THURSDAY, OCTOBER 9, 2003 5:56 p.m. EDT
GETTING TECHNICAL |
By MICHAEL KAHN
The Correction That Wasn't
The Markets' Mood
WELCOME TO OCTOBER, one of the scariest months of the year for investors and trick-or-treaters alike. While it may be a few weeks early to reference Halloween here, October does have a reputation for some spooky returns and ghoulish behavior. Think 1987. How about 1929?
But statistics show that September is really the worst performing month on the calendar, and we made it though it OK. The correction that looked to be starting September 19 may have been good for 450 points on the Dow Jones Industrial Average, but given the 2200-point rise since March, it was barely a speed bump.
So now that the Dow and all the other major indexes have moved to fresh high ground for their respective rallies, it would seem on the surface that things are back in bullish mode again. After all, a higher high on the chart when coupled with a higher low is the definition of a bullish trend. That is what the Dow presents us with right now (see Chart 1).
CHART 1
On Tuesday (see Getting Technical, Sector Alert: "Small Stocks – Are They Back?," October 7), we looked at the resurgence of small and mid-capitalization stocks after a temporary stumble from their market leadership positions. These stocks were powering the rally, but they faded in August in what is traditionally a warning sign for the broad market.
We said a correction was likely to be just around the corner, because markets do not like being leaderless (see Getting Technical, the Markets' Mood: "The Makings of a Correction," October 1). The market had been churning and appeared to be in a topping pattern--not a major pattern, but something to worry about.
But in the tradition of Mad Magazine's cartoon persona, Alfred E. Newman, investors have said, "What, me worry?" And I don't mean the proverbial "Wall of Worry," either. Heck, there apparently are no worries. With all the negative technicals we saw last month, from frothy sentiment readings to support breaks to waning momentum, the stage was set for something important to the downside. Because it didn't happen, we can only assume that the market was stronger than we thought it was, because strong markets do not correct for long.
But frothy sentiment readings are still with us. As a contrarian indicator, sentiment is based on the notion that the crowd is wrong at the extremes. Extreme bullish sentiment means that there are no converts left to buy more and keep prices rising. No converts means demand dries up, and the forces of supply and demand tell us that any new supply of shares will have a very negative effect on prices.
Sentiment is not a timing indicator, though, and selling stocks just because the masses are bullish is not a very good strategy.
What we have is a background condition that could make negative price action -- and price is the only thing that really matters -- more likely to "stick." When it doesn't, we can then look at another analogy, that of a stretched rubber band. The market was stretched from a sentiment point of view and the higher it goes the more it stretches. Eventually, something snaps. Perhaps the Wall of Worry appears and sentiment eases. Or, prices break to force sentiment back to normal ranges.
Judging by Thursday's early breakout rally, however, it looks as if the market is saying, "sentiment be damned."
Judging by the afternoon sell-off, there may be more traders who think that the rubber band got one notch tighter.
Earlier this week, we also looked at a price pattern on the Standard & Poor's Mid Cap 400 index that goes by several different names: expanding triangle, broadening top, megaphone (see Chart 2).
CHART 2
In it, the market makes higher highs but also makes lower lows in a show of clear indecision and increasing volatility. As one of the names implies, it is usually associated with tops, but usually does not mean always.
In the case of the current market, the pattern appears to be breaking to the upside, albeit a lot of its credibility was lost in Thursday afternoon's sell-off.
So, why not become a roaring bull, or at least a happy bull? I am on record here as looking for a true market top in the second quarter of 2004 (see Barron's, "Still Going North," October 6,) and it still seems very unlikely that we'll get there in as straight line, especially when sentiment is at levels last seen at the top of the bubble in 2000.
But the market is in charge, not me -- and right now, the market looks as if it wants to probe a little to the upside before taking a real breather. So, while my personal feelings may say otherwise, I have no choice but to do what the market tells me -- while silently screaming like Chicken Little that the sky is about to fall again, at least at some point.
October 7: Getting Technical, Sector Alert: Small Stocks -- Are they Back?
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Getting Technical Mailbag: Send your technical analysis questions to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
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Michael Kahn writes the daily "Quick Takes Pro" and the weekly "Quick Takes Lite" technical newsletters (http://www.midnighttrader.com). He is the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple, and was Chief Technical Analyst for BridgeNews. He also is Director of Marketing for the Market Technicians Association (www.mta.org).
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