Patience is power; with time and patience the mulberry leaf becomes a silk gown. — Chinese Proverbs, Sayings of Chinese Origin

The following content has been extracted from the Feb 2, 2010 Market update that was sent out to subscribers.

  
20 day moving average of new lows = 4615 (New all time Record set on Sept 16th 2008).
1 year moving average of new highs = 10 (New all time low set on Nov 25th 2008)
1 year moving average of new lows= 2225 (New all time Record set on Sept 16, 2008)

The number of new highs has moved up slightly but the 20 day moving average of new lows is still leading although the market has mounted a very strong rally over the past 2 days. Another revealing factor is that the 100 day and 1 year moving average of new lows are virtually unchanged from last week’s numbers. This action clearly indicates that all is not well in the markets as the internal structure is weakening.

In one week the Dow was able to take out 10400 and 10200 and the interesting part is that both price points were taken out on volume of over 7 billion share. If the Dow remains below 10,200 today it will have traded below 10,200 for 3 days and will now issue a stronger signal that it is ready to mount a decent to steep correction. The break below 10,200 is significant for it was the bottom of a channel formation that took shape from Nov 2009. A break below a channel formation, especially when the markets are extremely overbought usually produces a strong move in the downward direction. Market update Jan 26, 2010.

The Dow traded as low as 10050 and Dow futures traded as low as 9994 and then bounced back very strongly. The break below 10,200 turned the trend negative but the Dow needs to stay below this level. Trends are determined by key price points and for a trend to remain valid the market must remain below that price point. Thus if the Dow trades past 10,200 for 3 days in a row it will neutralize the previous signal. It will not however, negate the fact that breaking below a channel formation after a strong run up usually produces a strong downward move; it will only delay the action. We have further signs that all is not well in the markets. MMM a stock that rallied strongly with Dow actually closed lower on Monday, and today it closed unchanged; in the past two days, the Dow has tacked on over 200 points. If you look at the banking sector many former higher flyers are also not performing all that well.

The Dow dropped from 10729 to 10000 in a very short period of time; the intensity of this pull back was extreme. The markets had not experienced anything like this since March of last year. Thus this pull back has fooled many players to adopt the old strategy of buying on the dip. We also have a large group of traders that sat out of the market for a very long time, and they probably view this large pull back (large only because it took place so fast) as a buying opportunity. This is more like a trap than a buying opportunity. The safest position is to be on the sidelines until a very strong sell signal or another buy signal is generated. To let out enough steam and move the risk to reward ratio in our favour, the Dow would have to at the minimum shed 1500-1800 points, and so far it barely shed 700 points.

Despite the strong rally, the Dow has mounted in the last two days, the volume has not even hit the 6 billion mark; on Monday volume barely hit the 4.7 billion share mark, and today it came in at 5.47 billion. On the 21st and 22nd of January when the market sold off, volume spiked on both days and surged past the 7 billion mark. If you need one thing and one thing only to remind you of the very dangerous structure of this market then remember this. The Dow put in 22 new highs (this is a huge number) in a period of just a few months and not even once did the volume surge to the 6.8 billion mark let alone the 7 billion mark. Yet when the market sold off, for two consecutive days in a row, the volume surged over 7 billion shares. Remember this for it is a very important development. Long term the market is clearly treading on a very shaky ground.

We would like subscribers to remember just how fast the Dow dropped from 10729 to 10050; this is just the prelude of what lies in store. If the markets should surge to test their old highs or maybe even put in new highs do not let this move up fool you. Pay attention to the volume and to the divergences.

The Dow utilities broke down one month before the markets, and so they appear to have resumed their leadership role. If the Dow should rally to new highs, a failure by the utilities to match them and surge to new highs before the Dow would be another clear signal that the markets are heading into a danger zone. Copper another leading economic indicator is trading well of its highs and the Baltic dry index has put in a double top formation.

If the Dow rallies to test its old highs without pulling back to the 9200-9400 ranges then it will be setting itself up for an extreme correction. This rapid move down was simply not enough to let out all the steam this market has built up and a strong rally now will result in a move similar to one that took place in the bond markets between Dec 2008 and July 2009. Bonds shed over 20% in 6 months, for bonds this is a massive move, so for stocks a comparable move would be in the 40% plus ranges.

Volatility readings have surged to yet another new high indicating that violent moves are going to continue to plague this market. Look how fast this market pulled back and look how fast it reversed. The moves though have still been one sided in nature (mostly to the upside) for the most part, but the next move will be for the majority of the swings to occur on the downside.

Finally, if the current daily sell is neutralized and a buy signal is issued on the daily charts, we will send out an interim update as it could be an early signal that the Dow is going to re test its old highs. Right now we still have a daily sell signal, in effect; the weekly while closer to the sell zone has not generated a sell signal yet.

Conclusion

If you take the very short term view you are going to get frustrated with the concepts of patience and discipline, but understand that one needs to look further out and check to see if everything is clear before jumping in. Big gains are not made by taking the very short term view. For several months in a row we stated that palladium was an incredible buy (several times we went out and called it a screaming buy) and from Oct 2008 to March of 2009 it did virtually nothing. Short term traders were bored by this talk but those that waited and held did very well. The same can be said for the markets; we spoke of the markets putting a bottom, well in advance of them putting in the final bottom. In fact, when we issued our targets for Dow 10,500 in Feb 2009; at that time the market was taking a beating, and we looked like bloody fools for stating that it was going to eventually rally to the 10,500 ranges. We have run into this same situation over and over and from each encounter, we have discovered the same principle always applies. Those who have no patience or discipline end up giving up all their gains and then some. Do not join this crowd for they are always looking for new members.

The daily trend is still down and all long term indicators are clearly stating that the risk to reward ratio is not in our favor when it comes to opening up long positions. Only very short term indicators are giving off some bullish readings and these indicators change direction very fast. We got a small taste of how fast the markets can move downwards when the selling started. The Dow has been trying to trade to the 10700 ranges since Nov 2009, but in just a few days the Dow dropped from 10700 back to its Nov 2009 levels. It took a few days to drive the markets back to the starting point.

Market internals are also suggesting all is not well in the markets going forward as is the volume. Therefore, despite the urge to jump into the markets, we urge long term investors to sit on the sidelines and maybe ease into a few put positions as a hedge.. Once a full fledged/Strong sell signal is generated you can start to purchase puts more aggressively.

A full fledged sell is a sell signal from our smart money indicator. A very strong sell signal would be a sell signal generated on the weekly time frames. Right now we have a daily sell signal, in effect, only.

Looking further down the line (7-12 months ahead) there are going to be many opportunities in the commodity's sector as the world’s central governments are going to continue to destroy their currencies. Furthermore, supplies of many key commodities are declining across the board. The precious metals sector is certainly going to shine strongly over the long term as central bankers are creating new money at a mind numbing rate. Many countries will have to restrict their mining activities because of electricity shortages; this is yet another factor that will come to play when the dust finally settles down. There are so many overwhelming reasons to support a very strong sustained rally in the commodities sector (especially in the Energy and Precious metals sub sectors) that we would have to write a whole article just to cover them; however, when it comes to the general markets there is very little to support a long term rally. In fact one would have to really push ones imagination in an attempt to find evidence that supports a long term rally in the markets.

Thus patience is warranted for many sectors that have rallied since March 09 are rotten to the core and will crumble once reality sets in.
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An ounce of patience is worth a pound of brains. — Dutch Proverbs, Sayings of Dutch Origin