 70 percent of employment, will not benefit from this fraudulent activity by the Federal Reserve. Where on earth is it right for someone to print trillions of Dollars out of thin air and then buy legitimate legally binding debt instruments in exchange for this printed paper? Anyone else doing this would be arrested and thrown in jail, with the key tossed into the deep blue sea.

But forgetting that this is probably a criminal act, and assuming that it is legally acceptable because the Central Planners enact legislation to permit QE2, let’s explore why it is a fraud on pretty much everyone except the sellers of the fixed income securities the Fed will be buying, primarily mega Wall Street firms, surrogates for the president’s Working Group (the Plunge Protection Team).

Bernanke suggested in his speech in Boston Friday on the subject of QE2, that he is justified in doing this to raise the inflation rate, which he believes is too low, and to increase employment. His economics are dead wrong. He believes it is perfectly appropriate to print trillions of dollars of U.S. Federal Reserve notes (Dollars) out of thin air, and then send this money from the Fed’s print shop across the invisible wall that separates the real economy from the non-economy (the Fed) to the lucky recipients of this cash. Here is the problem: This transfer of printed cash for securities in the market are normally known as open market operations, and the point of this exercise is to lower interest rates in the market to spur lending and filter cash through Wall Street intermediaries to banks to borrowers which would stimulate the economy and multiply the money supply in the market. However, short-term interest rates are already zero, and long-term interest rates are at historic lows. So QE2 will not reduce interest rates. Therefore it will not increase borrowing. Therefore it will not multiply the money supply or spur spending, ergo it will not improve GDP, will not help households or small businesses. The cash will simply move from the Fed to Wall Street where the mega banks can then leverage their investing and trading activities which will improve their short-term profits. There will be no trickle down benefits to households or small businesses. Without benefits to households or small businesses, there will be no improvement in spending (GDP) or employment.

What will result from QE2 is the devaluation of the U.S. Dollar as there will be too many Dollars floating around, in relation to hard assets such as precious metals, and foreign currencies. This reduces the purchasing power of Dollars, and reduces the value of cash in bank accounts. In other words, the consumer gets hurt.

The only way QE2 makes any sense at all is if it is conducted in such a way that the cash being printed by the Fed finds its way directly into the hands of households and small businesses, instead of Wall Street. The only way for this to happen is if newly issued debt from the U.S. Treasury is sold to the Fed for newly printed Dollars, and then the trillions of QE2 Dollars sent to the Treasury from the Fed are sent directly to U.S. Households in the form of a massive income tax rebate, and tax cut, with a minimum amount of $50,000 rebated to every household, since many good folks did not have jobs over the past few years to receive rebated taxes. Then half the income tax rebates, which would be ideally two years worth, would be required to pay down debt, with the other half available to be used at households’ discretion. The result would be an immediate improvement in household and bank balance sheets, and an increase in consumer spending (GDP). This would increase small business revenue, which would increase hiring, which would result in an increase in demand for large firms’ products and services, which would mean more investment banking business for Wall Street. The economy would grow, increasing the overall pie for all to share and prosper, with a resultant corresponding desirable modest level of inflation. Local, State and Federal governments would benefit immensely as they get an increase in tax revenues from the trickle up economic growth, capturing taxes at every level of spending, which can be used to reduce government deficits and debt. Stock Markets would rise as corporate revenues and profits rise.

If the intent of QE2 fails to include the household, it should not be allowed to happen. Congress must put a stop to QE2 immediately, and require a full explanation of the intended program before Bernanke destroys our economy. There should be an open debate in Congress on the merits of QE2, with testimony from all interested parties, in front of television cameras, for the American public to study before QE2 is effectuated. This is not something the Fed should conduct in secret. This is new turf, new territory for the Fed, and warrants careful scrutiny. The Justice Department needs to study if in fact the Fed is legally empowered to conduct QE2. This is serious stuff, an intentional devaluation of the U.S. Dollar, and thus needs to be treated as such. Intelligent, thoughtful contemplation is essential in an open public forum. Households and small businesses need to be able to weigh in by calling their congressional representatives before QE2 happens. QE2 should require an act of Congress. The Fed should not be allowed to do this on their own.

Unfortunately, the language of the markets, price patterns and indicators, have been warning for months that the U.S. Dollar is headed to 40ish (it knew QE2 was coming), and is telling us the stock market will react very badly once QE2 starts.

