The Dow breaks

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Not only did the Dow break January's lows, it also broke its multi-year trendline. Charts eventually revert to their moving average, which is the basis for trend channel trading. In the case of the Dow, it fell about 13% below its 200dma back in January. That was considered an unusually large drop for the time frame in which it happened, and was so devastating to America's wealth that the government resorted to historic measures to prevent it from getting any worse. All they accomplished was delaying the inevitable. That and adding over $400B to the federal deficit. Ok, so now we're back to reality.

A 13% move below the Dow's 200dma now puts it at 11200 or so. Our guess is that it will hold 11,000 no matter what. After that, we'll have a very tradable rally back to the 200dma. Beyond that, it's anyone's guess. Whether 11,000 holds as the year's lows or not is too far away to guess at.

What will stop the Dow from falling this time? This is obviously not your average little correction. This one is big enough that it needs a "story". The January bottom came with the "SocGen" story and the March low came with the "Bear Stearns" story. This selloff won't end without a bang. Here are some possible catalysts that could end this drop:

1.) A full 20% correction for the Dow (occurs at 11,340 or so)

2.) The collapse of a major company (LEH or an airline come to mind)

3.) Oil spikes for real. (Chart of OIL hits top of channel at $88)

4.) The government intervenes with an emergency speech. (That's all the ammo they have left)

Any of these, or a combination of them, would provide the story Wall Street needs in order to make headlines that people understand. It's very important that average middle class working people understand the "reason" why the market is falling, so they can be scared into selling their stocks at the bottom. Without this, the very foundations of Wall Street would crumble.

We haven't changed our tune. We're waiting for Ag to correct. In recent past corrections, Ag was always the last sector to correct. When it finally did, it got hit hard, but only for a day or two. The Ag stocks are the leaders, the generals of the army. It isn't until these generals are taken out back and shot that the market can begin anew. This is no different than the market's action of 15 years ago when it was DELL that told us when the bottoms were in place. This is like dejavu all over again just like last time.

Confession: we bought a little DDM today at 62. For as many guesses as you can come up with as to where the bottom will be, no one really knows. Over the long term, buying the Dow when it's down about 20% is a winning hand. Only for the indexes themselves would we ever buy a downtrending chart trading below a downtrending moving average. If the Dow were a stock, we would want nothing to do with a chart like that. Our shorts prove our theory about downtrending stock charts, that an object in motion remains in motion until it goes bankrupt.

See BCSI, CROX and C to see why you never buy a downtrending stock.

OIL

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The chart of OIL (above) shows that while CNBC reports a lower Dow due to an oil "spike", we haven't really spiked at all... yet. When a chart hits the same top (or bottom) multiple times in a short period of time, as OIL is doing now, the odds favor it breaking through that top or bottom. Our guess is that OIL will actually spike when it breaks resistance at approx 83. It could go as high as 88 on its next run. A spike like that could cause the Dow to truly capitulate and put in a real bottom.

It's hard to mention oil without reminding everyone how we got into this mess to begin with. Here's a quick recap:

Dick Cheney was the former CEO of Halliburton. Upon his acquittal (lol), he left with some parting gifts, namely, stock options. Once he became the VP of the United States, he was able to impact the success of Halliburton by giving tens of billions of dollars in Iraq war related oil services contracts to them. In addition, he was in a unique position to encourage America's overconsumption of oil by offering tax incentives to consumers who purchased vehicles with the highest gas consumption. Now, as the Fed wants to intervene by raising rates to keep inflation at bay (at 8% a year), they find they cannot because Americans are spending so much on oil that they can't afford higher interest payments.

In lieu of rate hikes to help the situation, we could all benefit from a check sent to each household that comes from Cheney's Halliburton stock option profits, which are in the tens of millions. We check our mailbox every few hours waiting for that check, but it has yet to come. Accountability is only for members of the middle class.

Mosaic - MOS

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Mosaic has already corrected to the center of its channel. If MON pushes Ag lower tomorrow, there could be a chance to buy near the quarter mark or lower. Because the lines of the channel move higher every day, buying at the quarter mark and waiting a month puts you in at a price equal to the bottom of the channel. We generally don't like holding through the consolidative phase of the cycle, but if the price is attractive, we buy a partial position early on. The earliest purchase is often the cheapest one. Buying Ag here should not be done without also holding some insurance (SMN), in the event that this iteration of the cycle is its last.

It's unlikely that this is the last iteration of the bullish cycle because the latest highs easily took out previous highs, suggesting a continuation of enormous upward momentum. It's only when a chart barely posts new highs (or fails to alltogether), that the following retest of the bottom of the channel (support) is likely to fail.

