Making Smarter Investing Easy.

Exploring the mechanics behind the behavior:

8/4/08 - Dusting the Archives. Norman Fosback's classic book "Stock Market Logic" was first published back in 1976 and has sold over 1,000,000 copies. His insights and confidence in "beating the market" inspired countless investors into the unforgiving world of investing and provided solid evidence that anyone could consistently invest profitably. Plus through his example, he undoubtedly inspired many to pursue research into this area and thus the massive wave of computer simulations began in earnest.

So here is a current review of one of his favorite indicators - the non-member short sales ratio. In addition, the graph below also illustrates his own refinement which was in his own opinion an improved version of this indicator - the non-member to member short sales ratio. In his book, he illustrated just how prophetic these indicators were and highlighted these ratios for three different periods. He showed that they were great predictors of future stock market rallies for all three forecast periods: 3, 6, and 12 months. The problem however, is that these clarvoyant indicators are no longer reliable and have become victims of their own success. While it is true that these indicators no longer produce signals as they did in the past, it maybe time to update these indicators so that they can once again produce tradable signals. By incorporating some familiar statistical calculations/manipulations that impose statistical normalization techniques, you'll see that this former winner may still have be relevant today.

The non-member short sales ratio has effectively become useless in its original form but it can be restored to its former usefullness by simply using statistics to normalize these data. By applying the statistical z-score to the data series, this uptrending series can be converted into an oscillator. By computing the weekly deviation from the quarterly average, this difference is then divided by the quarterly standard deviation to compute the quarterly z-score. These values are then summed a 5 week rolling basis to create the 13:5 z-oscillator, which is displayed below. Below is a graph that illustrates the new 13:5 z-oscillator of the non-member short sales ratio along with the two original series that were once prominent indicators: 1. the non-member short sales ratio (raw) and 2. the non-member to member short sales ratio. As was cited in Fosback's book, the only manipulation that he applied to the data was a 10 week simply moving average, which is not displayed. As you can see, these two original data series exhibit uptrends and no longer oscillate between low and high values. They now simply rise to higher values which makes applying his rule to predict future stock market rallies useless. However, when you look at the 13:5 z-oscillator, you can plainly see cycles which highlight "buy zones".

BTW, for those of you interested, the non-member short sales ratio is computed from the NYSE's weekly report which reveals these two pertinent facts: 1. the total short sales volume and 2. the NYSE's member short sales volume. From these two facts, the non-member short sales volume is computed (via simple subtraction) and the ratio between the non-member short sales volume to total short sales volume is computed. In addition, if you wanted to compute the non-member to member ratio, then divide the non-member short sales volume by the NYSE's member short sales volume instead, which is the sum of the three groups cited in the report: Specialist, Floor Traders, and Others.

5/13/08 - Let's talk about FUEL. The obvious is crude oil, but to investors, cash is the fuel that drives markets. So let's discuss both since they are the most important topics today.

First there's crude oil. Big media is all over the record setting prices. Everyone knows prices are higher each week. This is old news. What you need as an investor is uncommon information. So once again The Small Investor's Software Co. will provide it. In summary, crude oil prices are high but commercial participants are expecting lower prices. How do we know this? Well, the answer lies within the data released each week by the Government. And with regards to the stock market, prices are also relatively high, but the amount of "fuel" (cash) to propel prices higher isn't there. Again, we turn to the Government's data for the details. Basically, the stock market rally is running out of "gas". For details read on.

Below is a graph (data source: cftc.gov) depicting what the energy industry is doing in the future's market. For those of you unfamiliar with the futures market, don't worry. All you need to know is that there are little guys and there are big guys in these markets. In technical terms, there are commercial participants and there are non-commercial participants. And fortunately for us, the government tracks their activity in a weekly report known as the commitment of traders (COT) report. In this report they summarize the long and short positions taken by all participants in a particular futures market and report the totals. Below is a graph showing what these two groups of participants are doing.

As you can see, the price of crude oil is setting record highs, but those within the industry are shorting these prices. This means that they expect the price to decline. Now in reality, they are currently losing money by holding these short positions because the price is rising while they are holding a sell position at a lower price. This may be difficult to understand for those of you not accustomed to selling short. So here's a quick explanation. If you sell short, you are betting that you can exit the market at a lower price. Your profit is the difference between selling at the higher price and buying at the lower price. If you can't, you lose money. This contrasts to what you do normally when you buy something hoping to sell it at a higher price. Normally you buy at a lower price and sell at a higher price. So these commercial participants sold short and the price of crude oil is still rising, therefore they are currently losing money. But they are so big and their pockets are so deep that this loss is calculated into the cost of doing business. So they can afford to hold onto these losing short positions for a long time.

