July 17th, 2008

Expanded Head-and-Shoulder Top Formation Emerging

If the talk at your dinner table was anything like mine then the discussion may have been about whether the market has bottomed, whether there’s now been capitulation, whether we’ve seen the worst in financial stocks and the best in oil & gas stocks. Or perhaps it was “I can’t stand this volatility. I wish we had just put all our money in cash at the beginning of the year. I hate the market and now want to sell everything until the dust settles.” Let’s step back for a minute and put into some perspective what’s been happening over the past several days by looking at it with a longer-term perspective.

O.K., the S&P 500 tacked on 2.51%, not too shabby an increase. But how does that stack up with other volatile days since this market cracked last October 19?

Today’s increase in the S&P 500 ranked 6th from the top. But what makes a bigger impression for me is that the closing prices of each of the five larger moves was higher than today’s close. In other words, the Index has declined since each of the days when it’s had huge increases. To drive the point home, when the market opened this morning at 1200, the Index was 9.8% lower than where it was on March 18, when it posted a 4.24% increase. Conclusion: big daily moves mean nothing in predicting future direction.

Let’s take a look at the chart:

Even though it felt big and all the talking heads were calling it “important”, today’s move is almost imperceptible on the chart. It’s similar to the big 3.69% move of April 1, a move that was labeled “the best first day of a Second Quarter since 1938”. What I said back then holds true today:

“…the market still needs a lot of mending before a full bull market takes off. And when that happens, there will be lot’s of profits to harvest. So stay tuned.”

And what we see is that market, after a 45-day reprieve, lapsed into the bear market we know today. But that’s only background history. The important question is what can we expect over the near term and what strategy should we follow. Here’s a longer term chart:

Yesterday’s close is a pivot point which, when connected to pivot points in May, 2006 and June, 2005 might be an emerging downward-sloping neckline for an expanded head-and-shoulder top. The November, 2005-May, 2006 “hump” might be replicated as we move forward over the next 3-5 months as the hopes brought on by lower oil prices (if they stick) come into conflict with the economic realities of inflation, continued $US erosion, etc., etc.

How do I dare contradict those talking heads on CNBC? It’s because I know based on a study of prior market crashes that the damage caused by this bear market can’t be corrected or reversed in a day …. or a week …. or a month. It takes an extended base-building process.

The MTI rules dictate that a rising market index has to cross a declining 180-day moving average, at a minimum. The gap between these two today is 11.1%. So be patient and continue to stay mostly on the sidelines. The time to jump in with both feet is still way off.

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