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From the desk of Robert Christy

From the Trading Turret

May 27, 2005

Current Field Position

1. Offense or Defense?

NYSE Bullish Percent is in Bear Confirmed Status - Os @ 54%

Optionable Stocks Bullish Percent is Bull Confirmed Status – Xs @ 50%

OTC Bullish Percent is in a Bear Confirmed Status – Os @ 38%

2. Sector Bell Curve: Average Sector Bullish Percent is 47.57%

3. Favored Sectors: restaurant, Builders, gas utilities, Electric Utilities

4. Strategy: DEFENSE We are currently in the Capital Preservation Mode but some players are ready to move onto offense: Semiconductors, Internet, Software, Machinery and Steel (if you would like to see a list of possible buy candidates, please send me an email)

This week’s comment …

Over the past month, I have held my ground and let the indicators do the talking for me. Even though the market looks vulnerable a few months out, (the likelihood is high that we’ll have lower prices well into the second half of the year), I’m seeing a strong indication that we are due for a trading rally. Three reasons why: (1) the extreme oversold condition, (2) overly pessimistic investor sentiment and (3) important support levels of 10,000 on the Dow Jones Industrial Average and 1140 on the S&P 500 held the decline in check in late April.

Today, an overwhelming majority of investors are pessimistic and knowing that the market will do whatever it takes to prove the majority wrong, I expect that the counter trend rally to be with us long enough to change a few minds. This rally has been quick and in terms of breadth – not very deep. This past week, I noticed a few sectors shifting to offense, but there appears to be a lack of conviction by institutions and other big money investors.

So far this year the Dow Jones Industrial Average has had two rallies of 500-points or more, yet it remains down more than 300-points from where it started the year. That pretty much sums up the first five months of 2005. Corporate earnings have also been stronger than expected. This in and of itself could have sparked a strong rally but the major indices are still close to where they were prior to the start of earnings season. First quarter earnings growth came in well into double-digit territory, making it 12-consecutive quarters of double-digit earnings growth. The second quarter, as well as the rest of the year, is likely to be more challenging with earnings growth slowing into the single-digits for the first time since March 2002. So, strong corporate earnings were not the catalyst that sparked the counter trend rally.

In addition to the technical reasons above, I’m hearing a lot of talk about the possibility of a "soft landing" orchestrated by the Federal Reserve. A soft landing is a slowdown in economic growth without a recession. A soft landing would be great for the economy, and it appears that the bond market may be discounting such an event with long-term interest rates declining even after the Fed has hike rates at eight consecutive FOMC meetings.

One of the very few times the Fed has been successful in steering the economy to a soft landing was in 1994-1995, which happens to also be one of the few times in history when long-term interest rates also fell while the Fed hiked short-term rates. However, soft landings are very rare. According to Ned Davis Research (NDR), in 12 out of the last 14 times (86%) when the Fed hiked interest rates three times (or more), we soon found ourselves in a recession. 

These statistics don’t tell us anything new. Especially that the Fed has a tendency to overreact. According to InvesTech Research, only three of the last 10 Fed tightening cycles did not end in a bear market. Even in those three cases, the S&P 500 still declined by an average of 13.9%. 

Even though I’m a techno geek, I still make it a priority to keep my finger on the pulse of the “fundamental” community. That said, there has been a lot of it in the news recently. The biggest item was the release of the May 3^rd FOMC minutes. They show that the Fed was more concerned with rising inflation than signs of slowing economic growth. Quoting:

"Although downside risks to sustainable growth have become more evident, most members regarded the recent slower growth of economic activity as likely to be transitory. All members regarded the stance of monetary policy as accommodative and judged that the current level of short-term rates remained too low to be consistent with sustainable growth and stable prices in the long run."

The Fed has tripled the fed funds rate over the past year from 1.0% to 3.0%. While there is hope that the Fed will stop raising interest rates, it may be premature. They next meet on June 29-30th. As I mentioned above, the Fed has a tendency to overreact and if history is any guide, they will again.

That’s about it for now.

Have a great week.

Bob

Robert Christy is a professional stock trader, an author and a money manager. Mr. Christy is also the President/ CEO of Christy Investment Group, Ltd., a registered investment advisory firm. At the time of publication, Mr. Christy may from time to time write about stocks in which he, Plato Advisors LLC, or Christy Investment Group, Ltd.  has a position. In such cases, appropriate disclosure is made.  Under no circumstances does the information in this column represent a specific recommendation to buy or sell stocks. Mr. Christy appreciates your feedback and invites you to send it to rac@christyinvestments.com.