Musing on the Markets : Technical Thursdays

We (Still) Don't Know What We Don't Know

Vinny Catalano, CFA — Thu, 19 Nov 2009 02:08:00 GMT

So, here we are. More than two years into what started out as a credit crisis, one plus year after the Lehman collapse and a question that pertains to the one of the central workings of the equities market cannot be answered.

At last evening's Market Technicians Association Educational Foundation seminar, the question your trusty moderator (that's me) posed to the esteemed panel with its decades of experience was in regards to volume. Specifically, the equity markets' volume as recorded each day for every stock traded. That is, the volume that accompanies the price action that results in the market capitalization of the stock market that results in the market value of every investor's portfolio.

Many market analysts have noted the low volume that has accompanied this bull rally. Some have used this fact as a reason to be more cautious, even bearish. Others have cited that low volume bull rallies have occurred in the past and this one is no different. However, in the past, the volume recorded for equity trades completed were quite accurate and reliable, being recorded on exchanges and reported accordingly. Today, the picture is not quite so clear.

With so much trading occurring in the off the exchanges hidden recesses of dark pools and structured products, I asked my very knowledgeable panel, can any investor rely on the volume figures being generated in this current market to measure the strength of the price action of a stock? The answer received was, "We don't know". Well, if this well connected, highly informed group of individuals doesn't know, you can easily assume that just about no one knows. Do you?

The importance of understanding this issue goes beyond its impact on basic market analysis tools (such as technical analysis) and cuts to the heart of a financial system that is still shrouded in opaqueness.

Transparency remains elusive. Yet, transparency (knowing what investors need to know) is vital to the restoration of a sustained confidence in a system that can be measured. When trades occur in the dark corners of dark pools and other off-exchange structured products, clarity as to what exactly is transpiring becomes the victim and investors seeking to measure the market become the equivalent of a bystander to a drive-by financial shooting.

Investment Strategy Implications

Nothing increases the risk factor of any investment more than the dangers posed by ignorance. Yet, here we are. More than two years into what started out as a credit crisis, one plus year after the Lehman collapse and we still don't have a clear idea of what exactly is transpiring in a central part of the capital markets - equities.

For those who might be tempted to dismiss such concerns I simply point to the two key impacts of changing equity prices: the wealth effect and the cost of capital. Both directly impact the real economy, in the current case in a positive way. Were it not for rising market values, the current government policies designed to rescue the US (and global) economy would be brought into doubt. And doubt, a close cousin of uncertainty, is a bad thing for a fragile economic environment.

Price without volume is an incomplete measure of the strength (or weakness) of a market move. Yet, in the current environment, price is the only metric that can be tracked with clarity. Volume, its indicator of power, cannot.

Two years and running and we still don't know what we don't know.

To further the exploration of what we don't know tomorrow I will describe how hedge fund replication products pose a potential threat to the equity markets.

Vinny Catalano, CFA, Global Investment Strategist with Blue Marble Research publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

Beyond the Sound Bite: An Interview Phil Roth

Vinny Catalano, CFA — Wed, 14 Oct 2009 02:35:00 GMT

Always good to check in with the Wall Street veteran and Chief Market Technical Analyst for Miller + Tabak, who stills sees an absence of public and traditional institutional investor participation in the equity markets, no trend divergences to signal a major market decline ahead, recognition that a 10% correction can materialize without warning, expectation that gold will double or triple from current levels, and a country, sector, and style outlook.

The length of the interview is 13 minutes 48 seconds.

(Please visit the site to view this media)

The Head and Shoulders Rorschach Test

Vinny Catalano, CFA — Wed, 08 Jul 2009 12:32:00 GMT

In case you hadn't noticed, there’s a big head and shoulders debate brewing. A bona fide bulls versus bear story. One side (the bulls) sees the stock market world from a decidedly more optimistic perspective with the potential of an upside breakout and a stock market run to new recovery highs. This view is exemplified by the first chart with the neckline somewhere around the 950 level (S&P 500).

