Is the market topping?

The stock market is very bullish. Despite a usually bearish September, we will have a good month. I guess a lot of short sellers are being caught this month.

As I sit back and look at the market, I can hardly build up a bullish case.

There are plenty of reasons for me to be bearish.

· Car sales slumped in August to 11.5 m. It is the worst in 28 years
· In September, Univ of Michigan confidence index falls to 66.6 – worst since August 2009
· Unemployment is still high at 9.7 %. It is stabilizing but high. If it includes those working part time looking for a full time job and those who have given up looking for a job, the percentage is more like 16.7 %
· New home sales plunged 12% in July. This is the lowest ever. Existing home sales plunged 27% to 3.83 m. It is the lowest since 1995. Bank repossessed record number of homes in August. It is up 25% year on year. Home builder sentiments hits lowest since March 2009 in August. Construction spending slumped 1% in July to lowest in 10 years to 805 m dollars.
. Europe is not getting better. Germany reported good manufacturing growth but troubles in Ireland, Greece, and Iceland are getting worst.

· Despite all the cash pumped into the banks that failed, they are not lending. They probably understand the threat of the business environment. Instead of lending, they use the cash to strengthen their balance sheet. Commercial and Industrial loans shrink 16 quarters consecutively. Bank failures hit 119 this month. Altogether, there are still 829 banks that are in trouble.

One very important point is that much of the growth of GDP is inventory building. Once inventory achieves equilibrium but the end of the year, I do not foresee current sentiments that consumers are going to come out and help. We may slight into negative growth.

Finally, major companies warned the last 2 months on their forecast.


o CSCO – cut Q1 sales forecast
o INTC warned about weak sales in semiconductor
o Home Depot and Lowe slashed sales target
o BBYT showed virtually no sales growth
o FDX ( bell weather of economic climate ) missed expectation

If the economy is so rosy, why does the Fed still express so much concerns? Why does the bond market still attractive to many investors?

Interesting to note the stock prices for all the companies still go up in September.

There are of course some reasons for the bullishness.

Most important, the market believes the Fed will do everything to support the market. The Fed has hinted on QE 2. A “Bernanke put” has been bought for the market so it eliminates any fear.

Corporations are accumulating plenty of cash. It is about $800 billion which is roughly equivalent to the stimulus plan. The results are stock buy backs, increased dividends and a big increase in merger and acquisition.

Earnings are also positive so far mainly due to cost cutting, increased productivity and vibrancy of overseas market especially in China and India. According to Thomson Reuters, analysts project that companies in the S&P 500 will earn a cumulative $92 per share in 2011. That's the highest earnings in over 10 years for the large-cap index. This is more more than the bull markets of 2006 and 2007.

Added to the sentiments are the Christmas season and election which are normally positive for the market.

I really think the market is topping. Looking at the chart above on the sentiment indicators. It is extremely bullish. This indicator is a contrarian indicator. When investors are extremely bullish, a top is imminent. The last time, the sentiment indicators are at these level, it was followed by a correction or even a crash.

But it is hard to pin the top. The market can be irrational longer than we can remain liquid. Rationally, there are not enough fundamentals to support such a bullish sentiments.

My inclination is for a correction in October. Stock had risen more than 10% in September. This is the best September in 70 years! Expectations are high for earnings. Once a company fails to meet expectation, the stock will drop like a stone. Look at ADBE for a recent victim.

A friend pointed me out those momentum indicators like Stochastics and RS are greatly overbought. My reply is that the market can stay overbought for a while. It is a lagging indicator.

I have learned from experience that it is important to be patient and wait for signals like bearish candle formation and price breaking the channels and resistance. Meanwhile I am enjoying the ride but exercising vigilance and caution.

Make no mistakes. I am still making bullish trades. Trade with what you see not what you feel. As long as it is bullish, I will continue to ride the trend. At the same time, I am ready to pull off my trigger for hedging my record profits this year when my bearish signals are triggered. The drop will be fast once it starts

Also, I am selectively shorting stocks with synthetic puts ( short stock + short puts ) of fundamental weak companies with some bearish signals. It is my belief in a bull market, there are still more than 50% of companies that will under perform the market. Interestingly, I am making money on 70% of these trades. I believe I will make money on all these trades.