It does not look like there is any stopping QE2. The Central Planners are convinced that the more they do, the more control they take, the more they couch their activities with terminology that makes it impossible for the average Joe and Mary to understand what they are doing, the more they involve mega Wall Street firms in their fixes, the better. It is becoming very difficult to know if the Central Planners are simply misguided in their policies, that their intentions are good, that they really care about households and small businesses and the economy, or is this all an intentional game to benefit only the few large and powerful Wall Street banks, to build an oligarchy of Centralized power by design. That is for those who can figure out the schemes to decide for themselves.

The market’s language, technical analysis, suggests that regardless of intention, mistakes will be conducted, and the worst will occur.

We cover a host of indicators and patterns, and present charts for most major markets in our International and U.S. Market reports, available to subscribers at www.technicalindicatorindex.com

If you would like to follow us as we analyze precious metals, mining stocks, and major stock market indices around the globe, you can get a Free 30 day trial subscription by going to www.technicalindicatorindex.com and clicking on the Free Trial button at the upper right of the home page. We prepare daily and expanded weekend reports, and also offer mid-day market updates 3 to 4 times a week for our subscribers.

“Jesus said to them, “I am the bread of life; he who comes to Me
shall not hunger, and he who believes in Me shall never thirst.
For I have come down from heaven,
For this is the will of My Father, that everyone who beholds
the Son and believes in Him, may have eternal life;
and I Myself will raise him up on the last day.”

John 6: 35, 38, 40

The Dow Industrials have declined sharply eleven out of the past thirteen Autumns, from 1997 through 2009, and it is setting up to do so again in 2010. Only 2006 and 2009 failed to see a significant autumn fourth quarter decline.

Seven of the eleven declines were stock market crashes, with declines greater than 15 percent, and an eighth was nearly a crash, plunging 13.2 percent! The smallest decline of the eleven was still a significant 4.7 percent.

The declines typically started in the July to September period and lasted into the September to November period. Ten of the eleven significant declines were occurring over the autumn equinox, and all but one declined during the month of September.

Here’s the data:

1997: A stock market crash that began on August 7th at 8,340.14 and fell for 57 days to a low of 6,936.45 on October 28th, a 1,403.69 drop, or 16.8 percent.

1998: A stock market crash that began on July 17th at 9,412.64 and fell for 32 trading days to a low of 7,329.70 on September 1st, a 2,032.94 plunge, or 21.6 percent. It hung around that low through October 8th, hitting a bottom that day at 7,399.78.

1999: A near-crash that began on August 25th at 11,428.94 and lasted through October 15th when it fell to 9,911.42, 36 trading days, a 13.2 percent sell-off.

2000: Another stock market crash, this one commencing September 6th at 11,401.19 and lasting until October 18th’s 9,656.12 bottom, a 30 trading day plunge that saw prices fall 1,745.07 points, or 15.3 percent.

2001: Again, a stock market crash. It began on August 27th at 10,441.37 and lasted through September 21st, bottoming at 8,062.34, a 2,379.03, 22.7 percent bloodbath that took only 14 trading days.

2002: Again, the sixth stock market crash in a row if you consider the 13.2 percent 1999 wipeout a crash. It started innocently enough on August 22nd, at 9,077.01, and lasted until October 10th at 7,197.49. When the carnage was over, the losses were 1,879.52 points, or 20.7 percent.

2003: Even in 2003, when a glorious rally was in full swing, the Dow paused to follow tradition by dropping a measurable 4.7 percent, or 455.61 points from 9,686.08 on September 19th to 9,230.47 on September 30th.

2004: A significant 6.2 percent drop followed suit, markets in the tank from September 13th’s 10,348.39 high to October 25th’s 9,708.40 low, a 639.99 sell-off.

2005: A significant 5.8 percent drop followed the August 10th, 2005 top from 10,719.41 to October 13th, 2005′s low of 10,098.18.

2006: This is only the first year out of the past thirteen years (1997 to 2009) where stocks did not experience a significant autumn decline.

2007: The current Grand Supercycle Bear Market started from October 11th, 2007′s all-time high in the Industrials of 14,279.96. A stock market crash followed over the next three months to the January 22nd, 2008 low of 11,508.74, a 19.4 percent plunge.

