Finding A Floor?

My earliest mentor in Technical Analysis was Guy Ortmann. He’s is a pure technician, and now works for Capital Growth Financial as their Technical Analyst. Early in my career, when I was the Research Assistant to the Chief Technology Strategist at Prime Charter (now Oppenheimer), Guy rescued me.

Guy opines today that "recent events have established a SIGNIFICANT FLOOR in the equity markets on a technical basis that is also supported by a major fundamental indicator. The major support levels for the various indexes as described on the above charts are 10,400 for the Dow Industrials, 1210 for the SPX and 2100 on the Nasdaq."

Similar to the chart I showed Tuesday, Guy looks at the recent up-trends and support levels:

Dow Industrials
click for larger chart

SPX Industrials
click for larger chart

Guy observes:

"What we believe is of primary importance is HOW THE MARKETS HAVE RESPONDED to the recent events surrounding Katrina. The week prior to Labor Day weekend was laden with some of the most horrific news stories in terms of human tragedy, and potential economic impact since 9/11/01. With the fear of a loss of a major oil off-loading port, loss of a significant percentage of oil drilling and refining capacities, and the potential costs of rebuilding an entire city THE MARKETS FAILED TO BREAK DOWN IN THE FACE OF ONE OF OUR COUNTRY’S WORST NATURAL DISASTERS OF ALL TIME. As far as the markets are concerned, what is frequently more important is how the markets RESPOND to news events as opposed to the news events themselves. The fact that the averages were able to withstand the pressure of the news with such strength and resiliency is, we feel, an indication of the underlying health of the markets. Fear was extremely high as expressed by a large increase in put buying on the averages prior to the Labor Day weekend. Yet, upon our return to work the following Tuesday, the markets enjoyed on of their best performance days of the year. The crowd was again on the wrong side of the fence."

That’s a persuasive argument; the only disagreement I have with Guy is the "Why?"

Guy believes its a question of valuation; He favors the IBES valuation model (also known as the Fed Model) which compares the forward earnings yield of the S&P 500 to the yield on the 10 year Treasury note.

I, on the other hand, believe the market was in good technical condition prior to Katrina — the Valuation side of this is all but irrelevant to recent action. Further, I don’t see how the IBES methodology can explain why the Market got shellacked from January to May, when rates were lower and prices were higher. Just because something is cheap, don’t mean it won’t get cheaper.

Regardless, if you buy the Technicals argument — his or mine — then you would expect the markets to find support at the trend lines shown above . . .

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  1. Dean N. commented on Sep 15

    Some parts of the market wrongly or rightly believes that the “Greenspan put” will prevent a meltdown after any major disaster.

    The appropriate strategy then is to load up on risk right after a disaster since you get the upside with downside covered. This would explain why the last two run-ups started right after the London bombings and Katrina.

    Law of unintended consequences?

  2. Damian commented on Sep 15

    Barry – when I look at his uptrend lines, I see that he mainly ignores the July downturn. So if he was drawing trendlines from before the recent Katrina downturn, wouldn’t his uptrend have been violated?

  3. Brian Miller commented on Sep 16

    I agree the Fed model portrays stocks as the better investment, but there has been entire decades (70’s)where broad stock indices and bonds lost money at the same time.

  4. Tim commented on Sep 16

    Not sure if this comes under the category of “black helicopters” or “tin-foil hats” (I’m guessing it’s black helicopters, as I’ve assumed that tin-foil hats are what gold bugs wear, but I’ve never confirmed this and have not felt inclined to take time to confirm it), but I was wondering if you would care to comment on the “floors” that so marvelously held, post-Katrina, and this report from Sprott Asset management about intervention (it’s a PDF – you’ve been warned):

    Move Over, Adam Smith: The Visible Hand of Uncle Sam

    I mean, George Stephanopolous …

  5. Barry Ritholtz commented on Sep 16

    I’m not a huge Fed Model fan, for exactly that reason —

    it has no timing component, and is occasionally “wrong” — or at least misleading — for extended periods of time

  6. royce commented on Sep 16

    Comparing the reaction of the market overall with my own actions, I see we had the same attitudes. When Katrina hit I didn’t see any reason to sell a lot of stocks. Hurricanes trash property, but they don’t seem to drop output too much. Flooding that took out New Orleans took out a sizable chunk out of Louisiana GDP, but in a country this size that’s not enough to cause serious injury. I figured the region’s oil rigs, refineries, shipyards, etc. would be up and running pretty fast.

    The big downside to this from an economic standpoint is all the borrowing the government will do to cover cover the costs of recovery. But the market doesn’t seem to care about high government borrowing. So it’s no surprise there’s been a floor.

  7. Regis commented on Sep 16

    Brian, I have to concur with you, I read the Sprott report as well and so did my roommate, who’s well educated and is pretty knowledgeable. Our opinion is that it was well researched and the biggest give-away had to be the minor Dow rally the very Monday morning Katrina hit. Just enough intervention of the “Plunge Protection Team” to keep the market from nose-diving on bad news and little else to support it. Kind of odd, isn’t it? The market is up, when all else is down. Read this and you’ll understand the rationale for what brought this government-private sector team together and what drives it now.

  8. angryinch commented on Sep 18

    Leaving aside how a “pure technician” uses a classic fundamental valuation model like the IBES bond/stock ratio, I too place little confidence in the model.

    Many of the biggest bulls right now (Don “Jesu Loves America” Hays, Ed “100% Equities” Keon and Donald “King of Snark” Luskin) are hanging their horns primarily on the IBES model.

    Hays (who predicts the SPX at 2,850 by 2008 BTW) says stocks are cheaper than at any other time since 1979. Well, the SPX did climb 40% in 1980 off the 1979 low. But it was all given back within 2 years as the SPX fell 27% b/w 1981 and 1982.

    The question then, if you are using the late 70s-early 80s blueprint like Hays, is whether this is 1979 or 1980-81. Makes a big difference—the difference between a 40% gain or a 30% drawdown.

    And that’s assuming the current period even has any resonance with the earlier period.

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