Then there is the more pessimistic crowd who see the glass half empty with the threat of a downside break below the 880 level and the potential retest of the lows of early March (second chart above). The same price data but seen from different time perspectives.

In both cases, old school market technicians will tell you nothing can be concluded UNTIL the pattern is complete, meaning that the neckline has to be broken and the ensuing move underway. It is most interesting that all this is occurring just as the markets enter the all-important earnings season and the fundamental justification for higher (or lower) prices, the answers to which we will receive in the coming weeks.

Investment Strategy Implications

Anyone who has read the technical analysis side of my work these past years knows that I am not a big chart pattern guy. No doubt there are those who have found a way of producing a better than 50/50 chance of predicting future price actions via chart pattern analysis, however, I am not one of them. In my experience, the vast majority of chart patterns are like a Rorschach test – you see what you want to see. Frankly, the only consistent justification that I have found for paying any attention to chart patterns is the simple fact that many others pay attention to chart patterns, which then moves chart pattern analyses to the behavioral science realm – the study of your fellow investment rats and how they run the maze.

From the more bullish perspective (which is where I sit), the completion of a market bottom would be signaled by an upside break above the neckline. As I have written several times before, that would be the sign for the old school technical analysts to ring the bottom-has-been-seen bell. BUT, as noted above, that cannot/should not be done before the fact.

Or, to quote that investment sage, Yogi Berra, “It ain’t over ‘til it’s over.”

Vinny Catalano, Global Investment Strategist with Blue Marble Research, publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

9 ½ Weeks

Vinny Catalano, CFA — Tue, 12 May 2009 18:31:00 GMT

Time flies when you’re having fun. For it was a mere 9 ½ weeks ago stocks were as desirable as a hug and a kiss from a Mexican lover, a point President Obama made note of just a few days ago re he and Hillary. For the bulls, these 9 ½ weeks were like the movie of same name – hot. However, the bulls (including many new converts, especially from the land of momentum lemmings – the hedge fund world) should not forget that in the movie the lovers (Basinger and Rourke), drawn by the heat of the moment, have something as substantive and sustainable as a chimera.

At the historical average P/E of 15 times an optimistic $60 operating earnings number for the S&P 500 for 2009, stocks are projecting a robust earnings rebound into 2010, a point made by my “Beyond the Sound Bite” guest from last week, Subodh Kumar, with a $75 call for next year. Only if that occurs AND/OR only if one accepts the talk I hear from some institutional investor circles that a P/E above its historical average is fitting for the times courtesy a low inflation rate (18 times is the number I hear), can an investor find fundamental support for the fragile technical analysis base stocks have built. However, it does give one pause when the leadership for this market is the same leadership that existed before the great tumble. Generally that is not how new bull markets get started and sustained, as the more common occurrence is for new leadership to take the helm. Rather, bear market parades are led by those who led before.

Investment Strategy Implications

9 ½ weeks ago I argued that stocks were grossly undervalued. Now, 9 ½ weeks later, stocks, while not grossly overvalued, are more than fully valued. Built on the sand of a fragile technical analysis bottom led by those who led before make it more than justifiable to take some money off the table – most conservatively done by maintaining whatever the current equity percent of one's total investible assets at the current level, which in accounts that I manage is in the low 90% range.

In many respects the movie 9 ½ weeks was a study in extreme behavior devoid of real meaning and lasting substance. So, it is interesting to note that the stock market movie of these past 9 ½ weeks has brought out these qualities of extremes, including the expectations of more than a few investors with calls for more upside surges or great plunges. Therefore, allow me to offer an alternative view to this edgy thinking with a reference to another character from Tinseltown – George Costanza. Perhaps what investors will get in the coming months is a stock market movie not about heat but about nothing. A drifting, sideways, mini range-bound market where selectivity matters more than trend following, lemming-like momentum investing as investors digest what has occurred and guesstimate what 2010 has to offer and the appropriate P/E.

In such an environment, you can keep your (slightly bearish) hat on.

Note: Vinny Catalano, CFA is the publisher of "Sectors and Styles Strategy Report" is a weekly investment newsletter for the independent investor. To learn about the newsletter and other subscriber benefits, click here.