Plus since they are "in the trade", the rules governing their activity is different from those of us little guys. This is because they actually take delivery of the commodity being traded. The rules allow them preferential treatment with respect to many aspects of money management and therefore the loss that they are currently incurring is actually less than that of a non-commercial trader in these markets. This is because the rules governing their margin requirements are different for commercial participants. Again, these commercial participants represent "the trade", which mean they are either producers, suppliers, processors, or manufacturers, which means that they need a constant supply of the commodity, or provide it to the futures market. This means that they have deep pockets and are continuously in the market, so these losses only represent temporary paper losses. You or I, with a small account would not be able to sustain such a loss for any extended period of time, but for the large Oil companies, this is how they hedge, or control production costs. They lock in prices by using the futures market to stabilize their costs. This is a gross over simplication of the process, but hopefully this provides enough background to make the point that these temporary losses are not threatening these commercial partipants financially. Remember that these commercial participants are the most knowledgable and closest to the source of information that governs this market. So they have access to knowledge and information that others don't. They are the one in the back rooms making the deals and then implement strategies to capitallize on those deals. But collectively, they tip their hand and show the rest of us what may be lurking in the near future. Because afterall, they can't enter these markets to consistently lose money. At the end of the day, they need to make money or else they cease to exist.

In summary, the graph shows us that the commerical participants tend to anticipate market turns earlier and you'll notice that when they are heavy net buyers, prices eventually rise. Conversely, when they short the market, they anticipate declining prices. Currently, these commercial participants are heavily short. (Bet you didn't know that!)

So while the news is telling you what you already know, this graph is showing you what is really going on behind the scenes. The industry is expecting a drop in prices. You may ask why would they expect prices to decline particularly when the summer season in America is traditionally a season for increased demand in gasoline, and the answer lies with their expectation for global demand. They are already anticipating a major global slowdown plus they are discounting any current disruption in supply, which is temporarily lifting prices. They are betting that output will resume to normal levels and that there will a temporary over-supply condition.

However, the anticipated continuation of the current slowdown is the most important component based on the following facts. The USA continues to slowdown in consumption which decreases the need for deliveries and decreases the energy demand from manufacturing. Plus Americans are now driving less and are actually starting to implement energy conservation strategies. These are having a real impact on energy demand. In addition, as consumers spend less, this reaches over to China causing them to slow down and consume less energy. Plus, as the frequency of natural disasters increases, the destruction that follows causes the devistated areas to stop using energy. Next, China is increasing the value of its currency in an attempt to fight inflation in China, but that means higher prices for American consumers. Economics 101 states that this will only add to China's slowdown as American consumers buy alternative products to avoid higher priced Chinese goods. This scenario is driving the behavior of commercial particpants as they look forward.

So back to fuel. The activity of the participants in the energy market is showing us another story besides rising prices. This leads us to the other fuel - cash. As investors know, the stock market is driven by expectations but it is also driven by cash. Without cash, prices can't rise. So below is another graph (data source: Investment Company Institute) that shows you how much "fuel" is available to drive stock prices.

The graph below showing you how much cash is flowing into and out of a class of Mutual Funds call the Money Market Funds (MMF). In simple terms these are similiar to checking accounts but yet are different in many ways. For one they are not FDIC insured accounts, but as of today no money market mutual fund has ever went bankrupt. They are generally considered safe, but there is that small detail for those of you that weren't aware of it. There are other differences but that's getting off point. Basically, ICI summarizes the activity in these funds and reports their activity on a weekly basis. So below is a graph of the activity for the past four years.

As you can see, The Small Investor's Software Co. is bringing to your attention a startling fact that isn't being reported elsewhere. Notice how the behavior has significantly changed in 2008 from the earlier years. For one the volatility in the flow of cash is dramaticly different and is showing you how fast 300 Billion dollars has been lost since Feb 2008. This dramatic drop in MMFs can mean one of two things. One, the money was transferred back into the stock market. (The recent rise in stock prices is associated with the outward flow from MMFs) Or two, Americans needed the money to pay bills. In either case, the result is that there are fewer dollars remaining to invest in the stock market moving forward.

It's simple. The amount of cash, or fuel, to propel stock prices higher isn't there and individual investors appear to be tapped out. So where will the money come from to sustain higher prices? The obvious answer to this is from foreign investors. However, if the US dollar gets stronger because of China's revaluation of its currency, the Yuan, then foreign investors would lose money if they invest in the USA as their currency devalues. So a strengthening USD would initially spark a foreign buying spree so that they could buy hard assets (land, real estate, raw materials, companies, etc.) as cheaply as possible, but buying paper assets, such as stocks would be riskier because those investments would be subject to currency risk.

In an effort to answer the question posed by the graph above, how much of that 300 Billion went back into investments? The graph below attempts to provide the answer. The graph below plots the weekly cash flow into and out of the other categories of funds. In particular the two major categories are equity and bond funds. This graph is constructed in the same manner and shows you the same period of time.

In this graph below, the cash flow from other mutual fund classes is summarized. (data source: amgdata.com ) In this graph, the 8 week sum of the weekly changes in equity, bond, and municipal bond funds are plotted. As you can see, equity funds saw an increase in cash flow of approximately 65 billion from the end of Febrary. This implies that 65 billion of the 300 billion lost in Money Market Funds went into equity funds which includes ETF funds. This leaves 235 billion unaccounted for other activities. Plus as you can see, bond funds had a net decline of 8 billion which changes the net MMF total to 243 billion. Then if the change in Municipal bond funds is included (+1.5 billion), the net MMF total is 241.5 billion that is unaccounted for.

