Nowhere to go but down

“Once the top has been put in, the market has nowhere to go but down.” Thus spake Richard Russell, the doyen of financial newsletter writers. Now  85, Russell has been writing his Dow Theory Letter, virtually daily, since 1958. Not surprisingly, he is immensely knowledgeable and is regarded with awe by all financial writers, even those who disagree with him. So let’s stay with him a bit longer, in this quote from one of his daily missives this week:

“And the top has definitely been put in. What do I do next? My job is to get my subscribers OUT of stocks any way I can. I’ve used logic, technical analysis with explanations, threats, pleading, history, tears, arguments from authority (my authority), warnings about the treacherousness of the bear. What’s left? I guess more work on my part.” This ‘work’ is Russell’s daily analysis, which for him is a labour of love – otherwise he would have quit long ago. So he asks himself rhetorically “But is the top really in?” and proceeds to reel off a list of items that support this thesis, almost all of them based on technical analysis of the markets.

Since technical analysis is voodoo to most mainstream economists, they tend to pay no attention to Russell or others of his ilk. The fact that his record – stretching back over more than half a century — is infinitely superior to any of theirs, carries no weight. Dogma is everything, results nothing. But it is not only Russell, along with many other technicians, who has been hammering the message home that the writing is on the wall. David Rosenberg, who has been cited frequently in this column and who is an economist’s economist in that his analytical tools are ‘fundamental’, not technical, has been pounding the table for weeks that the US and global economies have turned down, so that the flimsy basis for the huge rally in the markets during 2009-2010 is rapidly evaporating.

 Nor is Rosenberg, a long-standing bear, alone any more. At the other extreme, as it were, stands Jim O’Neill, one of Goldman Sachs’ foremost strategists and a leading bull. Yet he was moved last week to pen a note listing 10 reasons for feeling bearish. He didn’t go all the way and say he himself was now in the bear camp, he merely identified a slew of reasons why one might be tending that way now.

 All this analytical discussion is taking place against a dramatic backdrop in terms of market activity. Russell and other technicians are convinced that the US equity markets topped in late April. Some analysts are making the point that the equity markets are actually lagging badly behind the credit and debt markets (ie the inter-bank deposit market and the bond markets), where the erosion has been going on for longer and is more advanced. The implication is that it is the equity markets which will have to catch up, and indeed Russell and others – including the highly-respected Bob Janjuah of Royal Bank of Scotland – are talking openly of the likelihood that the equity markets will soon suffer a sharp fall of 5-10% over just one or two days.

But the primary feature of all the markets these past few weeks has not been the weakness or prices, but rather the extraordinary, quite amazing, volatility. In the final months of the rally – basically the first quarter of this year – there were very few trading days in which the markets rose (or fell) more than one percent. In the last six weeks, there has hardly been a day when the main indices have not moved one percent, and often two percent, on the day – with intra-day swings of several percent in both directions becoming a seemingly normal occurrence.

This new state of affairs reflects many things — extreme nervousness among investors and growing liquidity problems within the markets. The volatility alone is a strong signal to people to get out of the way; the downward trend in prices – in commodities and in government bond yields, as well as in equities – is an even stronger one. There is no valid justification for maintaining exposure to the equity market, because the prudent investor should accept what the market is telling him – that this is very dangerous territory, that the potential for gain is outweighed by the threat of severe losses and that, in a word, what does he need this for? Russell et al are right, the logic is overwhelming: Get your money out, before it’s too late and it’s gone.

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