Wednesday, January 16, 2008

2008 S&P 500 Opening Range

Below is a chart of the S&P 500 showing the opening range for this year. The high of the first 3 days was 1471.77 and the corresponding low was 1411.19. This gives an opening range of 60.58. The opening range for 2007 was 23.67. The range being over twice that for this year should point to larger swings in the market.

S&P 500 Index(click to enlarge)


As this chart shows, the first target down(1411.19-60.58) is 1350.61. With the volatility of the market as of late, it should not take long to get there. The uncertainty about the size of the impending rate cut by the federal reserve should make the next few weeks very exciting to trade.

Friday, January 11, 2008

Suddenly, It's a Bleak Midwinter for Housing and Lending

By Susan C. Walker, Elliott Wave International
January 7, 2008

In the bleak midwinter,
Frosty wind made moan,
Earth stood hard as iron,
Water like a stone…
(From "A Christmas Carol" by Christina Rossetti)

Shawn Colvin sings a beautiful song based on this poem by Christina Rossetti, reminding us of the bleakness of midwinter. That is exactly where the housing market seems to be now – facing its very own bleak midwinter of falling prices, rising mortgage rates and growing inventories.

The latest report of the S&P/Case-Shiller home price index shows that the price of houses fell 6.7% in October, year over year. That is the largest year-to-year decline drop since April 1991. Think of it – if you had bought a home for $300,000 in October 2006, it is now worth about $280,000. And suppose you just got a new job and need to move? You are going to have trouble selling it at that price, too, thanks to so many foreclosed homes on the market. One realtor in Phoenix explained to a Wall Street Journal reporter that local residents are now competing with foreclosed homes selling for $50,000 to $100,000 less than other houses on the market. "The sellers now are having to reduce their prices by 20% to 30% to compete," she says. (Wall Street Journal, "Pace of Decline in Home Prices Sets a Record," 12/27/07)

At a meeting of the New York Society of Security Analysts on January 7, U.S. Treasury Secretary Hank Paulson said this about the U.S. economy: "We will likely have further indications of slower growth in the weeks and months ahead.''

Paulson and central bankers at the U.S. Federal Reserve recognize that they, too, face their own bleak financial midwinter. It's not just the mayhem brought on by the subprime mortgage debacle, the implosion of the housing market and the ensuing credit crunch; nor is it that the U.S. economy lurches toward a recession and hard times.

No, it is something bigger than that. Public opinion or social mood, as we call it here at Elliott Wave International, has shifted from positive to negative. When that happens, financial heroes find themselves falling from their pedestals onto frozen earth hard as iron.

Exhibit A - The headline of a recent article on Bloomberg: "Paulson Gets Diminishing Return with Bush, Like Powell, O'Neill" and the lead: "Henry Paulson escaped the Nixon White House with his reputation enhanced. He won't be so lucky this time around."

Exhibit B - The lead from a recent column by David Ignatius in the Washington Post:

"When airport rescue crews are worried that a damaged plane may have a crash landing, they sometimes spread the runway with foam to reduce the probability of fire on impact. That's what the Federal Reserve and other central banks are doing in pumping liquidity into severely damaged financial markets. Make no mistake: The central bankers' announcement Wednesday of a new coordinated effort to pump cash into the global financial system is a sign of their nervousness…."

Nervousness is in the air now. Investors are anxious about the markets; everyone is worried about the housing market. Our Elliott Wave Financial Forecast December issue explains how housing starts (and stops) are intimately tied to recessions: "One key indicator of success in pre-dating economic downturns is housing starts, which are approaching the 1-million-a-month level that has preceded all recessions of the last 40 years."

And the Fed is nervous, too. So much so that it announced a credit giveaway with four other major central banks (the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank) in mid-December to try to bolster the financial system and the banks that keep it humming. The Fed reports that banks have been stepping up to its auction window each week to purchase $20 billion. Unfortunately for the banks, most of this "liquidity" isn't that liquid. It has to be paid back within 30 days, with interest of about 4.65%.