Note that these graphs only track mutual fund activity and that they do not include individual investments outside of mutual funds. So some of this 241.5 billion could be used to invest directly but that this amount can't be determined. However another major expense that can be accounted for occurs every year around this time, and that is taxes. According to daily treasury statements released by the US Treasury Dept (source: fms.treas.gov), 471 billion in federal taxes was collected between the end of February and May 13, 2008. However, most of this represents the weekly withholdings that employees must pay. But it appears that the Government collected an extra 60 billion around April 15. So the 241.5 is adjusted to 181.5 billion and this figure of 181.5 billion represents a transfer of funds that can't be accounted for. Perhaps most of it was invested directly into the stock market, but this is pure speculation. It could also be that Americans had to withdraw cash to pay closing costs and other associated fees as they attempted to refinance their sub-prime mortgages. Time will tell. However, this exercise in tracking the flow of cash from the total money market fund pool of money is real attempt to quantity the flow of money and how much there might be left for any future stock market rally. In summary, the money market fund market lost 300 billion dollars in 8 weeks and we also know that 65 billion definitely went back into the market. The rest is subject to interpretation. But as for how much more money will be available for future rallies. The graphs show us that money is hard to find and investors have put in as much as they have into stocks as they have in the past. This implies that this rally has run out of "gas".

5/2/08 - Spring is here. Of course you know that. Everyone knows about the Earth's seasons. But as an investor do you about the earnings cycle? Chances are you look at investments as single entities without regard to the "big picture". But it would be in your best interest to consider where you are in the earnings cycle when buying and selling investments. Below are two charts that illustrate two aspects to the earnings cycle that you may not have been aware of.

The first graph simply illustrates the ebb and flow of company earnings reports. Every day companies release earnings, and generally you're not interested in them, but what if you collated all of these reports and tabulated them. Well, below is the result of those tabulations so that you can see when most companies report their earnings. This by itself is useful, but also notice how well timed these peaks occur with the intermediate trends of the stock market. It's no coincidence that these two are correlated and therefore you should be aware of this association. Of course, you probably suspected this correlation but you couldn't find the information anywhere on the web. If it weren't for The Small Investor's Software Co. who would bring this information to you?

The next graph actually tracks how many companies are making more money as compared to the previous quarter and tracks how many companies are making less. Basically, the graph below is showing you how many companies are doing better and worse than they were last quarter. But rather than show you the raw number of companies, this information is put into the context of how many companies reported earnings for the day. Therefore you can see the proportion of companies reporting their results relative to the others reporting for the day. In essence, these proportions show you the percentage of companies reporting increasing profits and decreasing profits. And if these earnings reports are related to stock prices then higher daily percentages of companies reporting improving earnings should be correlated with higher stock prices. Conversely, if more companies are making less money than this proportion should be less. (You'll see that this is true.)

The graph below illustrates two ratios named the positive and negative ratio. The positive ratio represents the daily percentage of companies making more money while the negative ratio represents the daily percentage of companies making less money. Remember that these ratios represent changes from the previous quarter and not simply the positive or negative results reported for the current quarter. These ratios represent deltas not current earnings data.

These daily ratios are then summed on a rolling weekly basis to smooth out the irradic daily fluctuations, and the resulting plots are depicted below. Once again, no where else on the web will you find data collated from thousands of companies presented in this fashion. But below you can see the dynamics of the positive and negative ratios and how they are correlated to stock market prices. As you can see in 2007, on a daily basis the percentage of companies reporting that they made more money was greater than those companies making less money (hence stock prices remained high). In 2008, these ratios have flipped and now the daily percentage of companies reporting that they are making less money is greater than those companies making more money (and now we have lower prices).

So why do you think the stock market is currently rising in price, despite the fact that more companies are currently making less money? As you can imagine, the current disconnect between earnings reality and stock prices will be resolved soon. But since the stock market always looks for forward, you can guess that the current expectations are high that the current earnings reality will change. But what if it doesn't change?

As evidence that this may not change, below on this page is another graph that shows you the current proportion of companies producing stock prices higher than one year ago is only 23%. In addition, the Federal Reserve Bank's recent actions were greeted warmly from investors, but that interest rates are as low as they can go (look ahead and you'll realize that interest rates can only remain the same or go higher). Now add to this the underlying reality that most companies are not performing well. This means that they are not making record profits nor are they making more money than they once did. So how can stock prices be so close to all time highs when the fundamentals such as low rates of returns, higher inflation, declining sales, declining profits, dwindling consumer credit, dwindling personal wealth, and stagnant personal incomes are restricting the available pool of money to invest in stocks?

This truly is a highly speculative environment for investing in any paper asset whether it be stocks or bonds or whether it be issued from a company or a govenment (future higher rates would be bad for current bond holders). Successful investing requires that you assess your risks so that you can invest your money commensurate with the level of risk that you can live with. If you believe that the summer housing season will be better than last year and that the President's Economic Stimulus plan will stave off further slowdowns in economic activity, then ask yourself how much higher will stock prices move from here? The SP500 has already moved 130 points higher off the recent lows, so what's left for you? And if you're fully invested, ask yourself how much higher to you think the stock market can go?

Secondly, from another point of view, here's another negative risk factor. The market has retraced more than 50% of the last downward leg. So if you apply the fibonacci rules of swing trading, this tell us that the stock market is at a resistance level and the market is at a turning point.

