In an interview on Fox Business News last Monday, I pointed out the same three levels of resistance to Fox viewers that I pointed out to IDE readers earlier that morning (it pays to subscribe).  One thing I did on Fox that I didn’t do in IDE was make a recommendation, so I feel like I owe readers something.  My recommendation on Fox was to buy the ProShares UltraShort S&P 500 ETF (SDS).  I still think this is a good pick and I think it could jump 30-40% over the coming weeks.  As a bonus pick, I think you can make every bit as much with the QID, which is the ProShares UltraShort QQQ ETF.

After looking even closer at the charts, I noticed what appears to be a very well defined inverse head and shoulders pattern.  Look at the weekly chart below to see the different parts of the formation.

One thing that strikes me about this chart so far is the symmetry of the move from the neckline to the head and from the head back to the neckline.  Each of these moves lasted nine weeks.  It doesn’t have to be that well defined to fit as an inverse head and shoulders pattern, but it struck me as interesting.

So where does this leave us?  It looks to me like the S&P will decline over the next 7-8 weeks and then should start to find support near the 750 level.  If the 750 level holds as support and we start heading higher again, you could play the up move for about six weeks or so and then see what happens after it reaches the 950 level again.

If all of this pans out the way I think it will, the end of this year could see an explosive move to the upside as it breaks above the neckline.

The thing about head and shoulders patterns is that you typically want to wait and play the break above (on an inverse) or below (on a regular H&S).  The big move comes after the pattern is complete.

In the interim, you can play the short side as I think the three resistance levels I talked about last week will be too much to overcome when the S&P is as overbought as it is on the daily and weekly charts.  We move down again, the moving averages have time to catch up, and we won’t be as far below the 52-week (360-day) moving average as we are now.

We saw a similar pattern develop in the 2000-2002 bear market.  It wasn’t as clearly defined as the one we are seeing develop now, but it was there never the less.

Be patient, the biggest gains are yet to come.  The rally from the March low was very enticing, but there is even more money to be made if this plays out as I think it will.

Source: Classic Chart Pattern Predicts Bad News Followed By Good News

In fact, the rally appears to be overdone.  We have jumped too much, too fast.  Looking at the chart of the S&P 500, the daily stochastics have reached their highest level in two years thanks to this rally.

A closer look shows three significant hurdles for the S&P to overcome in the immediate future:

• The 200-day moving average is in the 958 range
• The downward-sloped trendline is sitting just above the 200-day
• The high from January- 943.85

Combining the three levels of resistance and the overbought state (both on the daily chart and the weekly chart), there is little chance of the S&P breaking through the resistance in the immediate future.

While I still think 2009 will be a positive year, a decent pullback will be healthy for the market.  The monthly chart shows that we are barely out of oversold territory.  We are still 100 points below the 12-month moving average that I have talked about using to time your asset allocations.

If you are a short-term trader and have reaped the benefits of this massive rally, I suggest you take some money off the table.  If you are a long-term investor, I suggest you wait before committing any additional funds to equities.

A move back down to the 800 level and some sideways movement for a month or two would give the 12-month moving average time to catch up and then we could potentially see the 6-month moving average cross back above the 12-month.  And that is when you will know for certain that the bear market is over.

Source: Proceed With Caution

It’ll be to the downside.
Stocks are overbought right now. That’s clear. And there are times where extremely overbought markets get even more extreme. It looks like we’re now in one of those times. So the market can still work its way higher.

Buying into these conditions, however, is rarely a smart move. The risk/reward weathervane is blowing strongly in the direction of risk. In fact, we’re rapidly approaching the best short-selling opportunity of the year.

Source: Http://www.ritzholtz.com

This is a historical chart of the S&P 500’s Price-to-earnings ratio (P/E). For those that don’t know, a P/E ratio tells you how many years of a company’s earnings it will take to buy it outright.

So – if you buy a company for $1,000, and it earns $100 a year, you’re said to have a P/E ratio of 10 ($1,000 / $100).

In other words, it would take you ten years to break even (As a buyer).

Today, the S&P has a P/E of 12.6. But in the early 20’s, 30’s and late 80’s, this ratio dropped to as far as 5.
This can only mean one thing: Stocks have just entered fair value… the market as a whole isn’t even cheap yet!

The reason why is because we’re in a market where both earnings and stock prices are dropping dramatically.

