CCM Short Takes
Debt Concerns Remain
Inflation Remains Likely Outcome

02/08/2010: The recent sell-off in risk assets was in no small part due to concerns about high debt levels in Greece. Today's Wall Street Journal questions whether Greece is a significant threat to the global financial markets. Some key points in the article:

• Greece’s population is smaller than metropolitan Los Angeles.
  
• U.S. banks and financial institutions have very little exposure to Greece.
  
• Greece’s stock market capitalization is only slightly bigger than Citigroup's.

We do not discount the problems related to debt levels around the globe, but we do question the short-term focus on Greece. Global policymakers will continue to attempt to "inflate away" debts via money printing and deficit spending. In the end, inflation remains the highest probability outcome in the years ahead. The other alternative is default, which is not attractive to politicians hoping to remain in power.

02/05/2010 - Clients: While most markets have monthly, weekly, and daily support close to current levels, it is possible that we will see another leg down in the coming days. The rationale for remaining patient is that even if we move lower in the next week, the odds are good that the markets will at some point in the next few weeks be higher than today’s levels. Selling some positions today may look like a good move in the next few days, but it most likely will not look like a good move sometime in the next few weeks. If we tolerate some more pain in the coming days, we should get an opportunity to assess our options under better circumstances (during the next short-term rally).

Another leg down would only increase the odds of a short-term bounce. Notice that the 2nd leg down in the first correction in 2004, was followed by a sharp rally. While it is possible that the markets move down in a straight line with no intermediate rallies in the coming weeks, it is a very low probability event. Our plan is to assess the health of the markets on the next short-term rally; if markets have weak internals, we will consider reducing some risk in more favorable conditions. Recent economic news and market activity does have us concerned about the possibility of a multi-month, stair-step correction. Corrections, and even bear markets, always have some form of a countertrend rally, which is the basic rationale for remaining patient in the face of a painful market sell-off. Pessimism is high at the moment, which increases the odds of positive surprises related to future economic data. Oversold markets often rally on positive surprises related to the economic reports or earnings.

02/04/2010 - Clients: Jobless claims rose this week, which is the main catalyst for today’s sharp sell-off. For now, support and the blue trendline intersecting near 1,075 are holding. The 500-day moving average, shown in pink, currently stands at 1,069. Given the market’s oversold condition, if 1,074 does not hold, the odds are good that buyers will step in between 1,018 and 1,069. Today appears to be a panic sell-off. While very difficult to do, we will remain patient. Markets often reverse right after a period of high stress and frustration. The S&P 500 has not made any significant lower low, which means even the intermediate trend remains up. Before 2010 began, we said the key to making money in 2010 would be to hold during corrections. At some point, an oversold bounce of some significance will present itself. At that time (when buyers are in control), we can consider our options within the context of the information available to us. Experience tells us that participating in a panic sell-off is rarely the proper course of action. Even if a new bear market has started (which is not likely), the odds are extremely high an oversold rally will begin sometime relatively soon. Markets are cruel; significant rallies often follow panic sell-offs.

02/03/2010 - Clients: We are updating our economic cycle / asset class research, which will help us with allocations for the balance of 2010. We combine historical cycle data with CCM’s current Asset Class Rankings to produce targeted watch lists. We may see some shifts in market leadership between now and the end of Q1.

02/02/2010: If the markets can push higher in the next week or so, we will be looking for a few specific yellow flags that may point to some intermediate-term (multi-month) corrective activity. If we see the yellow flags, we may consider a more conservative mix of investments. If the yellow flags do not appear as the markets move higher, we will remain patient. While we have not yet fully turned the corner, the set-ups are in place for risk assets to rally in the short-term; another day or two of gains would increase the odds of a move on the S&P 500 back toward the 1,136-1,150 range. Presently, we are not concerned about the shift to a bear market, but we do have some concerns about a possible multi-month correction within the context of an ongoing bull market.

01/29/2010: Market corrections are never fun; they are painful and stressful. However, they occur in all bull markets. As stated in our recent client update, even if a multi-month correction has started:

• The odds are very low that the market will continue down in a vertical manner for an extended period.
  
• At a minimum, an oversold bounce of some significance should occur sometime in the next few weeks.
  
• It would not be unusual for the market to push back up toward the previous highs even in a circumstance where a major top has been made (little evidence to support a major top currently).

Therefore, sometime in the next few weeks (maybe as early as next week), when the markets find some footing, we will evaluate the health of the market’s internals as it moves higher. If we see strong internals, we can err on the side of holding our positions. If we see weak internals and significant negative divergences, we can sell into strength to reduce some of our more volatile holdings.

At some point during all violent corrections, the sellers become exhausted ("oversold") and traders step in looking for a favorable entry point. If we are patient, the market should give us an opportunity to make decisions in a more favorable environment (where most people are buying instead of selling). The current bull market has seen corrections in May 2009, June/July 2009, September/October 2009, and November 2009. Each time sellers rushed for the exits only to see new highs made soon thereafter. In the short-term, as painful as it is, the best thing to do from a probability standpoint is to remain patient and to focus on the longer-term. Stocks should be higher than they are today in January of 2011. If that is the case, then the correction of January 2010 will be long forgotten.

