Now that Federal Open Market Committee members have raised rates again and with the next meeting not until August, what can investors expect between now and then? For the Nasdaq, the current correction began the third week of April if one is counting from the index’s most recent peak. So this corrective phase is now at 10 week’s duration. How much longer will it last and will it get worse before it gets better? Every investor would like to know the answers, but no one actually does. We can, however, make some generalizations based on recent past corrections.

The chart below shows the Nasdaq performance over the past five years. Remember that the worst bear market ever for the Nasdaq began in 2001 and lasted through 2002. In 2003, the index rallied and posted a strong gain. Since then, the Nasdaq has moved upward in a gradual advance. The current correction is the fourth since the start of 2004. I’ve marked each with red arrows and numbers so they are clearly visible.

Here are some interesting points to consider about the current market situation. After the huge rally in 2003, the Nasdaq peaked at slightly above 2100. As I write this, the Nasdaq is at 2112. In other words, since January 2004, the Nasdaq has gained nothing. I’ve used a blue line to highlight the 2100 level so you can see how tightly the index has traded to that level for more than two years. During that period, the highest point reached by the Nasdaq was about 2375 in April 2006. If an investor bought the Nasdaq at the start of 2004 and managed to sell at the peak two months ago, he would have amassed a gain of 13% in more than two years. That’s an annualized rate of less than 6%. These have been tough times for investors.

Correction #1 lasted about six months and during that time the Nasdaq dropped about 15%. Correction #2 lasted about five months and the index lost about 10%. Correction #3 lasted three months and the Nasdaq fell about 7%. So far the current correction is going on 10 weeks and the Nasdaq is down about 13%.

Compared to the prior three corrections, this one is much steeper. So far it isn’t as severe as #1, but one or two bad days is all it would take to equal that intensity. That seems unlikely, however, because the economic fundamentals today are much better than they were at the beginning of 2004. With the most recent Fed rate hike now in the rearview mirror, there is a good possibility we have seen the bottom of this correction and could see market indices rally for the next few weeks.

As the market turns upward we should see confirmation of a new advance with a number of indicators including RSI, MACD, 200-day moving average, momentum and others. Investors should wait to see some of these indicators turn positive before buying back into the market. This could occur very quickly when the markets move like they did today.

Over the past month only two sectors have managed to break even or show slight gains. One is utilities, which should not be a big surprise because utilities are commonly purchased as a defensive strategy in negative market environments. The other is real estate. That is more surprising, because many economists and investment experts have been warning for months that real estate is overvalued and could crash at any time. Yet in spite of predictions of gloom, real estate continues to hold up. Yes, there are regions in the county where home prices are likely to slide because speculators drove the prices too high. But there are also many places where homes are still affordable and demand remains high. Mortgage rates have risen over the past year, but still remain quite low compared to average rates over the past couple of decades. None of this means you should go out and buy real estate funds right now. But it does help explain whey we aren’t seeing the collapse that many have predicted.

You know the saying about how a rising tides lifts all the boats. That is certainly true in the investment markets. We will see many industry sectors improve if the indices begin a new advance.

Another good technical indicator for identifying a buying opportunity is the number of new lows. When the number of daily new lows on the NYSE drops to 35 and on the Nasdaq to 50, that usually indicates that conditions are favorable for a new market advance.

Trading volume is likely to be light next week with a holiday on Tuesday and shortened market trading hours on Monday. Sometimes those light days can produce some wild swings, So be cautious about taking any new market positions right now.

Have a great Independence Day!

This is the first issue of our new blog format. I hope you like it. We plan to continue making changes and improvements over the coming weeks and we welcome your comments and suggestions.

After a nice rally a week ago, major stock indices have stalled and vacillated in a sideways pattern for the past few sessions. With just a week until Federal Reserve officials meet again to discuss interest rates and the economy, expect the sideways action to continue. That could change if if officials make comments prior to the meeting about their intent.

Wall Street expects members of the Federal Open Market Committee will raise interest rates another quarter percent at that gathering. But a few traders are concerned that the Fed could be more aggressive and go with a half-percent hike. Odds of that are slim, but it would probably send stocks plunging again. If the FOMC takes the expected action, the markets will likely continue the upward reversal of the really nasty recent correction.

The statement released after the last meeting included this paragraph:

“The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.”

The underlined portions are those that imply Fed officials are likely to vote in favor of another increase. Economic reports released since the last meeting show that while inflation might not be growing, neither is it decreasing.

