Belief:

Confidence in the truth or existence of something not immediately susceptible to rigorous proof.

Belief is what one obtains when facts and observations are made and a theory is developed. Last July, we began to observe problems developing in the financial system at a rapid pace, then facts started to become known which reinforced those observations. Since that time, the facts and the observations of patterns in the economy continue to show problems still worsening. So why is it that the equities markets are going up? It comes down to the most basic and simple of human traits: greed and fear. In the stock market right now we have the classic greed of wanting more, and fear of missing out on having more. When markets go up, fear turns to the feeling of missing out on something. When markets are going down, fear turns to the anxiety of losing money. You see, greed and fear take on different meanings based on what the market is doing at any given moment. If it were not for these simplest of human emotions, there would be no market in the first place for people to wage each other for price negotiation of stocks.

When the market has suffered large declines, as we have witnessed this year, and then starts reversing, there is a feeling of euphoria. The Webster’s definition of euphoria is "a feeling of happiness, confidence, or well-being sometimes exaggerated in pathological states as mania". The euphoria in bear markets is the feeling that a burden has been lifted, there is joy, and there is a feeling that the sun will come out tomorrow. Euphoria is what creates bear market rallies and is why advances in bear markets can be so extreme. Recall that in bear markets there are more 2% or higher one day advances than there are in a normal bull market.  And euphoria spreads quickly throughout the market as it feeds the appetite of greed and fear.

It is our belief, based on many facts and observations, that the economy is going to deteriorate much further in our view. It is because of this that we maintain our belief that a bear market is upon us. The advances in the market over the past few weeks is simply a bear market rally. And what happens in these rallies is that the euphoria wears off once the facts begin to set in again, and fear turns back to the fear of losing money and the markets begin the next downward path.

The euphoria of the markets also greatly influence the media and analysts. Before the market began to deteriorate last year Jim Cramer of CNBC was putting price targets on stocks like Google and Apple of $850 and $350 respectively. He, like so many, were caught up in the euphoria and based their future projections on greed, not on fact. Reality hit Jim Cramer in the behind and the market began to cave in.  Suddenly, he backed away from all of those claims, and in March he turned somewhat bearish in his view of the market. Was he analyzing any real data? No, he was only following the market sentiment as greed and fear propagated throughout. Now that the market has advanced since March 17th, suddenly everyone has become very bullish again, and even making some outrageous predictions of the DOW reaching 16,000 this year (Larry Kudlow, CNBC). Those who lose in the end are those who follow their emotions and ignore facts.

The bear market that began in 2000 is a perfect example of the process of events I just described. Lisa and I remember very clearly the media and analysts reactions during that bear market. What is happening now has happened before. Same story, different year. There were a lot of people who lost their life savings and more in that bear market, because they got caught up in the euphoria and started to go long and build up substantial positions everytime another ‘bottom’ was called. The euphoria of the bear market rallies prevented them from knowing when to sell and take their money out before the next down leg came. Many just left their money in the market, for they kept thinking "it has to turn around soon," only to find out that, no, the market does not have to turn around soon, and they lost.

The chart below is the S&P 500 from the bear market of 2000 - 2003. Each blue arrow was another ‘bottom’ which was followed by euphoria and the concept that the market was now bullish again. But, as you can see that euphoria was busted multiple times. Even a primary bear trend line can be breached for a short period of time before economic reality sets in again. I see our current situation as a replay of 2000. But some would say "you can’t fight the Fed", they said that all the way through 2000 to 2003 as well. In that bear market the Federal Reserve cut the Fed Funds Rate 12 times! And every time the market hit an intermediate low, people were saying "you can’t fight the Fed". Well, yes you can. And those who did fight the Fed were those who came out the biggest winners in the end because they stuck to their beliefs, and not their emotions.

 

 

 

 

 

 

 

 

 

 

(S&P 500 - Bear market 2000 - 2003)

Today’s advance was again on volume that was not good. The volume trend is declining while prices have been advancing and that spells big trouble ahead. There are many indicators that just scream out that a substantial decline is on the way. Technology, which so many in the media have been jumping on as the next bull market, is about to hit a major resistance level. The chart below is of the semiconductor ‘SOX’ index. Notice that it has fallen substantially out of a long term pattern and has been retracing back to the point of where it failed. That point will be a turning point back down once again.

 

 

 

 

 

 

 

 

 

(Semiconductor Index - Weekly chart)

 

And the Dow Transportation Index, it too is right at a resistance point.

 

 

 

 

 

 

 

 

 

(Dow Transports - Weekly Chart)

 

Tomorrow is the monthly unemployment report. Our own analysis of the employment situation tells us that the unemployment trend is still firmly in a deteriorating pattern. How will tomorrow’s data come in? Well, if the Government uses the correct birth/death calculations in their analysis, then it will be bad. Does the Government want to make the economy look as best they can in this election year? You bet they do. Will they stoop so low as to make the data appear better then it actually is? I’ll let history speak for itself on that one.

But from where I sit, the market is at, or near a major turning point. Each day that passes in this bear market rally makes me more and more concerned for those who are going to be trapped by it.

Now for some additional facts:

State and local budgets are running into trouble. Deficits in local communities are rising and so are budget cuts. In my area, I know of many budget cuts being proposed or having actually been enacted. And layoffs have been occurring within the State and local Government. Where is the next wave of unemployment going to come from? The Government sector.

The chart below shows the revenues lost from reduced tax income just in past three months!

 

 

 

 

 

 

 

(Tax revenue changes for January - March 2008)

 

And one more bit of information. Atlanta, one of the fastest growing cities in this decade is also becoming one of the fastest growing cities with the highest amount of foreclosures.  On average, 1 in 150 homes in the greater Atlanta area are now in foreclosure. To us that does not look like a healthy economy.

 

 

 

 

 

 

(Atlanta - Foreclosures as of May 1st 2008)