Thursday, November 16, 2006

WHERE ARE WE NOW

First let me toot my own horn for a moment, something I do very infrequently. My last post, which was on Walmart was not only timely but right on the money. The stock hit its closing high the next day, 51.75 and went south consistently hitting its low two days ago at 46.32. I took my profits a little early, but I'm not complaining. My post prior to that was also pretty good and timely in laying out the bull case for the overall market. Although it saved me a lot of money, I didn't profit quite as handsomely. It serves as a good starting point to review where we are now.

One of the points I was trying to make then, was how remarkable the stock market rally was in light of all the economic weakness. In that regard, not much has changed, and in fact the economy has deteriorated since then. Back then I argued that the first revision in 2nd qtr GDP, up to 2.9% from 2.6% is what swept away all economic concerns and accelerated the stock rally. Similarly, when the Dow declined 6 days in a row from 10/26 to 11/03, it was the strong rebound in the ISM services index and the large revisions in non-farm payrolls for the prior two months and corresponding drop in the unemployment rate, that once again swept away economic concerns and reignited the rally.

Now however, I believe the rally is running on fumes, and here is why:
Not only was 2qtr GDP revised back down to 2.6%, but 3rd qtr came in at 1.6%.
Auto sales have declined further to 16.1 mln in Oct from 16.6 in Sep and manufacturers have cut production further in the 4th quarter because they are choking on inventories.
Existing home sales and prices continued to drop. Sales to 6.18 vs 6.3 in Aug, prices another 1.9% vs a 3% drop in Aug.
New home sales showed an uptick has they have for the last several months but then is revised away in subsequent data. Prices, however showed a steep drop from 239,000 in Aug to 217,100 in September.
The ISM dropped to 51.2 in Oct vs 52.9 in Sep.
The Democrats have indeed taken the house and Senate.
Walmart sales have been below the low end of forecasts for two months and not at the high end as the were in Aug.
It's hard to be bullish about $60n oil, when most of my working life $40-$50 oil was looked at with aghast.
Eventually, the top line rules. You can continue to generate earnings for a while as the top line slows down as many companies have, but eventually they have to follow.
Technically and sentiment wise the market is extremely overbought. Barchart's momentum indicator shows 79% of stocks are over their 100 day ma and 71% are over their 200day mvg. Newsletter writers are at their most bullish since May.

Those betting on a soft landing are now bucking the trend. We have all been told, the trend is your friend. They economic trend is now down and bulls are trying to catch the bottom. If you are bearish be just as careful and do not try to catch the top. In momentum markets like this, the last 10% in time can be very large in amount. Like Barry Ritholtz said recently on his blog thebigpicture.com you can be early being long, you can even be early going to cash, but the death of a money manager is being early going short. Or as I heard said once, the canyons of wall street are filled with the corpses of those who where right but too early.

Conclusion: Its to late to get in or but more. Its time to scale out and prepare an exit plan. What will be the straw that breaks the camels back? It could be and ISM reading below 50, a drop in auto sales below 16mln units, a further decline in home sales or prices, a renewed climb in oil prices, and actual decline in Walmart SSS, or many other things. Or as John Mauldin discusses in his e-letter of 8/26, fingers of instability, it could be some seemingly trivial event, the market not acting well after a good news item, one bad earnings or Christmas sales report. So as usual, we wait for a fundamental, technical or sentiment signal to ell when to hit the exit door. Time is drawing near.