Timing Outlook Turns Negative

1. Summary

Normally I prepare these reports every other week, but last week’s action pulled The Timing Outlook below 5.0 into negative territory. It now is 4.5. So consider this to be a special report.

Last week, the market continued its “basically haywire” activity from the preceding two weeks, with two big down days and one big up day, netting out to a weekly loss of 4%. In the last four weeks, the S&P 500 has lost 11%. Volatility continues to be very high, with “big” moves (more than 10 points on the S&P 500) in 14 of the last 18 trading sessions. In 12 of those 18 sessions, the market declined. Average daily trading volume has remained elevated, as it tends to be when the market is unstable. Average daily volume has generally been higher on down days than on up days, which most technical analysts consider to be a negative sign.

The market is now underwater for the year, down 3%. The 11% loss over the past four weeks qualifies as an official “correction” in Wall Street parlance, being larger than -10%.

There is no change in the status of my Capital Gains portfolio: It is 100% in cash. Everything sold off during the swan dive on May 6. The portfolio will stay in cash unless and until the market clearly shows a reversal. My criteria for re-entering the market are explained in this article. In a nutshell, it will take 2-3-4 weeks of a rising market to lure me back in.

What’s going on? For one thing, the Conference Board’s Index of Leading Economic Indicators fell last week for the first time in 12 months. That may be a one-month statistical aberration, or it may portend a double-dip recession. For another, worries about the financial situation in Europe seem to be overwhelming the generally good news from earnings season, which is winding down. Many market participants may feel the market had become overvalued and needed a correction. The employment situation remains stubbornly unsatisfactory, the housing market is not recovering very fast (if indeed it is recovering at all), and the uncontained oil spill in the Gulf has everybody in a bad mood.

Unlike the 100% cash position in my Capital Gains Portfolio, my Dividend Portfolio is fully invested. That is because the focus there is on rising dividend streams, not on the prices of the stocks. Of the 40 stocks in my e-book, THE TOP 40 DIVIDEND STOCKS FOR 2010: How to Generate Wealth or Income from Dividend Stocks, 23 have already raised their dividend in 2010 (two have done it twice), and none has dropped its dividend. So the Dividend Portfolio is doing what I ask it to do, which is to generate rising streams of income.

2. Market Performance Since Last Outlook
(“now” figures are as of close Friday May 21, 2010)

Last Outlook (5/14/10): 5.0 (barely positive)

S&P 500 last time (5/14/10): 1136
S&P 500 now: 1088 Change: -4%

S&P 500 at beginning of 2010: 1115
S&P 500 now: 1088 Change in 2010: -3%

S&P 500 at close 3/9/09 (beginning of bull market): 677
S&P 500 now: 1088 Change since 3/9/09: +68%

3. Indicators in Detail

• Conference Board Index of Leading Economic Indicators: For the first time in a year, the LEI dropped from the prior month. That lowers this indicator from positive to neutral. (I require three consecutive increases or decreases to rate this as positive or negative.) Neutral. +5

• Fed Funds Rate: The Fed has left rates near zero for months, and it seems clear that the Fed will not change rates as long as the economic recovery remains slow and inflation remains low. Positive. +10

• S&P 500 Market Valuation (P/E): As the market continues to fall, its valuation continues to improve, especially with the favorable earnings season. Prices down and earnings up equals an improving market valuation. Morningstar shows the current P/E of the S&P 500 is 15.6, down from 16.6 just a week ago. This keeps it in positive territory. +10

• Morningstar’s Market Valuation Graph. Similar to the valuation of the market based on its P/E ratio, Morningstar’s proprietary market valuation graph has been improving. It falls from 1.00 last time to 0.95 this time. That keeps it within the “fairly valued” band that I use, which is plus or minus 10% of 1.00. Neutral. +5

• S&P 500 Short Term Technical Trend: The charts of all three major indices (S&P 500, Dow Jones Industrial, and NASDAQ) continued to deteriorate since the last report a week ago. Each index is now well below its 20-day SMA and each has also fallen below its 50-day SMA. So just looking at the two shorter SMAs, the charts are in their least favorable configuration: 50-day SMA > 20-day SMA > Index. Negative. +0

• S&P 500 Medium Term Technical Trend: The mid-term indicator uses the index plus its 50-day and 200-day SMAs. This indicator remains neutral: 50-day SMA > 200-day SMA > Index. However, note that many technical analysts use only the 200-day SMA, and they would interpret the index falling below it as a huge negative sign. Under the Timing Outlook’s approach, this indicator remains neutral, and it will remain so unless the 50-day SMA falls below the 200-day SMA. +5

• DJIA Short Term Technical Trend: This chart looks basically like the S&P 500 chart. Negative. +0

• DJIA Medium Term Technical Trend: Same as the S&P 500. Neutral. +5

• NASDAQ Short Term Technical Trend: The NASDAQ’s chart looks like the other two. Negative. +0

• NASDAQ Medium Term Technical Trend: Same as the other two. Neutral. +5

TOTAL POINTS: 45
NEW READING: 45 / 10 = 4.5 = NEGATIVE