October 14th, 2010

Sweet Dreams!

We try to find analogues (i.e. something to compare against) to help understand the condition of the market these days and, based on that comparison glean some idea of what the future might hold.

One comparison is with previous mid-term election years and know, because I’ve written about it here often, of the bullish impact those elections have historically had on the stock market for the following 12 months (see my “Mid-term Elections in 2010 and the Stock Market” of January 28, 2010). We know of one comparison because we hear it almost everywhere the conversation turns to politics. It’s the Republican sweep of the 1994 mid-term elections under Newt Gingrich and his Contract with America.

But have you taken a look recently at how the four moving averages (50,100,200 and 300 day) are converging as they were all trying to squeeze through the neck of a bottle? (click on image to enlarge)

First, it’s important to note that sometime next week, the dreaded “Death Cross” of the 50-dma crossing under the 200-dma that we were so fearful of at the beginning of July will be reversed and, by definition, will become the “Golden Cross”.

Also note that the four moving averages are transforming themselves into a bullish alignment so long as the Index itself remains above them all for the next month or so. That’s pretty monumental because it is a solid confirmation that a bull market is in place.

Finally, whether you are aware of it or not, this merging of the moving averages happens very infrequently. My database of S&P 500 Index closing values goes back to January 1, 1963, nearly 12,000 trading days. When I rank them all according to the range of moving averages each day (day’s maximum MA/day’s minimum MA), today ranked 375th, or among the top 3.12%.

But here’s the amazing thing. Almost half (167 to be exact, or 44%) of those 375 trading days where the moving averages were so closely squeezed together was in the end of 1994 and beginning of 1995. Not only can 2010 be compared to 1994 due to the election cycle, but the markets in both years are very similar.

And what happened after the 1994 election?

What you see is a 37% move from the election to the end of the graph 14 months later. Extrapolating a similar 37% run higher from a close of possible 1150 close on this years election day results in a close of somewhere between 1500-1550 by the end of January 2012. The market could be bumping against it all-time high 14 months from now. I have a hard time believing it myself. It’s a dream, a sweet dream. We should only be so lucky.

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  • Denali92

    I primarily trade the midcaps, and I have to say that the price action this year in the midcaps is remarkably similar to the price action in 2006

    Essentially, I am agreeing with you that a further rise makes a lot of sense – we are due a pullback, but based on history it will only be enough of one to shake weak longs out of their positions.

    THANKS!

    -D

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