Awaiting Confirmation

S&P 500 – 1075.51

DJIA – 10,099

February 16, 2010

“More than any other time in history, mankind faces crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have the wisdom to choose correctly.”

-Woody Allen

.

The Market Trend Indicator (MTI) is a moving average-based calculation useful for its ability to identify and follow trends lasting weeks to months. It’s back in NEUTRAL territory due to strength in the New York Advance/Decline line which is 1,800 net advances above its 18% weekly exponential average. Both the S&P 500 (SPX) and DJIA are still below their 18% averages, 1091.39 and 10,217 respectively. The MTI signals uptrend when all three key indexes close above their respective 18% averages.

Net volume readings haven’t yet confirmed an uptrend. Peak readings so far are +42.1 for the NYSE and +38.3 for NASDAQ compared to their hurdle rates, (69.6) for the NYSE and (50.7) for NASDAQ.

Price and time overbalanced on the decline, indicating the SPX’s January 19^th high (1150.44) marks the cyclical bull market’s peak. I don’t mention price and time overbalance regularly because it rarely comes into play; yet it is my most important technical tool. It is at odds with strength in the A/D line and other breadth indicators. Bull markets generally end with the A/D weakness and non-confirmations versus strength in the DJIA and SPX. We’ll discover which indication is correct on the next section advance.

Last week, I mentioned the SPX’s February 5 low (1044.50) might be the starting point for that advance. That view may still prove to be the case but the pattern on the SPX’s hourly chart between then and February 11 looks suspiciously like an Elliot Wave triangle (3-3-3-3-3), implying one more thrust down to put an intermediate-term low in place, mostly likely to support around 1029-1030, a few points above the 200-day moving average. The stock market is capable of any action at any time, so tactics, money management and discipline are more important than predictions.

Elliott Wave holds that wave patterns are subject to a basic form and continuity built on the Fibonacci mathematical sequence. It’s one of those technical tools that works often enough that it’s gotten too popular in my opinion. What I find is that different people looking at the same chart come up with various interpretations, and one particular danger is that preconceptions cloud what is actually happening. Still, we’ll know soon enough whether the idea of one more thrust down is valid or not. Specifically, I think a SPX close above last Thursday’s high (1180.04) would negate that interpretation while a quick break below last Thursday’s low (1060.59) would hint the thrust is underway.

Here’s an updated S&P sector weighting from Bespoke Investment Group (www.bespokeinvest.com). Groups in the Consumer Services and Consumer Goods sectors hold eight spots in the top ten group list as measured by relative performance. These groups are Airlines, Automobiles, Home Construction, Recreational Products, Consumer Electronics, Recreational Services, Restaurants/Bars, and Auto Parts.

At the January high, groups the Basic Materials sector held five spots in the top ten list but the count is zero now compared to four in the bottom ten group list. Still, Precious Metals, Gold Mining, Coal, Basic Resources, and Iron & Steel were among those that bounced the most last week and I suspect offer the best chance for intermediate-term performance versus the current leaders. Basic Materials comprised only a 3.5% weighting in the S&P 500 near the high compared to 9.8% for the Consumer Discretionary sector.

My view of other key markets is unchanged. The trend is down for long-term government bonds and I think the primary uptrend for gold has begun to reassert itself. A gold price close above its 50-day moving average (1113.72 2^nd London fix) would confirm the rally is underway. The U.S. Dollar index is at resistance but has yet to reverse amid Euro distress.

The Federal Reserve is beginning to lay out the tactics of its exit strategy. I don’t expect new problems out of left field but the consequences of actions already taken to avert a replay of the Great Depression will be reflected in these markets. The U.S. may be forced to choose between maintaining hefty annual deficits if foreigners back away from out debt or tolerate a double dip by accepting some measure of fiscal discipline.

“US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941,” wrote economic historian Niall Ferguson in the Financial Times last Friday. “On reflection, it is appropriate that the financial crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when the crisis will reach the last bastion of western power, on the other side of the Atlantic.”

The Fed finishes its $1.25 trillion mortgage purchasing program in March but there’s still an “overhang” of foreclosed homes. Mark Zanki, the chief economist at Moody’s Economy.com said, “Housing has been on government life support, and without it the crash would have been much more severe. This spring and summer as those policy efforts unwind, we most likely will see mortgage rates move higher and more house-price declines.”

Approximately $1.4 trillion of commercial real estate loans come due through 2014. Commercial property values are off more than 40% from the start of 2007 and nearly half the loans are under water. The Congressional Oversight Board expects about $300 billion of losses on commercial real estate loans.

Note in the following chart of the world stock market ex the U.S. how markets around the world continue to trade in lock step. China has raised reserve requirements for its banks twice in a month. Will a variation in the three steps and a stumble rule (the stock market stumbles after the Federal Reserve raises interest rates three times) come into play China?

Harmonic Preview:

(High Probability SPX Turning Point or Acceleration Days)

February 16     (Tuesday)

February 19*   (Friday)

March 1           (Monday)

March 4*         (Thursday)

*An asterisk denotes a dynamic SPX price square in time; different factors account for the other dates.

Conclusion:

The technical character of the next intermediate-term rally should tip us off whether the price and time overbalance signal was correct or not. I’m waiting for the MTI to signal uptrend to confirm that advance is underway. I think ETFs tied to either the NDX or SPX are the safest vehicles.

Morningstar reported investors put $2.7 million in U.S. stock funds in January after four consecutive months of taking money out. IRA contributions play a role. Determine how exposed you want to be in the next bear market; it may have already started from a January high. If technical characteristics on the next short-term rally are poor, I’ll probably recommend some selling into strength. Confirmation of a bear market comes with a lag but shouldn’t be ignored if and when it comes, particularly for baby boomers nearing retirement.

The information contained herein is based on sources that William Gibson deems to be reliable but is neither all-inclusive nor guaranteed for accuracy by Mr. Gibson and may be incomplete or condensed. The information and its opinions are subject to change without notice and are for general information only. Past performance is not a guide or guarantee of future performance. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without consent from William Gibson.