Diverging Technical Opinions
Over the past few weeks, I haven’t seen more disagreement among market technicians I follow, along with my own work, until now. Last September, I made a laundry list of items I wanted to see that would indicate to me that the simple correction down to 1430 would continue much further. Many of the conditions for an intermediate top were confirmed when the market opened for trading following the election results. Breadth has rolled over, moving averages have been pierced, and buyers have not only left the building, but they’re buying a ticket at the airport – destination: cash – until the Fiscal Cliff gets (un)resolved.
In technical analysis, it’s good to take both a long-term view and an intermediate view. Whenever I look at a company’s technical chart, three charts pop up on my screens: a daily chart over the last year, a weekly chart over the past three years, and a monthly chart over the last 10-15 years. When technical changes happen on a long-term scale, they’re a lot more significant than on a short-term scale. When a stock trades flat for 5-10 years and then begins a new trend higher, you won’t pick that up on a one-year daily chart, and it’s a lot more important. I wrote about this in March of this year, discussing the idea that we had some blue-chip stocks that were breaking out into new all-time highs. Just looking at the Dow 30 industrial stocks, 8 of them broke out to hit all-time highs including: IBM, DIS, KO, TRV, CVX, XOM, WMT, and HD. You wouldn’t know that if you only look at a 1-year chart; and certainly all-time highs in 8 of the Dow 30 stocks is nothing to scoff at. This is all to say, that when we look at the stock market, it’s always best to have our views placed in context of the short and the long-term view.
Here’s where I’m confused. While many of the technical analysts I follow are saying a top is in and the next bear market will begin, many others are not. And if there’s anything I’ve come to understand about technical analysis and analyst calls, it’s that they can change on a dime. One analyst that was bearish in the May correction, calling for the next bear market, can change his or her mind in a few weeks and say we’re headed 20% higher. That is to say, be careful about how much you read into guru calls, because most technical analysts will change their opinion quite quickly depending on the vagaries of the market. Many of those long-term calls get quickly unwound because, by definition, we all must report on what story the market is trying to tell.
Getting back to my list of conditions the market needs to fulfill in order to warn of a significant correction, many have changed since I originally laid them out and so too, I must change my view – both long and short-term views. Here is that list from the original September 27th article, “Don’t Fight The Fed” with changes noted in italics:
- A shift out of risk assets and into defensive sectors. (false – industrials, consumer discretionary, financials, and materials continue to be the best performing sectors mainly due to the housing recovery)
- Leading economic numbers and Fed surveys roll over (True – This week’s economic indicators clearly showed a down tick in retail sales, jobless claims, the Philly Fed and NY Empire surveys, and industrial production which economists are attributing to Hurricane Sandy. Additionally, the ECRI’s LEIs appear to have rolled over as they did in March.)
- Transport or Industrial indexes not confirming each other in new highs (true)
- We should now watch for the next signal. A break below 4800 would signal a bearish breakout for the Transport Index. A break below 12,000 on the Dow Industrials would signal a bearish breakdown for the industrials.
- A lower high, or at least a break, in the market trend (intermediate-term true, long-term false)
- Momentum failure (true)
- Flat/sideways market from support to break (true – as of 10/23)
- Momentum divergence at a higher high (false – only because we didn’t break above 1470)
- Distribution with 2400 or more declining issues on the NYSE in a given day (true – Wednesday’s correction saw 2704 declining issues on the NYSE)
There are a few more things I want to add to the laundry list here. One of the most significant indicators I follow, besides trend, is the breadth or participation in the stock market. If very few stocks are reaching new highs, or most of the stocks in the S&P 500 are well below the 50 and 200-day moving averages, that’s quite bearish. The opposite is of course true. As I pointed out in September, the market was very overbought with a majority of the S&P 500 well above their intermediate and long-term moving averages:
- 90% of stocks in the S&P 500 were above their 10-day moving averages (short-term)
- 86% of stocks in the S&P 500 were above their 50-day moving averages (intermediate)
- 81% of stocks in the S&P 500 were above their 200-day moving averages (long-term)
And now, these numbers have significantly dropped with the S&P 500 passing through both the 50-day and the 200-day moving average. The market is reaching oversold conditions now for both short-term and intermediate-term views.
- 11.8% of stocks in the S&P 500 are above their 10-day moving averages (short-term)
- 19.76% of stocks in the S&P 500 are above their 50-day moving averages (intermediate)
- 44.33% of stocks in the S&P 500 are above their 200-day moving averages (long-term)
The good news is that if we’re looking at another correction similar to this summer, we are near the same conditions the market bottomed in May. If we’re looking at a 2011 correction, the percentage of stocks above the 200-day moving average got down into the single digits, with a low of only 6% of stocks above the 200-day moving average.
Moving away from breadth indicators, I wanted to highlight the concept of trend in both an intermediate-term basis and a long-term basis for the S&P 500.
On the short to intermediate-term basis, the S&P has had a series of lower highs and lower lows from the high of 1470. So in the near-term, we are in a declining trend. Rallies are being sold, and buyers have not stepped in, not even at the 200-day moving average near 1380 last week. This is clearly a negative development for the bulls and as we’ve seen over the past two years, the drums have begun to beat again in the bearish camp calling for the next recession and the next bear market. Just look at the recent Barron’s covers to see how quickly the tide has changed:
October 15: “Almost There”
November 12: “Are We Headed for a Recession”
As I’m sure many of you have your eyes glued to the chart of the S&P 500, I wanted to point out two issues, both conflicting. The first is the bearish wedge setup I haven’t heard anybody talk about. Since the 2011 correction, we have formed a bearish wedge that has broken to the downside and completed. The bearish implication is a target much lower than where we are now. Essentially, a target that would place us back at the 2011 support levels.
The other point regarding the S&P 500 takes us back to looking at the longer-term view, which continues to be bullish with a series of higher highs and higher lows. We’ve yet to rally after a significant correction without hitting fresh 52-week highs in the S&P 500. We have had a series of lower highs and lower lows on a smaller scale within the larger trend, but the cyclical bull market has reasserted itself after every correction. Every correction thus far from the 2009 bottom has been a buying opportunity, not the beginning of a new recession or bear market, which has been contrary to many market calls over the past two years.
Is this the start of a new bear market? Will equities drop 30, 40, or 50 percent from here? It’s a possibility. The break of a two-year bearish wedge is a major concern, but it’s way too soon to make those calls based on how the market is trading now. That is why I continue to read or hear diverging opinions on the matter. But as I wrote in September, I think there are two fundamental catalysts that any bear must address, and that’s the rebound in housing and its widespread economic effects on jobs, consumption, credit, and materials as well as the effect of easing by central banks around the globe. ISI Research has counted over 258 eases by central banks in the last 14 months. I would be a lot more inclined to turn into a long-term bear here if banks were tightening rather than easing. Valuations aren’t cheap, but they’re not expensive either, nor did they ever hit ridiculous levels this year to trigger the next bear market. Was there too much greed near 1470? No, as usual, we continue to see ICI fund flows that suggest investors have avoided the stock market since 2009 based on bond flows and equity flows.
Regardless of the point of view you may have on the market and economy over the next few weeks, months, or years you’ll want to remain disciplined. Maintain a risk management discipline in these volatile times so that market correction or new bear market, you’ll be able to weather the current storm. But also be willing to step back into the market if the market begins to respond positively to a fiscal cliff compromise. A negative catalyst that is no longer weighing on investor sentiment can become the next bullish catalyst.
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