Bear Markets Don't Occur Until Liquidity Dries Up

We don't have to tell you that last week was devastating in its panic.  We saw one day with the Arms Index on the NASDAQ over 7.  That means that despite the weak ratio of advancing to declining stocks, the ratio of the volume being dumped on the stocks that were going down was 7 times as high.  Based on many years of observation, that is HUGE.  This action in the NASDAQ Composite shown below is what it produced.  We're using the NASDAQ Composite as our guiding index, since it does not have nearly as big of a distortion from the "big banks" or "big oil" stocks.  It also has the most reliable overall action in our opinion.

Click to view larger image.

We certainly didn't expect the decline of 11% on the NASDAQ (or 10.7% on the S&P 500) over the last two weeks.  The market had been holding up amazingly well until the debt limit turned out to be less than what S&P wanted.  The fast traders' computers don't have but one speed - full throttle - so once one of them sold, the rest of the pack piled on.  As you are well aware, we got a signal on June 13th that the conditions were optimal for equities.  You can see that blue arrow in the chart above denoting that timing.  The rally started almost immediately, which is always suspect, but the last two weeks now have the NASDAQ down 4% even from that positive signal.

So today, should we run from cover like those fast traders? No!! In fact, it is a truism that severe corrections don't stop until the pure technicians turn bearish.  Furthermore, as Ed Yadeni (http://blog.yardeni.com/)  points out, there is now $8.3 trillion in money market and savings accounts.  We've often said that bear markets don't start until the monetary liquidity dries up, and today the monetary liquidity is exactly the opposite.  You can bet on it, the Fed is going to do all in its power to entice investors (and corporations and banks) to put their low-yielding money to work. 

So...the bottom line is that this is "hard hat" time, a time when investors have to temporarily hunker down and resist the panic of the herd.  It is a personality trait that all good investors learn over the years, but it never gets easier it seems.  Every time there is a new threat trying to knock over those valuable disciplines of the past, but history tells us to stay the course, and continue to rely on the instrument panel.  These storms do die down, and your patience and fortitude will be rewarded.

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Don Hays

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