R. Russell's Daily Letter - comments on the Dow's break last week

November 23, 2007 -- Nov. 23 (Bloomberg) -- Two-year Treasuries headed for their longest weekly rally in five years as tumbling stocks and credit-market losses increased demand for the relative safety of government debt. The 10-year rate declined to less than 4 percent, the lowest since 2005.

Nov. 23 (Bloomberg) -- Smaller companies are grabbing a bigger share of U.S. exports, making up for some of the jobs lost as multinational firms move operations overseas. Exports have set records in each of the past seven months, the longest surge since 2000, according to the Commerce Department's monthly trade report. Trade contributed more to growth in the second and third quarters than in any similar period since 1990 and 1991.

Russell Comment -- As expected, the "cheap" dollar is giving a huge boost to US exports. Overseas investors are buying US companies, US homes, US land, US assets. The bargain US dollar is rendering the US one big "candy store." Walk down the main streets of La Jolla at night and you hear every language but English.
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Question: Russell, if a primary bear signal occurred on November 21, then when did the bull market end?

Answer -- People don't understand the significance of the "bear market signal" of November 21. I stated on Wednesday's site (Nov. 21) that the breakdown of the Industrials signaled THE EXISTENCE of a primary bear market. It didn't signal the beginning of a bear market, Wednesday's action gave us the final word via Dow Theory that a primary bear market was in force.

Question -- If a primary bear market was in force, then when did the bear market begin?

Answer -- A bull market ends at the time when the Industrial and Transportation Averages rise to their last confirmed high together. That occurred on July 19. On that day the D-J Industrials closed at 14000.41 and the Transportation Average closed at 5446.49. At no time since have BOTH Averages recorded higher closes. That was the bull market peak.

Question -- Doesn't that mean that the bear market has been in progress for a while?

Answer -- Yes, but we did not know for certain that it was a bear market until the bear market signal of November 21. In other words, the bear market has been in force since July 19. It is already four months old. The significance of last Wednesday's action is that now we know we're dealing with a primary bear market, not just some minor decline.

Question -- Russell, you say the bear market is already four months old. How long is it apt to last?

Answer -- A precept of Dow Theory is that neither the duration nor the extent of a bull or a bear market can be predicted in advance. It is far easier to IDENTIFY the end of a bull or bear market than it is to predict their end. Bull markets tend to build extended and often deceptive tops while bear markets tend to build more definite and identifiable and faster bottoms. Therefore, it's usually easier to identify the bottom of a bear market than it is to identify a bull market top.

Question -- In your November 21 report, you stated that by the close of that session, the stock market was severely oversold and that we should not be surprised by a rally. Would a rally, particularly a strong rally, wipe out the bear market signal?

Answer -- In a word, "No." Because there is so much news coverage, because volatility remains so high, I expect a lot of wild and confusing movements from the stock market in the days ahead. But I remind subscribers that a rally here, even a powerful rally, will not mean that the bull market has suddenly been reborn. This bear market will not end in four months. But any rally here will allow subscribers to "trim their sails."

Bear markets tend to be both costly and discouraging to stockholders. It is only natural and human nature that stockholders treat every rally as a sign that the bear market is over, and therefore that they'll "get their money back." I warn subscribers not to be taken in by the powerful rallies that are certain to occur. They'll be corrective rallies within the framework of a primary bear market.

Question -- Russell, do you see anything different or unusual about this bear market?

Answer -- Yes I do. It's unusual that there's so much bearishness and so many pessimistic forecasts this early in the bear market. Usually, at the time of a bear market signal there's a lot of skepticism about the significance of the bear signal. But there's so much bad news floating around now that I think people are ready to accept this bear signal and the thesis that we're in a bear market.

So where is the surprise and the denial that usually accompanies a Dow Theory bear market signal? I don't see it this time, which is very unusual.

Question -- So we have a lack of denial and a lack of surprise. What does this mean?

Answer -- Of course I'm only guessing. But one guess is that the real surprise will come later. The real surprise could be that conditions are fated to become much worse than expected. For instance, analysts are talking about a "difficult 2008, but maybe not a recession." Others are talking about just a "growth slowdown." I hope I'm wrong, but the surprise could be a severe recession, even a global recession. In which case people will look back and say, "I should have taken that bear market signal of November 21 more seriously. The US, the market and my finances are in much worse shape than I had anticipated."

Question -- Russell, is it possible that this bear market will be shorter and milder than most of us expect?

Answer -- The safest rule in this business is that "the market can do anything." Of course, it's possible that this could be an abbreviated bear market. Anything is possible. But it's always best to hope for the best and be prepared for the worst.

Obviously, I don't know the full meaning of the bear signal of November 21. Nobody does. That's the fascinating and also the frustrating aspect of this business. If you want a calm secure job, be a tenured college professor or a veterinarian. Dealing with the markets is no job for those who insist on eight hours of undisturbed sleep every night.

Question -- You wrote that you are very "light or out" in your personal investments. Does that mean that you've sold everything?

