It’s October – Should We Be Scared?

The month of October conjures up thoughts of market crashes and other frightful events. As we start the fourth quarter investors are wondering about the near term direction for the markets – are we dressed as bulls or bears? There are many factors that will come in play, that should clear up that picture very shortly. Make no mistake about it, regardless of whether you are a bull or a bear -we are extended and extended big time right here and now. I believe we will have some sort of correction in the near term. Its how deep and what follows that correction that matters most.

The markets staged a big run-up for the month of September. It was the best September since 1939. What happened after that run-up in 1939? Well it took until January 1945 to get back to those levels. If you recall your history – World War II may have had something to do with declines over that duration and I’m not predicting the next world war. However, there does appear to be a contest that is going on between countries across the globe to see who can devalue their currency the most and the fastest.

It appears that the US is winning the race to devalue its dollar. The stock market seems to leading the cheer for this catastrophe to happen. As the dollar declines the goods manufactured by US multinational companies are more competitive overseas. Also repatriation of foreign currencies back into US dollars can be a profitable endeavor, enhancing corporate profits as our money weakens. Oil back over $80 a barrel is another by product of a weak currency. The US consumes half the gasoline in the world. We’re pretty much a captive market for the foreign oil producing nations. As our money’s purchasing power declines – they demand more dollars to make up the shortfall – because they can! Is higher oil and a weaker dollar good for the average American?

According to the Commodity Futures Trading Commission the bullish sentiment for the US dollar is close to 0%. We, as Americans, can only hope that sentiment acts as a contrary indicator and the dollar starts to rally soon. Gold is giving all global currencies a thumbs down. Central Banks across the globe are trying to devalue their own currency, by printing more green, red, or orange dollars in their own countries flavor and using their freshly minted currency as bailout money. With the US Dollar as the global reserve currency – we seem to be winning the race currently, but is this really what we want to do?? I think not, but others are rejoicing.

As far as our markets are concerned, we have entered into one of the seasonally weakest periods of the year. Mutual Fund cash levels are at an all time low. Gold set yet another all time high Friday. Silver is at a new rally high as well. Gold and silver are fear trades. It seems contradictory that a weak dollar would drive the price of precious metals to new highs and indicate that the US business machine (as measured by the stock indices) would do well at the same time.

Technically, stock prices are at the upper boundary of a channel trend. Some markets like the NASDAQ 100 have formed an almost parabolic chart pattern since September 1st. Parabolas’ generally end and reverse into a mirror image. Daily stochastics are on a sell signal and the weekly stochastics are in nosebleed territory ready for a turn. Bearish divergence is occurring on the NYSE, RUT, S&P, and the NASDAQ Advance Decline lines. Advance / Decline divergence is a very reliable signal seen near market turns.

Fundamentally new home sales the last two months were the worst ever and second worst on record. The jobless claim numbers remain very high and sentiment seems to be getting worse. Make no mistake we are in a zone where a healthy sell off could occur. It's the magnitude of that sell off that we want to watch. Do we stop at 1122, 1105, or do we retest 1040 or more?
The real test will be what happens after we pullback and have a rally attempt. It will be interesting to watch and maybe worth a revisit! I believe the US dollar will be the key!