Stay Cautious As Bearish Signs Grow

03/05/2008 12:00 am EST

Focus: MARKETS

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer, editor of the Option Advisor, warns that some key technical indicators are giving off bearish signals—and the Fed’s doublespeak doesn’t help.

There are numerous indications of a significant buildup in bearish sentiment—from put/call ratios to investor polls to mutual fund flows to “doom and gloom” magazine covers.

But at the same time, the Standard & Poor’s 500 index continues to flirt with bear market territory. [As of February 21st], the S&P has now closed for seven consecutive weeks below its 80-week moving average. (It apparently closed below that moving average over the last two weeks as well—Editor.) And the S&P now sits just a fraction of a percentage point above its 160-week moving average, on which it has been leaning for support for the past six weeks.

I have also expressed concerns about the Federal Reserve and Ben Bernanke, most specifically about their obtuseness last year to the developing financial storm and their consequent failure to act quickly to cut rates. I did concede that “the Fed has indicated that it actually has brain waves and a heartbeat,” and additional rate cutting followed and there will be more rate cutting to come.

But the following quote from a February 21st article on Bloomberg.com demonstrates to me that this obtuseness dies hard: “Federal Reserve officials signaled they are prepared to quickly reverse last month’s interest-rate cuts after concluding that borrowing costs need to be kept low for now. Policy makers cut their 2008 growth forecasts and said that rates should be held down ‘for a time,’ minutes of their Jan. 29-30 meeting showed yesterday. They also called inflation ‘disappointing,’ and some foresaw raising rates, possibly at a ‘rapid’ pace once the economy recovers.”

This is certainly not what the stock market wanted to hear and, more importantly, I think it’s premature and a mistake to signal that there is an intention to raise rates rapidly once the crisis has passed. The bottom line is that it harms what the Fed is trying to accomplish now—repairing the economy—by raising the specter of rate hikes down the road to address an inflation issue that may or may not materialize.

My advice at this juncture remains the same as I stated last month: “A healthy dose of cash of 25-50%, an ongoing major investment in gold, some selected Internet plays, and some plays in the agriculture sector. And I would continue to avoid any exposure to the financial sector.” To this I would add my ongoing concern about the technology sector, which was subject last year to one of the most widespread barrages of bullish magazine cover stories since the bubble years, and on which analysts have barely budged in their bullish recommendations despite the major hit the sector has taken in recent months.

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