Monday, August 13, 2012

The S&P 500 is Close to a Once-in-a-Lifetime Signal

In this article, I'm going to focus on the long-term.  I'll discuss the generational nature of a certain signal shortly.

First, let me make one thing clear:  I don't like this market one bit right now.  Usually I can look at the charts and get a good feel for the market on either an hourly or daily time frame -- but for this past week, I haven't felt like I have a definite grasp of anything other than the shortest time frames.  I've been limiting my personal trades to the one-minute and three-minute charts, and haven't held any trades longer than a few hours recently.

I view the current price territory as something of a no-man's-land: the market is currently beneath long-term resistance, but above short-term support.    At times like this, we have to look at other signals besides price; the challenge is that price is the ultimate authority, and other signals are always hit-or-miss... and even some of those indicators are giving mixed messages.  I can't tell exactly what the market's going to do next here; all I can do is assemble the evidence, look at what's happened in the past, and then try to draw a reasonable conclusion. 

The short-term trend is up, and the long-term trend is up. So why be anything other than bullish?  Well, there are numerous signals which, in the past, have been precursors to bearish markets.  Accordingly, I'm going to continue warning of the intermediate bear case unless those signals negate.

And there are no guarantees that these signals will work.  If you're the type of trader who marries their position, or has a hard time (emotionally) with missing a move that went in the direction of the previous established trend, then just follow the trends and don't try to anticipate turns -- anticipating turns is extremely difficult and higher-risk. 

Of course, trading only the trend has its disadvantages, too -- but whatever we didn't do always seems brilliant (in hindsight) any time the actions we took don't work out.

At times like this, it pays to remember that one doesn't need to always be either bullish or bearish.  It's a mistake to think those are the only two options in trading -- in fact, believing one should always be either bullish or bearish is a sure-fire way to lose money fast, because it leads to over-trading when the market is ambiguous.  Cash is a position, too, and successful trading is as much about patience as anything else.

Smart traders will sometimes lean bullish or bearish and take a stab because there's a clear bull/bear battle line, and the risk/reward is good -- but they're also quick to exercise discipline and close the trade if it isn't working.  If a trade doesn't work, never get mad about "missing a move" -- getting stopped out means you did something right, not something wrong -- and as long as you continue making disciplined and well-reasoned trading decisions, you are acting correctly.

Last week the market did basically nothing, and I've been excluding the short-term section of the updates of late, because I haven't felt there's a clear short-term direction... and I suppose, given the meandering nature of the past week, that my read has actually been correct.  The market may drift around a while longer -- it appears that numerous forces are working at cross-currents to each other right now.  As I said last week, this type of top is a process, not an event.  Of course, with that statement, I am presupposing that this is a top, and that the current signals won't negate.  A solid and significant breakout would suggest bulls are still in control.

I'm going to continue limiting focus on the short-term until it clarifies again.  Instead, let's look at some of the intermediate and long-term evidence and signals.

The SPX monthly chart shows a rare event that I've been keeping my eye on for a while:  the pending potential cross of the 50 month and 200 month moving averages.  It's fair to call this signal "once in a lifetime," since these two moving averages haven't crossed on SPX in over 66 years (they last crossed upwards, in April, 1946).  When they cross downwards, this is commonly called a "death cross" and considered a bearish signal -- but before bears get too excited, it calls for some discussion.

While this signal hasn't actually happened in SPX for 66 years, SPX did come very close in 1978.  This was at the tail end of the long secular bear market of 1966-1982.  I say "tail end," but this is of course relative, and it was still 4 more years until the bear market actually ended.  This monthly death cross happened a couple years later in the Dow Jones Industrial Average (INDU), in August of 1980.  The INDU then crossed back up (called a "golden cross") in April 1982.  However, in both those death cross instances, the bear market wasn't over -- and while we can look back and say it was near the "end" of a secular bear market, two to four years is still a pretty long time by the standards of most investors.

The Dow also experienced a monthly death cross during the Great Depression, in January of 1934; and the moving averages didn't cross back up until February 1946.  There's no argument that this was a useful long-term signal at that time.

And then there's Japan.  The Nikkei (NIKK) experienced a monthly death cross in early 1998, when the index was trading near 17,000.  This cross is still active -- and the Nikkei is currently trading almost 50% below the signal level.

So while this signal is so incredibly rare that we have limited historical evidence to draw from, the past history suggests that it's a bearish signal for the long term.  But, as the famous last words go, maybe "this time will be different."

The next chart I'm going to share discusses another recent signal that tends to be a top precursor. Last week, ten-year bond rates hit a 50-day high, as did the S&P 500 (SPX). The last time these two things happened together was March 13, 2012 -- and before that, October 27, 2011.

Note that this signal led the top in March by several weeks.  While not quite as long-term as a monthly death cross (what else is?), this is still an intermediate signal, so it doesn't mean the market's necessarily going to collapse tomorrow -- it just increases the odds that an intermediate top is under construction.

The next chart is the SPX daily, and discusses the next resistance levels, should the bulls break through 1407.

Next is the NYSE Composite (NYA), and I find the current fractal interesting for its similarity with 2010-2011.  The fractal here does suggest more upside is possible before a significant turn.

Trying to fit an Elliott wave count to the current charts is still an exercise in patience/frustration.  This chart shows one of the mixed-message signals -- as I mentioned on August 5, the breakout and backtest of the blue trendline can't be viewed as anything but bullish.

Finally, my best guess at the short-term.  This chart is materially unchanged since August 3rd, when I suggested an ending diagonal as a potential resolution to the present move.  I suspect the market might need to test higher prices eventually (not necessarily immediately) -- though as long as the bears hold 1407, there is always a chance that level ended the wave.

Of some note, with Friday's close, the SPX had 6 positive closes in a row.  When this happens, there is a 70% chance that the 7th close will be negative.

In conclusion, I'm effectively neutral on the short-term.  I remain cautiously bearish on the intermediate-term -- however, the market's behavior in late 2011 and early 2012 is still fresh in my mind.  During that time, the indicators repeatedly gave signals which were historically bearish, but the market ignored them and kept marching higher anyway.  As a result, I'm still hesitant to suggest anything but caution on either side of the trade.

On a lighter note:

In weekend Olympic news, the United States beat Spain on Sunday to win the gold medal in Men's Basketball.  At the press conference which followed, Fed Chairman Ben Bernanke stole the show when he revealed that the Fed "is standing by and has all the tools necessary to obtain gold medals for each and every U.S. Olympian" -- provided that nobody cares if all the gold content is replaced with paper. 

Later Sunday evening, Former MF Global CEO Jon Corzine announced that he had officially won the Fed's first "gold" medal -- in the challenging and aggressively-competitive category of Creative Accounting.

Trade safe.

Reprinted by permission; copyright 2012 Minyanville Media, Inc.

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