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Special Alert: America On Sale

(January 16, 2008)

Dear Subscribers and Readers,

There is no other way to put this – but yesterday’s selling on the US stock market was very intense.  The S&P Financials sector was the worst-performing sector, declining 3.7% for the day.  Energy, pricing in a global economic slowdown, declined 3.5%.  On a year-to-date basis, the three worst-performing sectors (out of a total of ten sectors) on the S&P 500 are information technology (-9.34%), consumer discretionary (-9.21%), and financials (-7.99%).  The S&P 500 Index, on the other hand, was down 2.49% for the day and 5.95% on a year-to-date basis.  It has gotten quite ugly out there.

The upshot to all this is that the US stock market – especially the financials and consumer discretionary sectors – is now severely oversold.  To put this in perspective, let us take a look at our Overbought/Oversold Model for the various S&P 500 sectors (this model is constructed using the same methodology as utilized by our Global Overbought/Oversold Model, which is discussed in our December 6, 2007 commentary).  Note that we have utilized January 15th data in place of January 2008 month-end data:

S&P 500 Sectors Overbought/Oversold Model as of January 15, 2008

Using this methodology, both the consumer discretionary and financials sectors are now at their most oversold levels since September 30, 2002.  In fact, on a 12-month moving average basis, the financials sector is now at its most oversold level over the last 10 years (this model uses 10 years worth of historical data).  Looking at historical data going back to October 1989 (S&P has only regularly published sector returns data since that time), one would have to go back to October 1990 in order to witness a more oversold level in the consumer discretionary sector on a 12-month MA basis.

As I mentioned in our discussion forum earlier yesterday, there is always a possibility we could be entering a “full-fledged bear market” or crash as early as next week.  In the prior scenario, subscribers should remember that even during the 2000 to 2002 bear market, the bounces off the severe oversold conditions of May 2000, April 2001, September 2001, etc., were strong and highly profitable on the long side.  We are at such an oversold condition right now.  In the latter scenario, there is no doubt that many investors are now in “full panic” mode – which can be conducive to a stock market crash.  In both cases, I would argue otherwise, given that there are now two strong tailwinds that the U.S. stock market has which was not in place in October 1987, August to October 1998, or during the 2000 to 2002 bear market:

  1. Valuations: Based on both straight P/E ratios and the “Fed model,” the current U.S. stock market is now significantly more undervalued than it was during those time periods.

  2. Valuations in the U.S. dollar – Based on power purchasing parity basis, and based on global equity allocations, the U.S. Dollar Index and U.S. dollar-denominated assets, in general, are now undervalued.  Again, this was not in place during any of those three scenarios.

In the short-run, a strong tailwind is mutual fund inflows from pension fund money, which we have previously discussed in our commentaries.  They should have gone into many defined benefits pension trusts across the country at the close yesterday – those funds should be put to work as early as this morning or at the close today.  In other words, there should be an upward liquidity bias in the stock market over the next several days.

Moreover, in our last “Special Alert” on January 9th, we had discussed the oversold condition in the NASDAQ Composite – based on the number of new 52-week highs versus new 52-week lows.  Since January 9th, not surprisingly, the NASDAQ Composite has continued to get more oversold.  An additional metric which I have been tracking is the percentage of stocks on the NASDAQ trading above their 200-day EMAs.  The following chart, courtesy of, shows this metric over the last six years:

Percent Nasdaq Stocks Above 200/50/20-EMA (Long-Term)

The percentage of stocks on the NASDAQ Composite trading above its 200-day EMA touched 18.44% at the close yesterday, which is on par with the oversold conditions in the NASDAQ during the July 2002 and October 2002 bottoms.  Given the reaction to Intel’s earnings in after-hours trading yesterday afternoon, and given that the NASDAQ 100 futures are now trading more than 30 points below “fair value” as I am typing this, I would not be surprised if we actually get a capitulation low as early as tomorrow.  However, I will still not rule out another low next week (assuming the Federal Reserve does not implement an inter-meeting rate cut) – but again, while I would not be surprised if we see further downside, I think we are close to a significant tradable bottom and do not expect a crash from these levels – as US equities, ladies and gentlemen, are now ON SALE, and this will start to become more evident to investors around the world over the next couple of weeks.

Given the fast-moving market, I will not commit to making a decision in our DJIA Timing System just yet, but at this point, there is a good chance we will go 100% long in our DJIA Timing System sometime soon, maybe even as early as later today.

Best of luck,

Henry To, CFA

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