This also means that shorting the S&P 500 as a whole is still a generally safe bet. You can do that by issuing a short-sale on the SPDR S&P 500 ETF (NYSE: SPY).

No, I didn’t alter my genes to gain an unnaturally strong sense of smell. And no, I can’t really lock my jaws like a Pit Bull. I just look at the S&P 500 Volatility Index (VIX) and everything becomes clear.

What Is the VIX?

The VIX is a basic measure for volatility in the market. Higher levels of volatility in the market coincide with higher levels of fear. Higher levels of fear usually mean investors will pull money out of the markets and you see an overall drop in market value. So when you see the VIX rising, the market usually drops.

How Do You Use the VIX?

The best way to use it is as a tool to supplement your existing technical analysis.

Let’s say the market takes a huge drop one day. How do you know that this is the beginning of a genuine leg down? Sometimes it can be hard to tell. But if you look for a major technical break in the VIX to occur around the same time, the odds of you being right about that drop increase substantially.

A Major Opportunity in the VIX

Take a look at this chart to see the opportunity I’ve been talking about…

This is a three-year chart of the VIX. As you can see, it’s been marked by very clear support and resistance lines – one just under 20 and the other just under 40.

As you can see, the one just under 40 was tested earlier this year. More important, in the past few weeks it tested it again… and managed to close significantly above it.

At the same time, the Slow Stochastic indicator at the bottom of the chart (which is smoothed out over 14 weeks) is showing the VIX as oversold. Nearly every time the Slow Stochastic indicator has become oversold – meaning the red and black lines drop under 20 – the VIX went on to rise for the next ten to twelve weeks.

If the VIX is rising, that means the Dow Jones should be falling, possibly breaking under 8,000 sometime in the next few weeks and head towards 7,000.

The play should be obvious. But I’m going to point it out anyways because I’m feeling saucy.

If the Dow Jones drops under 8,000 as the VIX spikes, buy a put on the Diamonds ETF (NYSE:DIA), which is an ETF that tracks the value of the Dow Jones Industrial Average.

Amid all the advice on investing that sometimes works and sometimes doesn’t, one tenet remains our bedrock. Put your money in stocks for the long run and you will do OK.

From 1940 through the end of 2007, over 90% of all three or five-year stretches were winners. And there were no, zero, zip, zilch losing 10-year periods.

By rolling 10-year periods, I don’t mean just 1950 to 1959, but also 1951-1960, 1952-1961, 1953-1962 and so on. Since 1950, there have been 60 rolling 10-year periods. And no matter where you started in them, you would have made money.

S&P 500 1940 through 2007

Chart source: The Principal Group

But if you are beginning to doubt if that’s right, the results from this decade have given you plenty of reason. We started out with three back-to-back bear markets this decade: 2000, 2001, 2002. We had a strong bull in 2003. Then we got a lame period for the next two years. Finally, in 2006, the market got strong again. It stayed that way late into 2007 before it nearly fell to its open and went negative again. The calendar turned just in time. Then last year it was back down again.

At this point, nearing the end of January 2009, as Barack Obama steps up to the presidency, we are into another bad year. Two and a half good bullish years out of nine years and one month have left U.S. stocks in the red. So far this decade (since the close of 1999), the Dow has lost 30%, the S&P has shed 45% and the Nasdaq is still down 65%.

That hardly inspires confidence in the infallibility of the long run. We may be about to see the first negative 10-year period for stocks since the Great Depression.

Do you still buy stocks, and if so, what stocks?

I am buying stocks, yes, because at present valuations the market is so low that once the recession ends, the probability that stocks will rise quickly is as near to certain as you can get. The market is also likely to begin rising before the recession ends, by up to six months.

Even with this confidence, though, I am buying with the notion that I might or might not see the price rise in the next 12 months and may even see it drop before it recovers and rises. We could have a negative 10-year period, but I don’t foresee a negative 12- or 15-year period.

Interest rates on fixed income investments are now so low that many stocks pay better dividends than even junk bonds do.

What stocks do you buy for the recession? What stocks for the coming Obama years? What stocks are the best for 2009?

You’ve seen dozens of ads that purport to answer those questions. You have probably read advice like “buy utility stocks” or “master limited partnerships” or “get into medical equipment and research stocks.” Those may be fine answers as far as they go, though they aren’t the answer I would give.

I would say this: look at what a company expects to earn over the next two years. If that number is positive, buy the stock if you can get it at less than 10 times its estimated earnings for 2011.

