March 3rd, 2009

Which Way Is It Safe To Run?

I often fell these days like one of those squirrels I see while driving down the street at 35 miles an hour, minding my own business. The squirrels always stop on the center line in the middle of the road, look at the car barreling down on them, look to the right, look to the left, and start running to the right. Just as I feel I’m not going to have to swerve or come to a screeching stop to avoid them, they switch direction and decide to run in the opposite direction in front of me seemingly under the wheels.

That’s how I often feel in this market–like I’m the moving target. Sometimes I feel it’s safe to run left (short the market) but, equally suddenly, that it’s safe to run in the other direction (go long). All the while, I feel that at any moment I’m going to be roadkill with tire marks all over my back.

On the one hand, the market feels to be tremendously oversold when viewed from a momentum perspective. As others have written elsewhere, the distance between the Index and its 200-day moving average (in my charts either the 180-day or the 300-day moving averages) historically is the widest it’s ever been because of the crash’s steepness. On the November 20 low, the Index was 42.97% and 39.10% below the 300-day and 180-day moving averages respectively. As of yesterday’s close, the distances were 40.01% and 32.19% narrower but expanding again.

Another indication of an oversold condition is the chart of the S&P 500 (1939-Current) included in several previous posts (October 11 and February 25) showing the Index crossing under the lower boundary of an upward-sloping channel enclosing the Index. That lower boundary has been violated only infrequently over the past 60 years:

The table on the left indicates that the month-end index closed below the lower boundary 11 times over the past 60 years and 7 of those times were at the end of the 1981-82 bear market. They launched the huge bull market drive ending with the Tech Bubble Crash during which the market increased over 1500%. The other period was 1973-74 Oil Crises Crash which also led to a bull market. The same table sorted differently on the right above indicates that as of Friday’s close, the 9.0% gap between the Index and the lower boundary was surpassed only by 1982 bottom.

That confirms for me that we’re close to the bottom and, given enough recovery time (say, sometime in June-Sept), the market will soon launch a healthy recovery move. On the other hand (running in the opposite direction), the S&P chart looks horrendous:

The break down since mid-February violated the symmetrical triangle, a pattern considered by many to be merely a continuation pattern rather than reversal. The Index also crossed below the double-top neckline extending back to the 2002-03 Tech Bubble Crash Bottom (see February 19 post). Finally, On-Balance-Volume (OBV) has completely disintegrated and the cross of the 60-day over the 90-day moving average – the first step required to mark the beginning a market remediation process – seems to have been deferred. There’s little to build confidence in this picture.

So which way should I run because, if I don’t run the right way or run at all, I’m going to get run over. Some say that past models are now irrelevant because there’s no precedent for the whole world simultaneously being in a recession/depression. I agree, it’s pretty frightening.

However, I think I’ll stick to the optimistic-contrarian view that this is part of the bottoming process, the chart is morphing into a true reversal pattern (perhaps an inverse head-and-shoulder with the current downleg being the beginning of the middle head) and, like 1982, the market will begin crawling its way back above the bottom of that long-term channel on its way to another long-term bull market that most can’t see today and couldn’t rationalize if they did.

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