Editor's note: Elliott Wave International has agreed to make available to our readers a 2-1/2-page excerpt from Bob Prechter's Elliott Wave Theorist in which he describes exactly how the Fed's latest effort to shore up banks' balance sheets has become "High Noon for the Fed's Credibility." Click here to read the Theorist excerpt.

Just how bleak is the future for central bankers if this recently implemented plan doesn't work? Bob Prechter explains in his just-published Theorist:

"Nevertheless, this is probably the single most important central-bank pronouncement yet. But it is not significant for the reasons people think. By far most people take such pronouncements at face value, presume that what the authorities promise will happen and reason from there. But the tremendous significance of this seismic engagement of the monetary jawbone is that if this announcement fails to restore confidence, central bankers' credibility will evaporate."

"At least that's the way historians will play it. But of course, the true causality, as elucidated by socionomics, is that an evaporation of confidence will make the central bankers' plans fail. The outcome is predicated on psychology."

The "socionomics" Prechter refers to is a new social science he has introduced that studies how humans behave in groups within contexts of uncertainty – where fluctuations in social mood motivate social actions. It explains that rather than an event happening that affects social mood (for example, falling home prices make people feel bad), what really happens is that social mood changes first from positive to negative and then lousy things happen (for example, unhappy people make home prices fall). If you can adopt this point of view, then you can see that, in poetic terms, we are fast approaching a bleak midwinter for the economy and the financial markets.

Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. Her columns also appear regularly on FoxNews.com.

Tuesday, November 13, 2007

How To Recognize a Financial Mania When You're Smack Dab in the Middle of One

By Susan C. Walker, Elliott Wave International
November 12, 2007

When you're caught in the middle of a bad storm, you don't really care whether it's a tropical depression or a full-strength hurricane. You just know you're hanging on for dear life. The same idea applies to financial markets. When a market is trending up strongly, it's hard to tell whether it's just a bull market or a more dangerous financial mania.

The recent tremendous ride up for global and U.S. financial markets, including the Dow, looks and feels more like a mania than a mere bull, says Elliott Wave International analyst Peter Kendall. This distinction is important to recognize in the rising stage, because manias always result in a crash that takes them back beneath their starting point.

Kendall recently published his research into current financial manias throughout the world in SFO (Stocks, Futures and Options) magazine. The article, titled "Financial Manias and the Trade of a Lifetime," suggests an even more stunning finish for the current manias: "The speed and global scope of the unfolding credit crisis suggest that most of the fast-rising markets of the last decade will crash in unison," he writes.
-----------------------------------------
Editor's note: Elliott Wave International invites you to read the full five-page article with charts from the October 2007 SFO magazine by Elliott Wave International's Pete Kendall called "Financial Manias and the Trade of a Lifetime."
-----------------------------------------

As co-editor of The Elliott Wave Financial Forecast, Kendall searches for trends that help traders to move in and out of markets. By comparing other historic manias with the impressive rise of the DJIA since the late 1970s, he focuses on the skyscraper pattern that they all have in common. The four historical manias are the Dutch Tulip mania of the 1630s, the South Sea bubble of 1720, the U.S. stock crash of 1921-1932 and the dot.com bust of the 1990s and early 2000s. Once you can see the similarities, you will be better prepared to face the music when the crash comes. As Kendall writes, "once the belief that the markets will always rise becomes widespread, it actually signals the start of a price swing that tends to be a career-breaker for any trader who tries to oppose it."

He also discusses current manias, such as the Nikkei, which has yet to return to its start after a manic rise to its all-time high in December 1989, and the Dow, which reversed from its rise in 2000 but made a U-turn in 2002. The starting point for the Dow's mania as shown in the chart included in the article is at the 1000 level.

Kendall, who is also writing a book about financial manias, titled The Mania Chronicles, describes five telltale signs that help an investor to tell the difference between a regular bull market and a mania. It's a mania if:

1. There is no upside resistance, and rising prices seem to be perpetual.
2. Everyone in the market looks like an expert.
3. There is a flight from quality investments to riskier investments.
4. As financial bubbles pop in one area, they bubble up in others.
5. The crash after the peak takes back all the gains the mania made.

