What a difference a few days can make. Last week, when we penned these commentaries, the S&P was plunging toward a retest of its lows with strong support clearly pegged in the 1360 zone. We wrote at the time that,
“Against this backdrop, a medium term low of some degree should form with prices rising in coming days to establish a “failing” right shoulder high. The momentary relief of a stock market rally says nothing about larger problems, and is the reflex action of crowd psychology gone a few steps ‘too far’ right out of the gate. In the case of the S&P 500, the 20 week or 100 day lower band closed today at a reading of 1360.50, and that area should be major support if tested tomorrow."
As it happened, the sell off did indeed continue into the next trading session where prices fell to a reading of 1363.98 at which point, they began to reverse sharply higher. Since putting in that important short term low, the stock market has been solidly back in rally mode, with the S&P 500 rising four out of the last five sessions and ending today back above 1400 with a close of 1410.94 (a gain of nearly 50 S&P points since last week's intra-day low). Has our outlook changed? To this point, not one bit. We continue to view this advance with the broad stock market as very likely akin to the ‘eye of the storm,’ wherein the sun can shine brightly for a brief period of time. In our view, the stock market rally now underway should still most likely be viewed as a ‘right shoulder’ rally which would still be targeting prices above 1425 to 1430, and as high as 1450. Thus, for the time being at least, both the US and Global Capital markets have regained their footing. This thesis is also supported by the fact that the Japanese Yen has sold off against the Dollar, representing at least a partial stabilization in the unwinding of the Yen-Carry Trade. With liquidity trends stabilizing, we have also seen a healthy recovery in commodity prices with the Precious Metals stabilizing as seen with Gold back above $650, Silver back above $13.00 and Platinum back above $1200.
Another question that needs to be addressed, in all fairness, relates to the bullish possibility that what we have just seen is a correction and nothing more, and that in the weeks to come, the rally could continue and make new, even higher 52 week highs. In our view, we will remain from “Missouri” on that one, and insist that if the market is going to re-vitalize a damaged bull trend, it will have to “show us” by pushing into new high ground and staying there for several weeks.
This is not an impossible outcome, but is less likely given the severity of the recent decline and the fact that it is a high probability that more housing and economic pain lies directly ahead. As a result, the correct approach to the stock market going forward will be one that focuses on relatively short term trends for “traders” and stock/sector selection for more medium term investors. In the final analysis, where stock market “tops” are concerned, prices have not “completed” a top until there is a top visible on the charts, and a top from which prices have broken down. To this point, the farthest on point for this market would be that a top is under construction. True bearishness cannot spring from the wellhead until a top is constructed and prices have actually broken down. In the real McCoy, the actual construction of a top is usually measured in weeks, by a series of rapid fire back and forth swings, with prices ultimately breaking down in violent fashion. For the S&P a ‘would be’ topping formation would need to see a few important elements. First of all, it is important to note that the 100 day moving average (or 20 week MA shown last week) is now flattening out. This is a big change from the strongly advancing moving average seen during Q3 and Q4 2006. With the flattening out of the middle band, we will also see the lower band begin to flatten out in the weeks ahead, and over time, the upper and lower bands will likely begin to “pinch in,” converging toward one another. A powerful top, would ultimately break down (Point A) below the recent lows in the 1360 area, and in the process downside penetrate a declining 100 day lower band. In the world of technical analysis, moving down to a rising lower band, and moving down through a declining lower band are two entirely different animals.
What was seen last week, while scary, had the protective overlay of a rising 100 day lower band; in other words, support rising underneath the market that could “catch” the market as it fell. In real “bear turns,” this is normally a ‘one off’ event. Put another way, the first crack at this band, prices always hold and usually recover nicely (what we are seeing now). The second crack at the lower band, and the whole edifice begins to topple over with a mess of much larger proportions gets underway.
At present, we have time to judge and make sense of what will come next, and for now we do not want to pre-judge the stock market too harshly. We remain acutely aware of the fact that in recent years the great credit bubble has ballooned to such epic proportions that, if a real unwinding were allowed to take place at this late date, the consequences would most likely be both a capital market crash and an economic crash of epic proportions. Michael Panzner's “Financial Armageddon” (excellent read) springs to life with a speed of frightening proportions. For the “powers that be,” all bears need to remember that every effort will be made to avoid this unwinding, and to prevent the US Humpty-Dumpty from falling off the proverbial wall. In this sense, if a Fed-engineered “re-inflation” has any real chance, then keeping the stock market buoyant amid the Real Estate/Housing Correction is vital, and with the housing slump accelerating, now would be the right time to start pulling out all the stops where the stock market is concerned. Since not one of us can know what lies ahead, the best we can do is watch closely and try to evaluate where things presently stand.
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