MTL and SID

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The chart at the top is MTL and the one below it is SID. Both are at the very bottoms of their channels and also near or at their 100dma's. This is the point where it is hard to buy because you envision the chart breaking down and falling off a cliff. On the other hand, it's also the point that you look at in hindsight wondering what kept you from buying there.

We bought small amounts of both of them because we know that playing the odds is profitable over time. Whether or not these two particular stocks rebound and remain in an uptrend is anybody's guess. Your guess is as good as any "professional's". The benefit of buying at the bottom of the channel is that if they do break down, they will likely rebound to roughly where they are now. After all, they're significantly off their highs already.

MTL and SID are not our real focus right now either way. They aren't the "hot" stocks we normally gravitate to. We're focused primarily on MON's earnings report tomorrow morning, and its affect on the Ag sector. Given the recent volatility in the sector, there is no question the report will move all of the Ag stocks substantially tomorrow, especially in the first half hour. We're looking to do a lot of buying of any Ag names we can get below midchannel.

Monsanto - MON

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Monsanto reports tomorrow before the bell. We don't mention MON much just because the percentages on its chart make it less attractive for trading than the other Ag stocks, but MON is actually the largest of the typical Ag names. We just bought some MOS ahead of the report in the 142's. These stocks are still in corrective mode. Any negative (or perceived negative) in tomorrow's report and these stocks could really take a beating because their short term momentum is currently down.

We're hoping for a huge selloff, because we'd be backing up the truck. Of course it could go either way, though. After today's MOS purchase, we're about 10% invested. 16% if you count SMN, MTL and SID. We couldn't resist buying some SID, right at the 100dma and at the bottom of the channel.

Let's all hope for a huge Ag selloff in the morning with a nice afternoon recovery. That is the quintessential entry point.

Long term Dow

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The chart above shows the past 4 years of the Dow's action. This chart shows that in addition to being near the short term support level created by this year's lows, the Dow is also near the support of its longer term trendline. This level (11,600-11,700) is critical for the market as a whole, not only from the perspective of whether or not the Dow will break near term support, but whether or not the multi-year bull is coming to an end. At approx 11,360, the Dow will have completed a 20% correction, and we will officially be in a bear market. This jives with the technicals in that if the Dow reaches 11,360, it will also have broken its multi-year uptrend.

It's incredible to think that despite all of the damage to date, the bull is by definition, still intact. Only in an election year, with massive Fed intervention, is such a phenomenon possible.

Potential trade

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Here is a trade in the making, which may or may not materialize. The chart at the top is OIL. It is at the center of its channel and could easily go either way. The chart at the bottom is DDM, Ultralong Dow. Here's the trade... if OIL spikes, the Dow will drop. The next stop for OIL is approx 86, or a gain of about 5%. If this happens, we expect to see the Dow down approx 200 to 11800. DDM would be at approx 66.

If it played out this way, we would buy some DDM at 66. For one thing, OIL is likely to turn back once it hits 86, making the Dow rebound. Of course, at the bottom of its channel, the Dow wants to rebound anyway. Furthermore, we would be very close to the Dow's lows. Although we think they will be broken at some point, we expect a few tradable rallies to start from their level prior to the eventual breakdown.

This trade, if it pans out, would break the basic rules of buying strong, uptrending charts on weakness. For that reason, you should file this trade in the "just for fun, don't bet the farm" folder. Of course, it's premature to talk about a trade that may or may not present itself, especially considering this one is primarily dependant on OIL's next move. Nevertheless, we must have a game plan going into the next several trading sessions now that Ag is off the table for the forseeable future.

DDM is something you can feel good about buying knowing that someday you can pass it on to your grandchildren. It's a low risk purchase if you think of it as a long term investment. And at these levels, you're certainly not buying at the very top. Using wider scales (buying larger and larger amounts as a stock drops in price), would eventually pay off if applied to DDM. At some point, the Dow will rebound and reach 15,000. Problem is, your money may be tied up in a relatively slow moving asset while individual stocks outperform it. Still, as a small piece of a large portfolio, it's not a bad addition here with the Dow over 2,000 points off its highs.

The Dow

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Above is a chart of the Dow. It remains trading below all major moving averages (the 200, 100, 50 and the 30), all of which are downtrending. Only one thing could make this chart any more bearish than it already is, and that's a new low.

Our recent poll on the left side of the blog screen asked readers whether or not the Dow would break its January lows this year. We weren't suprised to find that the vote was divided pretty evenly. We voted yes. Here we are, midyear, and nothing about the economy has improved since January. If anything, things have gotten worse, and the "powers that be" have no intention of providing any real relief. Wasn't it just 5 years ago that Bush passed a tax law incentivizing people to buy the largest SUV's? Wasn't it around this time that the Honda Insight (at 70mpg, it put the Prius to shame) was mysteriously removed from the list of cars available to the American consumer? Current oil prices are enough to stop the U.S. economy dead in its tracks. For all of the media coverage it's getting, we feel that we haven't even yet to scrape the surface of the devistation it will have on the bottom line of just about every company this quarter. This earnings season you'll see company after company blaming their shortfalls on the crippling price of oil. We feel that analysts have estimates too high for Q2 2008. We'll find out in July, or even sooner if companies warn ahead of time.

