Technically Speaking
Monthly Newsletter
Paul T. Carroll, Chief Investment Officer
Brian C. McCracken, Vice President – Portfolio Manager
February 2011
“If you mean whiskey, the devil’s brew, the poison scourge, the bloody monster that defiles
innocence, dethrones reason, destroys the home, creates misery and poverty, yea, literally takes
the bread from the mouths of little children; if you mean that evil drink that topples Christian men
and women from the pinnacles of righteous and gracious living into the bottomless pit of
degradation, shame, despair, helplessness, and hopelessness, then, my friend, I am opposed to it
with every fiber of my being.
However, if by whiskey you mean the oil of conversation, the philosophic wine, the elixir of life,
the ale that is consumed when good fellows get together, that puts a song in their hearts and the
warm glow of contentment in their eyes; if you mean Christmas cheer, the stimulating sip that
puts a little spring in the step of an elderly gentleman on a frosty morning; if you mean that drink
that enables man to magnify his joy, and to forget life’s great tragedies and heartbreaks and
sorrow; if you mean that drink the sale of which pours into our treasuries untold millions of
dollars each year, that provides tender care for our little crippled children, our blind, our deaf, our
dumb, our pitifully aged and infirm, to build the finest highways, hospitals, universities, and
community colleges in this nation, then my friend, I am absolutely, unequivocally in favor of it.
This is my position, and as always, I refuse to compromise on matters of principle.”
1952, Noah S. “Soggy” Sweat, Jr., Member of the Mississippi House of Representatives
This certainly has to be one of the all time great political quotes. We joke around about politicians
taking stands on issues based on poll numbers, but rarely do any articulate that thinking in such an
exquisite manner. Yet it does point out how views can be spun on the same subject, depending on
our perception. In fact, perception is such a key ingredient to how we view things that we even
have a saying about it – perception is reality.
When it comes to the market things are no different. Everyone has their own opinion and view
about what’s going to happen and why. As we’ve mentioned before, it seems you can lineup a list
of “experts” equally divided between optimism and pessimism regarding the stock market. They all
sound so convincing it seems like the last one you heard is what you’re sticking too.
Why does this happen? Aren’t we all looking at the same data? Yes, but how we perceive and
interpret that data - just like in the whiskey quote – is what makes the difference.
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The Example of Inflation
Consider the example of inflation. At first it would seem rather easy to determine whether or not
inflation is a problem. After all the government tracks inflation through the Consumer Price Index
(CPI) and publicly releases this information monthly. From the government’s own website, here is
the purpose of the CPI – “The CPI measures inflation as experienced by consumers in their day-today living expenses;” and “The CPI is generally the best measure for adjusting payments to
consumers when the intent is to allow consumers to purchase at today's prices, a market basket of
goods and services equivalent to one that they could purchase in an earlier period.”
There we have it. You just can’t get much more straightforward than that. In fact, many cost of
living adjustments are tied directly to the CPI (i.e. social security). You would think we could all
agree on whether inflation is creating a problem or not. But, then again, you’d be wrong.
Why? First, consider just the behavioral aspect of dealing with inflation. If the goods and services
I’m spending money on are rising faster than the overall CPI, then it’s not going to be an accurate
representation to me. Second, what if the government changed the way it was reporting CPI?
Surely they wouldn’t do that, would they?
The chart above and much of the information that follows is courtesy of www.shadowstats.com.
Their website provides a wealth of intriguing information. The red line above represents the official
CPI figure. The blue line represents the CPI as if it were calculated using the methodologies in place
in 1980. You’ll notice there is some variance through the 80’s and early 90’s but the real disparity is
seen from the mid 90’s on. Why?
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Originally, the CPI was figured using a fixed basket of goods. The identical basket of
goods would be priced at market prices at different points in time giving a fairly
straight forward figure.
In the 90’s, the weighting shifted from a straight arithmetic weighting to a geometric
weighting. In short, in geometric weighting, it automatically gives a lower weighting
to those CPI products that are rising in price and a lower weighting to those that are
dropping in price.
Geometric weighting is purely a mathematical calculation and not based on
consumer behavior.
