The Right Side of the Market

SPX – 1114.05

DJIA – 10,414

December 22, 2009

“The market is trickier than it was in the summer, and frankly, most stocks have stagnated with the major indexes. So it’s not like the bulls are running wild. Even so, the major trends are up and the broad market remains in good health.”

-Michael Cintolo, Cabot Market Letter

The growth-oriented Nasdaq 100 (NDX) closed on new recovery high yesterday; that’s positive. So did the Nasdaq Composite while the S&P 500 (SPX) is close. At this point, the SPX needs to close above its December 4 intraday high (1119.13) and ideally above the halfway point of the bear market (1121.44) to confirm a bigger move is underway.

NYSE net volume generated a (39.4) reading last week, exceeding +32.5 on the prior rally but there wasn’t enough selling to qualify as a short-term decline under my rules. If the SPX trades out of its range on the upside today, NYSE and NASDAQ net volume could both swing back to being in synch with the uptrend. NASDAQ’s hurdle rate is (42.6).

The Market Trend Indicator (MTI) is signaling Uptrend as each key index remains above its respective 18% weekly exponential average. This week, the 18% average is 1102.47 for the SPX and 10,168 for the DJIA. The New York Advance/Decline line is 6,057 net advances above its 18% average.

To my thinking, the SPX would be in a stronger technical position for 2010 if it first broke out of its trading range to the downside. If the SPX rallies to a new recovery high, it will mark the 13^th swing on its weekly swing charts from its July low, an unusually high number and the same as the U.S. Dollar index had in its downtrend before beginning a sharp rally.

Potential resistance levels on an upside breakout begins with the most important immediately overhead, 1121.44 (50% bear market retracement). Above that, there’s potential resistance at 1134.19 (an average of the 50% level and the next two resistance points)- 1136.35 (75% of the 1974-2007 range) and 1144.78 (62% retracement of the May 2008-March 2009 bear market leg).

The technical tool that’s flashing the strongest warning signal is weekly net volume. It is constructed just like the shorter-term signals, only it is based on three week volume differentials instead of three days. I mainly use weekly net volume to confirm intermediate-term swings because the signals come late, so I don’t write about it much. That said, the peak reading into the November 2 low (1029.38) was (19.2) and the highest reading on the rally since is only +12.8. This same phenomenon occurred at the top in October 2007.

Based on weekly net volume readings, I consider the rally from the November 2 low to be the third section of the cyclical bull market. The rule is to count three sections and expect a fourth. The key to the primary trend is to watch price and time after a three section advance. If both overbalance (by declining more in both price and time than any from the start of the bull market) it signals a change in the primary trend. It’s often the first meaningful indication of a change in the primary trend, followed later by other indications such as moving average crossovers and Dow Theory. I operate under the assumption that the stock market itself is the best indictor of both future market action and business.

Still, technical analysis has its limitations. In an interview with Charles Kirk (www.kirkreport.com), the author of Capturing Profit with Technical Analysis, Sylvain Vervoort, explained, “Technical analysis is not an absolute science. Nothing is ever 100% certain! You are looking for a higher probability, but there is no guarantee. Do not interpret technical analysis as black and white, but with shades of gray. There is no Holy Grail!”

Barron’s reviewed the forecasts of twelve strategist, evenly split between money managers (buy side) and brokers (sell side). SPX price targets for 2010 averaged 1239, ranging from 1150 (Tobias Levkovich at Citigroup & Francois Trahan at ISI) to 1350 (James Paulsen at Wells Capital). Strategists missed badly in 2008 but most were timely with bullish recommendations near the 2009 low. These are all smart people with access to the best data but no one really knows.

When economics becomes important enough, it become political. That’s what happened following the mortgage/derivatives crisis, creating an intense focus by the general press on the economy and government’s response. The stock market takes it all in and discounts it accordingly. The market is rarely influenced by something that is already known, but prices are influenced by unknown but anticipated news. For traders, speculators and investors alike, it’s generally best to act on the news before it appears in print.

The time element for intermediate-term swing traders is really the market’s trend. The idea is to follow important moves and trade conservatively. In momentum markets, it pays to be long the strongest stocks in the best acting groups. As for the lack of momentum this year, Michael Cintolo summed up, “2009 was not an easy year for anyone, despite the solid advance in the major indexes. Our growth stock system, which has been refined over nearly four decades and outperforms over time, was not the ideal system for this particular year; investors were better off buying all the beaten-down stocks they could find or simply sticking with broad market funds.”

Reflecting the contrary nature of the market, Gold Mining was the worst group for the second week running while two of the worst groups (weighted toward nine month performance), Home Construction and Heavy Construction, were both in the top ten performance list last week along with Airlines, Aluminum, Independent Oil Exploration & Production, Pipelines and Coal. Steel climbed into the top ten group relative performance list and Banks fell to the bottom ten group list. Note how the New York Financial Index, which led on the advance from March is not confirming recent index strength.