Answer -- My main holding is gold. Yes, I still hold dribs and drabs of items like NEM and SU and COP and XLF, but not enough to worry about. I own my own house free and clear, gold, some GDX, cash, a few utilities, some bonds, and two standard poodles. So at this stage of my life, I worry more about my kids than I do the markets.

Question -- Russell, what's your worst fear regarding this bear market?

Answer -- A tough question. You know, I've said all along that the Achilles Heel of the US is the dollar. The dollar continues to be the world's reserve currency. This allows the US, and the US alone, to pay off its debts in its own currency, a currency which the US alone can create. But the rest of the world is becoming suspicious of the US dollar. Increasingly, the oil-producing nations don't want more dollars.

Yet the US insists on being both an "empire" and policeman to the world. But it's doing it on borrowed money. This is a very dicey and questionable proposition.

What happens if the dollar fails? What happens if we come to the point where the rest of the world actually balks at taking in more dollars? What are all our investments then worth? What will be the discount faced by any items denominated in dollars?

I've said before that if the US continues producing monster current account deficits, one of three things must happen -- our standard of living will go down along with the dollar. The US "empire" will fall apart. Or the dollar will collapse. One or more of these will be our fate if we continue to be an empire backed by borrowing.

Question -- We see an incredible separation between the average American and the small percentage of wealthy Americans. The wealthy Americans (probably less than 5% of the population) are steeped in luxuries. Auction prices for prized paintings are going through the roof. Diamond prices are surging (the price of five carat and larger stones went up 8-9% last week). Collectible prices are surging. Mountains of money are pouring into gambling casinos and resorts around the world. How will this all work out?

Answer -- The separation between rich and poor becomes ever wider. There are far more middle-class and poor than there are rich. Politicians will always favor the group with the votes. I expect new laws to appear that will be stacked against those who have money. This will prove discouraging to the big earners. Warren Buffett now heads those who want to keep the inheritance tax in place. In my opinion, Buffett is a genius in investing but a self-satisfied old fool where free enterprise is concerned.

All of this, I believe, will be discouraging to the formation of capital. Creative Americans will be tempted to move out of the country. Other nations will collect our brains and talent.

Is this my biggest worry? Maybe not, but it will be a by-product of overspending, debt-building and national "over-reach." It all has me worried about the world my kids will inherit. Is it "the fire next time"? Or has the fire finally arrived?

The chart below is a daily of the broad Wilshire 5000. As you can see, the Wilshire has not violated its August 16 low. A rally is now underway. But this chart shows the massive supply that now hangs over the market. Any rally will have to plow through all this overhanging stock. That will not be easy.



Below we see a P&F chart of the Dow. The chart deals with all of the Dow action, not just the Dow closes. On August 16 the Dow plunged intra-day to the 12550 box that you see on the chart -- but on that the day closed at 12845. An interesting and very significant test now lies ahead. The test is this -- will the bear market take the Dow below 12550? Remember, 12550 was the panic intra-day low recorded on August 16.

My reading -- if the Dow can hold ABOVE 12550, this will be a huge plus for all those who remain optimistic. However, if the Dow breaks below its panic intra-day low of 12550, such action will be a forecast of a much more severe bear market ahead. If 12550 is violated, my suggestion would be for subscribers to be in an extremely defensive position with major holdings in both gold and currencies. Note that on today's action,. the Dow bounded four (green) boxes to the upside. Much of this could be short covering.


TODAY'S MARKET ACTION -- My PTI was up 8 today to 5943. Moving average was 5943, so my PTI is again back to neutral. Strange but true.

The Dow was up 181.84 to 12980.88. One mover today, BA up 2.19 to 89.54.

Transports were up 84.47 to 4451.07.

Utilities were up 1.88 to 523.75.

There were 2717 advances on the NYSE and 561 declines. UP volume was a huge 93.2% of up + down volume.

There were 17 new highs on the NYSE and 100 new lows. My 5-day high-low differentials improved from minus 2247 to today's minus 2051.

Total volume (many traders absent) was only 1.55 billion shares.

S&P was up 23.93 to 1440.70.

NASDAQ was up 34.45 to 2596.60.

My Big Money Breadth Index was up 6 to 829.

No currency or bond trading today.

CRB Commodity Index was up 5.10 to 457.39 and close to its high.

Dec. gold up 26.01 to 824.70. Dec. silver up 31 to 14.73. Jan. platinum up 13.30 to a record 1480.50.

GDX up 2.03 to 48.05. HUI up 15.21 to 429.88.

ABX up 1.36, AEM up 1.44, NEM up 1.53, SSRI up 1.70.

Gold again moving in on that 850 high. And one of these days it's going to surpass it. Right now I'd settle for gold holding stubbornly and decisively above 800.

STOCKS -- My Most Active Stocks Index was up 15 to 501.

The five most active stocks on the NYSE were PFE up .63, C up .97, F up .24, GE up .50, CRC up .23.

The VIX was down 1.23 to 25.81, and investors are obviously still very nervous.