No. 5 can be viewed only with hindsight. But the first four signs provide essential clues to what's shaping up in the markets.

"By studying past mania experiences, traders can gain valuable insight into the collective emotions that drive their markets," writes Kendall. "It's possible to make significant money in the advancing stages of a mania with no knowledge of its existence. But there is nothing like recognizing a mania for what it is in real time to help a trader keep those gains and deal with the relentless crash after it peaks."

In the last part of the SFO article, he asks the key question, Are we at the peak yet? Find out his answer by reading the whole article for yourself.

Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. Her columns also appear regularly on FoxNews.com.

Friday, November 9, 2007

Linear Regression Changes In Trends

The previous post covered using a linear regression line with standard deviation channels. This is helpful to define the trend and to statistically define where the underlying stock or index is in relation to the trend. Below is a three day chart with the same linear regression and standard deviation lines used previously.

MER - Merrill Lynch & Co.(click charts to enlarge)


In this chart the red line running up the center is the linear regression line(377 period). The blue lines are one standard deviation above and below the regression line. The yellow lines represent two standard deviations. Two standard deviations should include 95% of prices. Any price outside this area should be looked at as an extreme in relation to the trend, and should revert back to the mean. If prices stay outside these areas, it signals a change in trend.

As can be seen, one standard deviation acted as support for most prices. Recently prices broke through this area and went straight to the two standard deviation line, where prices paused before breaking strongly lower. This is a great visual picture of the change in the state of affairs for companies with exposure to the sub-prime lending issues. Below is the same chart of Merrill Lynch except it is a daily chart as opposed to the three day chart.

MER - Merrill Lynch & Co.


The daily chart shows more volatile price movement. The three day chart takes some of the noise out of the price movement and smooths the data. The daily chart is helpful for looking for entry points for those who trade more actively.

Below is a chart of Roper Industries Inc. It might look like a pretty boring chart, but is one that has been very profitable.

ROP - Roper Industries Inc.


Applying linear regressions to Exchange Traded Funds can be a helpful tool in identifying leaders. Below are charts of the XLE Energy ETF and the XLB Basic Materials ETF.

XLE


XLB

Tuesday, November 6, 2007

Smoothing Data and Using Linear Regressions

Linear regression analyzes the relationship between two variables, X and Y. For each subject (or experimental unit), you know both X and Y and you want to find the best straight line through the data. In some situations, the slope and/or intercept have a scientific meaning. In other cases, you use the linear regression line as a standard curve to find new values of X from Y, or Y from X.

In most instances when it comes to trading it is best to keep things as simple as possible. It is possible to write intricate formulas for analyzing and back-testing data with linear regressions. Through personal experience it seems best to focus on the time frame or the length of the linear regression and the overall slope of the regression line. Below is a chart of the S&P 500 with a longer term linear regression line. This regression line is shown as the red straight line that bisects the prices over the past 377 days. On either side of this red line are lines which show one standard deviation (blue lines) and two standard deviations (yellow lines). These lines run parallel to the linear regressions and act as channels.

S&P 500 Index


This is a longer term view of the market, but it does help in showing when the market is at mathematical extremes. It can help in knowing when not to fight a trend and when to expect support to possibly help adding to a position. It is important to note that the entire slope of the linear regression is positive. Creating long positions when the market is 2 standard deviations above this line could prove to be positive, but looking for better entries on pull-backs to the regression line or to the one standard deviation line could be significantly safer.

The chart below further smooths the data by using a three day chart. This is a custom time frame that is longer than a daily chart, but is shorter than a weekly chart. When using the 3day chart, most of the data will stay within one standard deviation of our linear regression line.

S&P 500 Index 3 Day Chart


Looking back to the late 90's, it is possible to see how the market reacted to these levels as the trend changed. This chart below is a three daily chart with the same linear regression line.

S&P 500 Index 1997-2002

Search

Google