Third, after carefully studying the graph above did you notice that prices declined after each earning season since last summer? That's four quarters of investor dissatisfaction in a row. So do you think the news is going to be surprisingly good this quarter when there are daily ecomonic reports being released confirming the economic slowdown has not abated?

Fourth, let's add in political uncertainty to this earnings cycle with regards to the next election in November. We've now entered the final 6 months to the election and the amount of pandering will increase at the expense of corporate America. It's politics 101. Look at your own community. Did you ever notice that new playgrounds get installed during an election year?

Fifth, another cycle of sorts is about to begin and that's the supply of stock cycle. Every spring, the supply of stock expands during May and June after everyone files their taxes and puts money into their IRAs. This can be seen in the SPX supply of stock graph posted on this website. Increasing the pool of available shares that can be traded adds pressure to deflate prices. So companies try to time this event in the spring when most investors enter the market. Therefore, if less money is invested in the stock market then the pressure exerted by the increasing the number of shares will have a greater impact. Of course, since companies are making less money, it could conceivably be a season in which the supply of shares increases very little compared to previous years when both companies and investors were optimistic.

The evidence is there and those who use it wisely will keep more of their wealth than others.

4/24/08 - Our primary webhost provider is experiencing a major disruption in service, which caused us to switch to a secondary webhost provider. This drastic step creates a delay lasting up to two days as the new nameservers get propagated to all of the DNS servers on the internet. For those of you familiar with the operational challenges in getting a website restored, you can appreciate this mandatory waiting period. For those of you unfamiliar with the mechanics of the internet, let's just say that when the computer that your website resides on breaks and the company that you hired to maintain the hardware experiences a catastrophic failure, (such as a building collapse, a broken utility pole, a flood, a tornado, etc.) they can't switch to their backup servers because they are also broken. At that moment, the only way to get your website up a running is to find another computer that is working and move your website to the new working computer, which can be anywhere in the world. The problem however, is that the name of your website is associated with the old broken computer. Basically, the traffic to your website is still being sent to the old address. The problem is that after you inform the postmaster (your domain registar and the accompanying DNS servers) of your new address, the news of your new address spreads to all of the other computers around the world. This unfortunately takes approximately 24-48 hours. It's funny that computers which operate at the speed of light and process requests in terms of nanoseconds, still take 24-48 hours to update their databases with the new address. It's just the way it is. So in summary it takes up to 48 hours to notify every computer in the world that you've changed your address, despite the fact that you can physically change your website's location (for example from Orlando, Florida to Seattle, WA) in one minute.

4/20/08 - Whew, Income Tax season is over. Who cares? Well, as an investor you should. But not for the reasons you think. Generally, taxes are viewed in the context of funding many worthwhile programs and that taxes fund these budgets at all levels of Government (local, State, & Federal). But let's flip conventional wisdom regarding taxes upside down. Let's examine tax receipts to the Government from a new perspective. Let's forget about tax rates, and how the money is being spent and focus on the mega-trend of largest and most important pool of money amassed each year and what it means to you as an investor.

The graph below simply displays two simple moving averages of the Government's daily Federal Tax Deposits. The quarterly and annual moving averages are displayed along with the SP500 Index daily close. As you can see, the peak quarterly receipts made a higher high each year for the past four years. However, this year's peak was only slightly higher. And compared to the same day last year , the quarterly moving average is slightly less than it was a year ago. As for the annual moving average, it has flattened out for the first time in four years. In addition, March 2007 saw an 8.5% increase in receipts while March 2008 saw only a 3.6% increase over the previous year. This is a 43% reduction from 2007!

These facts by themselves give everyone concern because salaries appear to have "topped out". So the current perception in Washington isn't rosy, and both Government and Corporate America are anticipating bad times ahead. In typical fiduicary double-speak, "we would expect less growth next quarter". But in reality, the mere perception that the good times may be over has an enormous impact.

Commentary

We all hate to pay them, but our economy depends upon taxes because the US Government is the largest employer and is the "great distributor of wealth". Basically, we pay them to give our money to someone else. (I know we do get some services, but that portion is becoming less each year.) A kinder definition of Government is that they we pay them to manage services that we all need to share, and they can't be fired for doing a bad job. (yes we can elect new policitians to replace the incumbents, but since there is no mass over haul of incumbents, the newbies represent the minority and they are therefore powerless to change the system.) Regardless of how you define Government (ask a poli-sci major for a real definition) it's simple, if Government can't raise enough money, they will go broke. So tax season is a big deal for politicians and their budgets.

So like any other business their forecasts and projections are predicated on past receipts. So let's look at the Federal Government's income side of the balance sheet and examine the Federal Tax Deposits (Source: Federal Reserve ). In short these data provide many insights for you as an investor. Whether you consider these facts as an indication of our Government's solvency, or as a proxy for personal income data, the rate of change of this metric is closely watched by those in Washington. However, the most valuable aspect to these data is that these tax receipts are the only public record of all employees salaries. This is only place where you can see a total daily summary of all federal income tax witholdings. In one fell swoop, you can determine whether or not total income from millions of employees (salaries) are rising or falling. Now these data don't tell us how many employees are paying taxes, but from a statistical point of view, this is somewhat less important since these values encompass over a hundred million employees. The mega-trend to follow here is whether or not employees are paying more or less taxes, which is directly correlated to their salaries.

