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TECHNICAL ANALYSIS


Is The Stock Market Bottom Here?

01/27/09 08:42:16 AM
by Alan R. Northam

News reporters, economists, and stock market forecasters view the current low in the stock market as the stock market bottom. There are many ways to measure to find out if it is. Here is one way.

Security:   $CYC, $CMR
Position:   N/A

News reporters keep asking economists if the stock market is finally at a bottom, and these economists keep saying they believe the stock market is either at or near the market bottom. I read the same thing from stock market forecasters. It seems like everyone is looking for and talking about the stock market bottom. Is the stock market really at the bottom? No, we are not, and here is why.

There are many ways to measure the stock market to determine if it is at its bottom. One way to make this measurement is to compare an index of consumer-related stocks to an index of cyclical stocks. An index of consumer stocks is made up of stocks such as food, drugs, and beverages, to name a few. An index of cyclical stocks, on the other hand, is made up of stocks such as aluminum and copper, to name just a couple. Consumer stocks normally do better when the economy is weak and cyclicals do better when the economy is strong. By comparing these two market sectors, it is possible to measure how investors feel about the future of the economy. Since the stock market is a leading indicator of the economy, it too will turn upward once investors start to feel good about the future of the economy.

To get a pulse on the feeling of investors toward the future of the economy, we compare a consumer stock index to a cyclical stock index. To accomplish this, I have chosen to use the Morgan Stanley Consumer Index ($CMR) and the Morgan Stanley Cyclical Index ($CYC). Figure 1 shows a weekly chart of $CYC divided by $CMR. I have also shown the S&P 500 plotted in red dots on the chart. When this chart rises, investors are feeling good about the future of the economy, and when it is falling, consumers are worried about the economy. This chart shows that the ratio of the Morgan Stanley Cyclical Index compared to the Morgan Stanley Consumer Index peaked in July 2007 ahead of the peak in the stock market in October 2007, three months later. In May 2008, the ratio of $CYC compared to $CMR and the S&P 500 have coupled together and have been falling together since then. As long as this ratio line continues to fall, investors do not feel good about the future of the economy and the S&P 500 should continue to fall along with the ratio line.

FIGURE 1: $CYC WEEKLY RATIO LINE DIVIDED BY $CMR. When this ratio line moves upward, investors feel good about the economy and when it moves down, investors are worried.
Graphic provided by: StockCharts.com.
 
Once investors start to feel good about the future of the economy, I would expect a bullish divergence to develop between the ratio line of $CYC divided by $CMR. This bullish divergence should then take the form of the ratio line moving higher, while the S&P 500 continues to move lower. Once this divergence occurs, we can expect the S&P 500 to turn up several months later.

In conclusion, by comparing a cyclical stock index by a consumer stock index, it is possible to measure what investors think about the future direction of the economy. When the ratio line derived from this comparison rises, it signals that investors feel good about the economy and the stock market should follow its lead. When the ratio line falls, it is a signal that investors are worried about the economy and the stock market should fall as well. From this analysis, it has been shown that this ratio line peaked in July 2007, signaling that investors had become worried about the future of the economy. Three months later, the broader stock market, as measured by the S&P 500, started to fall as well. Today, this ratio line continues to fall and the broader stock market should continue to fall as a result. Once a bullish divergence develops between the ratio line and the S&P 500, we can expect to see a bottom in the stock market to form several months later, followed by a new bull market rally. Until this divergence appears, the higher probability is for the broader stock market to continue to move lower.



Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

Garland, Tx
Website: www.tradersclassroom.com
E-mail address: inquiry@tradersclassroom.com

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Date: 01/27/09Rank: 5Comment: 
Date: 01/28/09Rank: 5Comment: Very interesting analysis. Thank you!
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