The hidden Decline in the Stock Market

Below I have created a very interesting (and I think very telling) chart. I have taken the S&P500 index and adjusted it for inflation by using the price of Gold. The green line graph is the $SPX as typically measured, in US Dollars (at $1092 as of the time of the chart). The candlestick graph is that of the S&P500 divided by Gold which takes out the $USD part of the equation.

This chart is very telling from the standpoint of an American investor. The Rally of the past few months is what I am coining, "the rogue rally". Since July the market has risen significantly, but this chart shows only a portion of that was for reasons other than the $USD decline. In fact, this chart peaked in August suggesting that since then the primary driver of the rally has been the decline in the $USD (increase in Gold's price).

If this is true then in fact the market peaked in real dollars in August and has been making lower lows ever since. Another way of thinking about this is that Gold (inflation) has been rising faster than the market and that an investor is actually losing ground from a purchasing power perspective since August.

A theory resulting from this is if the dollar is in a bottoming process (Gold Topping) then I expect the market to also be in a topping process. Also, the spread between the two indices is pretty wide. I expect them to converge over time as they did during the decline.

The same divergences I am seeing in the cash index are also showing up in inflation adjusted charts as well. Just another tool supporting a topping process may be playing out.

Another version of the options index

I read an article today that got me thinking about this index. The theory is that most speculators buy call options near the tops and buy put options near the bottoms. Therefore, you can use an options index as a contrarian indicator. Even better since 2004, the CBOE has given us data that allows us to split equity options and index options. Simplistically the big boys use the options index and the speculators use the equity index more. The speculators help us to pick euphoric highs and lows since they are usually wrong at the tops and bottoms.

Looking at the chart and the history there is some pretty favorable data that may help us confirm the next top. The way to use this chart is not to look for a peak or trough in the index and call a bottom or a top, but to use the chart to help confirm a top or bottom and tell you when things are getting a little out of hand. I have also added moving averages to help smooth out the data.

Right now the index and 30 day MA are below .60. This has only occurred a few times in the past few years and not once since the 2007 top. Those times have also in all 4 instances called decent few months tops.

This is just another indicator that is helping me get comfort that the market's top will soon be upon us.

Market Update 10-16-09; Still think top is soon.

I continue to think the top is very close. There are now numerous technical signals that lead me to this. For one, there is a possible 5 wave move in its final gasp. Also, volume continues to be weak. Divergences are all still very strong. And, all the markets are still in typical retrace area. See the chart below and compare to the former post Market Update 8-31-2009. Not much has changed as far as technical signals when looking at the two charts.

It will be interesting to see if the Dow closes above 10K today, my guess is yes. I may put a small put on the market at the close just for fun.

On another note Gold and the US Dollar also look to be at potential turning points. I heard on CNBC today that Tiffanies is going to be selling gold bricks, and Pisani said "looks to be the top in gold", which I agree with. There are other reasons to think gold is close to topping as well. The reason I mention the Dollar and Gold is that all these markets are interconnected and should all turn around the same time.

Good Luck