Below is a year-to-date chart of the Nasdaq. The daily price activity is represented by candlesticks. (I’ve included an explanation of candlesticks below, if you’d like to know more about them.) The red candlesticks shows days when the market declined and the white or open candlesticks show advancing days. Notice that in spite of a few days with significant swings, the Nasdaq is still about where it was two weeks ago. The gold line is the Dow, included for comparison.

The bottom portion of the chart is a Moving Average Convergence Divergence (MACD). It shows that market momentum has switched to the positive side, but barely so. It could quickly turn negative again, as occurred the first couple of days in June.

We could see more day-to-day volatility over the next week with indexes up big one day and down big the next. But when the Federal Reserve meets on the 28th and 29th, I expect the major indexes will be just about where they are right now.

Candlestick Components

When first looking at a candlestick chart, the student of the more common bar charts may be confused; however, just like a bar chart, the daily candlestick line contains the market’s open, high, low and close of a specific day. Now this is where the system takes on a whole new look: the candlestick has a wide part, which is called the “real body”. This real body represents the range between the open and close of that day’s trading. When the real body is filled in or black, it means the close was lower than the open. If the real body is empty, it means the opposite: the close was higher than the open.

Just above and below the real body are the “shadows”. Chartists have always thought of these as the wicks of the candle, and it is the shadows that show the high and low prices of that day’s trading. If the upper shadow on the filled-in body is short, it indicates that the open that day was closer to the high of the day. And a short upper shadow on a white or unfilled body dictates that the close was near the high. The relationship between the day’s open, high, low, and close determine the look of the daily candlestick. Real bodies can be either long or short and either black or white. Shadows can also be either long or short.

Buying back into the market after a major correction can be emotionally wrenching for investors. We all know that successful investing is measured by buying low and selling high. As a result, we want to buy at the very bottom of a correction and sell at the very peak of a major bull move. Fortunately, it isn’t necessary to positively identify every low and every high to be a successful investor.

The recent correction has been steep and severe for major averages and for individual equity investment vehicles. Now investors and traders are wondering if the market has bottomed and this is the time to buy or if the correction will continue. A few weeks ago I wrote that I thought the market would bottom in mid-June and then rebound ahead of the Federal Open Market Committee meeting at the end of the month. But I must admit that I have been surprised by the steep slope and the amplitude of this downturn. I anticipated something milder. So is this it, or is there more to come?

Below is a chart of the Nasdaq showing the recent correction that saw the average drop about 13% from its peak. The past couple of days we’ve seen a nice recovery which could mean that the worst is behind us and the bottom is set. But how can we confirm that the Nasdaq won’t pause for a few days and then drop again? In all honesty, we can’t.

On the chart I’ve added some pink circles that show places during recent corrections where one might have mistakenly believed the Nasdaq had bottomed. In each case, that assumption was wrong and the index continued to decline. So what would have been the result if an investor purchased the index during one of those false bottoms? In each case, the real bottom occurred within a few days or weeks and within a few weeks or months the investor would have reaped a nice profit. Buying at a false bottom is certainly less painful than buying at a market top.

One of the oldest investing axioms is to “buy on weakness and sell on strength.” Buy that definition, this would be a good time to buy back into the market. Certainly it is about 13% better time to buy than at the recent peak in mid-April.

For more conservative investors, there are some ways to reduce the risk of buying during a market downturn. The gold line on the chart is a 200-day moving average. An investor who wants confirmation of a change in trend could wait to buy until the index crossed back above the 200-day MA. Notice that the other times on the chart when that occurred, using the 200-day MA as an entry point would still have resulted in good returns.

The middle portion of the chart shows a Moving Average Convergence Divergence (MACD). Another way to avoid jumping in too early is to wait to buy until the black line in the middle switches back to the positive side. That shows that the index’s momentum has shifted upward. The bottom portion of the chart is a Relative Strength Index (RSI). Right now the RSI is below 50. Once it crosses back above the 50 level that is an indication that the Nasdaq has enough strength to advance.

These are just a few of the technical analysis tools that can help an investor decide the right time to enter the market. They can be used individually or collectively. Unfortunately none are foolproof and any trading system an investor creates using such tools will invariably be wrong at times. In that case, you might wonder why we should even bother to use these tools. Perhaps the best answer to that question is to go back to the statement above about buying when the market is weak. Buying during those periods will always feel uncomfortable and sometimes downright frightening. So sometimes the technical tools do nothing more than provide us with the confidence to jump in when our gut is telling us to stay out.

