Earlier this week, NewsMax reported an alarming warning by Morgan Stanley about the stock markets. Here's an excerpt from the article, "Morgan Stanley Says Sell, Sell, Sell" - taken directly from our own NewsMax wires:
"Morgan Stanley issued a "full house sell signal," saying three of its leading indicators - bond yields, Institute for Supply Management new orders, and valuation and risk - showed it was time to sell. MarketWatch reported that analyst Teun Draaisma stated in a European strategy research report that, "Such a full house sell signal across these three indicators is rare and has occurred only five times since 1980."
She added that, "Equities have always been down in the next six months, on average by 15 percent. Previous occasions include September 1987 and April 2002. We prefer to be on the right side of those odds."
Now, if I were an investor and saw that headline, I imagine that my knees might suddenly begin to go weak. Just what does a "full house sell signal" really mean?
Do I sell everything and run for the hills? Do I do a portfolio review and sell what I consider might be any "weak sisters" in my portfolio (assuming I even have the ability to determine what constitutes a weak sister)? Do I just hold on to my stocks and hope Morgan is wrong? Holy Cow, tell me, what should I do?
Well, let's begin at the beginning. Yes, Morgan Stanley is a much respected brokerage house. And yes, Morgan Stanley has some very capable folks that call their "buy" and "sell" shots. And yes, Morgan Stanley has an in-house criteria model for determining what market direction may turn out to be over the next six months, and yes, they believe it works well. All of these points I will grant you.
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But, let me make a few points of my own, too. When you issue a major statement about the market and never give investors a clear road map to begin to save their hides, you are truly playing with fire. Morgan is bright enough to know this.
Further, the seasoned veterans of Morgan Stanley know that there is only a 60 percent likelihood they will be right (that the sky is falling). Using only a fundamental approach (they cited just three fundamental criteria as their reason for the warning) to call markets has proven over the last 50 years to be a very problematic way to make money in the stock market. Check the history.
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I say this because I am a "Chart Man" and my 40 years in this business has taught me that you never make highly regarded and important market calls without including the data a chart generates. Leaving out the chart data is like making a cake and leaving off the best part, the icing - and folks, the icing is what make the cake a winner or loser.
But, you might say in defense of Morgan, they have only had this call five times since 1980. As I read their warning, they only told us the results of two of the five calls. The one in 1987 and the other in 2002. What happened to the outcome of the other three calls? Hmmm.
Like Morgan, I too issue major market turning reports. I have issued two major market turnaround "sell" signals since 1987 and two major market turnaround "buy" signals since 1987.
I issued the first sell warning in mid-September of 1987 (Dow @ 2525), almost like Morgan did. But, I issued the sell based on my charts first, plus the backing of some well overextended fundamental data. The 1987 chart data was primarily initiated by the presence of a seldom seen "parabolic" formation and I said so.
Then, I issued a buy recommendation one year later (almost to the day) in Sept.1988 (Dow@ 2098). I issued another sell in mid-November 2000 (Dow @ 10,630). My most recent signal was a buy issued mid-June 2003 (Dow@ 9,200). That is it. Today, I am not even remotely close to a "full house" type sell signal!
So, you say, what do you think is going on here, Max? Well, I will give you one scenario that is plausible. My major signals are all major market turnaround signals. Such moves, usually in excess of 15-20 percent, are clearly a major danger to investors. When such moves occur, they usually destroy the foundations of the current direction of the market for what is generally a long period of time.
I guess it might be possible that the Morgan Stanley model issues buys and sells only if it sees a correction coming (a move that is less than a 10 percent move, most often), one that may or may not eventually prove to be a major market turnaround. Yes, I'll give them that. Maybe they just don't have a better model than that. Maybe that is the difference between my style and theirs.
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But, let me pose another scenario. Let's suppose (and understand that I have no access to the Morgan model) that the model they use is designed only to call corrections. If that is the case, their model will call full house buys and full house sells much more often than mine. Of course, such signals prompt lots of selling or buying activity - and big commissions.
Now, don't get me wrong here. They are in the business to make a profit. There's nothing wrong with that. I was a broker once and know that commissions are a broker's life blood, so to speak.
However, by issuing "full house" (still don't really know what that means) buys and sells that generate huge commission flows, tell me, who is best served by the selling and buying if the signals turn out to NOT be major market turnarounds?
Let's say, in response to a sell signal, you sell lots of stocks and, after only a minor market correction, the market starts back up again. Do you buy those stocks back? Do you buy other stocks? And when?
Or let's say you buy lots of stocks on a buy signal and the market starts back down after less than a major market turnaround. Just when do you sell those stocks to stop the losses from piling up? Those questions I leave it to you to answer.
But to me, it is obvious the upset to an investor's portfolio structure, his psyche, his life's outlook, maybe even whether he kicks the dog that night, can well be influenced by such a broad and frightening printed warning as that issued today by Morgan.
And if you have read it and have lots of money tied up in the market now, you don't even have to be a customer of Morgan's to feel the effects of such a bone chiller from such a prestigious firm in print!
How I Would Have Handled the Warning
But, enough about Morgan. Let's talk about how I would have approached this matter if I went to print with a "full house" signal.
