October 10th, 2012

Assessing Market Opportunities and Risks

It’s been some time since I last posted because, well, because there wasn’t much new or much positive to write about.  As a matter of fact, the last time I wrote about the market was on August 29 in “Every Trading Range Is Not a Reversal Top“; the market is a mere 1.56% above the level at that close.

I pretty much fully invested now; I like most of the stocks I own since I’ve been cleaning house as this bull run has progressed.  There are a ton of stocks that look like they, along with the over-all market are struggling to clear an intermediate sort of resistance level (the market Index may actually be stuck in the claws of a tiny “buyers’ remorse” correction after having barely crossed above that resistance at 1420-1425.

One must always evaluate the market in two ways : what are the upside opportunities and what sort of downside reversal risks are there.  When I step back today from the market’s day-to-day noise, I see upside potential to the 1567 all-time high level.  However, I also see what I hope will be only short-term obstacles.

My longer-term optimism comes from the fact that the market has steadily crawled up the lower boundary of an ascending channel emanating from last year’s low connecting with this year’s March low.  The parallel upper boundary of the channel conforms nicely.

Furthermore, this spring’s correction can be interpreted as a flag pattern.  Traditional chart reading rules of thumb suggest that the consolidation pattern will be approximately midway between the trough of the channel and the peak.  If that turned out to be true, then the peak should be somewhere in the 1600 area (1410/1125*1280), or not far from the all-time high.

The fly in that ointment is volume which just doesn’t seem to be cooperating so far.  Since 2011, the 50-dma of daily volume of the S&P 500 stocks has been trending lower (with the exception of last summer’s correction).  Even more ominous is the divergence that’s emerged between the Index levels and the on-balance-volume.  For those who need a refresher, OBV is Joseph Granville’s indicator in which volumes on up days are added and volumes on down days are subtracted from a rolling total.  A declining OBV indicates that volume on days when the market closes lower tend to exceed the volume on days when the market rises.  A divergence indicates that a rising market isn’t supported by adequate volume.

There’s sufficient cash on the sidelines waiting to be put to work and fixed income with it’s low rates isn’t the place to put it anymore.  ZeroHedge had an interesting piece this morning entitled “Are Businesses Quietly Preparing For A Financial Apocalypse?” about all the cash sitting on corporate balance sheets.  If the uncertainty coming from Presidential Election, Fiscal Cliff and continuing Eurozone saga then a good chunk of that money, both investor and corporate, could come into the stock market and make up for the volume drought.

While prices haven’t indicated a reversal process emerging yet, there sure are a lot of risks out there, both fundamentally and technically.

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