Tuesday, May 05, 2009

Stock Market Update 05 May 2009

Since my last update the markets have continued to rise against all reason. Did I somehow miss the memo telling us the worst economic contraction/deflation in history somehow magically disappeared over the past 6 weeks?

Nope; I don't think so.

This rally has been extreme and has left many (including yours truly) scratching their heads trying to figure out what "Mr. Market" is telling them. As near as I can tell, this bear market rally is no different than any other bear market rally over the past 100 years. These occur during times of severe market declines to release oversold readings until the resumption of the next down leg. I think that next down leg is coming very soon.

Irrespective of my personal feelings, I try to keep as open a mind as possible. As such, I have to look at the charts to tell me if this is truly the start of a new bull market or just a bear market rally due to fail in time (as always, click on the charts to enlarge):

SPX 10 year monthly chart:

Starting with the clearest view possible, here is the S & P 500 Index monthly chart over the past 10 years.

Note that the previous bull market as well as the previous and current bear markets were well defined by a monthly closing price above/below the 12 month simple moving average. As can be seen on the chart, we are still well below this level (991.84 as of today).

Also note that during the previous bull and bear markets it was not uncommon for price to challenge the 12 mMA but until a definitive close above/below this level the current market trend is assumed to be in place.

I would strongly suggest that no long term bullish positions be taken until the SPX closes above the 12 month MA on a monthly closing basis.

SPX 1998-2004 weekly chart:

I thought it would be interesting to have a look at the SPX in the period 1998-2004 to gain some insight as to how our weekly moving averages performed.

Note how during the past bear market there were no less than 7 attempts (and, in fact there were 10 attempts if you count multiple weekly attempts in short time frames) to breach and hold above the 34 week exponential moving average (wEMA).

While it can be seen that there were a number of weekly closes above the 34 wEMA during that period, these were "head fakes" that resulted in further market declines.

The "all clear" signal was not received until the 13 wEMA crosses above the 34wEMA along with MACD confirmation with a cross above the zero line (as noted on the chart).

Now look to our current chart:

SPX 3 year weekly chart:

It is clear that price has risen above the 13wEMA and looks set to challenge the 34wEMA. Note the same thing happened early in this bear market (late March-early May 2008). During this time price spent approx 6 weeks in a narrow range (3 weeks > 34wEMA and 3 weeks below the 34wEMA) before resuming the downtrend. As a result, the 13 wEMA rose but did not cross above the 34 wEMA confirming it was a bear market rally.

Going back to the last bear market, this sort of action occurred at least 7 times. What makes this different from the previous bear market? Can we expect price to rise well above this level and start a new bull market or can we expect price to find resistance at this level prior to commencing a further decline within the current bear market?

I would strongly suggest that no long term bullish positions be taken until the SPX 13 week exponential moving average closes above the 34 week exponential moving average.

SPX 1 year daily chart:

A closer view of the current market action and the reason most analysts (including myself) have been caught off guard with this current rise.

The markets were in a clear down trending channel that "should" have broken back to the downside when price rose to test 850 in early April. This is the reason why I did not commit much capital to the current rally. Funny how sometimes the markets don't do as they "should".

It can be seen that following a break of the channel near the 850 price level it held in a fairly tight band until a test of the resistance at 877.86 noted on the chart. This level to the upside was broken yesterday and is bullish.

Unfortunately the markets are so overbought at this point that it would be foolish to commit capital at these price levels. In fact, in my trading account I am looking to short the market on a short term decline before the next leg up in this market as I believe the smart play is to the downside.

SPX % of stocks above 50 day moving averages:

This chart shows the percentage of stocks within the S and P 500 index that are currently above their 50 day simple moving averages. When this chart is above 50 it indicates the majority of the 500 stocks in the SPX are in short term bullish patterns. When below the 50 level the opposite is true.

In general great buying/long opportunities are present when this chart is at or below 10 (indicating an oversold condition) and great selling/short opportunities are present when this chart is at or above 80 (indicating an overbought condition).

Note that at a current level of 91.00 this chart is at its highest point since Nov 2004 (which at that time was a bull market). In a bull market this would be a sign of strength and the expectation would be for a slight pull back-to-flat market before another up leg. However, in bear markets it tends to be a sign of a severe overbought market primed for a substantial decline. That is the case currently.

SPX 3 year 60 Minute chart:

A zoomed out view of the 60 minute chart clearly shows the downtrend channel that was broken to the upside and the resistance level at 940-950. Also shown is the current controlling downtrend line (at around 1000 currently and descending)along with Fibonacci retracement levels from the start of the decline.

During bear markets it is very common for price to attempt to challenge either the 50% or 61.8% retracement levels. I suspect once this short term overbought condition is alleviated (via a price decline) a new uptrend will begin taking the markets to at least the 50% retrace level at 1123.

Bottom Line:

There is no change to my view of the markets from my last 2 blog entries. This market is overbought in the extreme and due for a price correction. Following that correction it is entirely possible price will rise up to the previous levels mentioned but to commit money to this market at this point in time is very dangerous.

I still am of the belief that this is a bear market rally and before all is said and done we will at least go back down to test the March, 2009 lows (and I suspect go below those levels). As such, until the 12 month simple moving average and the 13/34 week exponential moving average crosses occur, you must consider this to be a "traders" market and not an "investors" market. Those willing to trade may be able to scalp some money but those who are not traders should not be in this market.

As of today, my "strategic" positioning in my provident fund account remain as follows:-100% Black Rock/MLIM US Dollar Cash Fund (actual positions: USD cash 88%, equities 12%)

**Strategic allocated percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).

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