Many companies already have 2010 earnings estimates. Not all of them have projections for 2011 yet. You can take the 2010 estimates and do your own projection for an additional year by estimating conservative growth, say 5%. Most companies will do much better than that if they are going positive at all.

This is not hard to do, either. Yahoo Finance, among many others, gives analyst estimates for stocks along with estimated 5-year growth rates. The five-year estimates are inclined to be a bit optimistic in many cases, so just use the 5% rule to be safe. Take the 2010 estimate times 1.05 to get your 2011 number. Multiply that by 10 (which would be the price of the stock at a P/E of 10), and there’s your target buying price.

Many companies are worth more than that, and you should consider them on their individual merits if you are confident in your projections. As an analyst, I will be using somewhat more tailored P/E ranges and growth rates, plus considering dividends case by case.

But if you do a quick scan and use 10 times 2011 earnings, you are so far inside the margin of safety that you can relax and feel good about doing the right thing. This is as close to a sure bet as you can get.

Source: Going Against the Evidence – Who Says Stocks Make Money?

This from Smart Profits Report:

I’ve been spending the past two weeks intently trying to make sense of the dramatic shifts in our financial markets, the U.S. economy, and even our societal mood.

The news is not good.

In fact, a friend of mine who’s an investment banker summed up the current conditions best, using just one word: “Brutal.”

She reports that her business hasn’t just slowed… it’s at a complete standstill. As a result, she and her colleagues won’t receive any bonus this year.

Meanwhile, the mainstream media continue to rant and rave, almost relishing the situation. A popular radio talk show host is predicting financial Armageddon in the United States, terrorist attacks and pretty much every other type of catastrophe. Frankly, I’m surprised a devastating locust attack wasn’t mentioned.

And I bet that if you talk to people you do business with – from your local shop owner, to gym manager, they’ll tell you that business is off considerably.

Before we dig into the other side of this mess, let me just state for the record that this is a scary time – and things will probably get worse before they get better.

But if you’re one of those folks who are having a difficult time picturing the other side of this mess – a brighter side – you need to realize just how extreme market conditions already are. As the saying goes, “This, too, shall pass” – and the market will eventually return to normal.

Here’s a little perspective – and some common sense…

Perspective Amid The Panic

Take a look at the following facts – ammunition that suggests we’re due for a bull market.

Okay, maybe not today… maybe not next month… maybe not even in the first half of next year. But the numbers below should give investors confidence that it will soon be time to back up the truck and load up on stocks.

#1: Excluding the 1929-1932 crash, bear markets recouped their losses in an average of 22 months.

With the exception of 1929, the largest declines were as follows:

– The 1937 Bear Market: A 50% decline, which lasted 13 months and recovered all its losses in 58 months.

– The 1974 Bear Market: A 43% decline, which lasted 21 months and recovered all its losses in 21 months.

– The 2002 Bear Market: A 45% decline, which lasted 25 months and recovered all its losses in 40 months.

The current bear market is down 52% – from peak to trough – and has lasted for 14 months.

#2: According to Wells Capital Management, between 1984 and 1994, the loan delinquency rate was above today’s level.

In fact, current business loan delinquencies are actually near record lows and consumer loan and credit card delinquencies are at the same level as they were three years ago.

And while delinquencies will rise further as the economy regresses, Wells believes this doesn’t support a depressionary debt collapse.

#3: Volatility is at an all-time high.

During 1929, volatility peaked at 68%, according to Barron’s. In 1987, it peaked at 64%.

The Volatility Index (VIX) recently set an all-time closing high of 80.9 on S&P 500 options expiring in 30 days, which indicates an average daily move of 5%.  That’s an unsustainable amount of volatility and the markets will certainly slow down and become less frenetic.

#4: At the recent lows, the S&P’s annualized 10-year real return was a negative 3.8% – an all-time low. At market lows of 1974, the trailing real 10 year annual loss was 2.7%.

#5: Only 16 stocks in the S&P 500 are positive on the year.

#6: Morningstar tracks over 11,000 equity mutual funds. Every single one is down for the year.

I share these statistics with you, not to show you how dire things are, but to illustrate the excessive fear that investors are experiencing. So what’s the solution?

In Times Of Pain, Go Against The Grain

Market history teaches us that during these kinds of extremes, it’s usually a good time to move in the opposite direction.

I’m not necessarily recommending that you load up on stocks today, because I think we have a little more pain to experience yet.