Interestingly enough, our recent Ag trade was profitable despite taking place coincident with a 1,000 point drop in the Dow. We've learned to not let the broader market affect our trading decisions for this reason. We just buy at the bottom of the channels and sell at the top. The actions of the broader market do not factor into the equation. Still, it's fun to guess at its next direction. And despite billions of dollars sitting on the sidelines waiting to get back into the market, our vote is that we break 11,600/11,700 this year. Perhaps this earnings season. Or when the Fed decides the rates need to be hiked because despite the election, immediate action is necessary because the inflation picture is growing desperate... to be determined.

The market's current weakness won't end until at least one major airline goes under. That's been our prediction since our post on the cost of firewood doubling this winter, and we're sticking to it.

Ag top here?

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Most of the Ag stock charts look similar to the chart of CF above. We did a lot of selling this morning. We may have to sit back and watch these stocks go a little higher, but we're confident that at the very least we'll be able to buy them back at today's prices at some point in the future. Of course the hopes are that they'll retreat to the bottom of their channels where we'll buy them back cheaper. We sold CF, MOS, AGU and some POT. We're still holding some POT because it's best of breed and it even comes with a memorable slogan "It's illegal to sell POT". That's worth another 5 points at least. Our short term target for POT is 250.

We should probably stay out of the market until these stocks consolidate their recent gains. It's more likely, though, that we'll trade them as they drop, particularly if they have large one-day losses. This type of trading is just a series of small, fun trades to pass the time until the next real move. It's the big moves (like the one we just traded) that really advance your bottom line. Although we were only approx 70% invested for this last move, our portfolio gained 15.5% overall since late May. It only takes 3 moves like this each year to post incredible gains.

We're holding MTL which looks like it just broke out to the upside today. OIL is at the center of its channel, so it has no predictive value for the next Dow move at this point.

Potash - POT

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A logarithmic chart of POT for anyone interested. We sold some MOS today just to take some profits along the way. In order to be tempted to sell heavily, we'd need to see a ridiculous run over the tops of the channels which happened in April as you can see from the chart above.

MOS is nearing the top of its channel, but it's an arithmetic channel. There's nothing stopping it from going parabolic like POT did. We're not calling a top in MOS yet, just lightening up because we hold nothing but Ag (and some DXD / SMN)

Ag top forming

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The chart above is MOS. The ag names are beginning to get overextended short term. They have an enormous amount of momentum and can run a bit further, but we're reducing exposure here as they are making a quick run for the tops of their channels. We'll probably see higher prices over the short term and wish we hadn't sold, but in a month or so we'll be able to buy them back at today's prices or cheaper. There's no sense in holding them if they will return to these levels at some point in the future. Our strategy is to sell half now and play a "wait-n-see" game. If they rally further, we'll sell the rest. If they drop, we'll be looking to repurchase the shares we sold closer to the bottom of the channel. The action today particularly in MOS and AGU suggests that these stocks are putting in a "blow off" top (opposite of a capitulative bottom).

As for the Dow's action, what is there to say? We're entering one of the darkest eras in American economic history. There is no suprise that the Dow is in freefall. We're holding DXD until it's all over. We're also holding SMN, which we will add to if the Ag names have a quick and incredible run to the upside from here. Now is not the time to aggressively buy SMN, but if Ag gets ridiculous, we'll be backing up the truck. At some point, these stocks will see the bottoms of their channels once again.

Solar (FSLR)

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Anyone with a question about RIO, please see the previous post about Brazil. For those interested in solar, your ship may be coming in. We're sticking with Ag, but couldn't help but notice that the solar leader has dropped to the bottom of its long term logarithmic trend channel. Log charts must be used for longer term charts because the percentages involved are so great that they would otherwise skew the chart to the point that lines connecting tops and bottoms could not be drawn.

The two moving averages on the chart of FSLR above are the 150dma and the 200dma. It has recently responded best to the 150dma, which it is currently at. Solar as a group has never fully recovered from January's losses, but FSLR has clearly been the outperformer. If one were to buy a 33% position in FSLR here (or preferably a little closer to the 200dma at $200) the odds favor that the worst case scenario would be to break even. If FSLR breaks down from here, it will likely rebound back to these levels at some point, considering it's already approx 25% off its highs. If instead it rallies back to the top of its channel, investors entering at these levels will do very well in a short amount of time. When viewed from this perspective, the risk/reward ratio makes FSLR a buy, particularly for those with the mindset that their second buy will be at the 200dma at $200 and their third buy will be upon a capitulative intraday bottom somewhere between January's low of $150 and March's low of $180. We're not calling for FSLR to return to $150. But entering the trade with this mindset is important to help maintain psychological control over your position.

