May 16th, 2012

The Difficult Choice

The times aren’t easy for market timers.  The market has declined around 6% since the April 2 peak of 1419.04 and the anxiety level is rising.  The question of every market  timers lips are: “Should we sell into this decline and, if so, how much?  Is this a collapse similar to the stealth bear market brought on by last year’s Federal budget deficit crisis, the S&P downgrade of US debt and the deepening lose of confidence in the Euro currency?  Or, as many have discussed before, are we merely going through a typical “sell in May” correction which, if we stay put, we’ll recover from relatively unscathed in the fall?

Contrarians might take the opposing side and ask “Should we take advantage of the opportunity presented by lower prices and begin to pick up some bargains while we have the chance?”  As the saying goes, that’s what makes a market.  Two diametrically opposing views leading to two opposite courses of action, both coming from the same set of facts.

Unfortunately, the chart of the S&P 500 doesn’t provide much insight as to the best course of action.  I first began surveying what I called a “congestion zone” on April 12 in “Identifying the Boundaries of Stock Chart Congestion Areas” and followed that up on April 23 with “The Lower Boundary is Becoming Clearer“.  Here we are, just over a month later, and without any clearer idea of what the boundaries of the zone are or whether we may have actually fallen through the bottom of the zone and began a downward trend.  The striking thing is the apparent similarity between March-April hump this year and the April-May hump last year.  Let’s hope the slide when the Index crossed below the 200-dma last year isn’t repeated this year.

The market index has fallen through the lower boundary of what could have been a flag pattern.  It fell below what I was hoping would be the neckline of a small head-and-shoulders pattern.  It fell below the 100-dma and is quickly approaching the 200-dma (which, coincidentally lies just above the 300-dma).  If last year is any example, then the selling could again be quick and deep.  But the recovery 4-6 months later was just as sudden and it may be so again this year.

The Market Momentum Meter was tested against nearly 50 years worth of stock market history and in the process identified the conditions (as reflected in the relative positions of the moving averages and the Index itself) under which exiting the market was the best strategy.  At other times, staying in the market, regardless short-term fluctuations, was the best long-term strategy.

So far, the Meter is still signalling a full commitment.  However, extrapolating further straight-line declines of an average -0.168% per day (the average daily rate of market declined between March 26 and yesterday’s close), the signal would turn a Cautious/Yellow when the Index hit approximately 1290 and a Bear/Red at 1240.  Coincidentally, those are the approximate levels of the 200-dma and of a long-term trend line that has been the locus of multiple pivot points since the Tech Bubble began in 2000, respectively.

Last year, however, the market’s decline was so steep and rapid that the Meter’s exit signal was too late.  Furthermore, the recover was rather quick so that it failed to signal a timely return.  Unfortunately, the difficult choice being faced is between violating our discipline and sticking to the discipline and risk further losses.

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