If employees pay more taxes, then it can be said that they earn more. But these data can't tell us if employees earned more because the number of employees isn't known. And if additional employees were hired, more employees paying taxes would also cause the tax receipts to increase. So an increase in these doesn't let us state that employees earned more. But again this becomes irrelevant, because we're not interested in the employees perspective here. We're interested in two other perspectives - Government's and Corporate America's. So even if employees didn't earn more and more employees were hired, the fact that the economy is growing is what both Government and Business are interested in, and that's what is implied when tax receipts are up. (Your slice of the pie is irrelevant to them because in a Democracy, you're expected to fight to survive within the context of the law.)

It's a simple statistic and the simplicity of this is that it enables you to see the "big picture" from Government's perspective. In fact, they are only interested in the total pool of money that can be spent. So if personal incomes are rising, that's nice, but that's irrelevant to them. The only fact that policy makers are interested in is whether or not the large pool of total salaries is increasing because it means that revenues to them are increasing. The Government in this respect acts like any other business. If revenues are down, then their bottom line is less. So they become concerned only when the total pool of salaries, which affects their tax receipts, shrinks. And this is what all of the hullabaloo is all about. The current banking crisis has interfered with the Governement's tax receipts.

However, what's more important is what rising tax receipts mean to those who control the lives of employees And it's their perception that counts. If the Government's tax receipts are rising, then everyone's outlook is brighter. So from the Government's perspective, it means that they can continue to spend and it validates their projections. Plus, if tax receipts are growing then politicians are inclined to believe that their policies are working. Growth is good, so they will continue down the same path until proven otherwise. Like to old adage says, "if it ain't broke, don't fix it.". This is why it takes politicians so long to take action. It's because of their "wait and see" approach to all things. Well, as you can see from the graph. Something is broken and they can now see it. They finally have proof that their policies have gone awry because they are noticing that they are taking in less money. So they need to act and fix something. Did you ever see the White House, Federal Reserve, and Congress work together before?

From Corporate America's perspective, their upbeat outlook is validated by increased revenue, and when they make more money, it usually means that employees make more money. But what's not so obvious is that everyone's outlook for the future is understandably "rosier". Forecasts and predictive models would point to future gains with the expectation that next's year would be a better year financially. And this would give those in executive postions the confidence to expand or at least allow them to expect increased sales/revenues, which facilitates indulgences from their wish-lists. This last point is important because it dictates the behavior of millions of companies. If they have the perception that business is good, then they are more likely to borrow and spend. Afterall perception is everything, and as an investor you need to be aware of the current perception facing Corporate America.

Just imagine one million CEOs changing their minds nearly simultaneously to the new reality that they need to respond to reduced sales/revenue. The first casualty will be plans for expansion. So there's a reduction in sales for someone in the construction industry and office supply. The next fallout could be lay-offs or downsizing, which leads to other cost cutting measures. These events all lead down the same road - less spending which permeates quickly to "Main Street". The mere "hunch" that things aren't going to be better, is enough to force executives to "dig-in" which will slow the economy simply because of their increased conservative outlook. The fact that perception can influence economic output is real and when that perception is amplified by a million CEOs, the effect becomes a self-fullfilling prophecy.

But this graph shows you that Americans have slightly more money than they did last year, so where's the problem? In actuality, they don't have more money to spend because of inflation. Simply put, the average employee's purchasing power has declined due to the effects of inflation. Basically, since the total amount of money that each family can spend is nearly the same as it was last year, they will be forced to buy less with the same dollars they had last year because each item costs more. Therefore, this translates into a real reduction in sales, not "less growth". Plus we already know that millions of employees have lost their homes, which means that the financial sector's gross receipts must be lower because there are fewer mortgage payments being paid. This loss of cash flow to the related sectors of the economy will impact even more employees as those employees within these sectors will feel this loss of cash flow immediately; whether it be through lay-offs or a reduction in compensation (no bonuses or commissions this year). This then causes the contagion to spread throughout the economy affecting an ever increasing number of employers and employees. Therefore, the fact that tax receipts are flat is only a harbinger for more bad news to come. That's why the FED and the White House are working together to mitigate the impending disaster that no one is publicly talking about. Why else would Congress, the White House, and the FED all act so swiftly? One, it's because they are really scared, and two, they can't afford any loss in revenue (tax receipts) because this will impact their ability to repay their loans (Treasury Notes). The direct consequence of all of this is reflected in the value of the US dollar. Hence, that's why its value is dropping like a stone.

As an investor, assessing the perception of Corporate America is important and as you can now understand, no one is wearing rosy glasses. And so you must consider the possibility that the recent bounce in the stock market indices will be short lived as the reality of fewer "dollars to spend" (despite the White House's infusion of cash via the economic stimulus package) permeates the economy.

Tax season may be over, but the next "housing season" is about to begin. The question to you as an investor is will the cash infusion from the economic stimulus package be enough to replace another poor "housing season"? Now, that's real speculating. If you answer this question correctly you'll be the big winner on Wall Street next quarter.

