July 7th, 2010

New Bull Run or Sellers’ Remorse Correction

A readers asked a very pertinent question: “Do you think time may be right for an update on MTI?” The answer is an emphatic yes, especially after today’s 3.3% gain in the S&P back up to 1060, an important level for multiple reasons.

Before translating this to the MTI, the Market Timing Indicator, let me point out what’s important for me on the charts. Last Friday, the S&P did experience a “Black Cross”, when the 50-dma crossed under the 200-dma. As I pointed out to my subscribers, not all Black Crosses are equal and this one was one was among the bearish ones. What makes it a signal to go all cash is that the moving average cross is aggravated by the fact that the Index itself was below the 300-dma. A combination of these two factors, according to 50 years of history has proven to be a time when it was more prudent for investors to be in cash than invested (click image to enlarge):

But today’s nice gain brought out all the “talking heads” asking the same question, “Does this signal the bottom?”. Doug Kass thought so and bet his impartiality and credibility last Friday (probably if he didn’t he would have lost his gig at Cramer’s TheStreet.com). I don’t think so:

  • The “Black Cross” hasn’t yet been reversed
  • The increase could be nothing more than a “seller’s remorse” correction back to the neckline/lower boundary breakout level (depending on whether you see a head+shoulder top or an ascending-widening-wedge). I was relieved that Carter Worth agreed with me on that.
  • This combination of Index and moving averages has occurred only 14 times over the past 50 years. Eight times, or 57%, it devolved into a worse situation (the 100-dma following the 50-dma and it, too, crossing under the 200-dma), 6 times the Index next crossed back above the 300-dma.
  • Even if the Index closes back above the 300-dma tomorrow, the Black Cross hasn’t been reversed and the all-cash signal remains in place. It would take a move above the descending 50-dma at around 1080-1100 for the red light to turn yellow.

Many of the talking heads were forced to find some explanation, any explanation, for the day’s strong move. There were explanations of strong Euro, weaker dollar, stronger than expected earnings reports starting next week, short covering. Right or wrong, I stuck with my discipline and was a seller into the close of today’s move up.

What I found most interesting is that many blamed computers for today’s run. While I was an early advocate of chart reading and technical analysis (I’m not going to divulge how long ago that was but, trust me, some of you were probably just in elementary school), it appears that now all the hedge funds and institutions have taught their computers how to read charts and generating huge volumes and increased volatility.

The computers are now stuck in equilibrium struggle. But once directional momentum begins, we’re going to see a quick and huge run as all the computers read the same chart patterns and start spitting out similar orders. Over the past several years those were sell orders; soon we’re going to see, I believe, a deluge of buy orders. That will be unbelievable if we’re patient and put up with the frustrating wait.

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  • Anonymous

    How does MTI chart for 1998 correction looks like ?

  • Joe

    You're good, really good. You're correct, 1998 is eerily similar to this year and about as confusing as this year is turning out to be.

    The major difference is that the 1998 correction was in the middle of a generational bull market (the tech bubble) that began in 12/04 resulting in a 165% increase up to that point.

    The correction began in mid-July and ended in October with a 19.15% loss. During that whole period, the MTI flashed an all-cash position only Oct 2-15 during which time Index actually wound up 6%.

    Having said this, I still place a lot of confidence in MTI, when sprinkled with a liberal dose of judgment.

  • Bala

    nasdaq will soon test the recent lows