SPX – 1132.99

DJIA – 10,583

January 5, 2010

“Individually, everybody is doing the right thing. I can’t tell you to stop paying down debt. But when everybody does it at the same time, who is going to borrow and spend?… The only way the government can turn this economy around is to do the opposite of the private sector- borrow the money the private sector saved and spend it, which means fiscal stimulus.”

-Richard Koo, Chief Economist, Nomura Research Institute

(Barron’s, January 4, 2010)

Corporate earnings are the glue behind stock valuations and first half comparisons are easy. Tenuous recoveries gain a foothold around the world, likely aided by inventory restocking. I’ve been in the “square root” camp but am open to an upside surprise or second half dip; I’ll take my clue from the stock market. “Spending gone wild” defines Congress and the best guess for this year’s budget deficit is $1.5 trillion or so on top of $12.1 trillion we already owe. Interest rate hikes are likely to be delayed and modest. Can the Federal Reserve get its stimulus exit strategy right in an election year?

Wall Street knows all this and more; it incorporates everything known by anyone who could possibly affect future business conditions and corporate profits. There’s little the stock market does not know in advance. By the time the news is published, it’s already priced into stocks. Still, the outcome of all the buying and selling is often contrary and contradictory, regularly unfolding in a manner that fools the participants. I suspect 2010 is his no exception as wary bulls, unremitting bears and a suspicious public mix it up, along with all their emotions- anxiety, anger, caution, confidence, enthusiasm, jealousy, greed and fear.

Technical analysis studies the stock market’s action. While day-to-day prices are often random, trends exist and trends tend to persist and that’s what I endeavor to determine. Three levels of trend interact- primary, intermediate and minor. The primary trend is governed by the business cycle and fundamental conditions. It generally lasts for years and is labeled a bull or bear market, swinging between discounting the worst that might happen (bear markets) and best (bull markets). Valuations typically overshoot in either direction.

S&P 500 – Quarterly (Source: BigCharts.com)

Intermediate trends generally last weeks to months and can move in the same direction as the primary trend or as a secondary reaction against it. I think the safest trading in on the intermediate trend. I confess to maintaining an hourly SPX chart as well as a 3-hour swing chart, but short-term trends are the least important, reversing quickly in either direction due to temporary factors and far too precarious to trade in my opinion.

Back to the primary trend, the SPX’s annual swing chart turned up yesterday, yet another indication (albeit late for trading purposes) that a cyclical bull market is in progress. As for the intermediate-term trend, the Market Trend Indicator (MTI) remains in Uptrend. There’s no change this week unless one or more of its key indices closes below its respective 18% weekly exponential average. The SPX’s 18% average is 1096.17 week and it’s 10,267 for the DJIA. The New York Advance/Decline line is 7,317 net advances above its 18% average.

S&P 500 – Daily (Source: StockCharts.com)

Net volume is in synch with the uptrend with peak readings of  +39.4 for the NYSE and +48.4 for NASDAQ, higher than their peak readings on the prior short-term decline- (39.4) and (42.6) respectively. For new readers with an interest in what’s behind this indicators, scroll down to the October 20, 2009 posting (“Technical Dichotomy).

The uptrend deserves the benefit of doubt until proven otherwise but I’m edging up stop orders on outstanding trades and I recommend keeping exit points particularly tight on any new trades. The SPX’s move above its consolidation appears to be more a function of limited selling than spirited buying. Could momentum pick up? Sure; that’s why you let profits run. However, the rally to new recovery highs wasn’t confirmed by weekly net volume readings and the SPX is also the thirteenth swing for the weekly swing chart from its July low, an indication the intermediate-term rally is late in its move. Note in the second SPX daily chart, if you drew a trendline connecting the March and November lows, it has been tested three times since; once it breaks, it’s likely to be meaningful.

S&P 500 – Daily (Source: BigCharts.com)

As for groups, Bespoke pointed out the worst in 2008 were the best in 2009. More than one-quarter of all groups bottomed before the low in March and most of the others near the low. Participation was broad but there was little sustained leadership. That’s likely to change in 2010 but there’s little technical evidence to support that view.

In other key markets, the Treasury sold more than $2.1 trillion in bonds and notes in 2009 in a series of successful auctions, but I suspect the consequences of massive government intervention is likely to show first in the debt markets. I use TLT (Barclays 20-yr+ Treasury ETF) as a proxy for long-term government bonds; note in its weekly chart how it appears to be forming a short-term bottom near support where I think it could find support and possibly rally in a spurt of “flight-to-safety” buying early this year.

TLT (Barclays 20-yr+ Treasury ETF) – Weekly (Source: StockCharts.com)

In the search for yield, Thomson Reuters reported that municipalities sold $409.1 billion of debt in 2009, up 5% from 2008 and a new record. It included nearly $84 billion of Build America Bonds and other taxable debt.

Gold pulled back enough to reach oversold territory on its daily chart and rallied yesterday back above its 50-day moving average. Oversold conditions don’t last long in bull markets and I don’t think the multi-year gold bull market is over. That may have been it for the correction; I’ll know more by the end of the week. Gold has traded contrary to the U.S. Dollar index throughout its bull market and I think the dollar rally has further to run and I want to see how gold reacts.

GLD (SPDR Gold Trust ETF) – Daily (Source: StockCharts.com)

Harmonic Preview:

(High Probability Turning Point or Acceleration Days)

January 5         (Tuesday)

January 12       (Tuesday)

January 13       (Wednesday)

January 14       (Thursday)

January 20*     (Wednesday)

January 21*     (Thursday)

The dates with asterisks are dynamic SPX price squares in time. My December 22 posting (“The Right Side of the Market”) explains the rational. The other dates are either fixed squares, anniversary dates, 3-day swing highs and lows or something even more esoteric.

Conclusion:

The trend remains up and stick with the trend, but technical evidence indicates it’s late in the intermediate-term advance. A close below the SPX’s rising trendline or a second close below the bear market’s halfway point (1121.44) would be an early signal the rally is over. I think it makes sense to raise stop sell levels to just below the December 18 low (1093.38) from just under the November 27 low (1083.74) previously.

Once the trend reverses, I believe some of the best shorts are likely ETFs tied to cyclical groups or small cap indices. I know the rules call for shorting weak groups but given the contrary nature of the advance, investors are likely to seek safety in lagging, defensive groups so greater profits are more likely catching the turn in currently strong sectors.

For investors, it’s time to plan ahead as to what percentage of assets to hold in stocks once longer-term technical tools indicate that the cyclical bull market has run its course. I’ll keep you up to date on that front; it’s not even close yet. For those with individual stocks, I think it’s best to hold quality merchandise and it makes sense to raise cash on holdings with business and balance sheet risk as prices advance.

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.