01/29/2010: The trend denoted via the blue lines below will not hold forever. However, we are at a point where the odds of a reversal have improved. From Point A, the market reversed and rallied 8%. From Point B, the market reversed and rallied 8%. An 8% gain from the recent low would put the S&P 500 at 1,164 (not a forecast). We will have to see how things play out over the coming days. A bearish break of the blue trendlines below would not signal the end of the bullish run, but it could mark the beginning stages of an intermediate topping process. Regardless, if the markets are able to move higher, we will be watching closely for signs of internal weakness. Seasonal and cyclical factors align well with an intermediate top, within the context of an ongoing bull market, occurring in Q1 or Q2.

01/27/2010: We are working on a detailed client update which should be completed in the coming days. We will notify you via email when it is available. It is important that we remain focused on the longer-term outlook for asset prices, which remains positive. Corrections are a normal part of any advancing market. Making decisions based on short-term fear, in the context of bullish long-term trends, is something we need to avoid.

01/26/2010 - After The Close: Possible price and trendline support intersect near 1,083. In the past, price has clustered and found support near the 75-day MA (see pink boxes). On balance volume (OBV shown at top) made a new high as price made a new high earlier this month, which tells us that making a push back toward the recent highs is likely after the current correction. CCI (shown at the bottom of the chart) is also supportive of a potential end of the correction occurring in the coming days. A shakeout push below 1,083 would not be surprising given the market’s current weakness.

01/26/2010 - Before The Open: We remain in a bull market. The longer-term trends remain bullish. Corrections are always a part of any longer-term advance in any market. We are currently experiencing a normal correction within the context of an ongoing bull market. The markets are cruel; corrections create fear and cause many investors to sell. We cannot profit from the longer-term trends if we are shaken out during corrections. All bull markets experience volatility. If markets went up in a calm and non-stressful manner, then it would be easy to make money since it would be easy to stay invested.

The McClellan Oscillator is a market breadth indicator which is calculated using the number of advancing stocks vs. declining stocks. The S&P 500 reached a short-term oversold condition on Friday of last week. On Monday, the oscillator moved higher from oversold levels. While the indicator’s reversal can occur prior to the market’s reversal, Monday’s move higher tells us the current correction may find some buyers in the coming days. The S&P 500 Index is shown below the McClellan Oscillator in the chart below. Notice how oversold levels (green circles) often precede short-term bottoms in the S&P 500 (denoted with green vertical lines). The odds of positive outcomes improve when the S&P 500 also has some price support (blue arrows). Oversold markets can continue to decline (see 2008); so this indicator should not be used in isolation. However, 2008 was within the context of a confirmed bear market. We are now in a confirmed bull market. The odds continue to favor higher highs later this year. The only way to capture any potential future gains is to remain invested.

01/25/2010: Short-to-intermediate-term technicals showed some improvement today, but some more work needs to be done. The longer-term outlook remains positive with the intermediate-term outlook moving to a tentatively neutral stance, from the previously neutral-to-bearish stance (slight improvement). While short-term concerns remain, the chart below shows there is some basis for optimism.

01/22/2010: Most leading markets were overbought on January 11, 2010, which meant the risk-reward profile became less favorable on a short-term basis. Today, most leading markets are oversold, which means the odds favor an end to the current correction sometime between 1,097 and 1,080 on the S&P 500. Overshooting those levels on a short-term basis would not be a surprise. Based on what we know today, we are more interested in buying, rather than selling, near current levels. If we see some buyers step in sometime next week, we are ready to redeploy some cash. Today’s silver lining was that volume was relatively light, which may indicate the sellers are getting a little tired. There is little evidence to suggest the current declines are anything more than a correction within the context of an on-going bull market. As long as that remains the case, we will continue to err on the side of holding our core investments.

01/21/2010: While multi-week corrections can occur at anytime, the concepts covered in Bull markets don't end when lots of stocks are hitting new highs align well with our research.

As we noted in Short Takes on 01/12/2010, we sold a few positions on 01/11/2010 because we saw some developments on the charts that “may lead to corrective action.” Corrections are never easy; they create pain which prevents investors from staying invested. The markets remain in a bullish stance longer-term. On a weekly chart, strong support exists for the S&P 500 around 1,097. The S&P 500 remains above its 22-week moving average (MA) and above its 200-day MA, which send bullish signals longer-term. Taking a longer-term view is important, especially when the big picture still favors higher asset prices in the months ahead. A decline to 1,080 on the S&P 500 is also possible within the context of a bull market correction.

01/20/2010: Corrections are always a part of any bull market. We have seen nothing to be too concerned about from a longer-term perspective.

01/19/2010 - After The Close - Clients: Today was a mixed bag; breadth was decidedly bullish, but volume was light. We did deploy some conservative amounts of cash today. We would like to see some follow-through gains in the coming days since the Massachusetts Senate race could have skewed things a little today.

Before The Open: While the big picture still looks bullish, the short-to-intermediate-term outlook remains in somewhat of a neutral-to-slightly-bearish mode.

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Chris Ciovacco
Ciovacco Capital Management