But with the market so far past its normal limit, I fully expect it to return to a more typical environment. And in order for that to occur, the market must rise significantly.

I believe the next six months will be a once-in-a-generation opportunity to buy assets at irrationally low prices.

Source: The Numbers Don’t Lie… Why A Bull Market Will Arrive Sooner Than You Think

Brokers everywhere will tell you that small investors should buy index funds—meaning those of us with less than a billion to buy their valuable time and attention. Message from New York City to us: “Rest your pretty little heads—stop reading financial reports and analyzing stocks. Buy index funds. Average is good enough for the likes of you.”

And when the average is negative for eight years, do they change their tune? Heck no… they still tell people index funds are what smart people buy. My foot.

I’ve met hundreds of people who invest in index funds, but I have yet to meet a person who did it without being talked into it by some combination of insults and funny math. Add in phony comparisons to “funds in general” rather than to individuals making particular stock choices, lack of better alternative choices in the company 401 (k), or deep insecurity.

For every other kind of fund, investors at least make a decision to buy based on some rational footing—“this fund has earned 16% a year, that one earned 10%. I’ll take the one that does better.” Or, “this fund is 40% in bonds, so it’s got more safety built in, and I prefer its steady performance to the risk of the other one.”

The reasons may involve errors. Notoriously, funds that have done best one year have an embarrassing tendency to consort with the laggards the next. But I’ve found that investors’ decisions are still respectable efforts at taking responsibility, which I admire. And when it comes to investors buying stocks one-by-one instead of shopping for fund managers, a whole lot of thought goes into the process, as I have discovered from talking to investors.

When it comes to index funds, though, it’s usually a case of being embarrassed into it by some sharpie who implies we’re all too stupid to do any better. Or that we’re too small to compete against institutions that know everything first. Nobody can beat the market, so just buy the market, the aloof pro says to the poor little sucker. And boy have investors gone for it.

I should add that I have also met hundreds of people who made money in stocks, and not a one of them has ever told me it was thanks to buying index funds. Some made money in areas I don’t know and wouldn’t succeed in myself, like Canadian junior golds. Others did it in growth, value, tech, dividends, buying naked puts to accumulate blue chips…

But Wall Street and the newspaper from the same city want us in indexes. They are evidently winning the war against the public’s lack of self-confidence.

This chart was just released by Standard and Poor’s last week. It shows $1.4 trillion dollars in S&P 500 index funds. S&P puts total index fund investments at $1.7 trillion, which includes mid-cap and small-cap and other index funds as well as the S&P 500. Wait a minute; let me put all those digits in front of you… $1,700,000,000,000.00. The words make it seem so tiny. It’s not.

This does not even include the stealth indexing that goes on. A number of mutual funds pretend to be actively managed but actually shadow the S&P 500 by heavily investing in the larger S&P 500 companies.

This chart makes an interesting contrarian indicator. Index investing peaked in 1999, the last full year of the 1990s bull market. But if it appears that investors wisely got out of funds in 2000, looks are deceiving. If everyone froze and left their money in place, adding none, the 2000 bar would have been a fourth lower than the 1999 bar. This small drop means that investors were still adding money to index funds as the market fell. Probably because the market fell—everything else was suddenly confusing.

Then, indexing was least popular in 2002, when astute investors were setting up for a breakout bull market that began early in 2003. Anyone who bought index funds in 2002 did much better the following 12 months than anyone who bought them during the peak years.

Now, indexing is extremely popular again. I certainly hope the current high interest in indexing doesn’t foreshadow a 2000-style breakdown. It’s more likely, though, that the current popularity has to do with the market’s lack of direction.

Should you be in index funds?

Well, if your plan is to match the market over a very long term and you don’t want to work, sure. But don’t overestimate what the market returns. The U.S. average from 1802 to 2002 was 9.2%. Early data are a little shaky in places regarding dividends, but another study of returns from 1900 to 2000 (Triumph of the Optimists, Elroy Dimson, Paul Marsh and Mike Stanton, Princeton University Press, 2002) makes the case more clearly. Total returns were 10.1% average per year, and returns minus dividends were only 5.4% a year.

At that pace, considering the modern low dividends, investors should not expect anything close to the 12% a year they’ve heard investing pays—at least not from floating on the lazy river of index funds. I wouldn’t count on anything higher than 6% total for the long-term index return for the next many years. Even that’s optimistic.

