Technically Speaking - Where the Market Stands

I combine technical analysis with my fundamental analysis because technical analysis helps with the timing of expected fundamental changes. Often, economic changes take longer to develop than I expect. I think the economic reality will be less rosy than expected in coming months, but I don‟t know when that realization will occur. And, there is always the potential that my analysis is wrong. Getting this stuff right is not easy, especially since the market does diverge from reality from time to time. Maybe QE2 and Congressional gridlock will prove far more beneficial than I expect. If that is the case, the stock market will perform better than I expect. Technical analysis helps to minimize the damage when I'm wrong.

Over the years I have developed a number of technical indicators and have contracted with Larmee Associates, a third party programming firm, to put them into a cohesive money management program. The Flexible Asset Allocation program (FAA) is the result of this effort, and the Major Trend Indicator (MTI) is an important component of the FAA program. I‟ve discussed the MTI on a number of occasions, since it is part of my market analysis. My goal has been to begin managing money, using the Flexible Asset Allocation program as the centerpiece. By the end of November, all the pieces should be in place. Along with this month‟s letter, I‟ve included a brief overview of the FAA program. The returns shown are based on the back testing that was performed by Larmee Associates, and were produced by Larmee Associates according to the strict rules included in the FAA program. There is no assurance that results will be similar in the future. Please review this information carefully, and let me know your interest and questions. Given our economic uncertainty that we are facing in the next few years, traditional asset allocation is likely to disappoint most buy and hold investors. I believe a flexible approach to investing is warranted, and the FAA program could be a viable alternative for a portion of your portfolio.

Based on the close of September 3, the Major Trend Indicator gave a Bear Market buy signal. As noted in the August and September letters, my expectation was that the S&P would rally to 1130-1150, with the possibility of 1160 being reached. I certainly did not expect investors to embrace QE2 or the Republican's election prospects to the extent they have. But that‟s the beauty of combining technical analysis with fundamental analysis.

8 embrace QE2 or the Republican‟s election prospects to the extent they have. But that‟s the beauty of combining technical analysis with fundamental analysis. Let‟s review the MTI. The buy signal on March 13, 2009 was a Bear Market rally buy signal because the MTI was below the Red line, which indicates the market is in a bear market. The strength of the March 2009 rally pushed the MTI above the Green line, confirming that a new Bull market was in force. In June 2010, the MTI fell below the Red line suggesting that the probability of a bear market had increased. On July 13, the MTI generated a Bear Market rally buy signal, which didn‟t carry very far, and was reversed on August 13, when the MTI gave a sell signal, and sell short signal for those willing to go short. The strength of the rally since the Bear Market rally buy signal on September 3 has carried the MTI back above the Green line. Although a new bull market may have begun, it is more likely an indication that the current rally has some staying power. This would mean the market is likely to hold up for awhile, and potentially challenge the April high. A new bull market is unlikely, since the market was not deeply oversold, which is normally a precondition for the birth of a new bull market. Plus, sentiment has gotten very optimistic, based on investors faith in the Fed and the upcoming election. However, as long as investor‟s perception that these two factors will be helpful, selling pressure will remain muted, and any correction will likely hold above 1130.

The bear market rally buy signal on September 3 may have easily been a dud, as the July 13 signal was. Instead, it has turned out better than I expected which is why I think combining technical analysis and fundamental analysis provides a more balanced approach that over time can improve investment results. Please note that the dates in the table below reflecting the buy signal on July 13 and September 3, and sell signal on August 13, reflect the opening prices of the ETFs on the morning after the buy signal, since the FAA model is run after the close each day. Each position is allocated 25% of the portfolio.

In April, I recommended selling and becoming more defensive when the S&P moved above 1210. The high was 1219. Over the last few months, I suggested selling and taking a more defensive posture when the S&P was between 1130-1150. The S&P has pushed above 1180, and may challenge the April high at 1219. The Republicans will be riding into Washington on November 2 armed with platitudes and promises, and a sincere reluctance to address our problems. The Federal Reserve will commit to round 2 of QE with much fanfare and bluster. The markets have already responded with hope, which might be sustained until early next year. But at some point investors are going to confront a reality that isn‟t pleasant. We‟re in for an extended period of slow agonizing growth, even if we are fortunate to avoid a second dip. Who knows, maybe the Fed will buy state and local debt when they decide QE3 is needed.