Sinko de Mayo

Vinny Catalano, CFA — Tue, 05 May 2009 16:14:00 GMT

For many, today’s date has a special social significance. For prudent investors, however, today is a day that this year marks a point of caution – unless you buy into one of two arguments being passed about: stocks warrant a higher than average P/E or stocks have made their lows as certain trading patterns say the bottom has been formed.

Fundamentals First

For those who favor the first point, the arguments I hear reference inflation and the appropriate P/E for stocks. Historically, when inflation runs in the low single digits P/Es have tended to be in the higher teens – above the long-term average of 15 times. All well and good provided other conditions in the economic and financial arena are balanced - which they are not. What makes the low inflation=higher P/E argument more than a touch suspect is, frankly, a blind faith in the ability of the Fed (and other central banks) to time the withdrawal of monetary stimuli BEFORE inflationary pressures begin to build – which, if unsuccessful, would thereby blow up the low inflation leg of this fundamental stool. More importantly, given the highly fluid nature of the global economic and political environment (can you say "nukes and Pakistan"?), ascribing an above average P/E during above average times of risk(despite whatever may be possible - not probable - in the inflation end of the equation) seems to require an above average degree of faith and a below average degree dispassionate logic.

Now The Technicals

As for the technicals of the market, certain technicians of the chart pattern stripe note the various breakouts as reasons supporting the “bottom has been formed” argument. There are others, however, who are purists in this chart pattern field who would counter argue that only when a completed bottom has been made in the major indices can a bottom-has-been-formed view be agreed to. Since I am not a chart pattern guy, I will leave this debate to those in the two camps. What I will put forth is something readers of this blog are very well aware of – the Mega Trend.

The Mega Trend is the Investor's Friend

Only when price is above both moving averages AND the 50 day has crossed the 200 day AND both the 50 day and 200 day have turned up can an investor confidently declare a Mega Trend change has occurred and a new market cycle is underway. Let’s look at the performance record in this regard using two indices as evidence – SPX (S&P 500) and EFA (Europe and Asia).

As both above charts* show, when a Mega Trend occurs that trend tends to stay in place for years. In this longer-term context, you can see that considerable improvement has occurred recently, HOWEVER, neither index is fulfilled the requisite conditions to warrant a Mega Trend signal change. Price is not above its 200 day moving average and the 50 day has not crossed the 200 day. Therefore, while the 50 day has turned up and the 200 day has begun to flatten all conditions have not been met and should not be anticipated to do so until they do so. (Or as Yogi Berra would say, "It ain't over 'til it's over".)

At present, to achieve all facets of a bullish Mega Trend stocks must build on their 30% plus rally thus far and rise significantly further from here, which, unfortunately, will produce a set of overbought conditions that are unlikely to be sustained. Moreover, any further near term rally would put both indices in a sharp near term uptrend, which is not indicative of the bottoming process that precedes a Mega Trend reversal. In this regard, there are several near and short term technical analysis reasons (momentum and MACD, Slow Stochastics, respectively) that argue against stocks making such a move anytime soon.**

Investment Strategy Implications

To be clear, Sinko de Mayo does not mean Plungo de Mayo. It simply means equities have gotten more than a touch ahead of themselves and some contraction, a healthy contraction, would be best. Since articulating cyclical bullish sentiments in early March, readers of this blog acting on the views expressed have enjoyed a very healthy boost to their portfolios. Now, however, we seem to be at the opposite end of that spectrum for exactly the same reasons - only in reverse. Therefore, when both fundamental and technical analysis flash the yellow caution signal, it is advisable to, at a minimum, maintain the equity percentage of a portfolio through selective selling.

Going forward: Sinko de Mayo will likely be followed by Drifto the Summero leading to Uh Oh the Fallo. Enough with the bad rhymes. Let’s go make some money.

*click images to enlarge
**for more information on this, see yesterday’s complementary report offer. If you have not received such an offer, simply send me an email at vinny@bluemarbleresearch.com.