In other markets, the dollar’s rally continues. There’s resistance for the U.S. Dollar index around 80.50–81.50 versus a close at 78.05 yesterday. Gold, which typically trades contrary to the dollar, is likely to remain under pressure until the dollar rally nears completion.

The press, particularly last Wednesday’s Financial Times, is starting to highlight the speculative bubble in gold, complete with lots of warnings and predictions the move is over. These are the sorts of articles that appear long before the final blowoff, particularly with regards to price. Climaxes in booms may only last a short while but can tack on a lot of points and I think it still lies ahead for gold. Hedge fund maven, James Paulson, agrees. He’s seeding a new hedge fund with a $250 million personal investment dedicated to beginning January 1.

As for long-term government bonds, the trend remains down. There’s probably a flight to safety rally once the stock market peaks but I think the primary trend remains down with only intermediate-term corrections offsetting that trend. The easiest way to participate is via TBF (ProShares Short Barclays 20-year+ Treasuries ETF) and TBT (ProShares UltraShort Barclays 20-year+ Treasuries ETF). My recommended stop point is just above the TLT’s November 30 high of 96.73, so size your positions accordingly.

Barclays (formerly Lehman) corporate bond index closed at higher price than its government bond index for the second week in a row. Bloomberg reported Bill Gross shifted PIMCO’s $199 billion Total Return Fund investments to 51% in government bonds in November from 63% in October, and has nearly 7% in cash (and virtually zero return), its highest level since the Lehman collapse. If you haven’t looked in awhile, check out the U.S. debt clock at www.usdebtclock.org.

I decided to begin sharing my “high probability days” preview, those days when the stock market is most likely to be at a turning point of some degree or a price acceleration day. The most important harmonics are tied to dynamic squares in time of previous highs and lows in the S&P 500. The key is determining which squares are working, a breakthrough I realized about 25 years ago after studying a geometric system (pre-Euclidian) based on absolute unity.

These dates are not the secret to stock market success, but dynamic squares are a marvelous phenomenon that often aid profitable trading and market understanding. You’ll be astounded at how many times the press struggles to come up with a reason for monster moves on these days in the absence of market-moving news. Of course, sometimes nothing happens; if confused, reread the Vervoort quote about technical analysis.

The veracity behind dynamic squares is tied to the belief that energy unity in its various vibrations and structures creates the multiplicity of all forms in the universe. Force-field theory holds that the material world is knowable only through its underlying patterns of wave forms, which is what pre-Euclidian geometry attempts to achieve with geometry and number depicting the fundamental nature of causal energies in their interwoven eternal dance. I find it fascinating that the stock market, which is nothing more than human psychology in action wrapped around the business cycle, dances to these squares. An asterisk by the preview day is a dynamic square that is kicking.

I also cross reference my dynamic square projections with anniversary dates of important highs and lows, Bradley days and a few other dates tied to the sky. For example, yesterday was the Winter Solstice which would have qualified and on December 31 there’s a lunar eclipse and full moon (the 2nd of the month, so it’s a blue moon). In addition, I track the days that mark the highs and lows on 3-day SPX swing charts, a technique I picked up from the late Jerry Favors. I use trading days to determine 3-day swing charts while Jerry used calendar days, so I have fewer dates.

Harmonic Preview:

(High Probability Turning Point or Acceleration Days)

1. December 29* (Tuesday)
2. December 31   (Thursday)
3. January 6         (Wednesday)

That’s enough new stuff for traders. For more passivie investors, a friend passed along an explanation of what commonly used terms in fund brochures really mean. I don’t know the original source but it was good for a smile.

1)  Core = No need to spread your assets out; send us everything you have.

2)  Ultra = Leveraged to the hilt.

3)  Aggressive Growth = A portfolio of Chinese gaming stocks and U.S. biotech startups.

4)  Global Growth = Momentum investments in whichever country is the most  overheated.

5)  Deep value = Investments in low multiple sewing machine and typewriter companies.

6)  Balanced = Likely to underperform both the stock and bond market.

7)  Quantitative = Bonuses paid in good years and computers blamed in bad years.

8)  Enhanced = Utilizes exotic derivatives.

9)  Diversified = Leaves time for golf after matching the index.

10) Socially responsible = A sucker is born every minute.

11) Clean/Green = Shares of GE plus a basket of government-subsidized experiments.

Here’s wishing everyone a fine holiday. Don’t make the news.

Conclusion:

The stock market advance has stalled with a series of upward sloping but overlapping waves since August. Most recently, SPX prices have traded sideways in a tight range for six weeks. The market generally emerges from a consolidation in the same direction it was headed prior to the start of the trading range, but it is important to plan in advance to follow a move that breaks out of the range either way, particularly if volume increases.

The trend remains up but it’s not a time to slip into complacency or back up the truck with new positions. It’s no secret but the keys to successful speculation are based on discipline, money management and trading with the trend. My recommended stop sell point for positions tied to the SPX is just under its November 27 low of 1083.74.

It’s positive that the Nasdaq 100 and small cap indexes have started to outperform again but there’s no change in my belief that once the trend reverses, the best shorts are likely ETFs tied to small cap indices.

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.