PS - Hopefully, you're starting to see how all of this fits together and why the stimulus package checks are being sent out this summer. These checks are being timed to minimize the economic impact from another dismal season when most American move - exchange one house for another. These summertime handouts from the Government are supposed to replace the lost dollars that Americans would spend on new items for their new homes, which they did not buy. Will it work? The recent rally on Wall Street is evidence that some investors are betting that it will. What do you think? Remember successful investing is about looking ahead and hopefully these insights illustrate how professional traders use information to look ahead. And you thought paying your taxes was hard. Whew, What a tax season?

3/26/08 - Fibonacci revisited. Despite the fact that the "Bear" has awakened from hibernation, technicians are well aware of the of the Fibonacci principle behind all market swings. Below is a graph that reminds those "bears" out there to be mindful of important technical events that will revitalize the "bulls". For those of you unfamiliar with Fibonacci expansions and retracements , please google the web for more information. The important fact to know is that despite the news which caused the recent bounce (Federal Reserve intervention), technical traders viewed this event from a different perspective. It just so happens that the "big save" by the FED coincidentally occurred at a Fibonacci turning point, which caused many technical traders to "buy-in-to" this rally. Here's the graph to explain what Fibonacci traders have been expecting. They have been waiting for a low near 1254 (38.2% retracement) and another major low in the neighborhood of 1161 (the 50% retracement). So the intermediate "buy zone" is between 1254 and 1161. But as Fibonacci traders know, all rules are meant to be broken. Just look at the down trend from March 2000 to the low of 2003. It had several large swings until it reached the low of 769. I have to ask you Fibonacci traders, will the market break the 50% retractment and go for a total retracement in an attempt to retest the previous low of 769? Or will this current "buy zone" be the next launching pad to new highs?

Commentary on the current Fibonacci Retracement zone quandary.

Here are some mega-trends to consider in making an educated guess ....

1. Interest rates are extremely low. The reason for these low interest rates is contrived and they are not due to natural market forces. While these low rates are meant to spark economic activity, they also act as leading indicators for future stock market performance. Wall Street isn't going to give you 15% annual returns in an environment when risk-free Treasuries are offering 1%-4% returns. History tells us that the rates of returns between bonds and stocks move in tandem. [BTW, here's the reason why Wall Street can't offer 15%-20% returns. If they were to do that, then no one would buy Treasuries and our Government would default on their loans. And if our Government can't borrow money (because they "stiffed" the previous borrowers) then the game is over - buy a gun and try and keep what's yours.]
2. The economic stimulus package is a shell game. The goverment is giving away money it doesn't have. Increasing the future burden of borrowing.
3. Europe is the economic powerhouse today and the value of the US dollar proves it.
4. Brazil, Russia, India, and China's (BRIC) economic output is growing so fast, there are bound to be "hiccups" and "bumps" in the road ahead, but these problems will be trivial as they improve their citizens incomes and increase their global market share. Simultaneously, expect the USA's status as a major economic force to decline. This is already evident as the number of international transactions in US dollars is dwindling.
5. The USA's demographics tell us that more Americans will become non-producing laborers as they enter retirement while those countries "formerly known as third world countries" (the BRIC) are bringing billions of new laborers into the market.
6. Banks have already begun the transfer of wealth and the destruction of individual wealth as predicted by President Andrew Jackson 200 years ago. Americans are losing their biggest single asset - their home. The persistent weakening of the Glass-Stegall Act at the hands of our elected officials has brought this travesty upon us.
7. Wall Street's recent "bear market", is destroying Americans second largest asset - their savings / pensions. This is the root of all American anxiety that no token hand-out can cure. The lack of consumer confidence is deep and profound when all you have is withering away.
8. Our government has announced the dire status of Medicare and Social Security, and continues to waste Trillions. Who will pay these bills? Corporations are paying less of their share each year and the taxpayer is more in debt than ever. Interestingly, this is the same problem that the banks are in. In summary, defunct homeowners can't pay their mortgage and the bank can't find anyone to buy their foreclosed home. So the bank's money is tied up in hard assets that can't be converted into cash. Hence the current banking crisis. However, now with respect to our government, just replace our government with the homeowner in the previous synopsis. The situation is exactly the same except that the government can print more money. If the taxpayer becomes so poor that they can't pay their taxes, who will. Secondly, if the taxpayer is poorer then the amount of money that the Government can collect is less. If the taxpayer earns less, then their taxes are less. In this scenario, you have to ask how will the government be able to continute to spend money? The answer is that they can't. And when this happens, the jig is up. Our government will be forced to stop spending, or print money. But our Government in the mean time is borrowing heavily and needs taxable revenues to pay off those debts. When the governement defaults on these debts, then who will we borrow from? If no country on the planet buys our debt, then the USA will default. Just like a bank fails, our government will fail and our creditors will own us (China, Japan, & OPEC). However back to printing money. You can only print more money for so long before the other countries of the world decide your currency is worthless and they avoid you like the plague. So printing money will work for only a short time before the system breaks. As a reminder, just ask the Germans about their currency during World War I - the keyword here is hyper-inflation. Now put this all into context and now you understand why the US needs to exert control over the world's fossil fuel trade (middle east). If we still control or influence the energy market, then the world has a reason to respect our currency.
9. Our government has not taken steps to develop a new economy to grow our way out of the current maturing/aging one. The PC economy is 25 years old and the internet economy is nearing 15 years old. It hasn't latched on to a new industry similar to Europe's championing renewal energy or south Asia's electronics industry.
10. The underlying summary is that when the USA is viewed as a company, here are its facts:
    1. Sales are down. Consumption is waning.
    2. Profits/tax revenues are down.
    3. The number of employees are declining.
    4. Debt is rising.
    5. Production is down. Even the last bastion of manufacturing (building homes on American soil) is down.
    6. Intrastructure is obsolete and needs replacement (this of course can be a positive if it weren't for the fact that as a country we're broke and we've maxed out our credit limit from the world).
11. Climatic events will only introduce more chaos and destruction of property. These events will also have the potential to alter food and water sources, which will alter the balance of power and influence. All of which will change the status quo. For example, what if the USA's grain belt becomes a dust bowl? As you can see this is highly speculative, but given that the world's energy markets now routinely spike on any hint of extreme weather, these events are more likely to become an increasing factor as the world's resources become scarcer.
12. The world's population will grow from 6 billion to 9 billion people in less than 50 years! Projections indicate that these new inhabitants will not be Americans, which makes us even more insignificant as a country as our share of the world's population diminishes.
13. Everything on the planet is now a commodity. There are too many people on the planet and in just 50 years there will be 50% more of homosapiens. We see it already in the middle east. We're fighting to protect our way of life which is based on fossil fuels. These battles are expensive and we're borrowing to proscecute these wars. Second, the next fight will be for water. The Southwestern US is already "duking it out" over water rights and the fight in the East has begun between Tennessee and Georgia. Look for more turmoil over this single most important commodity.
14. Finally, the country with the perceived highest standard of living can no longer maintain this status in the context of having the G-7 expand to G-20, who are all competing for the world's limited resources. The "pie" is being sliced into smaller peices and USA can no longer keep such a large share of it.

