Thursday Market update

The stock market is still trying to make up its mind as it hovers above its November lows.

The government said construction of homes and apartments tumbled by 16.8 percent in January to a record low annual rate. Applications for building permits also dropped to a record low and inventories continue to climb. This deflationary cycle continues to get worse.

Investors reacted coolly to a $75 billion mortgage relief plan President Obama introduced on Wednesday, which would provide incentives to mortgage lenders to help borrowers reduce their payments.

SIX MONTH CYCLE

It has been observed that there is a six month period between October/April that is generally a favorable period for the stock market.

Even in the Great Depression, the market bottomed in the fall and rallied to the spring before collapsing in the summer of 1930.

What I have observed in many years is the market advances out of the October/November lows. This is followed by an intermediate term advance lasting approximately six weeks or about to mid-January.

This brings about an intermediate-term correction, retracing a portion of the previous advance during February.

However, in the March/April period we often see the intermediate term cycle turn back up again, with the six month cycle ending at the end of April, followed by a renewed down leg developing in the May-June time period.

If you observe the Fidelity Select Family Stochastic Oscillator, which is set to measure the six month cycle you will see that it remains positive with %K at 59 and %D at 51. This argues that there is more room to go on the upside before this cycle is likely to be completed later this spring.

However, the stock market doesn’t always follow this pattern, so we can’t be guaranteed the market will hold above the November lows given worsening conditions.

MAJOR TESTING

The market is now testing key lows and to be honest it is a toss up whether the market can hold here.

Over the last couple of days the Dow Jones Financial Index has now taken out the November lows (with the Dow Jones Industrials hovering just above its November lows).

Once again the critical financial sector can’t set up a bottom, given the severity of this financial meltdown. I don’t know how far the market can go up if the financial sector keeps crashing.

This is the sector that needs to lead the market out of this hole and it just failed to do so, despite passage of the largest stimulus bill ever.

The Dow Jones Industrial (Dow 30), holding the likes of Citigroup (C), Bank of America (BAC) and General Motors (GM) is just a hundred points above its November lows. A closing breach below 7,449 could induce more serious selling.

It also isn’t a good sign that the Dow Jones Transportation index has also breached its November lows. The recession is taking a big toll on the demand for transportation.

The two key indexes that we need to watch closely now are the S&P 500 and the Wilshire 5000 indexes, both being broader market indexes. What we want to watch is the S&P 500 November lows at 741 and the Wilshire 5000 at 7,340. Today the S&P 500 closed at 788 and the Wilshire 5000 at 7,988.

Inter-market analysis doesn’t bode well that these indexes will hold. As energy and the financial sectors are huge components of the S&P 500, a plunge in crude oil prices will certainly make it difficult for energy stocks to hold above the November lows.

As I have pointed out the weekly stochastics for crude oil are at %K 95 and %D at 93. Oil prices looks primed to sell off here and have been steadily losing ground.

Yesterday I showed you a chart of the US government long bond whose weekly stochastics are at %K 7 and %D 21 and setting up to turn higher. I think if the stock market fails to hold here, it would send investors looking for safety in government bonds again and that seems to be what the charts are telling us.

The S&P Europe Index just established new lows this week and looks vulnerable. A market meltdown is occurring in Central and Eastern Europe on the same scale as the Asian Crisis of 1997. Many of these countries are facing double digit declines in their GDP.

I am also concerned that the weekly stochastics for the Nasdaq 100 is now negative at %K 92 and %D at 93, suggesting there is plenty of downside potential if the bulls are unable to hold the line here.

Notice in the following chart that the advance/decline line for the OTC is fast approaching its 2008 lows.

This certainly argues for caution as the stock market tests not only the November lows but perhaps the 2002 lows as well.

I hate to pile it on, but note that the McClellan Summation Index for both the NYSE and the OTC look to be in a topping pattern---not exactly inspiring.

As you can see from this chart the McClellan Summation Index is now beginning to roll over to the downside and looks poised to fall.

Another issue I see is that the McClellan Summation Index for the OTC continues to trend below the zero line which makes it difficult for the bulls to mount any kind of lasting offense.

Lastly, I don’t think we can ignore the fundamentals.

According to Standard and Poor’s, the quarterly, year-over-year earnings are now projected to be at a negative 62%. These are horrendous losses.

" This is the worst; after the sixth quarter of negative growth, it will be the first quarter ever of negative earnings," said Howard Silverblatt, senior index analyst at Standard & Poor's.

A sixth quarter of negative growth ties the record set when Harry Truman was president, running from the first quarter of 1951 to the second quarter of 1952.

Next quarter, we're expecting a new record of seven quarters of negative growth.

Has the stock market fully discounted this? We are about to find out.

My advice for investors is to stay on the sidelines, protecting capital as the market proves whether the lows can hold or not.