Have a great weekend. Remember to look for our new blog format next week.

I knew Monday that this would be a bad week for the markets. Driving to work to start the week I heard an ad on the radio for a large regional bank. The ad touted an 8% return on new business money market accounts. Ouch!

You are probably thinking that an 8% rate on money markets is good. After all, that’s a pretty nice return with very little risk. Rates on Certificates of Deposit have been going up, too. Not many months ago CDs were paying 2%. Now the rate on CDs is creeping up toward 6%. But the rates are going up because of rising inflation and because the Federal Reserve is hiking its lending rates. In other words, the banks can pay more because they are going to be able to charge more.

The Federal Open Market Committee meets again at the end of June. This is the group that determines whether or not the Federal Reserve will raise interest rates. Right now Wall Street expects that the group will again increase rates to try to slow inflation and economic growth. Wall Street also understands that the Fed usually goes to far and ends up sending the economy into recession. I wrote a lengthy piece explaining that tendency a few weeks ago. Here is the link if you want to read it. http://www.strategisfinancial.com/newsletter/040606.htm

For anyone looking for an explanation about why the market is correcting like this now, this is probably as good as it gets. After all, GDP growth is strong, unemployment is low, and corporate earnings are good. There is no reason for stocks to be tanking. But Wall Street looks ahead and traders anticipate a major economic downturn because of Federal Reserve action.

The Fed funds rate and the discount rate impact consumers because many interest rates are linked to them. The prime rate, for example, is directly tied to the Fed rates. It is the underlying rate for most consumer rates like credit cards, home equity loans and lines of credit, auto loans, and personal loans. The prime rate is currently 8%. Consumer spending accounts for about two-thirds of U.S. economic activity. So an increase in consumer lending rates significantly impacts the economy because consumers feel less inclined to make credit purchases.

The Nasdaq has now fallen about 11% from its recent high, depending on where it ends today. The next logical support would be the October 2005 low. Right now the index is barely above its level at this time last year. In other words, a year’s worth of gains have disappeared in about seven weeks. The chart below illustrates the situation. The black line is the Nasdaq price. The gold is a 200-day moving average. The bottom sections of the chart are a momentum indicator and a Moving Average Convergence Divergence (MACD).

The downturn is hurting virtually all industry and market sectors. Over the past month about the only thing sector moving up is government bonds. Health care and utility sectors are holding their own. These are all defensive positions.

I hoped major indices would bottom about now and then rebound sharply until the FOMC meeting. Now that scenario seems less likely. I am more inclined to believe there will be sideways consolidation ahead of the meeting. The market’s direction will then be dependent on the size of the rate hike. If the Fed raises by a half point, stocks will likely fall further.

Have a great weekend.

As I read reports from other market analysts and as I watch financial commentary on the news, I’m surprised by the number who claim they accurately predicted this current market downturn. I follow the comments of most of these folks regularly and I don’t recall many of them saying that a major correction was on the horizon. Of course, there are always a few who constantly predict we are on the verge of a market meltdown. And each time there is even a minor correction they claim vindication.

Many years ago I wrote for Howard Ruff when his investment newsletter was the most widely read in the country. He said the key to being a good market forecaster was to forecast often. I’m sure he was only partly joking. That was almost two decades ago and in the ensuing years, I’ve learned that no one can accurately predict what the markets will do in every situation. Even powerful men who wield great influence over the markets like the Federal Reserve Chairman or legendary investor Warren Buffet are sometimes surprised by market events.

Today I can add little to last week’s assessment of market conditions. The investment community around the world is waiting for the major U.S. averages to confirm that they have bottomed. Until that happens, most sectors will tread water or lose ground. Once the bottom is in place, watch for a powerful surge in stock prices. Today’s action might be the start of that move.

As I wrote earlier, as an individual investor I would monitor this current market using a 200-day moving average. I would take long positions (buy) when the Nasdaq crosses back above that 200-day MA. The sectors that usually perform best on the upswing tend to be those that were strongest before the correction. In this instance that would include international funds, gold funds, and energy funds. In addition, technology funds usually perform well coming off of market bottoms.

I’m including a chart of the Nasdaq. You can see that the index appears to be advancing, although it has not yet exceeded its 200-day MA. The momentum indicator on the bottom of the chart is on the verge of going positive.

I’m also including a table showing the performance and ranking of most Exchange-Traded Funds (ETFs) over the past month. You can see that only a handful avoided negative returns.