Technical Analysis: Caveat Rally


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Technical Analysis: Caveat Rally

Posted By: USCoralSea
Date: Saturday, 7 November 2009, at 6:50 a.m.

Jordon Craw, Optionetics.com.au
November 6, 2009
Accepted truths are an interesting concept, especially in the stock market. In February this year, the fact that banks, the stock market and the economy were all falling apart was an accepted truth. Few saw the low coming the next month. By the end of March, it was accepted by most that this was just a bear market rally. I too was in this camp. By July this opinion had only become more widespread - which was when the penny finally dropped for me.
The tide is starting to turn a little now, with a more even amount of bullish and bearish opinion appearing - this generally makes for choppier market movements which is what we are seeing currently. By the time most people 'know' the market is going higher, a bubble has formed and is close to popping. Thankfully at this point, it won't take much in the way of falls to bring back bearish sentiment by the bucket load. Believe it or not, this is a good thing for the market. As the saying goes, "buy while others are fearful and sell when others are greedy."
For most of the rally so far there has always been a "but." "The economy looks better, but..." Or "The market is strong, but"" It is why I've dubbed it a 'Caveat Rally.' Few, even now, have been willing to call this a bull market, even though a greater than 20% gain is a fairly widely accepted measure.
So while sentiment is becoming more positive, it doesn't seem we've reached bubble-like levels just yet. As I've mentioned previously, everyone will 'know' the market is going higher when greed out strips fear. The market may well have to reach some extreme levels for this to be the case.
One of the arguments for the negative case is that the market has gotten ahead of itself and the economy. Really though, the market is always ahead in both cases. It looks to the future and discounts it into today's dollars. To quote Mr. Buffet:
The market will be higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
With that in mind, let's have a look at what the market is saying about some key areas of current concern. The idea being that if the worst is still to come, it should be reflected.
The housing market is regarded as the trigger of GFC when its declines caused complex debit instruments to unravel. The US Homebuilders Index is as good a gauge as any of what the market thinks about this sector and it is up over 90% higher from its lows.
Chart 1 - RUF Home Builders Index
click here to enlarge
Next is the US consumer. Consumer spending contributes to over two thirds of US GDP. The US Consumer Cyclicals Index is up over 55%. Stocks like Ralph Lauren and Tiffany's are up even more.
Chart 2 - DJUSCY - US Consumer Cyclicals
click here to enlarge
Last, what about economic activity? The DJ US Industrial Index includes companies like Fedex and UPS, which according to Dow Theory are a good measure of economic strength. The DJUSIT is up over +70%.
Chart 3 - DJUSIT - US Industrial Transportation Index
click here to enlarge
Certainly for now the market seems to be suggesting the economy is looking ok, otherwise you would expect these areas to be underperforming the SPX which is up just over 55%.
Does this mean its all blue skies and sunshine? Unfortunately not! There will no doubt be some scares along the way and there is a potential for the market to repeat the large sideways ranges of 70's. Also as mentioned earlier, the more even the number of bulls and bears, the greater the tug of war - which translates into more volatile returns.
However, it is still likely that the market will get higher than most expect before more big scares occur. There are still simply too many caveats about!
Happy Trading
Jordan Craw
Trading Tutors Team

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