Here is what I would do. I would tell you that my model had just signaled a major market turnaround signal, a move that will likely be in excess of a 15-20 percent correction. I would tell you that possibly because of (a) world events as a whole, (b) the economy as a whole, (c) the stock market as a whole (and I would detail each of these), we are now looking at either:
- a major market over extension — meaning SELL your portfolio down to 80% cash now and wait for further instructions as the sell-off proceeds — or,
- a major undervalued market condition - meaning BUY to a 100% fully invested position now
To my way of thinking, that is what would constitute a full house buy or sell signal, telling you what has happened and telling you what to do now!
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Now, let me tell you what I would do if I saw only a correction coming, but not a major market turnaround. Here is what I would do: I would tell you that the possibility of such a minor correction exists (minor is in the 8-12 percent adjustment range as a maximum move).
Then I would show you the chart structure, with comments on the current indicator structure — keeping it simple to understand - and then I would show you on the chart exactly what levels to expect in the correction as support (or if a sell, the resistance levels).
In other words, I'd tell you that if this support (or resistance) level holds or that support (or resistance) level holds (explaining what constitutes holding), that you should stand by and keep a watchful eye on your portfolio.
Then, when we began to again move in the direction of the current major market move, I would use the early stage of this renewed move to either buy (if the market's renewed move was up) or sell short (if the market's renewed move was down).
Lastly, I would tell you how to protect your current portfolio value by doing what you do with your house, car, and life every day - buy insurance against further portfolio losses.
That's right, pay a little today for some insurance that the portfolio values you have today are "frozen" until the minor correction is over. Now, that is what a signal issued to the general public, or even just to your own customers should contain.
HERE IS MY PRESS RELEASE
With that said, here is what a warning issued today should have looked like, in my view.
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Whitmore Warns Of Possible Market Correction
Today, Max Whitmore issued a warning to investors that his charts indicate a possible market correction. He estimates that the correction could be s little as 3.5 percent (to the area around Dow 13110 - see First Defense Line on chart below) and to as much as 6 percent (to around the Dow 12780 area - see high price in 2007 First Qtr at this price).
He estimates that these two levels will hold the correction, but adds that if they don't, the 12100 area (see Super Chart Keyline on the chart below), a correction of about 10 percent, should hold. If this support breaks we could then be entering a possible major market turnaround.
But, at this point in time, this last possibility is less that 1 out of 10, a rather low possibility for any major market turnaround scenario. Below is the Whitmore Daily Dow Jones Super Chart showing the current Dow chart since early 2006 and lines on the chart to indicate the support levels mentioned above which Whitmore feels might possibly be tested if the possible correction occurs.
Click for Larger Image
In addition, Whitmore says to watch the yellow "Momentum Indicator" at the bottom of the chart (tells when any decline correction is running out of steam). If the 50 level is reached as we reach the First Defense Line, it is a 65 percent possibility that this is the full extent of the correction.
If the First Defense Line does not hold, and the Second Major Support is hit and the yellow Momentum line is near the 20-30 area, the likelihood that the correction being over raises to 80 percent."
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Now, there you have it. This would be my entire warning. Simple, concise, and can be understood without a lot of charting expertise. The lines and numbers are quite clear and, of course, every two-three weeks I would issue an update to show you the progress on the chart and eventually to inform you when one of the key supports has held and the major market direction has resumed.
In fact, I am issuing the above warning today. But let me make this abundantly clear! We are currently 1,365 points on the Dow from a major market turnaround (see my SUPER CHART KEYLINE) and far from any major market turnaround!!! I DO NOT currently see any danger to your portfolio beyond a simple market correction.
A FINAL NOTE
But now for the icing. Remember I mentioned earlier the email I would send you about how to protect your portfolio value? Well, here is what I would say in it:
In order to protect the current value of your portfolio, I am suggesting that you simply sell one Standard and Poor Futures Index, sold on the Chicago Mercantile Exchange, for each $25,000 you have in your portfolio.
The index futures make a profit if the market declines. This usually about replaces the loss in stock price you might suffer if the market does go down. The net result is that your portfolio about holds it value as of the day you purchase the index, regardless of whether the market declines or advances.
The symbol of the futures index I recommend is the ZBM7. You will be required to post a $2,000 deposit for each of the futures index contracts you sell.
Expect to hold onto the index until the correction is over (assuming it does take place) and I tell you to buy it back and take any profit it makes to replace the loss experienced on your stock holdings. Then, expect your portfolio to resume equity growth as the stock market again begins to climb.
And it will climb! I told you several weeks ago that I expect the stock market to climb to the Dow 19,000 - 20,000 level over the next 3-4 years or so. That prediction stands! Don't let a correction ruin your opportunity to be in on one of the biggest moves since the 1995-2000 boom.
Well, that's all for today. Do hope Morgan Stanley gets the message. Warnings are OK. But hey, how about helping the investor out with some idea of WHAT TO DO!!!
So that's it for today. As always, I hope you have a great investment week coming up. In the meantime, you keep in touch, I do!! See you next week.
Editor's note:
12 Ways to Recession Proof Your Portfolio
The 3 Best Income Stocks in the World
Buffett: The best book ever written on investing.