A final thought. What hope does America have to maintain this high standard of living when it borrows to keep this status? Now put this into the context of future investor expectations and there you have it, the likelihood of a higher high is low, but then again ask an investor who was around in 1907. See what they have to say?

3/26/08 - Deja Vu - Why history matters? The question of the day is, does history repeat itself? Compare the graph below to the graph above. Do you see a similarity? Well, you should. The graph below depicts the DJIA's reaction to the banking crisis of 1907. Isn't it a remarkable coincidence that we also are in a banking crisis a century later?

Here's a graph from the archives of the DJIA. The chart below shows you the DJIA from 1903 to 1913 and how the market reacted to the banking crisis of 1907. Yes, in 1907 there was a run on the banks and a real crisis of confidence emerged. To be blunt the Federal Reserve at that time didn't react swiftly and decisively, but fortunately, JP Morgan, the man did. He nearly single-handedly saved the banking system back then and you can read all about it in the book "The Panic of 1907: Lessons Learned from the Market's Perfect Storm " by Robert F. Bruner and Sean D. Carr . It's unbelievable, but even the participants are the same a hundred years later. Of course today's banking crisis is different from that of 1907. The banks didn't default because of sub-prime mortgages, but in both cases banks crumbled and huge fortunes were lost.

As for the reaction from the FED and the White House, well, back then in practical terms, there really was none. The President was of the opinion that those scoundrels deserved it and the FED reacted too slowly. Interestingly, the FED at that time was also concerned about the impact on the US Dollar and tried to shore up its gold reserves, but in the day steam ships and telegrams, the transfer of badly needed cash took more time than the banks had. The gold was enroute but not in the vaults when depositors needed it. Depositors were withdrawing funds at such a pace, hundreds of banks went broke daily. In contrast to today, very few banks have collapsed and the FED responded in earnest, and creatively, to inject several hundred billion in liquidity to prevent a meltdown. This is diametrically opposite to how the FED responded in 1907. As for the White House, this time around they're joining in and giving away money. So there you have it. Two different crisis with two different reactions that only have a 100 years in common. So why is it that the DJIA's prices produced two price patterns that are so similar? One can only wonder and speculate. But the facts say that it isn't reasonable to expect the same outcome, but there it is. And so, one can't help but wonder and speculate.

As for the graph, notice the decline after the second peak. That's where we are today in 2008. And the yellow zone shows you the prices from 100 years ago, which coincidentally represents our future. Is the yellow zone our "crystal ball"? Only time will tell, but history is showing us that chaotic prices are more likely than a hopeful rebound to new highs. History class is now over. Go speculate.

2/19/08 - How about a new definition for a "Bear Market"? Would you consider it a bear market if 75% of all stocks trading at least one year were lower in price? Who would tell you if this condition occurred? Who would warn you? As always, The Small Investor's Software Co. will. Remember, you read it here first. BTW, who cares about a recession when you have a "bear" in your backyard?