And want to hear the ultimate comeuppance to index investing? It’s hard to be above average, but not so impossible as you’ve been told. The Vanguard S&P 500 index fund was launched in 1976. At the time, there were 308 mutual funds included in Forbes annual fund survey. Several have gone out of business or been merged into other funds. Even so, 29% of those funds beat the S&P 500 over these past 32 years. That’s far too much to be an accident.

The takeaway lesson here:

• The media are still pushing a bad idea. Without dividends, investors will be lucky to average 6% a year over a decade of investing in index funds. And that’s before any inflation.

• What’s more, the market enters a prolonged bear market about every third decade. It typically takes 10-15 years of investing to overcome the losses from a prolonged bear market if you enter at the peak of the previous bull market and do not own or buy any market-beating stocks during the bear market.

• Plenty of funds have beaten the market in the long run. Academic studies are set up to exclude them.

Respectfully,

Lynn Carpenter

Source: They’ve Got a Lot of Nerve

Meanwhile, on Wall Street, analysts are slashing profit forecasts that still look way too high to me.

Already, high-profile investment firm Lehman Brothers (which, like some other brokers, closed its books May 31) plunged in value because the market anticipated a large loss for this quarter. It will be Lehman’s first loss in nearly 25 years – and more asset write-offs are likely. Lehman will fess-up on June 16…stay tuned.

Also, two leading banks just sacked their CEOs amid mounting sub-prime losses. Wachovia got rid of Ken Thompson, who had the misfortune of buying California lender Golden West Financial for US$25 billion…pretty much at the top of the sub-prime boom two years ago.

That acquisition turned out… badly, to say the least. Meanwhile, Washington Mutual’s Chairman will “step down” according to the bank.

These are just the latest casualties from the sub-prime credit crunch, but rest assured, more heads will roll before this financial reign-of-terror is over.

So what’s ahead for earnings this quarter?

Financial stocks are expected to fare the worst, once again this quarter (surprise, surprise). Consumer discretionary shares are next in line, with an earnings hit of -10% expected this period.

There is some good news however. Energy sector stocks should post 16% earnings gains, which is no surprise with sky-high oil and gas prices. Tech-sector profits are also expected to shine this quarter, which is a pleasant surprise to investors amid a slowing economy.

Technology stocks are enjoying a healthy export boom, due in part to the falling buck, but also from healthy demand from overseas markets. Also, tech companies just aren’t as impacted by soaring raw-material costs, like rising oil prices, which does impact so many other sectors of the economy.

The result is likely to be 15%-plus profit gains for technology shares this quarter. That’s a very nice showing amid the Wall Street gloom.

MIKE BURNICK, Senior Editor & Global Markets Analyst

EDITOR’S NOTE: Right now, Mike is researching several key ways to play the technology sector for a possible double or triple-digit gain in the coming months. Keep an eye on his Market Shock Trader alerts for more updates on these stellar plays.

Source: Why More Heads Will Roll Down Wall Street

The Journal points out that after “a reign that began in February 2002, the financial sector” is no longer #1 in the S&P 500 Index. Last week, banks, brokers and other financial shares in the blue-chip index slipped to a 16% weighting.

That puts financial shares in second place, just a shade behind the technology sector that now makes up 16.4% of the index.

That’s the first time in six years that the leadership has changed in America’s most widely followed stock index.

As the article points out, this change at the top isn’t due as much to strength in tech – as to the shellacking financial stocks took in the past 12-months.

The S&P financial sector index has plunged more than 30% – or US$814 billion in lost market value since June 1, 2007. That’s the biggest loser by far among any of the 10 major sectors.

There’s a cautionary tale here for investors who believe that big financial stocks like Citigroup will quickly rebound from sub-prime woes. The technology sector was far and away the biggest sector in the S&P 500 back in the 1990’s, but suffered a long and painful fall from grace.

Tech shares peaked at nearly 35% of the S&P 500 back in 2000 then fell victim to a violent bear market that saw tech shares lose nearly 80% of their market value in less than three years. Tech stocks made up less than 13% of the S&P 500 by October 2002.

Judging from the dramatic reversals of fortune suffered by tech shares in the recent past, financials may have a lot more room to decline in the years ahead.

And since they are well represented in popular indexes such as the S&P 500 and the Dow Jones Industrials, financial sector shares could be a major drag on overall stock market performance for quite some time. Stay tuned.

MIKE BURNICK, Senior Editor and Global Markets Analyst

Source: The First Shall Be Last