So far each rally has been met by selling pressure. Last week the markets managed to continue their move up – is this the one? When we look for a bottom we review a number of indicators. We have certainly seen some positive indicators. One of those indicators is the TED spread, which is the difference between three-month LIBOR (the London Inter Bank Offered Rate which is in euro dollars, also called The Euro Dollar Spread, thus TED) and three-month US Treasury bills.
The 3-month LIBOR is basically what banks charge each other to borrow money. Many mortgages and investments are based on various periods of LIBOR. Typically the TED spread is 50 basis points (0.50%) or less. When it spikes up, it is evidence of distress in the financial markets. The recent spike to 4.75 was the highest spike since the market crash of 1987. The TED spread has been declining, which indicates that there is more appetite to lend. This trend needs to continue, but it is encouraging.
Another indicator that we are watching is whether or not the Dow tests its recent low and if so, does that low hold. We had a low in early October and many called that the bottom. But then a week ago, we tested and made a new bottom. The big question is does that bottom hold?
We are expecting this current rally to last a couple of weeks and then see a possible test of that bottom. If that test holds we are looking for a much stronger rally from there. It is very difficult to gauge the potential height of that next rally, but we could see it run through until March of 2009. It could be a very good trading opportunity.
If you want to get a read on how the global economy is doing, check out a chart is of the Baltic Dry Index which is the index of ship rentals. This chart is frightening as it shows the massive decline in the cost of renting ships. This tells us that shippers are not getting a whole lot of goods to ship as the index has dropped from almost 12,000 to its current level of 885. We have never seen anything like this – the demand for shipping has evaporated.
On a more positive note, the volatility in the market is starting to decline from its astronomical heights. The VIX index measures the level of volatility and we are finally starting to see volatility decline, but it has a long way to go. Typically in a calm market the VIX is under 15, Friday it closed at just under 60.
To determine whether or not you should enter the market at this stage is a decision that can only be made by you and your financial advisor. If you do buy some stocks now, understand that the market is still very vulnerable to a blast of negative news, so be careful. Do not get too greedy and save some cash in case of the possibility that the market drops further soon – which could easily happen.
Martin Straith is the Chief Editor of the TREND letter. www.thetrendletter.com