2008: A devastating stock market crash occurred from the August 11th, 2008 top of 11,933.55 to the November 21st, 2008 low of 7,392.27, an incredible 4,541.28 point, 38.1 percent crash.

2009: This is only the second year out of the past thirteen where stocks did not experience a significant autumn decline.

So here we are in 2010. We have huge Head & Shoulders top patterns showing up in major stock markets, have an Elliott Wave count which is close to topping, and the autumn is approaching once again, so the odds are high that another sharp decline is coming sometime in the fourth quarter 2010, according to this autumn declines study of the past 13 years.

We cover a host of indicators and patterns, and present charts for most major markets in our International and U.S. Market reports, available to subscribers at www.technicalindicatorindex.com

If you would like to follow us as we analyze precious metals, mining stocks, and major stock market indices around the globe, you can get a Free 30 day trial subscription by going to www.technicalindicatorindex.com and clicking on the Free Trial button at the upper right of the home page. We prepare daily and expanded weekend reports, and also offer mid-day market updates 3 to 4 times a week for our subscribers.

“Jesus said to them, “I am the bread of life; he who comes to Me
shall not hunger, and he who believes in Me shall never thirst.
For I have come down from heaven,
For this is the will of My Father, that everyone who beholds
the Son and believes in Him, may have eternal life;
and I Myself will raise him up on the last day.”

John 6: 35, 38, 40

The bears attack and are beaten back with the NASDAQ-100 breaking above horizontal resistance…

Recommendation: 

Buy Oct $106 DIA puts to cover your long positions at ten cents below the opening ask price.  For instance, if the opening ask price is $2.00, place an order to buy at $1.90.

Buy Oct $48 puts to cover your long positions at a five cents below the opening ask price.  For instance, if the opening ask price is $0.95, place an order to buy at $0.90.

Buy Oct $113 SPY puts at ten cents below the opening ask price.  For instance, if the opening ask price is $2.30, place an order to buy at $2.20.

Daily Trend Indications:

- Positions indicated as Green are Long positions and those indicated as Red are short positions.

- The State of the Market is used to determine how you should trade.  A trending market can ignore support and resistance levels and maintain its direction longer than most traders think it will. 

- The BIAS is used to determine how aggressive or defensive you should be with a position.  If the BIAS is Bullish but the market is in a Trading state, you might enter a short trade to take advantage of a reversal off of resistance.  The BIAS tells you to exit that trade on “weaker” signals than you might otherwise trade on as the market is predisposed to move in the direction of BIAS.

- At Risk is generally neutral represented by “-“.  When it is “Bullish” or “Bearish” it warns of a potential change in the BIAS.

- The Moving Averages are noted as they are important signposts used by the Chartists community in determining the relative health of the markets.

Current ETF positions are:

Long at DIA $102.80

Long QQQQ at $44.76

Daily Trading Action

The major index ETFs opened lower and immediately headed lower but that move lasted only about fifteen minutes before the bulls took control to move them higher but the major indexes had a problem moving into positive territory and rolled over by late morning heading into a bottom shortly after noon.  The rally that began during the lunch hour was thwarted and the bulls waiting until shortly before 2:00pm to once again assert themselves and this time were successful in breaking the hold of the bears.  The NASDAQ-100 finished with gains of a bit under one half of one percent and the Dow notched a gain of about a quarter of one percent while the S&P-500 finshed a few one hundredths of one percent below Wednesday’s close with some weakness in the final half hour leading to a negative close.  All three major indexes moved now share a BULLISH BIAS and are in uptrend states.  The Russell-2000 (IWM 64.94 -0.42) actually lost ground and was down more than one percent intraday.  It is also in an uptrend state with a NEUTRAL BIAS.  The Semiconductor Index (SOX 334.24 +2.60) was the big winner in terms of notching gains for the day.  It is still in a trading state with a BEARISH BIAS.  The Bank Index (KBE 23.42 -0.14) lost about one half of one percent and the Regional Bank Index (KRE 22.43 -0.26) lost more than one percent on the day.  Both bank indexes remain in trading states with BEARISH BIAS.  The 20+ Yr Bonds (TLT 101.26 -1.01) lost another one percent under heavy selling pressure.  NYSE volume was light with 812M shares traded.  NASDAQ volume was below average with 1.786B shares traded. 

