Market in Perspective

The following article appeared at HorsesMouth.com on 8/11/2011. After publication the market had four out of five up days and the media was full of “turnaround” stories. However, since then the article has been a bit more prescient, especially after yesterday’s drubbing.

With today being a bit more normal than we’ve been having (ok 6% up day isn’t “normal,” but at least we haven’t had the wild gyrations of the last few days, I thought it would be a good time to step back and gain perspective on the markets. And make a guess or two as to where we might be heading.

First, for that perspective, below in Chart 1 is a graph of SPY, the SPDR S&P 500 Index ETF, since 1993 using monthly candlesticks. I like candlesticks because they clearly show ups vs downs for the time periods being used. The first thing I looked at was that in only one instance since 1993 did we have three consecutive down months during a bull or rising market. And that was in mid-1999, so that could be said to have been a warning sign. Assuming August stays in the red, we will have had four consecutive down months. This is a bearish indicator.

A second bearish pattern is seen in the magnitude of the drops. The second thing  I like about candlesticks is that they clearly show magnitude of market moves. We just don’t see such big drops in the market during rising markets. The one exception being in 1998 and highlighted by the white arrow. Bull markets are characterized by less volatility. You can clearly see that the bull markets from 2003 – 2007 and 2009 -2010 were characterized by much smaller price swings than the big bear drops.

Technically, this is looking like a pretty negative setup.

Chart 1. Spy 1993 – Present

Source: Freestockcharts.com

Question could be asked as to whether this could be a bottoming with such a washout coming after such a sharp turn around from rather bullish sentiment in the spring. Chart 2 below looks at the end of the 2002 bear market and Chart 3 the end of the 2008 bear market.

In Chart 2 we do see that after two large weekly drops the market began a ten month trading range before  finally breaking out into a short term bull market.

Chart 2. Spy with Weekly Candlesticks

Source: Freestockcharts.com

In Chart 3, again using weekly candlesticks, the big consecutive weekly drops wiped out a lot of value, but hardly formed a bottom. The area between the white lines show an additional 20% drop from around 87 to 67. And again, another 10 months before the market finally broke out.

Chart 3 SPY Weekly Candlesticks

Source: Freestockcharts.com

I like to look at the market using candlesticks because they give me a picture of the markets psychology. I personally don’t trade based on the many different formations that are used for technical trading. In Chart 4 below I’ve again used weekly candles to look at the current market. What this is showing me is that sentiment was really bad earlier this week. This is shown by the long string, or tail at the bottom of this week’s candle. As of the 11th, we’ve finished well above the weekly lows.

Chart 4 SPY Weekly Candlesticks

Source: Freestockcharts.com

While this looks like it could be an indication of some sort of bottoming, it could also be easily explained by short covering. Judging by the market reactions to similar selloffs during this secular bear market, I don’t see any reason to be in a hurry to jump back in the market. If we had some sort of positive “event” to spark a turnaround I might be more optimistic. But frankly, the news hasn’t changed. One half way decent employment report is hardly enough to justify a rally from here. I used the big up day to sell half of one of our less liquid positions in our dividend income portfolios. (note: we have added to both our “cash positions and short ETF positions since this article originally ran at http://www.Horsesmouth.com)

Bottom line here in my opinion is to follow the Wall St. adage, “Don’t fight the Fed.” And in this case Ben Bernanke pretty much said we’re heading into a recession, and there isn’t a whole lot we can do about it. Recessions see a 40% drop in stock prices, we’re only half way there.

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bill@401advisor.com • 937.434.1790

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Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.

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