For full article please contact me.
Caution Stills Reigns, Despite Positives
Some indicators have recently turned positive. But here’s why it may still be too early to deploy large amounts of cash.
The S&P 500® and Nasdaq would need a heavy-volume break above their resistance levels before I’d recommend making a significant investment.
Generally, I like small-caps to lead on any rallies from lows, and the S&P Small Cap 600® Index has taken a nice turn to the upside, increasing that possibility in my view.
Positive developments are certainly taking place in the indexes, but without higher volume, I believe it’s best for investors to bide their time before getting too aggressive.
In past columns, I warned investors that they need to remain defensive, cautious and in cash. This strategy has certainly paid off during the recent market carnage. This year’s market meltdown has taken all 10 sector indexes in the S&P 1500® Index down at least 13% and the overall S&P 1500 Index is down over 37% as of November 13.
We saw an important intraday reversal in the indexes on November 13. This happened as the prices broke below the October lows, triggering traders’ sell stops, and then reversed sharply higher, closing at the high of the day.
The market remains bearish
This market continues to exhibit bear characteristics from an intermediate- to long-term perspective. However, the short-term picture looks promising. The longer-term problem remains in the massive debt that is being created by hundreds of billions of dollars in bailouts, capital infusions and takeovers. Investors need to be aware that this money is not coming out of a safe somewhere. It’s borrowed money for which, to raise the necessary funds, the U.S. government will have to sell $550 billion in new Treasury debt during the last quarter of 2008.
I see a tremendous number of technical, sentiment and breadth readings that imply a high possibility of an intermediate-term rally during the final quarter of this year. However, there are also a lot of never-before-seen readings that could be misleading.
I believe that this intermediate-term rally could still play out, and there’s a possibility that we’ll get a sharp rally higher, since the major indexes are so stretched below the 50-day moving average; the reversal on November 13 may be the start of it.
If you look at the first chart of the S&P 500 Index below, you can see that two of my short-term indicators, the Moving Average Convergence/Divergence (MACD) and the stochastic oscillator, have recently turned positive (indicated by the green circles). Even though the price is encountering intermediate-term resistance around 1,000, I believe that the washout on November 13 may set the tone for a possible break above that resistance level. If that happens on increasing volume, I believe we’ll see an initial run to 1,200 or so.
Click to enlarge.
Source: TC2000, as of market close on November 13, 2008.
Below, the second chart shows the reversal that took place in the S&P 500 on November 13. The MoneyStream (MS) at the bottom of the charts also ticked higher, but it still needs to break out above the past two months’ resistance. I believe the key will be for the average to break above the upper resistance levels in order to confirm the reversal on November 13. If that happens, I believe there may be a good opportunity for the indexes to climb near the 200-day moving average.
Click to enlarge.
Source: TC2000, as of market close on November 13, 2008.
The Nasdaq also made a double bottom and put in a key reversal on November 13. If we can see a break above the 1,750 resistance level in the Price Chart, I believe there’s a good chance that an initial run up to around 2,200 is possible. From that point, we will have to see if institutions continue to support the move.
Click to enlarge.
Source: TC2000, as of market close on November 13, 2008.
When the major indexes move higher, I usually find it to be a good sign when small-cap stocks take the lead. In my view, the chart below shows that the S&P Small Cap 600 Index may participate and possibly lead the next move higher. Of course, this pattern would be null and void if the price breaks below the October lows. But I believe that if the price rises above 50, we may see a quick run to at least 55–60.
Click to enlarge.
Source: TC2000, as of market close on November 13, 2008.
Some upbeat signs
On a more positive front, we usually have a strong seasonality pattern during the first week of November, and over the past 10 to 15 years, it’s been exceptionally positive. Another positive development that was reported on Sentiment.com is that insiders have turned into net buyers, instead of sellers, of their own companies’ stock. In my view, this also has been a pretty good buy signal on average. The fact that this bullish indicator just spiked up to a new high certainly seems to be a positive sign, but unfortunately the history here is very limited.
Click to enlarge.
Source: SentimenTrader.com, as of market close on November 10, 2008.
Another positive development is the recent reading from the American Association of Individual Investors regarding asset-allocation holdings. If you look at the chart below, you can see that stock holdings have dropped to a six-year low, and cash and bond holdings have increased to nearly six-year highs. We haven’t seen this type of pessimistic reading since the end of 2002. I believe this is a contrarian indicator, and expect it to be a positive for the market over the next couple of months.
Click to enlarge.
Source: SentimenTrader.com, as of market close on November 10, 2008.
The last chart shows the Financial Select Sector SPDR ETF (XLF). I continue to remain cautious about the financial and banking sector. Although we may see a rally from its extended downside condition in the near future, I believe there’s much more downside to come.
In fact, one might think that XLF would be able to rally from the recent weakness, but as you can see from the chart, any rallies have come on lower-than-normal volume and decreasing institutional money stream. The washout pattern is somewhat similar to the other indexes, and we should also see some upside here, but there is a tremendous amount of resistance near 17.50–22.50. I remain very cautious on this sector and see much more trouble with derivative assets in the future. You should also notice that the chart is forming a technical pattern called a descending triangle. In most cases, this pattern signals that the price is likely to break to the downside instead of up.
Click to enlarge.
Source: TC2000, as of market close on November 13, 2008.
Even though many of my short-term indicators have turned positive, my intermediate- and long-term indicators are nowhere close. We’re obviously very stretched to the downside, and a sharp rally could occur at any time. Aggressive investors might want to take a small position in the S&P 500 Depositary Receipts (SPY) or the double-long index proxy ProShares Trust Ultra S&P 500 (SSO). (The latter fund is designed to approximate twice the return of SPY, but you should keep in mind that it will also incur higher downside volatility.) If you take a position in either, be sure to place protective stops under the October lows.
What to watch
I’ll continue to stay very cautious and defensive until we get some better action in the indexes, along with some leading growth stocks breaking out of sound bases. Until that happens, I believe these wild swings are bear market moves.
I’ve scanned thousands of stocks over the past week and have yet to see many positive developments in price patterns. That means I’ll continue to keep a heavy cash position with a few index longs until I see a catalyst that could lead to a strong intermediate-term rally.
A break above the current resistance levels with increasing volume on the above charts would prompt me to add to positions.
Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.
Exchange-traded funds are subject to risks similar to those of stocks. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Past performance is no guarantee of future results. |
