Market continues down, my stock list goes up

Starting in mid-March, the market rallied and didn't look back. During those 10 weeks, the market dipped 7 times. So strong was the rally that with one exception, every dip was a little bit higher than the previous one. That's a classic sign of strength.

But the opposite is also the case. The market has been bearish for 5 weeks. Each low is lower than the previous one. In fact, if that premise is correct and the market is moving down almost as linearly as it moved up, then the next low will be ~12,300 before it pulls up a bit. Some would say that 12,300 is a resistance point.

I think any pullback now can be expected to worsen as hedge funds look to lock in profits.

Some might even argue that I am being too positive.

I start my analysis back in early May, when the market first topped out. Others would start in mid-May when the market last peaked. The difference is one of severity. As I've mentioned in the past, with my Last Gasp Theory, compared with the rally, the market crash happens more severely and much faster.

- If we start with early May, the pullback is happening at the same rate and degree as the rally: 700 points in 5 weeks.

- If we start with mid-May, the pullback is much more pronounced: 700 points in 2 weeks.

I'm not going to get too hung up on this, but the difference means where we will be if this is a bear crash. We could see 12,000 a lot faster.

I note that oil has pulled back. Not sure if anyone followed my suggestion re: DUG. I didn't do anything.

The market pullback has not resulted in any pullback in my target stocks. So it looks like I'm going to have to buy.

Gearing up for the end of Q2

Back in March, I positioned the portfolio for what I thought would be a rash of bad earnings. I focused on long term short positions:

Consumer discretionary spending: ZLC (jewelry), AGN

Recreation: MGM

Autos: AN, HOG

Clothing: NKE

Construction: VMC

and so on

Indeed, I was not disappointed. Earnings were lousy. But the stocks rose.

In fact, the theme that bets describes Wall Street's mood is that things are bad but not THAT bad. No over-the-cliff type of contraction. Look at the S&P earnings results as compiled by Zacks (sorry, you'll have to enlarge)

Projections for 2008 call for continued growth in almost every sector.

Check out the earnings surprises. I don’t read too much into earnings surprises, it’s easy for a company to guide estimates down and then beat them. Goldman did that last quarter - guided earnings down ~70% and then beat the newly revised estimates. This was logged as a positive surprise when the really meaningful thing to note was that their earnings had crashed and burned.

But it's precisely because it is so easy to manipulate guidance that any negative surprise is noteworthy. Despite this type of behavior, negative earnings surprises still shot up to a rate that hasn't been seen in a few years.

But 2008 projections remain positive, so Wall Street has no reason to turn negative.

Is that a safe assumption as we move into the end of Q2? To understand how business and consumer spending is faring, I looked at the recent April import/export data. http://www.bea.gov/index.htm
*Agriculture and energy companies are doing especially well. In addition, the weak dollar and cheap energy makes US manufacturing and products cheap on the world stage. Exports of staples and machinery are up. US wine exports are up

* Consumer and corporate belt tightening is massive and significant. Reduced imports of : computers, telecommunications equipment, cars, clothes, consumer durables, and recreation equipment. We are talking about a 1 month $8B pullback in consumer spending imports.
* Gold hoarding is accelerating. Non-monetary gold imports have rocketed up while jewelry is down.

* Corporate spending is dropping. IT spend is drooping, telecommunications imports & exports are down, construction spending is down, cars are down. Cars are a big issue because of the massive economic requirements: steel, rubber, parts, retailers, and so on. There is the theory that any softness in the US auto market will be offset by rising demand in China/India. The US market is on course to buy 2M fewer cars in 1 year - and that's a bigger than expected gap.

The US consumer is toast. No more cars, clothes, electronics gadgets, and so forth.
Non-oil imports dropped 3.5% in March. Consumer spending rose only 0.2% in April. http://ap.google.com/article/ALeqM5jsanM66tszKz1zFq0LOG4XvWS7zAD91075E00
The shift to wholesale retailers like Walmart and Costco shows the challenges facing consumers.

In fact, things are getting worse:

- Inflation is up
- Incomes are flat.
- Unemployment continues to grow
- Foreclosures are increasing

The US business world is faring better in select sectors: mainly plastics, chemicals, metals and agriculture. These are benefitting from the weak dollar. Volume production is not rising so much as pricing has surged. Rising production drives more employment and infrastructure investment - which is not happening as much as desired.

It’s all about the global market. And there is good news.
- China continues to grow at >10%.

- The dollar weakness will continue to make year-over-year earnings look good for
multinationals.

Notice that starting this summer, if the dollar does not weaken further, the impact on earnings slows by Q4.

In any case, the theory is wrong that the US will export out of a pullback - overall exports are falling. And as we buy less from our trading partners, they will buy less too. Food and fuel inflation doesn't help: whereas food is only 10% of the US income, it is 30%+ in most of the developing world.

One thing to consider. A lot of the surge in commodity prices, from food to oil and steel, are tied to Chinese demand. Some of the surge could be temporarily caused by a China preparing for the Olympics. That is, to keep the air clean and the water available, China expects to stop manufacturing and farming starting in July. They could be ramping up production now just to ensure satisfactory inventories while they sit idle.

In any case, I could still see a market downturn starting this month and accelerating through the year:
In June we have:
- Hedge funds locking in profits for the quarter
- The start of corporate earnings guidance and warnings
- The Fed meets and signals interest rate direction

In July we have
- Q2 GDP figures. They won’t be very good, if the consumer spending data and import data are any indication. They may even be negative, which would be problematic fo rthe market.
- Corporate earnings season kicks off with forward guidance

So I don’t like being bullish going into the next 6 weeks. And most of the companies I like seem overbought.