Market Signals with ETFs

Vinny Catalano, CFA — Tue, 21 Apr 2009 15:30:00 GMT

On June 25th I will have the privilege of conducting a webcast series event for the Market Technicians Association on an aspect of ETFs that gets far too little recognition – market signals with ETFs. The webcast will describe how EVERY investor is now empowered to monitor market activity via ETFs and effect an investment strategy that works. The following is an example of how to do this using three major market ETFs:

* For the US, the S&P 500 ETF tracker - SPY
* For Europe, Australia, and the Far East – EFA
* For Emerging Markets – EEM

The power rests in a comparative performance analysis that an investor can employ by delving into those indicators one chooses. As readers of this blog and my newsletter know, in the technical analysis aspect of my work I emphasize divergences and momentum analyses over chart patterns. Therefore, the accompanying charts* help to identify areas of strength or weakness beyond the surface action of each market index. For example, note how the flight to quality in equities produced the above average relative strength while the most recent months show that trend shifting in favor of emerging markets.

Other comparative points worth noting are the never ending high correlations between and among the indices in nearly all aspects of their internals. However, while momentum, MACD, and Show Stochastics all move in unison, at key points divergences could arise. This was the case in early March when Momentum and MACD for EEM was clearly stronger than that for SPY and EFA. As a result, a 1,000 basis point better performance since that time occurred. This should be monitored for future divergences when they occur as they signal a more defined shift in capital allocation among investors.

Investment Strategy Implications

Market signals using ETFs can also be done via size and styles, as well as in other combinations such as country to country. For example, large, mid, small, and even micro cap can be compared and contrasted (to use CFA® terminology) to enable an investor to identify trend changes as well as measuring the breadth of the market’s moves. Then there is the cost factor.

An investor no longer needs to spend thousands of dollars a month on expensive services to achieve most of what they need to do. With the Internet, free or low cost services (such as Yahoo Finance and the Wall Street Journal), a computer, and ETFs, an investor can accomplish most of what he/she needs to in making effective investment strategy decisions.

Now For the Soapbox Speech

Far too many individual investors use ETFs in the most limited fashion, which is to play a hot idea via a sector, industry, style, region, country, or asset class. That’s fine but that’s not helpful in the far more significant area of investment performance – the asset allocation decision. Representing 85% of investment performance, the asset allocation decision is where most investor SHOULD spend 85% of their time. Unfortunately, that’s just not sexy enough for many who would rather spend 85% of their time on the 15% that contributes to the investment performance of a well-diversified portfolio – the individual issues. This fascination with individual stocks is a disease I call “individual stockitis”. Focusing on what matters most – investment strategy and the asset allocation decision – is the cure for underperforming portfolios populated with individual “fast, mad money” ideas. (hmmm. I wonder what that refers to?) Utilizing ETFs for market signals empowers all investors in ways far beyond the hot idea du jour.

*click images to enlarge

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Equity Market Headwinds: No Margin for Error

Vinny Catalano, CFA — Fri, 17 Apr 2009 14:28:00 GMT

While it is encouraging that equities have rallied to the point where many 200 day moving averages are either flat or nearly so and nearly all sectors, styles, regions, and countries are above their 50 day moving average, not to mention the fact that many 50 day MAs have an upward slope, there are reasons, both fundamental and technical, to be more cautious about stocks over the near term.

The concern on the fundamental side is centered on valuation. For investors may have looked into the Great Depression II abyss and concluded that the worse case scenario (under $50 operating earnings for the S&P 500 for 2009) is less likely than it was 30 days ago. However, the current level of 850 for the S&P 500 implies either an above historically good time average P/E of 15 and/or earnings above $60. Look at it this way, if stocks are a forward looking discounting mechanism and if its projected return is its historical average of 12%, then 850 today implies a 12 month price level of 952. That then supposes that 12 months forward to the end of 2010 would put the S&P 500 at 1066 (952 plus 12%). To justify 1066 and assuming the market’s historical good times P/E of 15 assumes $71 in operating earnings for 2010. That may come to pass but the great economic unknown is not 2009 but 2010, for it relies on the economic handoff from government to private enterprise and the consumer. The fundamental valuation conclusion then becomes a future time period that does not warrant an above average margin of error. Frankly, at 852 that’s a conclusion I am less than fully invested comfortable living with, more so when considering the following technical analysis points.