There were seven economic reports of interest released:

• Initial Jobless Claims for last week came in at 450K versus an expected 460K
• Continuing Jobless Claims came in at 4.485M versus an expected 4.450M
• PPI (Aug) rose +0.4% versus an expected +0.3% rise
• Core PPI (Aug) rose +0.1% as expected
• Current Account Deficit (Q2) came in at -$123.3B versus an expected -$125.0B
• Net Long-term TIC Flows (Jun) saw inflows to U.S. of $61.2B
• Philadelphia Fed (Sep) came in at -0.7 versus an expected +2.0

The first six reports were released a half hour to an hour before the open.  The final report was released a half hour into the session.  On deck for Friday are the CPI and Core CPI reports (pre-open) and UofMichigan Consumer Sentiment twenty-five minutes after the open.

The bears came out swinging but lacked conviction to get the job done.  With the S&P-500 basically flat and with the Dow and NASDAQ posting gains, the day went to the bulls.  However, with the Bank Indexes and Russell-2000 showing weakness, all wasn’t warm and fuzzy.  Contradicting that weakness was a rally in the semiconductors.  Which was is did the market go?

Tech (+0.7%), Materials (+0.4%), and Telecom (+0.2%) moved higher on the day while six out of the ten economic sectors in the S&P-500 posted losses.  Consumer Staples were unchanged.

Implied volatility for the S&P-500 (VIX 21.72 -0.38) declined modestly as did implied volatility for the NASDAQ-100 (VXN 21.81 -0.34).   

The yield for the 10-year note rose four basis points to close at 2.76.  The price of the near term futures contract for a barrel of crude oil fell $1.45 to close at $74.57. 

Market internals were mixed with decliners leading advancers 7:5 on the NYSE and by 5:3 on the NASDAQ.  Up volume led down volume by a two percent on the NYSE and by 5:4 on the NASDAQ.  The index put/call ratio fell 0.32 to close at 1.05.  The equity put/call ratio rose 0.03 to close at 0.58.   

Commentary:      

Thursday’s trading saw the bears slow the bullish assault but were basically unable to contain it.  The NASDAQ-100 broke above the horizontal resistance level and the Dow is just above that level but not definitively breaking out.  The S&P-500 actually had a fractional loss but is basically where it left off on Wednesday.  Is this going to be a triple top for the S&P-500 or will the markets surge higher?  The levels we are monitoring are:

          Index            Resistance     Actual

Dow              10,590          10,594.83     

NASDAQ-100    1,940          1948.11

S&P-500          1,130          1124.66

Often the most frustrating thing in trading is to be patient.  I have been looking for topping action and caught a glimpse of it at the close but really only on QQQQ and sort of on SPY with a unique indicator I developed.  With all the major indexes in uptrend states and now sharing a BULLISH BIAS, however, the intermediate term pressure is still to the upside.  I have been waiting for the participation of the semiconductors to signal that the leading indicators are in sync heading higher and then we get bearish action on the Russell-2000 and the bank indexes.

Friday is quarterly options expiration known as quadruple witching.  This usually sees unusually high trading volumes as many contracts expire and traders continue to square their positions.  I am concerned that we could see topping action soon but we will hold onto our long positions until we see something more definitive.  As a precaution, however, we will look to buy puts to insure against a top.

Periodically, the question of manipulation comes up and I’ve recently been asked if the Dow theory or any other technical method is still of value because of all the efforts to manipulate the markets. The short answer is, yes. While manipulation can have a temporary effect on the market, it cannot fix the problem, it cannot stop the inevitable and in the end it will only serve to make matters much worse.

I think we can all agree that every known influence, be it positive or negative, false or real, fundamentally sound or not, big or small, founded or unfounded, manipulative or not, all impacts price. Well, the very basis of technical analysis is that everything is discounted into price. So, if every influence known to man and the market is reflected in price and technical analysis is a study of price, then absolutely the Dow theory and other technical methods are just as valid today as they have ever been and the manipulative efforts to “fix” things does not matter. The only variable that I see in technical analysis, like anything else, is that one person will see the data to mean one thing, while another person may see it to mean something different. Therefore, opinions may vary, but still everything is discounted into price and it all boils down to the technician and his methods.

