Thursday, December 10, 2009

The S&P Review

It has been a few months my last review of the market - so what is the state of play? In September I summarized:

Given the S&P's sharp move off of lows it would appear momentum is set to continue in favour of bulls as sideline money steps in on weakness. But look for this rate of ascent to slow as markets work off overbought conditions and MAs 'catch up' with the index.

The 50-day and 200-day MAs should provide support and buying opportunities for new long positions. Stops can be placed on a decisive break (>1%) of the 200-day MA, protecting against any 1987 like outcome. But even here, the losses of 1987 did little to erase the bulk of the gains the S&P had chalked up earlier during the decade.

Although pre-1950 was excluded from the dataset it would appear unlikely a major downleg will follow.

Once again I took a look at the S&P and how it lay with respect to its key moving averages (20-day, 50-day and 200-day). As of last Friday the S&P was 17% above it 200-day MA, 3% above its 50-day MA and 1% above its 20-day MA. Again, digging back through the archives to 1950 identified some (close-to) matching scenarios.

In September, the markets were pacing the action of 1955, 1975, 1980, 1982, 1983, 1986, and 1987. As of last Friday, markets were pacing action from 1971, 1975, 1983, 1986, 1987 and 1997. In terms of overlap, scenarios from 1975, 1983, 1986 and 1987 are still in play.

So what happened after matching conditions occurred? The arrows in the following charts represent the matching conditions to the S&P from last Friday.


Although 1971 is a new candidate in the comparison stakes, the resulting downward (scrappy) action would fit with a mixed market psychology likely to permeate into 2010; too skeptical to believe the market can go higher - but too afraid to miss the next rally. Markets fall under their own weight from lack of participation rather than any aggressive selling on the part of traders. A 15% range from high/lows (or thereabouts) for 2010 would not be unreasonable after the gains of 2009. Market action fits for an economy which had emerged from a recession - mild though the 1969-70 recession was.


The first of the matching scenarios and very similar in action to 1971, but with a more bullish bias. Given we are entering into the third year of a cyclical bear market I think it's possible 2010 will see a new cyclical bull market confirmed. However, for a cyclical bull market scenario to emerge has the 2009 low come a year too early for it to be true?


The second of the matching scenario is like a rinse and repeat of what's gone before. Can we expect 2010 to see a straight continuation of the rally? The backdrop here was the end of the Iranian oil crisis recession. Perhaps this says more about the year which has gone more than the year which is coming?


The third match is interesting because here markets enter a trading range, but a range where all of the prior gains are held. This range continued for a while before breaking upside in 1987 - but then there is the caveat...


The fourth match is still in play and is the worst case outcome of all matches. The trading range break from 1986 produced a brief rally before the events of 1987 emerged. Whether a double dip recession could trigger a similar crash is something which needs to be considered - but given other scenarios favour more neutral/neutral-bullish action this may not happen at all. Psychologically, a sharp crash like 1987 would be far preferably to a drip-drip deflationary spiral; a spiral which would cause the same net damage (or more) to the market, but over a much longer time frame.


The last scenario is practically a cut-and-paste of 1986. The biggest difference been 1986 led the crash of 1987 while 1997 led to the biggest bull market in history! Bulls will love this - but it seems far fetched to believe the fundamental and economics events of the past couple of years will not produce some serious repurcussions down the road. However, it is a scenario on the table and so cannot be ignored.

My favoured outcome for 2010 is perhaps one along the lines of 1971. A market which has seen huge outsize gains in one year is likely to follow with another where very little happens at all. 2010 will likely be a difficult year to trade, but hopefully it will be viewed more in the context of a psychological recovery rather than a material one; it could set up 2011 to be a very good year for all...

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Dr. Declan Fallon, Senior Market Technician, November 2009 has seen a significant upgrade to the site on the course to becoming the eBay of finance with our new Beta MarketPlace and a new rich internet application for finance, the Zignals Dashboard. Zignals now has new fundamental stock alerts, stock charts for Indian, Australian, Frankfurt and soon Canadian stocks, tabbed stock list watchlists, multi-currency portfolio manager, active fundamental system stock screener and trading system builder. New Forex and Index data.

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