From a technical analysis perspective, many market technicians point to the favorable chart patterns, with bottom formations and upside breakouts. They may be right but it has been my experience that chart patterns have a far reduced predictive value than momentum and divergence indicators, and those indicators are not so sanguine right now. As the above chart* illustrates, for example, Momentum is clearly in deceleration mode and not confirming MACD’s sustained and confirming strength. Experience shows that only when both are in unison (confirming higher highs in price, for example) can an investor feel more confident of the sustainability of the move. Added to this concern is the high overbought readings in the short term indicator, Slow Stochastics. Readings above 80 typically cause markets to pause.

Investment Strategy Implications

For the above stated reasons, taking some money off the table is advisable. Granted seasonal factors, such as April being the second best performing month of the year (historically), are supportive of higher stock prices. Moreover, there is every reason to feel more confident that, for the very short term, the worst of the economic and credit crisis has passed. However, concerns both fundamental and technical seem to warrant a less than fully invested posture at this time.

*Note how the Momentum reading is nearly flat while MACD is steady up.

Mismatch

Vinny Catalano, CFA — Tue, 10 Feb 2009 21:21:00 GMT

Now that the outlines of the fiscal stimulus package and the so-called bank bailout plan are fully in the public domain, in other words now that the big news is out, experienced investors know it is time to see if the market action matches the real economy rhetoric. For these are such times when a mismatch between the news and the markets, between fundamental and technical analysis can yield positive returns in both absolute and certainly relative performance terms.

Under such circumstances, the investment trap less experienced investors can get into is to assume that after so much news has been disclosed all in one direction (bad, in this case) and the markets have moved in that direction (down, in this case) that new news, especially big new news (bad, again in this case) will be matched by a similar market action (down, as before). Au contraire, says the experienced investor.

Investment Strategy Implications

“What’s past is prologue”, advises the Bard. Investors would be wise to heed these words, particularly in times when big news does not produce the expected inexperienced investor results.

Key to watch for is the following:

• Price, Volume, and Volatility declines (all versus earlier in the cycle periods)
• Performance variance of sectors, styles, regions, and countries versus the broad market indices

For the more bullishly inclined longer-term investors, both sets of observed data will strongly imply a cyclical rally is in the offing. This does not mean a sustainable secular bull market is about to erupt. Rather, a cyclical bull rally WITHIN A SECULAR BEAR MARKET would be a distinct probability. Watch for the mismatch. And don’t miss the potential for a money making opportunity in stocks. Heaven knows we could all use some ways to make money.

Note: Since the fall of last year, key technicals analysis indicators of the equity markets have improved, most notably the near term Momentum and MACD.

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

A Short-term Breather

Vinny Catalano, CFA — Tue, 09 Dec 2008 12:57:00 GMT

A number of market technicians have pointed to the S&P 500 and its approach to its 50 day moving average (see accompanying chart). While such levels have a spotty predictive track record, it does seem likely that stocks are poised to take a breather from their 20%+ climb off the floor (752.44, which some are calling a major market bottom).

The more predictive element in this bear market rally breather view is the just barely short-term overbought reading (third indicator on the chart, Slow Stochastics >80), providing the trading justification for a pause. That said, it must be noted that the near-term indicators tracked – Momentum and MACD – have rarely been more bullish (first and second indicators on chart).

Investment Strategy Implications

The bottom forming debate now rests with whether we are experiencing a 1974 style process (September/December 1974) or the 2002/03 variety (October 2002/March 2003). Its resolution remains to be seen as the longer-term mega trend reading across all markets and styles is decidedly bearish and will take many more months to resolve*. For the near term, however, the strength in current rally run has solid technical legs underneath, a near-term breather notwithstanding.