I know that some believe that the March 2009 low marked the bear market low, that we are now in a recovery and that the worse thing they see is maybe a “double dip” recession. I have stated all along that my research suggests to me that the rally out of the March 2009 low has been a bear market rally and that it should ultimately prove to separate Phase I form Phase II of a much longer-term secular bear market. Point being, we are all looking at the same price data, but different conclusions are being drawn.

As price moved into the July low, it seems that most who were even remotely familiar with Dow theory were proclaiming a so-called Dow theory “sell signal.” As the July 2nd low was made, I told my subscribers that this was not a so-called Dow theory “sell signal.” Rather, I explained that it was an intermediate-term low and that higher prices were expected. Point being, this was again another example of everyone looking at the same price action, but with varying opinions.

So, what may be occurring is that some people will look at specific technical opinions and then when they don’t come to pass, they conclude that technical analysis no longer works and it’s always easy to blame it on manipulation and the PPT. Again, everything is discounted into price and if a given forecast, based on a particular technical discipline does not pan out, then its because the analyst that made the forecast was in error in that he did not read the meaning of the price action correctly. We have all certainly been there before. It’s not that price was wrong and it’s not because of the PPT or manipulation, because regardless of what is driving price, everything is still reflected into price and price is what it is. It’s only the interpretation of price action that varies. With that all being said, any technical picture can also evolve, morph, take more time, or even less time than originally anticipated. As a technical analyst, one must be able to recognize when this is occurring and adjust with the new data. If not, then he will likely find himself out of step with the market.

Personally, it is my belief that manipulation only makes matters worse. As an example of this, all throughout the period between 2003 and 2007 I explained that we were seeing a stretched 4-year cycle. I recognized this based on my statistics, cycles work, and “DNA Markers” and I was able to adjust as the technical picture morphed and stretched. But, I knew that the 4-year cycle had not bottomed and I explained that the efforts by the powers that be to hold things together would ultimately only serve to make matters worse. There is no doubt that the manipulative efforts seen during this period contributed in a very negative way to the credit and banking crisis. In my eyes, this was largely accomplished through the unscrupulous lending practices and the financially irresponsible, resulting in the housing bubble, which Greenspan tried to tell us did not exist. But, in the end, the manipulation did not prevent the inevitable decline into the 4-year cycle low. All the manipulation did was blow the balloon up tighter and tighter as the 4-year cycle stretched and then, when it popped it simply produced a bigger bang, in that the manipulation did in fact make matters worse.

There have been continued efforts to “manage” the market throughout the bear market rally that began at the March 2009 low. Once the bear has sucks enough of the misguided victims back into his grip, the bear market rally will conclude and the assent into the Phase II low will begin. When this occurs, we will again see more manipulative efforts to stop the inevitable. But, once the bear market resumes, and if the “DNA Markers,” that I have identified at all other tops since 1896, are confirmed, then it will not matter. Once the proper setup is in place, all the manipulation in the world will not stop the natural forces in regard to the Phase II decline. I hope people are listening. If not, you have been warned!

The following text on Manipulation was taken from Robert Rhea’s book, The Dow Theory.

“Manipulation is possible in the day to day movement of the averages, and secondary reactions are subject to such an influence to a more limited degree, but, the primary trend can never be manipulated.

Hamilton frequently discussed the subject of stock market manipulation. There are many who will disagree with his belief that manipulation is a negligible factor in primary movements, but it should always be remembered that he had, as a background for his opinions, a most intimate acquaintance with the veterans of Wall Street, and the advantage of having spent his life in accumulating facts pertaining to financial matters.

The following comment, taken at random from his many editorials, affords convincing proof that his views on the subject of manipulation did not vary:

‘A limited number of stocks may be manipulated at one time, and may give an entirely false view of the situation. It is impossible, however, to manipulate the whole list so that the average price of 20 active stocks will show changes sufficiently important to draw market deductions from them.’ (Nov. 29, 1908)

‘Anybody will admit that while manipulation is possible in the day-to-day market movement, and the short swing is subject to such an influence in a more limited degree, the great market movement must be beyond the manipulation of the combined financial interests of the world.’ (Feb.26, 1909)

‘…the market itself is bigger than all the ‘pools’ and ‘insiders’ put together.’ (May 8, 1922)

