INTEREST RATES, VALUATIONS, SENTIMENT, AND MARKET ACTION HAVE FULFILLED REQUIREMENTS FOR A BOTTOM. HOWEVER, WE STILL NEED THE CRITICAL DOW JONES UTILITIES INDEXT TO JOIN THE PARTY FOR A 'FULL PULL.'

Three major factors that affect the market are: interest rates, valuations, and sentiment. With the US Fed Funds Rate at 2.25%, almost the lowest in a generation (except for 2003), no one needs a chart to see that US interest rates are very positive for the markets and the economy. The chart below shows that US equity valuations (based on forward-looking earnings) are at a price earnings ratio of 14, which is lower than it has been for over a decade. This is also very positive. Last Wednesday, I wrote a special update with a chart showing that advisory sentiment issued a buy signal. Since optimism increased there was pretty well the same level of pessimism as there was at the end of the bear market in October 2002. Putting this together with a rebound from clear double bottom since Mar. 17 means that all of the basic requirements for a market bottom are in place. Since the lows, the SP 500 has risen 5.25% percent and the TSX has risen 7.1%, which brought them to a short-term overbought level. While the rebound was nice, there was some strength missing. The DJ Industrials and Transport indexes had nice rebounds from depressed levels but the DJ Utilities Index, which usually leads the markets higher, has stubbornly refused to budge. I do not know why this is the case, but the Utilities index needs to ‘join the party’ in order to give any upside momentum the power it needs to verify that a new long term up trend is beginning. Fortunately, the long-term oscillator for the DJU turned up from an extremely oversold level as the DJU rose 1.18% today. Perhaps this will produce the extra strength that has been missing since Mar. 17.

Since the equity markets are now overbought for the short-term there could be a pause to consolidate the recent gains. At the beginning of a rise, the initial corrections are often very minor. While there are many diverging opinions about the future, the action of the equity markets and the DJU Index during the next week or so should provide further evidence of how strong the rebound we have experienced really is.

Bonds – Bond prices are holding firm, as investors are reticent to assume risk. However, bonds are overvalued while equities are undervalued. While government bonds could be safe, they may not provide an acceptable rate of return in the future.

Commodities – Many commodities are correcting after a sharp rise. This could continue for weeks as money shifts from commodities, which had a good run to record highs, to equities, which are undervalued and still near the lows.

Currencies – The USD$ should gain strength as the equity markets gain a stronger foothold. However, to date, these rallies have been minor rallies in a longer-term bear market. With US interest rates much lower than many competing currencies, these is very little to indicate that this rise will be any different.

This chart shows that forward looking earnings for the SP 500 is very low, especially when you consider how low interest rates are. At a PER of 14, it is well below the 3-year average of 16.6% and the 10-year average of 19.8%. US stocks have not been this cheap in many, many years.

For the very short term, equity markets have used up their upside momentum and need a rest before moving higher. If this is the beginning of a new long-term up trend, this pause should be short with minimal downside action.

For the longer term, the markets are still just rising off of the lows and have a long way to go before reaching the overbought level. This supports the comments for the short-term chart above.

The long-term oscillator for the DJ Utilities Index turned up from an extremely oversold level today. This may be the missing link in concluding that the corrective phase, which began eight months ago, is over. A strong rebound here could be the extra spark to really add some strength to the overall advance.

The peaks for the long-term oscillator for the Volatility Index have been lower and lower even as the VIX had a triple top. This also supports the case that the worst is over. Downside volatility has subsided for over a week now.

This up trend/downtrend chart for the VIX has been green (meaning higher volatility and risk) for over a year now. When this chart turns red, it will be another clear sign that the character of the market has changed for the better.

The long-term oscillator for bonds is moving lower, implying that bond yields should trend higher (and prices lower). Even though prices appear strong, this suggests that there is the potential for weakness.

The long-term oscillator for gold has some distance to go before reaching the fully oversold level. This would normally takes another month or so. This suggests either more downside, more time, or a combination of both before another rise can begin. However, stocks can often follow the equity markets more than the price of the underlying commodity so this does not necessarily mean that gold stocks follow the price of gold.

Oil is also vulnerable to a decline since the oscillator peaked and is now declining.

The CAD$ is weak after being relatively strong since the end of 2007. This weakness could continue until the oscillator turns back up again. Weakness should be mild if it follows past patterns.

The USD$ is oversold and turning up against the euro which has had a huge rally so far this year. Previous rallies by the USD$ have been half hearted. With US rates so low this pattern could be repeated.

Data supplied by