*To learn more about how the mega trend works,click here

Beyond the Sound Bite: An Interview with Phil Roth, CMT

Vinny Catalano, CFA — Tue, 02 Dec 2008 02:33:00 GMT

My interview with the Chief Market Technical Analyst for Miller + Tabak includes the conditions necessary for a successful stock market bottom, the positive secular story for commodities (especially agriculture), attractive market action in water related companies, and a dismal longer term outlook for financials and info tech and telecom.

The length of the interview is 12 minutes 3 seconds.

(Please visit the site to view this media)

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

For Whom The Deep Oversold Bell Tolls (again)

Vinny Catalano, CFA — Wed, 12 Nov 2008 18:40:00 GMT

Whatever the fundamental rationale may be – November 15th and hedge fund redemptions; capital gains sales in anticipation of tax increases next year; fears of a global recession; concerns re FAS 140 and QSPEs (more on this one in a future posting); S&P 500 earnings closer to $50 with a 10 or less P/E – the technicals of the market are once again on the verge of signaling another strong non-confirmation low.

As the accompanying chart shows, the deep oversold in Slow Stochastics (below 20) combined with a vastly improved Momentum and MACD readings point to a bell ringing non-confirmation low. In my experience, when combined in this fashion these indicators have a > 80% probability of success. And when they fail, the worst-case result is breakeven.

Investment Strategy Implications

Will this time be different? Perhaps, but only the nightmare scenario of plunging earnings and deflationary level P/Es justify lower prices.

An Overbought Pause

Vinny Catalano, CFA — Tue, 04 Nov 2008 14:05:00 GMT

As delightful as the rally has been, a key super short-term technical indicator, Slow Stochastics, is registering an overbought reading (above 80) and a cause for a pause.

As the accompanying chart* shows, while the near-term indicators, Momentum and MACD, are in fine shape (especially MACD) and supportive of further market strength, Slow Stochastics suggest that the market may have reached a near-term peak.

As was the case with the recent oversold levels and near unanimous non-confirmation readings, overbought readings are abundant (most indicators registering the same readings) and give further evidence of a peaking out in the rally.

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

The (Mega) Trend is Your Friend

Vinny Catalano, CFA — Thu, 24 Jul 2008 11:56:00 GMT

Bottom fishers, short term traders, and market timers aside, some investors might be tempted to conclude that the sell oil/buy bank stocks trade is a sustainable trend. If, however, an investor takes a step back and utilizes one of the most consistent longer term technical analysis tools a decidedly different conclusion would be reached.

To illustrate, take a look at the accompanying chart for Financials (XLF).

The technical analysis tool I am referring to is called the Mega Trend. The Mega Trend (as I define it) is a multi-year stock price trend analysis where price and two moving averages (50 day and 200 day) are measured. In well-established Mega Trends, price is above (or below) its moving averages, the shorter term (50 day) Moving Average is above (or below) the longer term 200 day, and both moving averages are pointing in the same direction, either up or down.

Using Financials as an example, price has been below both of its moving averages AND the 50 day has crossed the 200 day (to the downside) and both moving averages are headed in the same direction (which is this case is down). For Financials, a bearish Mega Trend is well established. Now, let’s consider a few related points.

When price has rallied and touches one of its moving averages (which will be the 50 day), a potential Mega Trend reversal may be in the works. In the case of Financials, price has rallied to its 50 day. However, for a Mega Trend reversal to be complete, price must cross both moving averages AND the 50 day must cross the 200 day AND both must point in the same direction with price leading the way. Looking at the accompanying chart, this is precisely what occurred to the downside in mid 2007 after Financials had been (for the most part) in a bullish Mega Trend since the spring of 2003.

Investment Strategy Implications The recent bounce in Financials is justified due its deep oversold condition and a degree of pessimism that was (and largely still is) so thick you could cut it with a knife. Short term sector allocation warranted (and rewarded) investors who increased their weighting in anticipation of and during the recent Financials rally within its bearish Mega Trend. It should not be construed, however, that deep oversold bounces signal sustainable trend reversals.

