November 10th, 2011

Caught in a Whirlpool

At times, the market these days makes you feel as you might when you’re caught in a whirlpool while kayaking down a raging river. You know the current’s general direction but all you sense at that moment is that you’re unable to extricate yourself from being whipped around in circles.

While “whirlpool” might describe how we investors feel, a better description of the market might be “unprecedented”. Frequent readers here know that my market timing discipline rests on the alignment of the S&P 500 Index and its 4 moving averages (50-, 100-, 200- and 300-dma). The alignment that indicates clearly that the market is in a bull trend is when the Index is above each of the moving averages and those averages trail the Index with them stacked from shortest to longest. Since 1963, that alignment has existed 34.5% of the trading days. As you might expect, the alignment that typifies a bear market is the mirror image with the Index below the four moving averages which are stacked from longest to shortest (300-, 200, 100- and 50-dma). That alignment has existed 9.2% of the days since 1963.

There are 120 possible combinations of the Index and its four moving averages in addition to the above two. Each combination has in the past nearly 50 years has been associated to so degree with a bullish or bearish market trend. Actually, 25 of the combinations have never existed because they would have required nearly impossibly extreme moves in either one of the moving averages or the Index itself. As of two weeks ago, one of those impossible moves actually did occur(click on image to enlarge).

For the first time in history (at least according to my records going back to 1963), the Index crossed above the four moving averages which were nearly in perfect bear market alignment. The crossing each time was so rare that it couldn’t be sustained for a day or two.

The problem is that the market jumped so far ahead of the prevailing consensus of market participants as reflected in the trend of its moving averages. There only one of three ways for the market to correct this imbalance:

  • Continue advancing far ahead of the moving averages and hope that the averages eventually catch up from this unprecedented situation
  • Stay generally at the current level until the moving averages catch up and return to a more common alignment
  • Decline to more quickly bring the alignment into balance and then turn up again in sync with the moving averages in a more typical reversal.

There’s are two out of 3 chance that the market can’t advance much further without the moving averages turning and heading higher. As my subscribers know, I remain skeptical and mostly on the sidelines.

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  • Anonymous

    I vote #2 :

    "Stay at the current level until the moving averages catch up and return to a more common alignment"

  • Kos

    More like white water rafting! LOL Just when you think you've got it under control, *wham* you're reversing direction. If we're stuck in a 1960's-70s market while world economies [and job growth] heal, it's going to be a long, bumpy ride. Life jacket essential.