Arms Index May Not Be What it Once Was

A lot was made last week of a rare buy signal in the technical indicator known as the Arms Index, only the eighth buy signal in 34 years.

The Arms Index is the 10-day moving average of the TRIN, which measures buying and selling pressure on the New York Stock Exchange. A TRIN reading above 1.0 indicates selling pressure, and a TRIN reading below 1.0 indicates buying pressure. Arms Index founder Richard Arms and others say a strong rally is coming based on last week’s Arms Index reading above 1.50, including a couple of days above 2.0.

Unfortunately, we would argue that high TRIN readings have lost their predictive value, and we offer a monthly chart of the TRIN to illustrate that point (see chart below). TRIN readings above 2.0 have occurred every month for the last 30 months; before that, they were a rarity. The number of new issues and volatility of the last couple of years have made high TRIN readings commonplace.

Technical analyst John Roque pointed out that the Arms Index readings haven’t yet reached the high daily readings reached at the bottom in March and April, when they hit 3.0-4.0.

Despite claims to the contrary, the market has not yet displayed anything like the extremely oversold technical or sentiment readings produced at the bottom in March and April.

Japanese banks won’t have to “mark-to-market” until the end of September, not at the start of the month, as we reported last week. But the new accounting standard – which will force banks to acknowledge the extent of their investment losses – could put pressure on the Nikkei until then.

As the size of their investment losses are realized, Japanese banks will be forced to sell shares to meet capital adequacy requirements. “Cross-held” shares – shares held between banks and manufacturers – are expected to bear the brunt of the selling.

Separately, the International Monetary Fund and the Japanese government remain at odds over the extent of bad loans held by Japanese banks.

It may take some time, but the current reform efforts in Japan are the best thing to happen to that country’s troubled banking system since the brutal contraction began in 1990. If the IMF can force Japan to resolve the bad-loan problem sooner rather than later, the result could be a compelling investment opportunity.

The latest Semiconductor Industry Association report issued after the close on Friday showed an accelerating decline in semiconductor business. Throw in a Lehman downgrade ahead of Intel’s analyst meeting on Thursday and earnings warnings from Ericsson and Sanmina , and the positive effect of the merger between Hewlett-Packard and Compaq is being neutralized this morning.

A follow-up to last week’s GDP report: If government spending is taken out, the rest of the U.S. economy shrank 0.7%-0.9% in the second quarter. Not much to cheer about in that report.

Warren Buffett recently sold shares in First Industry Royalty Trust , a real estate investment trust (REIT) he had invested in a few years ago. With The Master selling financials (Fannie Mae, Citigroup, and Wells Fargo) and REITs, the picture that emerges isn’t a great one for financial stocks or the real estate boom. However, Buffett never explains his moves, so it’s anyone’s guess what he sees that the rest of us don’t.

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