CONCLUSION -- A big 93.2% upside day, but it occurred in a holiday atmosphere with less than half the usual volume. What does a 90% upside day here mean? Is it just a powerful dead-cat bounce or is it telling us that the market is super-oversold and wants to go higher? I wish I knew, but holiday-type days are tough to figure so let's wait until next week.

One thing is sure -- volatility remains sky-high, with hundred-point Dow days appearing every other day. Trade wrong in this market and you have your head handed to you.

Note, by the way, that neither the S&P nor the Wilshire have yet confirmed the breakdown of the Dow.

At any rate, have a fabulous weekend, and steady your nerves for Monday.

Russell
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Bloomberg -- Freddie Mac, based in McLean, Virginia, said it expects credit losses to continue to increase into next year. The company and the larger Washington-based Fannie Mae guarantee 40% of the $11.5 trillion U.S. home-loan market. The government- chartered companies have lost $57 billion in market value because of writedowns caused by record U.S. mortgage foreclosures. Credit Suisse Group analysts said this week that Freddie Mac may lose as much as $5 billion on its subprime holdings next year.

Bank of America Corp., the second-largest U.S. bank, said this week that losses at Freddie Mac and Fannie Mae would make it harder for banks to sell their mortgage bonds, hurting the U.S. economy by limiting banks' ability to make new loans.

The world's biggest banks, brokers and insurers have announced write downs of more than $60 billion in subprime-related losses.

Russell comment -- Nobody yet knows how big the losses on subprimes is going to be. One estimate is above $300 billion. The number continues to drift up, and it doesn't get any better. The real problem is at what point the banks will be willing to make loans again.
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Hi Richard

I am a longtime subscriber who has enjoyed your sage advise over the years. My question is how does the fact that the $utility index remains in a thriving bull market affect the Dow sell signal if at all. Does it hold out the chance of a tamer bear if this index does not breakdown?

Kind Regards

Gordon E in West Vancouver BC

Russell response -- The Utility Average continues to do well, and I think this has to be taken as a plus in the big picture. GM is working on its "Volt" auto, which will be an all-electric car that can be recharged from a home outlet. If the car works, and it becomes popular, it will be a huge user of electricity. This would be a big power-user. For whatever reason, utilities are doing well. I've liked the utilities all along, and I still like them.
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Richard,

I'm confused. Is GDX a gold stock or a "common stock"? Are you telling us to sell our gold stocks????

You said you only had GDX...and that's what confuses me. What happened to your Newmont? What happened to ride the bull and not to be thrown off??? We've got a big position in gold stocks and are up about 70% as of yesterday. I assume we continue to hold thru the next correction as we've done over the past 7 years. Or are you saying we need to lighten up on those as well???

Rita

Russell answer -- GDX continues to be seen as a common stock, although I believe this will change IF gold continues to rise. I don't have a big position in GDX or Newmont, but I'm continuing to hold both positions.

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Dear Richard,

I read your post from today (Wednesday, 11/21/2007) with great interest.

I thought your remark: "I thought it was kinda cute that it happened on the day before Thanksgiving when many brokers and investors were away. Oh well, if you want to know what's going on in this business, one thing you have to do is -- show up," was quite ironic. In fact, if you look at it closely, it was even more ironic that the sell signal was triggered essentially in the last 5 minutes of trading hour, on a last trading day before Thanksgiving! I know many had to leave around noon hour for travel/ family get together, etc. You really had to be around...

As for why broader indexes are holding up so much better than DJIA and DJTA, following from Robert Prechter's site may interest you:

"Since over half of all listed NYSE stocks are bond-related, the strong upward push in bond prices should theoretically provide an upward bias to these issues. The fact that the a-d line has been in a downtrend since early June suggests that the remaining NYSE issues must be overwhelmingly negative on a fairly persistent basis." May be this is why you have not seen this phenomenon before.

Appreciate your "telling like it is." You are invaluable guide to this crazy, tumultuous market. Thank you.

Paul C

Russell response -- That's an excellent point, and it may well be the reason why the S&P and the Wilshire did not close below their August 16 lows.
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Richard,

Regarding your conclusion "Also, there was no big pick-up in volume, nor was it a dramatic smash-type break". Richard, consider that the majority of people were off today and that historically the day before and after Thanksgiving are positive. To me it's a clue just how badly this market really is.

We are also in the best six performing DOW months. Do not delude yourself into thinking that somehow this is going to be mild. Look at the charts of various companies, HD, TOL, HSY, FNM, MER, FDX, SBUX, IBM, HOG, GM. The list goes on and on. This country is in a liquidity crisis. Wake up already!

Kevin S.

Russell comment -- It's OK, I'm awake. But I still operate on what the market is telling me. If we're in a serious liquidity crisis, then the Dow will break below its panic lows of August 16. Until then -- stay calm and collected, and above all, stay awake.

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Saw the new film, "No Country for Old Men." The film received raves. I thought it was good but not great. It featured the new porn -- ultra-violence. The old porn (sex) is now mainstream, in case you haven't noticed.

By the way, latest studies show the early viewing of porn by youngsters breeds less rape and violence later on. Gosh, maybe porn is just another outlet.

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