There are other changes that have also had an impact (i.e. replacing steak with
chicken) but space does not permit us to look at every variable.
The main point here is not which figure is the “right” one. Rather, it’s to show how what seems like
a straight forward figure is still up for interpretation.
Is The Market Good, Bad, or Ugly?
It depends on who you ask and what they’re looking at. Take a look at the following charts:
The Good:
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The Bad:
The Ugly:
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The Good: chart shows the DJIA breaking above major resistance line. Last time it did this in 2006 it
continued to climb for over a year to all time highs.
The Bad: chart shows the market on a short term basis as overbought. Previously have had at least
short term pauses and pullbacks from this area. Notice in the upper left corner this was with the
S&P 500 close on 1/28/11 at 1276. Yesterday it closed at 1304.
The Ugly: Long term inflation adjusted P/E multiple shows the market in overvalued territory. Real
long term growth rates from this area have not been attractive.
The Lesson of the Ugly Duckling
Remember the lesson from the ugly duckling? In reality, he wasn’t so ugly. Consider the
implications of our previous section on inflation and the CPI. Most of us probably find ourselves
agreeing more with the alternate CPI computation than with the official number. We find the
things we actually purchase (like gas) seem to rise faster than what the government’s telling us it is.
With that in mind, consider what happens to our chart in “The Ugly” section. Remember, this chart
is based upon real earnings and the real monthly average daily close of the market. This simply
means it’s inflation adjusted.
See chart on next page
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This is the exact same chart as before except it replaces the government’s official CPI figure with the
alternate CPI calculated by ShadowStats.com.
Now the market is fairly valued, not overvalued, and perhaps more importantly, the P/E multiple in
March 2009 actually entered single digits – the area all secular bull markets started from. So now
the real question is which figure and chart is right? Probably depends on your point of view and
what tale you want to spin. This is why we rely on our primary trend indicators. Each of the
indicators we reference our driven by the price action of the markets and are simply a mechanism
for helping identify whether supply or demand is in control.
All of our indicators continue to reside in positive territory. Therefore, our default position is the
market is in a continued up trend. How far can the market rise? As far as it wants. As one veteran
put it – “the markets can rise much longer and farther than you think they should, and they will fall
much lower and quicker than you think they should.” Right now none of the indicators are even
close to changing. This doesn’t mean we can’t see a pullback in the short term. In fact, based upon
a couple of different short term factors (including the chart under “The Bad”), we’d be more
surprised if we don’t get a pullback. As we’ve mentioned before – short term cautious but not
bearish.
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Trend Indicator
The Dow Theory (www.thedowtheory.com)
Composite Indicator
Relative Strength: Market vs. Money Market
1,3,6,12 Monthly Returns: S&P 500 vs. Bonds
Signal
Positive
Positive
Positive
Positive
Paul T. Carroll, Chief Investment Officer * 417-886-6590 * [email protected]
Brian C. McCracken, Vice President – Portfolio Manager * [email protected]
Pinnacle Family Advisors
3010 E. Battlefield, Ste. A, Springfield, MO 65804
www.PinnacleFamilyAdvisors.com
Information provided in this report is for educational and illustrative purposes only and should not be construed as individualized
investment advice. The investment or strategy discussed may not be suitable for all investors. Investors must make their own
decisions based on their specific investment objectives and financial circumstances. Technical analysis is based on the study of
historical price movements and past trend patterns. There are also no assurances that movements or trends can or will be
duplicated in the future. The S&P 500 is an unmanaged, weighted index of 500 stocks providing a broad indicator of price
movement. The Dow Jones Industrial Average is a price weighted index of 30 stocks. Individual investors cannot directly
purchase an index.
The Dow Theory and Composite Indicator are based on and found at www.thedowtheory.com. The Market Relative Strength vs.
Money Market and all Risk Indicators listed are based on point and figure technical analysis provided by Dorsey Wright and
Associates. They may be found at www.dorseywright.com.
The analysis of Equities, Fixed Income, and Real Assets are based upon technical analysis and does not represent a fundamental
research position on any of the items listed. Technical analysis is based upon the price movement of an asset and not any
underlying fundamental research.
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