Consolidation

First, my apologies for my tardy blog (normally posted on Mondays). We have been attacked by a spam program- receiving about 1000 false comments to my various blogs on these pages. I had one of my staff clean the mess up yesterday which left me no time to post.

As I mentioned on my last report, despite some bearish comments by market followers in early April, the markets hadn’t ( in my opinion) put in a top just yet. In my upcoming book Sideways, I teach readers to break market movements into 4 phases. Briefly, these are the bottom, uptrend, top, and downtrend phases of a market. Each of these phases exhibits specific characteristics that help us identify which one we are entering into. My main point is to help readers understand that markets don’t usually go from an uptrend phase into a downtrend phase in a sudden manner. There is a topping phase in between (likewise, a downtrend doesn’t often suddenly reverse to an uptrend–there is a bottoming phase between them).

Right now, I believe that we are entering into a period of consolidation for the markets. This may turn out to be a topping phase, but certain rules must be met before we can call it that. Consolidations can occur in a trending market (up or down). These periods are characterized by chartists through names like “rectangles”, “triangles” and (on a smaller scale) pennants or flags. The main thing to watch for is a break of the last trough within the uptrend, in the case of looking out for a topping pattern. Currently, the S&P 500 and the TSX 300 have held above their old lows. Both have had two distinct runs at a high level without upside penetration (14,300 for the TSX 300, and 1340 for the S&P 500). These levels are resistance until broken on a meaningful level (3% penetration over 3 days is my rule).

During a consolidation phase, there is no sure way of determining whether the market will break to the upside or downside out of the pattern. Thus, one might normally be inclined to trade within the body of the pattern, or hold positions they have while waiting for a trading signal (upside or downside breakout). However, in this instance, I am actually beginning to take some profits as the markets reach the tops of their respective patterns (i.e. the levels mentioned above for the TSX 300 and S&P 500). No, I am not jumping out with both feet, but certain factors such as the end of the seasonal period of strength (despite Don & Jon Vialoux’s recent Financial Post article suggesting we may have a positive summer), and longer termed bearish sentiment /  fundamental factors that are getting closer to my “sell zone”. The markets may trade sideways and continue to consolidate over the summer, which is no reason to panic. But I am one to rather be safe than sorry. Thus, I have been increasing my cash holdings, and expect to do so more aggressively later this summer. Given my longer termed view of the markets as discussed in previous blog entries– the closer we get to S&P 500 1400-1500 zone, the more likely a true reversal in market trend.