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Today's WrapUp by Martin Goldberg 01.15.2004 Mon Tue Wed Thu Fri Archive |
"Stock Indices Go Parabolic! When Tools Do Not Work"
The recent behavior of the stock market averages has gone from a robust bull correction within a secular bear market to a mania. All three averages have gone from a linear uptrend to an accelerated advance. This has made many technical analysts with a longer-term viewpoint look like playoff-eliminated Green Bay Packers coach Mike Sherman. It’s difficult for technical analysts when the tools of the trade are not working. There are some technical tools that are working, though.
This has been a market where Investor’s Business Daily's (IBD), technical methods have worked very well. Buying stocks on “breakouts” to 52 week highs has been a successful game. Since October 2002, that general strategy would have provided better performance than a stack of analyst’s recommendations, or technical macro-market predictions regardless of how sound they will be in the long term. This rally has been about the stock chart base with the cup-with-handle pattern and the “breakout.” Buy high off a good base and sell higher! Momentum investing. It’s a simple and so far successful formula for today’s market.
It would have also been a successful venture to forget valuations and fundamentals and just follow Alexander Elder’s advice in Trading for a Living, which I referenced in my first article, “When you spot a hot new guru, it pays to follow his advice”. This time around the hot guru’s methods are working very well. Many people may be too quick to suggest that these methods work all of the time. However, I’m afraid that once the market puts in its 3 or 4 unequivocal “distribution” or high volume selling days, there will be a lot of hot-guru-followers and momentum traders thinking the same thing at the same time…Sell! I think the market can crash. Of course trading on this fear may be similar to the strategy used by coach Sherman against the Eagles on Sunday. He should have just run the ball straight ahead against a decimated Eagles defensive line instead of looking for a more complicated solution to the Eagles’ defense. Running straight ahead was what was working, and there was no reason to change. May be the situation is the same in today’s stock market.
Monday Morning Quarterbacking – When the Tools Failed
Over the last 16 months, what turned from a typical secondary correction to a mania has fooled many a technical analyst. For my part I have referenced (see archives) the following tools over the last few months to predict the end of the bull correction within the secular bear market:
· Victor Sperandeo’s 4-day rule and 4-day corollary
· Distribution days – high volume selling
· Overtrading – unprecedented volume at stock market bottom
· The apparent topping of internet stocks
· The same old suspect market leadership – technology stocks
· The Fan pattern – applicable to
They have all turned out to be failures.
So what happened? Are these technical tools mumbo-jumbo to be put away like so many old ouija boards? Why did they fail time after time over the last 16 months? I think it is because all of these technical tools are those used during secondary corrections within a primary bear market. What has been confirmed with the failure of the NASDAQ fan pattern is that we are in something different than a secondary correction. This is hard to believe given the absurd fundamentals, valuations, miniscule dividends (even after increases), and corporate governance issues. But it can be very difficult and expensive to fight the tape, especially without any technical basis to back a bearish strategy. At this moment, the technical basis for a bearish case appears to be gone.
Are we in a “New Bull Market”? I don’t think so. I do think that unprecedented mania that preceded the crash beginning in March of 2000 (earlier for non tech), suggested that we may see some more unprecedented market action many years into the future. We are seeing some of that unprecedented action now as evidenced by the failure of many “secondary correction tools.”
So it’s not a secondary correction, and it’s not a new bull market. Then what exactly is ” it”? I can only say that it is something different. I can also say that based on fundamentals, it’s a long way down and bears can afford to be patient and careful.
Indices Go Parabolic - Timing the Drop
All three major indices have gone from a nice leisurely uptrend into a parabolic move as the charts below illustrate. There must have been some new rosy economic conditions discovered that warrant buying this buying after such an impressive advance. Either that or we are now in greed-driven panic buying mania.
Is there any technical significance to the breaking of the linear “up” trends into the parabolic movements? Let’s take a closer look at the NASDAQ index. The NASDAQ has advanced by about 51% off the March 2003 “bottom” in two well-defined trendlines. After apparently violating the first trendline, the NASDAQ reclaimed its ground in August, and entered a second slower well defined upward trendline. Finally, the NASDAQ then launched into an accelerated uptrend, after having advanced about 51% in about 10 months. This occurred with trading volume that has not been seen since the beginning of the war rally. Are we seeing panic buying? Or has there been some fundamental happening to justify this parabolic move?
In Trading for a Living (page 91), Dr. Alexander Elder discusses acceleration of an upward trendline (emphasis and parenthesis inserts added by Martin),
“The angle between a trendline and the horizontal axis reflects the emotional intensity of the dominant market crowd. A steep trendline shows that the dominant crowd is moving rapidly. A relatively flat trendline shows that the dominant crowd is moving slowly. A shallow trendline is likely to last longer, like a turtle racing against a hare…Sometimes prices accelerate away from their trendline. Then you can draw a new, steeper trendline. It shows that a trend is speeding up, becoming unsustainable…When you draw a new, steeper trendline, tighten your stop (if you are long), place it immediately below the latest trendline, and adjust that stop at every new bar. The breaking of a steep trendline is usually followed by a sharp reversal.”
I interpret Elder’s discussion to mean that the acceleration of the trendline from shallow steep indicates that the latest sharp uptrend is likely “unsustainable”. He also suggests waiting for the steeper trendline to be broken before selling (and presumably short selling). How high can the current uptrend carry? In November to March of 2000, the NASDAQ accelerated from a shallower uptrend and almost doubled in about than 4 months before finally rolling over. While the 4-month duration was short-lived relative to the previous longer-term stock market advance, the intensity of the advance was extreme and damaging for stubborn short sellers. Can that happen again? Why not! As I said before, we have gone from a secondary correction within a secular bear market to a mania. However, I still think there are some dents in the NASDAQ armor, including the breaking of an important trend in one of the NASDAQ’s most loved stocks – Intel. This is illustrated in the chart below.
The long-term uptrend of Intel has been decisively broken. I think that this is technically significant. So is it time to short stocks? Not me. Not yet. It’s a long way down, and fundamental bears have the luxury to be patient to choose a safe and logical entry in my view.
Today’s Market
The stock market was about at the flat line today, but once again volume was huge. The consistently high volume suggests that something may be afoot. The market cheered IBM, and was pretty nondescript about Intel’s earnings. The House of Morgan is buying Bank One at a premium, thereby creating about 11% more stock market value (at today’s close). The 10-year note was up 6/32 to yield 3.97%. It will be interesting to see if the top of the right shoulder of the head and shoulder pattern will be broken, thereby signaling even lower interest rates ahead.
Gold was down $12.80 per ounce (3%) on the day, and the Gold Bugs Index (^HUI) was down 4%. The dollar was up in what appears to be a long overdue dead cat bounce. The longer-term charts of gold and the dollar will put the last few days’ action in perspective.
Have a great evening!
Martin Goldberg
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Copyright © 2004 All rights reserved. Martin F. Goldberg, MS, P.E. |
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