I’m a technician, but I also take strongly into account the fundamental economic environment. From that perspective, the pieces of the puzzle here, especially looking through my perpetual lens of optimism, seem to be fitting together in the shape of a market bottom.
Tuesday’s rally was significant for a number of reasons. First, it was lead by news of profitability coming from the leper colony that is the financial sector, and from Citigroup of all companies. I don’t think I need to explain any further why this is so significant in the face of the unbridled pessimism surrounding the financials, and the entire economy for that matter.
Second, promising news came down that the up-tick rule will be restored. This is crucial in the current market environment. (If you aren’t familiar with the rule read here: Uptick Rule) If reinstated as promised, this will do wonders for the stock market (and limit profits for short sellers, but I’m making the bull case here).
On to the technicals, here is a 6 month daily chart of the Dow, with three of my choice indicators:
Now that’s a pretty picture. MACD and stochastics extremely bullish, and with the 20 day moving average in sight at approximately 7,200 there is some serious short term uptrend potential here.
Let’s now take a step back to look at the weekly 5 year chart of the Dow:
Of course, this isn’t as good looking a chart but I see that short term uptrend turning into some serious long term upward motion if that 20 day moving average is broken. On the 5 year weekly, the stochastics are starting to turn up, with a bulling crossover in our sights. Also, the MACD is turning back towards positive territory. Although maybe premature, these would be leading indicators of a bullish reversal.
What really catches my eye on this chart, however, is what appears to be a text book first half of a head and shoulders reversal. Putting this all together, if the 20 day moving average is breached to the upside, I would look for an upward trend to about 9,000 followed by a pull back, for the second shoulder, to about 8,000 before we start our long term climb back to our pre-2008 glory.
For those of you who shun technical analysis and think that these are just wild guesses, I won’t waste either one of our time explaining the reasoning and actual forces behind these chart patters or movements in oscillators, as there is a myriad amount of literature on the subject. Instead, I will make a fundamental case for the prediction:
The short term rally, as I’m calling from the 6 month chart (assuming the 20dma is broken), can be attributed to strength coming from the financials as well as the positive legislative changes expected. A short term rally would in turn relieve the media’s DOOM AND GLOOM attack on equities, which would in turn alleviate much of the downward pressure from panic selling and zero confidence. How does the second shoulder correction fit in to this fundamental analysis? I believe that this long term rally will briefly correct downward because there are still some credit/liquidity issues stemming from contagious fear that need to be flushed out by some economic optimism:
On Tuesday, the day of the rally, an article was posted on CNBC.com entitled “New Red Flag for Markets: Credit is Tightening Again." The takeaway was that Libor rates, the “Ted Spread” (the difference between 3 month Libor and 3 month T-bill rates), 2 year credit default swap rates, and the Commercial Mortgage-Backed Security index, are all currently indicating an increase in the reluctance to lend; credit is tightening up again. David Lutz of Stifel Nicolaus says, “"With those four things showing more and more strain, there's a disconnect with equities rallying the way they are. If they keep trading this way it's definitely an indication that there could be another leg down in stocks."
Couple that info with the other two key takeaways from the article:
“To be sure, the credit indicators are nowhere near the depths of September 2008 or so when lending all but dried up completely.”
“"After several months of swift declines and an environment where global central banks continue to cut short-term interest rates, any increase in Libor rates is a troubling reminder of the tension in credit markets," says Greg McBride, senior financial analyst for Bankrate.com. "The equity markets have effectively been behind the curve of what the credit markets have seen and experienced first-hand."”
And what I put all this information together as saying, in conjunction with the fundamental support I gave for a near term rally, is that we will have our short term rally, and a good sized one at that (I’m sticking with 9,000 if the 20dma is surpassed), based on a snowball effect of positive sentiment and flood of capital reentering the market, correct down to 8,000 because of credit worries, and then resume our long term upward ascent as everyone in the world realizes that the economy was never really that bad. This will be accompanied by a beautiful symphony of markups by all the companies that wrote off everything in sight and all types of good news. (This is supported by a statistic that I cannot find the source again, Kudlow presented it a few days ago, that compared to the financial crisis of the 90’s, companies are writing down twice the amount of assets compared to actual bad debt).
Pretty upbeat isn’t it? Are you feeling the sun emerging from behind the clouds yet? Well, I for one, sure hope this all comes true, and I really hate to say it but it is all largely reliant on the government not doing anything stupid. If all goes as planned and as they say, and Geithner really provides solid incentives for investors to by the “toxic” assets off the banks’ books, etc. and the Dow breaks that all-important 20 day moving average, I think that we stand a darn good chance at the nation-boosting rise back up to equity prosperity.
1 comment:
Can I say "Second?" The bottom is indeed in! Despite me not being a full-out technician, if the market retests its lows (and hopefully doesn't, but does create new lows), it is like kicking down a door - you kick and do damage... you kick again and again and then boom, you are in!
Many investors and economists still seem to argue that this recent correction is just a bear market rally and that bearish sentiment still in the foreseeable future will prevail over bullish sentiment. With that said, what bearish sentiment could exceed the bullish sentiment such as Citigroup reporting a profit, a surplus in home sales slowly shifting towards equilibrium, not just retail investors contributing to the recent rally but the more sophisticated investors covering their shorts, and so on? Doesn't this say something? How can this negative sentiment be argued? I'm optimistic as well in our economy and securities markets, I'm just trying to understand both sides... I just cannot seem to find where such pessimism comes from.
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