‘One of the greatest of misconceptions, that which has militated most against the usefulness of the stock market barometer, is the belief that manipulation can falsify stock market movements otherwise authoritative and instructive. The writer claims no more authority than may come from twenty-two years of stark intimacy with Wall Street, preceded by practical acquaintance with the London Stock Exchange, the Paris Bourse and even that wildly speculative market in gold shares, ‘Between the Chains,’ in Johannesburg in 1895. But in all that experience, for what it may be worth, it is impossible to recall a single instance of a major market movement which depended for its impetus, or even for its genesis, upon manipulation. These discussions have been made in vain if they have failed to show that all the primary bull markets and every primary bear market have been vindicated, in the course of their development and before their close, by the facts of general business, however much over-speculations or over-liquidation may have tended to excess, as they always do, in the last stage of the primary swing.’ (The Stock Market Barometer) ‘…no power, not the U. S. Treasury and the Federal Reserve System combined, could usefully manipulate forty active stocks or deflect their record to any but a negligible extent.’ (April 27, 1923)

‘The average amateur trader believes the stock market is guided in its trends by a certain mysterious ‘power,’ this belief being the one factor, next to impatience, most responsible for his losses. He reads tipster sheets avidly; he scans the newspapers industriously for news likely, in his opinion, to change the trend of the market. He does not seem to realize that by the time the news of real importance is printed, its effect, so far as the basic trend of the market is concerned, has long ago been discounted.’

‘It is true that a flurry in the price of wheat or cotton may influence the day to day movement of stock prices. Moreover, sometimes newspaper headlines contain news which is construed as bullish or bearish by market dabblers, who collectively rush in to buy or sell, thus influencing or ‘manipulating’ the market for a short period. The professional speculator is always ready to help the movement along by ‘placing his line’ while the little fellow timidly ‘lays out’ a few shares; then, when the little fellow decides to increase his commitments, the professional begins to unload and the reaction ends, and the primary movement is again resumed. It is doubtful if many of these reactions would ever be caused by newspaper headlines alone unless the market was either overbought or oversold at the time—the ‘technical situation’ so dear to the hearts of financial news reporters.’

‘Those who believe the primary trend can be manipulated could, no doubt, study the subject for a few days and be convinced that such a thing is impossible. For instance, on September 1, 1929, the total market value of all stocks listed on the New York Stock Exchange was reported to have amounted to more than $89,000,000,000. Imagine the money which would have been involved in depressing such a mass of values even 10 per cent!’

I have begun doing free market commentary that is available at www.cyclesman.info/Articles.htm The specifics on Dow theory, my statistics, model expectations, and timing are available through a subscription to Cycles News & Views and the short-term updates. I have gone back to the inception of the Dow Jones Industrial Average in 1896 and identified the common traits associated with all major market tops. Thus, I know with a high degree of probability what this bear market rally top will look like and how to identify it. These details are covered in the monthly research letters as it unfolds. I also provide important turn point analysis using the unique Cycle Turn Indicator on the stock market, the dollar, bonds, gold, silver, oil, gasoline, the XAU and more. A subscription includes access to the monthly issues of Cycles News & Views covering the Dow theory, and very detailed statistical based analysis plus updates 3 times a week.

On June 30th both the Industrials and the Transports closed below their June 7th lows. In doing so, anyone who had not already proclaimed a Dow theory “sell signal” seems to have done so at that time. I stated here in my last post, as well as in recent audio interviews, that I disagreed with anyone who has made such statements in regard to Dow theory. I have since received a number of questions asking me how so many people could be wrong about Dow theory and if my position has changed.

My position has not at all changed. My read is that the Dow theory bullish primary trend change that occurred in conjunction with the advance out of the March 2009 low still remains intact in accordance to orthodox Dow theory. Reason being, once a trend change occurs, it must still be considered to be in force until it is authoritatively reversed. According to orthodox Dow theory, the decline into the July low was not an authoritative reversal because in reality price held above the previous secondary low points. I also continue to believe that the advance out of the March 2009 low is one large counter-trend move that will serve to separate Phase I from Phase II of the ongoing secular bear market. It is for this reason that I continue to refer to the advance out of the March 2009 low as a bear market rally. Once the proper DNA Markers are all in place and confirmed, the Phase II decline will assert its deflationary forces far and wide. The current Dow theory chart can be found below. For more details regarding my views that a Dow theory primary trend change, which is erroneously referred to as a Dow theory “sell signal”, has not occurred, please see the July 9th article that was last posted here.

