Spock Tries to Call a Top

Barely anyone seems to be willing to call a top in the DOW, so I'm going to go out on a limb and make that call - the annual high of 11670.19 that we saw on 5/10/06 in the Dow Jones Industrial Average will not be broken until the Dow Jones Industrial average makes a new low for the year (breaking below 10661.15). I do believe that forecasting can only be undertaken with humility, and forecasts should always be qualified in terms of probabilities, but I am going to make this public call nonetheless, and I will go out on a limb and state that I believe that there is an 80% chance that I am correct with this call.

I have been moving more of my funds into cash since February, so that I now stand at the most conservative side of the Efficient Frontier of asset allocation - 20% equities. My reasons for taking an increasingly defensive position are many, but here is a short list of some of the most compelling:

• An insider/outsider divergence of massive proportions: We have had more money flowing into individual investor's brokerage accounts this year then we have since 2000, at the same time the Vickers Insider Buy to Sell ratio has hit 4.5, well above the bearish threashold of 2.5. It is a market truism, and one that is well backed by data, that heavy, broad insider selling is a reliable sign of a market top, and aggressive buying by individuals at discount brokerages whose activities can best be described as hopeful entertainment is another sign of a top. To pinpoint stocks where this divergence is particularly pronounced, look at a list of top stocks being sold by insiders, and compare it to the most widely bought stocks published by Ameritrade or Scottrade.



• The sour stench of dashed false hope: Despite slim evidence in support of this view, we have had more and more rallies on any bit of data suggesting that the Fed might stop hiking interest rates sometime soon. The rally earlier this month caused by the Fed chair's comments, and the subsequent dashing of those hopes against the rocks this last Tuesday, are a sign of a market that is in the grip of a false hope that will only be broken by pain. A global/intermarket perpective suggests that the Fed cannot stop hiking rates immediately if it is to staunch the fall of the dollar and prevent a flight of capital from all things dollar-denominated, especially at a time when central banks in Japan and Europe are ending their policies of accomodation by offering better yeilds.



• Consumer Slowdown: Expedia's stock takes a dive, following the Dow Jones Housing Index down: 60% of economic activity in the United States is driven by consumer spending, and the best clues to the future direction of that spending are provided by current wage date, and and by current spending on consumer descretionaries (i.e., major purchases that can be delayed). The most widely followed metric of the heath of consumers, the unemployment rate, is much less useful because it is a lagging indicator, which is to say, it peaks after the economic cycle has already begun to slow down, and hits its lowest point in the cycle when the economy is about to turn up. Expedia's 50% profit drop this last week was a clear sign that consumers are choosing to delay the most discretionary of purchases: vacations. At the same time, inflation-adjusted wages appear to be peaking, GDP is decelerating (growing, but more slowing) and while housing data appears strong on the surface, many of the leading indicators of housing (including housing inventories and mortgage rates) are turning sharply negative.



• Evaluation of Market Sensor Readings: Cautious and over 80% in Cash.

Logical Thought of the Day:"...Hence in the wise leader's plans, considerations of
advantage and of disadvantage will be blended together. If our expectation of advantage be tempered in this way, we may succeed in accomplishing the essential part of our schemes. If, on the other hand, in the midst of difficulties we
are always ready to seize an advantage, we may extricate ourselves from misfortune." (Sun Tzu, Chapter 8: Variation of Tactics)