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Only a Bonkers Bull Would Chase This Rally

Wise investors waiting for inevitable pullback


Initial relief over Europe’s latest attempt to end its debt crisis faded on Friday as investors fretted about the plan’s lack of detail and grew more skeptical about Italy’s turnaround effort.  An auction of new Italian bonds was met with weak demand, forcing the nation to pay higher interest rates than in previous sales. (WSJ Oct. 29, 2011)

And so the U.S. markets Friday turned into a day of reflection with much lower volume — 1 billion shares vs. 1.4 billion, breadth about even on the NYSE, and 1.3 decliners vs. advancers on Nasdaq.  At no time on Friday did the DJI trade triple digits—just the second time this has happened since July 22.

The malaise occurred despite better economic numbers:  The consumer sentiment index rose to 60.9 from 57.5, and consumer spending rose by 0.6% matching expectations.  And with over 300 companies of the S&P 500 reporting earnings, over 70% have been above analysts’ estimates.

With the prior focus on Europe and a deal of sorts hammered out to help save the faltering countries there, investors seemed at odds as to how to proceed.

s&p 500 rsi
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Friday was quite a contrast following Thursday’s explosive break higher into the zone of maximum resistance between 1,250 and the May 2 high of 1,370.  Thursday’s high at 1,293 hit very close to the trend line connecting the July highs and squeezes the index between 1,293 and the 200-day moving average (horizontal red line) at 1,274.  And there are two other technical features that should slow the advance:  Note that the relative strength index for the 500, now at 65, is well within the range of the year’s prior highs at 67, 67, and 60.  Next, the Fibonacci number at 1,300, which is 76.4% of the April to October range, adds another element of risk to an advance.

s&p 17 mo chart
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Nevertheless, the bulls have taken the high ground and at a minimum reversed the short  and intermediate trends while the long-term trend is still in doubt.  Note the cancellation of the trend on the 17-month moving average at 1,218 that only 30 days ago issued a sell signal at 1,218.  Ironically, it was on the lowest day, October 4, that the press announced a bear market based on the index declining 20% from its highs.

If the trend has changed we have witnessed the shortest bear market on record—about 45 minutes!  Readers will remember that I pointed out that calling a 20% decline a bear market had no predictive value.

Conclusion:  The break of the S&P’s 200-day moving average was accompanied by the month’s second highest volume—the highest being the bullish reversal of October 4.  But the break was made on the first test against that major barrier, a very unusual event in a bull market recovery.  Bull markets are known for plodding days of pushing against resistance, while bear market rallies punch through zones of resistance on relatively light one-sided volume.  The big test may come late this week following the reinvestment of normal early-month deposits.  Caution to buyers:  Only a foolish calf would chase stocks at this level.

The wise old bulls will wait and if they decide to risk their capital, will most likely do it on a pullback.

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