Now, with this all being said, I want to explain another point in regard to erroneous Dow theory calls that so many made in regard to the June 30th violation of the June 7th closing low. Assuming for the moment that the violation of the June 7th low is correct in that it did trigger a bearish primary trend change, which I do not agree is the case, then by default this would in turn mean that these same people are saying that the June highs marked secondary highs points. More details on the reasoning for this is available at Cycles News & Views. Anyway, the June closing highs occurred on June 15th at 4,467.25 on the Transports and on June 18th at 10,450.64 on the Industrials. Therefore, if price were to move back above these levels on a closing basis, then the same people who called the erroneous Dow theory “sell signal” on June 30th would then have to call a Dow theory “buy signal.” By not fully understanding the Dow theory, which is likely a function of having not read and studied Dow theory, one can easily find themselves on the wrong side of the market. Right as everyone was proclaiming the Dow theory “sell signal” in late June, the market bottomed and at Cycles News & Views, I was calling for a low and a rally on July 2nd as the market was bottoming. This was based on both my Dow theory work as well as my cyclical and statistical analysis. The Phase II decline is ahead of us. We are monitoring the averages as we watch for the DNA Markers and confirmation that has been seen at every major top since 1896. Please, do not misunderstand the message here. Longer-term, the entire advance out of the March 2009 low is a bear market rally that should be followed by the Phase II deflationary decline. All I’m saying here is that we have not yet seen a bona fide Dow theory primary trend change at this time. What may or may not be occurring from other technical disciplines, be it cycles, statistics, my DNA Markers, Elliott wave, fundamentally or whatever are separate issues, which are outside of the scope of Dow theory.

I have begun doing free market commentary that is available at www.cyclesman.info/Articles.htm. The specifics on Dow theory, my statistics, model expectations, and timing are available through a subscription to Cycles News & Views and the short-term updates. I have gone back to the inception of the Dow Jones Industrial Average in 1896 and identified the common traits associated with all major market tops. Thus, I know with a high degree of probability what this bear market rally top will look like and how to identify it. These details are covered in the monthly research letters as it unfolds. I also provide important turn point analysis using the unique Cycle Turn Indicator on the stock market, the dollar, bonds, gold, silver, oil, gasoline, the XAU and more. A subscription includes access to the monthly issues of Cycles News & Views covering the Dow theory, and very detailed statistical based analysis plus updates 3 times a week.

I’m going to go through some signs that rabid bears might do well to pay attention to because I think the market is very close to a major bottom. (That doesn’t mean we are guaranteed to make new highs, although we might. Just that we can probably expect an explosive rally soon, even if it ultimately turns out to be a counter trend rally in an ongoing bear market).

First off, way too many people are counting on the head and shoulders pattern taking the market directly down to 850. Folks, historically these head and shoulder patterns have a success rate of about 50%. A coin toss, in other words. Didn’t we learn that lesson last July?

Let’s go now to the charts. We have a large momentum divergence that has developed on the daily charts.

Also, notice that the market dropped down to the 75 week moving average yesterday and bounced strongly. You can see this same support during the prior bull. The 75 week moving average acted as final support during the entire bull market. That level also happens to be the 38.2% Fibonacci retracement of the entire cyclical bull move. Not an unusual correction in an ongoing bull, on both counts.

Next, we are now right in the timing band for a major intermediate cycle low.

At 21 weeks it’s just way too late to press the short side. You risk getting caught as the intermediate cycle bottoms initiating a violent short covering rally.

And finally, breadth is diverging massively during this final move down. As you can see the NYMO often diverges at these intermediate cycle bottoms. The divergence at this point is the largest in years.

Finally, I’ll point out that the February cycle bottomed on a reversal off the jobs report. I think it’s safe to say the market has already discounted a bad number so we could see shorts begin covering in a buy the news type trade, even if the number is bad. And if the number is good, we will see the market gap higher huge, trapping shorts and throwing gasoline on the fire of a short covering rally.

It’s just too dangerous to continue pressing the short side at this point. Better to just step aside and not risk getting caught in the intermediate bottom that WILL happen sometime soon, maybe even on today’s employment report.