Traditionally, the definition of a Bear Market is a 20% decline in the major indices. So a 10% loss is a correction and doubling this loss means that you're wrong. A 20% loss in the major indices implies that most investors are losing money. However in the new information age of computers and the internet, tracking gains and losses from thousands of companies is easier than ever. So why not just produce a graph that shows the tally of companies that are higher/lower in price. As you can imagine, the problem here is in deciding higher/lower from what. Well, how about tallying the number of companies that are higher/lower in price from one year ago. This arbitrary unit of time seems fair since companies always disclose year-over-year comparisons.

The problem is that nobody shares this knowledge with you, and as ususal, The Small Investor's Software Co. will once again be the first to share with you the number of companies that produced stock price changes that are higher from one year ago and those that are lower than one year ago. These tallies only reflect companies that have been trading for at least one year, and as for the historical data, the chart shows you the tallies from only those companies that are still trading today. The historical data doesn't include data from those companies that are no longer in existence. Hence the total number of companies represented on the graph decreases as you move back in time. In 2004 there are 4,700 companies while in 2008 there are 6,600 companies. So from just these data it implies that slightly more than one quarter of all stocks trading today are new companies (interesting fact for any investor) from just 4 years ago. However in actuality, this percentage is much higher because there are 9,300+ stocks actively trading on US exchanges. This means that 2,700 of them have been trading for less than one year. So if you combine the 1,900 stocks that have been trading for more than one year to the 2,700 newbies you get 4,600 new companies in four years, which means that a full half of all stocks trading are new stocks. (I bet you, you didn't know that.)

(As a caveat to all of this, think about this [again more brain food - new information to process] 1 out of 2 stocks trading is new, which implies that these stocks have no prior history or any proven track record from which to assess their risk. As an investor, you always need to evaluate your risks before investing and if you can't then you should walk away from the investment. Ask a venture capitalist about investing. They only invest when they believe it is near a sure thing and they still lose 8 out of 10 times. So how are you going to assess the risks involved with a new company? [seriously ask yourself this question] Therefore, the volume of new companies inherently makes the constituency of the current stock market riskier than ever. Now add to this the fact that 3 out of 4 of all stocks trading are lower than they were one year ago. Your job is to now decide whether or not these riskier investments, which have shown investors that they are not solid investments by virtue of the fact that they are lower in value, represent bargains or not. How are you going to decide which of the 25% of the 9,300 actively trading stocks [see the graph below which shows you that only 25% of all stocks will produce gains of 10% or more] are going to be winners next year? Again ask yourself how can you be sure that the company you select is going to grow its business in this climate and be more profitable?)

Back to the task at hand. The goal of this graph is to make the case for a new definition for a Bear Market, which might actually reflect the odds of success that investors have had over the past year in finding companies whose stock prices are higher than they were one year ago. Currently, 5,000 stocks are lower in price from a year ago and only 1,600 are higher in price from a year ago. That means 3 out of 4 stocks are lower in price. We'll leave it to you whether or not the definition of a Bear Market should be changed from the simple 20% decline in price of the major indices. Afterall, your the investor. What's in your wallet - profits or loses? PS - you're not alone.

2/4/08 - Reality Check - it ain't pretty. Let's look at the universe of stocks that trade on the three major US exchanges (NYSE, AMEX, NASDAQ). The only criterion used to select stocks for this summary was if they were trading for at least one year. Each was then simply categorized as either up or down from last year's price and these data were converted into a proportion of stocks rising. The graph below shows you the proportion of stocks (1,900 out of 6,700) that rose in price from one year ago for the last 3 years. As you can see the proportion of stocks producing gains from a year ago acts like an oscillator and it is at its lows of the last three years.

This means that 71.6% of investors who invested one year ago are losing money. Add to this fact, that many Americans are facing foreclosure; personal incomes have dropped; personal savings are down; what's left of their home equity is gone; expenses are rising; personal debt is rising; and the fuel (money) to propel stocks higher just isn't there. The stock market needs new money to enter the market to keep it going, and if no money is flowing in, then it will be easy to predict that fewer bids means lower prices. Bargains-R-Us is now open for business, but who can afford these bargains? Whose got money to buy stocks?

1/22/08 - What are your expectations? Did you ever wonder how many stocks doubled in a year? (260 out of 9374) Did you ever wonder how many stocks gained and lost? Well, the two graphs below delves into these questions and shows you how prices changed for 9,374 stocks from one year ago. Basically, 35% of the stocks on the three US exchanges rose in price while 65% dropped in price. So if you thought that picking a stock is a 50:50 proposition well you're wrong - it's 35:65 or 1 out of 3 not 1 out of 2.

The first graph focuses on the dramatic changes of the last two weeks, which illustrates how the universe of stocks was affected as a whole. And the second graph, shows you how stocks performed over the past 365 days. In both cases, your odds of selecting winning stocks is much lower than you would expect. In addition, did you know that the average stock gained only 2.1% over the past 12 months? This paltry gain is less than the 5% you could of earned had you invested in bonds. Did you consider investing in bonds? Did you avoid bonds because a 5% return wasn't high enough?

So it goes back to your expectations. What do you think you can earn investing in stocks? Use these graphs to compare your expectations to the current reality. and hopefully, these facts will assist you in realigning/calibrating your goals.

Previous explorations into the mechanics of market behavior:

Charts introduced in 2007
Charts introduced in 2006
Charts introduced in 2005
Charts introduced in 2004