Other solars will benefit if FSLR rebounds, but we like to stick with best of breed because the odds of recouping your capital after a cataclysmic selloff is greater when you're invested in stocks that have widespread institutional support. In this way, the market is like high school all over again... one big popularity contest.

Brazil - RIO

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The chart above is not of RIO but of Brazil (EWZ). Petrobras (PBR) and Vale (RIO) are the two largest companies in Latin America, and both are Brazilian. Let's face it, a bet on RIO is simply a bet on the Brazilian index (EWZ).

The good news with RIO is that it is at the bottom of its channel and at its 200dma, suggesting that much of the damage has already been done. The bad news is that EWZ has further to fall. Our projection is that RIO could see 30 and then go sideways for 3-4 months as a worst case scenario. If that happened, we'd buy a stock like RIO at 30 for the long run.

Our overall concensus about Brazil is that decoupling is a joke and that it will not do well without America. And you already know what we think about the current state of the American economy... with oil prices rising this quickly, we're in for a long, deep recession. Ben's answer: raise the rates. Another round of foreclosures is on the way. For a great number of Americans, the lower interest rates are what kept them in their homes. Now if only they could find a job before Ben hikes them back up again. And a second job to pay for this winter's heating bill. And a third job to cover Obama's tax hike. We're in way over our heads right now. Americans are just going to have to get used to a lower standard of living for awhile.

A note about the chart above: It is a logarithmic chart, and the moving average shown is the 200dma. For log charts, Ameritrade does not offer a linear regression tool, so the lines are drawn freehand. Even if they are off a little, though, it is clear that there is room for EWZ to decline further. The 200dma alone suggests this.

Mosaic - MOS

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Looking to start lightening up on the ag names. We're not heading for the hills, just looking to take some profits while letting about 75-80% of it continue to run. The Ag names have all had nice runs, but are all at different points in their channels. This makes it too hard to call a top. If they all rallied strongly for a couple of days (got ahead of themselves), then a top would be in place. In the absence of that, the best we can do is to take some profits here and there while waiting for the "blow-off" top.

MON and AGU are at the very tops of their channels. POT is about 80% up its logarithmic channel (clearly above its arithmetic one), CF is about 2/3 of the way to the top of its channel, and MOS (see chart above) is at the midpoint.

Charts like MOS and CF lead us to believe that the Ag names have further to run. We'd be taking some profits in MON now, if we owned it. Instead, we own AGU, and will be taking some profits there. We're partial to POT, so we're keeping our shares of POT until a real top is in.

A quick gauge of the relative strength of these stocks (versus one another) can be seen by simply comparing their current prices to their April highs. While MOS, CF, and AGU are at or below their April highs, POT and MON are comfortably above theirs. MON has not typically been a strong name in the group, so we're reluctant to call it a leader, but the good news is that there is no slowdown in POT's leadership. It continues to be the stock to own this year. It is this year's Google.

OIL... again

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Seems like just yesterday we were pointing out that OIL could be ready for another run to the top of its channel, and here we are, nearing the top once again. There's still time to get the "cheap" gas at the pumps before the new deliveries are made.

Death of the SUV and the U.S. economy all in one fell swoop...

thanks Bush!

LEH and OIL

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We're just holding the Ag names as usual, waiting for prices where it's worth taking some profits. In the meantime, couldn't help but notice that we haven't gotten anywhere in the last 3 months. If you go back to mid March, Bear Stearns had just collapsed and people were worried about Lehman being the next major financial firm to go under. Then, along came the Fed, who swooped in and made everything all better. Now here we are, 3 months later, worrying about Lehman again. The chart at the top (LEH) shows little or no technical improvement from mid March. The chart still has that "about to fall off a cliff" look to it. LEH's chart tells the story of the economy in a glance... 8,350 layoffs at GM, massive job losses in the financial services sector, foreclosures biting into the normally bulletproof Hamptons market, and gas surcharges popping up everywhere in one form or another.

The chart below LEH is a chart of OIL. Although it is well above its moving average, it has formed a short term trend channel (an uptrending one, of course). It is due for another run up, which would take the Dow down another few hundred points. At some point, it will break the green support line and stabilize for some time, but until then, its staggering uphill climb is very much intact.

We don't trade on broad market timing (only on individual stock timing), but we enjoy guessing at the market's next move. At this point, we think that the catalysts are in place for a potential drop in the market. LEH may be on the brink of disaster, and OIL may be headed for a relief rally, if not a substantial move to new highs. With these two threats looming, the market by no means has a green light to prosperity over the short term.