Tags: Stocks | Severe | Drop | Danger

Stocks in Danger of a Severe Drop

Wednesday, 21 November 2007 03:41 PM

Stock markets throughout many regions of the world have been in a broad retreat since early October, with stocks in general trading at lower highs and lower lows.

For example, the S&P 500 Index fell 9.1 percent between October 11 and November 19, while the Mexico Bolsa Index fell 9.5 percent, and the Shanghai Composite Index declined 10.9 percent. The Nikkei 225 Index fell a whopping 14.0 percent during this same period.

Yet, the Wall Street cheerleaders have repeatedly told investors that stocks are undervalued. They've also stated that the recent downturn in stocks is merely a "correction."

My question for these "experts" is: If stocks were already undervalued three weeks ago, two weeks ago, and again last week, as they claimed, then what is being corrected? Obviously, the answer to this question is quite simple — the term "correction" is a word created by stock brokers to make excuses to their clients anytime a previously recommended stock declines in price.

On Monday of this week I was truly speechless when I heard one self-proclaimed stock market "expert" tell his audience that "we'll know we're in a bear market when stocks are down 20 percent."

Isn't that special? If stock prices decline by 20 percent, I presume this so-called "expert" will then tell his clients to sell their equity holdings. Personally, I would prefer for a financial expert to tell someone like my mom to sell her stock holdings before they decline by 20 percent!

Ok, enough of that! Let me get back to what this article is really about: What's coming next.

My research indicates that stocks in general are now in danger of a severe drop within the next week, with the Dow Jones Industrial Average setting up to fall by as much as 500 points in a single day between now and next Wednesday.

My forecast is based on several interacting factors, including recent developments pertaining to the economy, sector rotation and stock trading activity.

Economic Developments

As many of you, my investment models gave a "sell" signal in early July of this year for only the seventh time in the past 37 years, meaning that a preponderance of evidence suggested that stock prices in general would trend lower over the coming months and that economic growth in the U.S. would slow considerably during the fourth quarter of this year.

Although stocks rallied sharply during the second half of September and early October, primarily as a result of the Federal Reserve's surprising 50 basis-point cut in the federal funds rate, they have in fact trended lower over the past six weeks.

In light of the fact that the all-important manufacturing sector is continuing to experience a dramatic slowdown and that the U.S. consumer seems to finally be tapped out, the fundamental components of my investment models appear to have been correct in forecasting an impending economic slowdown.

Two weeks ago, U.S. retailers reported their worst October sales in 12 years and forecasted deteriorating operating results. According to a recent survey conducted by Unity Marketing, a marketing consulting firm that specializes in consumer insights, even affluent consumers have recently been cutting back on their spending at the local mall.

To be more specific, Unity announced in late October that consumers earning more than $150,000 per year reduced their spending on discretionary consumer goods by more than 20 percent during the third quarter of this year. This is a very significant development, because persons comprising this income bracket account for almost 40 percent of consumer spending in the U.S., which is the primary engine of economic growth.

In addition to the slowing manufacturing sector and the tapped-out consumer, numerous other fundamental components of my investment models continue to indicate that economic growth in the U.S. will slow dramatically over the coming months.

Sector Rotation

Meanwhile, my sector rotation models reveal that a growing number of investment portfolio managers have been rotating their holdings to defensive sectors of the market over the past two months — sectors such as healthcare, telecommunications and utilities that tend to outperform other market sectors during economic slowdowns.

The actions of these investment managers illustrate that they too are expecting stock prices in general to trend lower over the coming months.

Stock Trading Activity

Although defensive stocks have performed quite well over the past couple of months, stocks in the consumer discretionary, industrial, and financial sectors have fallen precipitously.

With these sectors comprising, by far, the greatest percentage of the S&P 500 Index, the S&P 500 recently fell below both its short-term (50-day) and long-term (200-day) moving average and is on the verge of breaking down below an intermediate price-support level.

This is also a very significant development, because many stock market participants base their investment decisions on such technical indicators.

Cyclical and Seasonal Factors

Last, but not least, are some very important cyclical and seasonal norms that my models suggest will be broken this year.

Historically, stock prices have tended to perform best during U.S. Presidential pre-election years and during November to December of any given year. In recognition of this fact, several well-known stock market pundits commented during the past week that they expect stock prices to rally between now and the end of 2007.

In contrast, my research indicates that this year will be one of those exception years when stocks don't experience the normal pre-election year and Christmas rally. Instead, my research indicates that the nation's retailers will experience a disappointing Black Friday on the day after Thanksgiving — the biggest shopping day of the year.

If consumers do in fact spend briskly at the mall this coming Friday, all bets are off: Stock prices will likely rally sharply over the next few days.

If they do not spend as predicted, however, you can expect the Wall Street cheerleaders to throw in the towel — and for stock prices to tank.

However, regardless of the very near-term direction of stock prices, nothing has changed from a bigger picture perspective. I therefore continue to expect stocks in general to trend lower throughout the remainder of this year. To stay abreast of my latest economic analysis and get my most recent ETF recommendations — click here.

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Stock markets throughout many regions of the world have been in a broad retreat since early October, with stocks in general trading at lower highs and lower lows. For example, the S&P 500 Index fell 9.1 percent between October 11 and November 19, while the Mexico Bolsa...
Wednesday, 21 November 2007 03:41 PM
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