The Mega Trend tool is a simple, elegant, yet highly effective tool for investors (and traders) as it keeps the longer term picture firmly into view and helps place in context the shorter term wiggles and squiggles.

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The "Inflection Day" Rally

Vinny Catalano, CFA — Thu, 08 May 2008 02:08:00 GMT

The granddaddy of the market confirmation principle, Dow Theory, states that each index (Industrials and Transports) must confirm the other in order for a move (up or down) to be considered sustainable. If one index makes a new recovery (not all-time, necessarily) high or low, the other must confirm that move with its own recovery high or low for the move to be considered sustainable.

In what is becoming known as “inflection day*”, March 17 witnessed the Dow Industrials break to a new low but the Transports failed to confirm that low (see first chart**). Subsequently, stocks marched ahead with each successive new recovery high in each index being matched by the other.

For some less-schooled market technicians, that’s all she wrote. We currently have a non-confirmation that occurred on inflection day and its off to the upside races. For the moment, let’s accept the trend call of the Dow Theory but not stop there. Let’s incorporate a few other indicators (specifically momentum related) and try to patch together a technical analysis forecast for the next several months (something that efficient market types say is impossible).

The second chart** provides several detailed momentum related indicators that I have found to be of considerable short-term value. A close examination of the Momentum, MACD, and Slow Stochastics indicators for the relatively strong Transports all point to one conclusion – the current rally has weak momentum underpinnings. Momentum has failed to produce a higher high, MACD is at a crossover point (to the downside), and the ultra short-term Slow Stochastics has already crossed and is headed south.

None of the above indicators suggest a reversal of the current rally. However, they all point to what is likely to be a very short-term mediocre to down period (probably lasting until Memorial Day, the unofficial start to summer here in the US). After that, a summer rally seems to be in store as the non-confirmation signal on inflection day was followed by a confirmation signal thereafter.

Investment Strategy Implications

Technical analysis (TA) is one tool that can be relied upon for market timing and portfolio strategy purposes. The above signal (one of several in the TA toolkit) suggests a tradable rally into the summer after a brief respite in the very short term***.

The other tool, fundamental analysis, tells a decidedly different story – one that will play out into the fall and 2009. I suspect that the technicals of market will begin to signal that ugly period once the current inflection day rally has run its course.

*Bear Stearns deal (steal?) results in a change in the credit crisis. **click images to enlarge ***expect to hear the tired phrase “sell in May and go away”.

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

Technical Thursdays: May's Market Flowers Will Wilt Before Blooming This Summer

Vinny Catalano, CFA — Thu, 01 May 2008 13:54:00 GMT

There’s a certain feebleness to the current US equity rally that the accompanying chart* shows quite clearly and should be a cause for concern to the bulls.

To begin, it is always more encouraging when Momentum (first indicator) is more robust. Failing to reach even the 100 mark is not inspiring. Moving in sync is MACD (second indicator). The slope of the MACD lines has diminished since mid April. And now the prospects of a crossover of the short-term (blue line) down through the longer-term (maroon) is a danger signal. Last, we have the slow stochastics where the short-term (red) has crossed the longer-term (blue) and appears headed toward oversold territory (under 20).

Investment Strategy Implications

From a technical perspective, the above points along with the chart pattern stuff (resistance levels at and above 1400 (S&P 500) as well as the concern that a failure to breech its 200-day moving average) suggest investors will likely be hard pressed to reasons to be overly bullish. Moreover, recent bullish sentiment readings (Barrons cover story, AAII survey) is a serious cause for concern.

From a fundamental perspective, while there has been some improvement equities have reached fair value (see table below)*, 1Q08 earnings and real economy data are being digested, and the Fed is likely on rate cut pause, the catalyst for a higher market does not exist.

Lastly, from a US domestic political perspective, despite the beating Obama (the nominee) and Clinton (the spoiler) have exacted on each other and themselves, McCain has yet to make substantial enough headway to alleviate concerns of his failing to win this fall.

The net result of all of the above appears to be a weak spell for most equity markets (except Brazil – see yesterday’s blog posting).

*click images to enlarge