Friday, June 19, 2009

At the 200-Day Moving Average

Snapback. As I mentioned in my December 18, 2008 post, a basic rule of technical charting and of Dow Theory is that the greater the gap between the Dow and the 200-day moving average, the more pronounced the snapback will be to the 200-day MA.

Jennifer recently had a discussion with a financial manager who stated that we are in a "recovery" but it isn't a "typical V-shaped recovery." No shit. This is the Great Recession and it isn't over yet.
Eddie Bauer just went bankrupt. Unemployment will continue to rise. Though there is some positive news. The worst might be behind us. It’s hard to tell.

Regardless, the manager Jennifer spoke with, and all of his ilk, have mistaken the recent rise in the markets as the leading indicator of a recovery when, in fact, all that has really happened is that the markets have moved back toward the 200-day MA because they had fallen so far away from it.

For example, on October 10, 2008, the Dow closed at 8451.19 but the 200-day MA on that day was at roughly 12,000, a difference of about 3600 points. That is an outrageous gap and it simply could not remain. At the time of the March 9 lows, the Dow closed at 6547.05 while the 200-day MA was at roughly 9850, a difference of about 3300 points.

By comparison, during the last bull run, the Dow closed at 10737.70 on February 11, 2004. On that day the 200-day MA stood at roughly 9575, a difference of about 1150 points. When the Dow peaked at 14164.53 on October 9, 2007 the 200-day MA stood at roughly 13100, a difference of about 1000 points. These are extreme instances. Typically, the Dow and the 200-day MA are within less than 1000 points of one another.

But that hasn’t happened in many months.

The discrepancies between the distances of the bull market rally and the bear market crash are striking. In each of the cases I just mentioned, for both bull and bear markets, there was a snapback toward the 200-day MA. Each of those moves by the Dow did not stop until they actually touched the 200-day MA.

Given recent history, it is fairly safe to say that all that has happened since March is what has always happened. The markets have rallied or declined back to the 200-day MA with relative intensity matching how far they strayed from the moving average to begin with.

That doesn't make any such snapback a "recovery" or a "breakdown". It is simply what markets historically do when they stray too far from the 200-day MA. It is a technical reality of the markets and really has little to do with the economy itself.

So, for the past couple of weeks the Dow has been at the 200-day MA.

On June 4, the Dow closed above the 200-day moving average for the first time since May 2008 when the Dow was above 13,000. This has as much with the moving average consistently falling over the last year as does the Dow’s recent, rapid rise from the March 2009 lows.

According to Dow Theory, the 200-day moving average is more important than the 50-day moving average. Obviously, it takes much more market action into account and is much more resistant to advance or declines than the shorter term average.

What is of equal importance is that we are rapidly reaching a “crossover” point between the two moving averages. Recently
the S&P 50-day MA crossed above the 200-day MA. Many felt this was a positive sign. In the next few days the same thing will inevitably happen to the Dow. The momentum of the averages makes this a mathematical certainty. Then, the faster moving 50-day MA will tend to pull up or drag down the 200-day MA depending upon the strength of the markets.

Often what happens is the market meets resistance when rising into the 200-day MA or it will encounter support when falling down into the average. The market will pause, hover, and hesitate naturally at the point of the 200-day MA. That can be clearly seen in these stock charts I created using BigCharts.

Since near the bull market high last June through today. The "marks" are each day as a candelstick. The paralleling blue lines are Bollinger Bands. The thin tan decending line is the 200-day simple moving average.

The final approach to the 200-day MA in May and the recent stall of the Dow. The 50-day MA is nearing the crosspoint of the 200-day MA but it is not shown in this graph.

As I posted a few weeks ago, there are many pundits who believe we are in a new bull market. Jack Schannep is among them. The widely-read Kiplinger Letter recently proclaimed: "The Bear market in stocks is over. Indexes are unlikely to visit the lows of March." Richard Russell, however, has remained very skeptical and continues to believe this is a bear market rally that will ultimately head lower. Who’s right?

No one knows.

But the hesitation is undeniable. A break by the Dow below both averages would indicate there’s more of the bear market to come. Conversely, if we steamroll upward through both averages the bulls could well run for awhile.

So, the crossover means that we are really at a critical time for the markets.

Back to Dow Theory. On June 12, the Dow recorded its most recent highest high of 8799.26. But, the Transports refused to confirm the high. Their most recent highest high was back on May 6 at 3404.11. This non-confirmation, combined with the impending crossover of the moving averages creates a great deal of uncertainty in the current situation.

Russell points to the non-confirmation of the Transports and the declining volume. Comparatively, few shares are trading. Could we be headed back to where we were a few months ago and no one is willing to buy? The VIX is respectable, suggesting stability. Perhaps a lackadaisical trading range? I dunno. It’s an interesting juxtaposition of functional forces.

On a slightly different matter, I note that back when I proclaimed this recession as "The Great Recession" late last year you couldn’t find the term if you googled it. As of today you can google the phrase and you can find it at numerous places on the net.

Guess I should have copyrighted the idea.

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