The long and short of it

December 15, 20112 Comments

The long view

This commentary is a bit longer than my usual weekly blog, but please bear with me, as I think it might be a useful read for you.  I’ve drawn a trend channel on the DJIA going back to 1900. A trend channel tries to contain the greater amount of movements within a trend to visualize the approximate top zone and bottom zone for that security. You can also use a trend channel to project where future extremes might come into play. For the Dow chart presented here, I’ve made a couple of observations that might be of interest. First, I’ve marked the sideways periods with  gray boxes where the market couldn’t penetrate an overhead “ceiling” for an extended period of time. Since 1900, there have been four such periods including the sideways market we’ve been stuck in since 1999. Each of these four sideways periods have been “lost decades” or more—the last sideways market was about 17 years long (1965 -1982).  All were characterized by high volatility and large price swings hinged on various worry-inducing events of the time.

On the chart (courtesy freestockcharts.com) , I have projected the current sideways market forward so that it meets the bottom of the trend channel. The Dow would reach the trendline in this projection around the year 2020, with a potential low point of around 7500 (the same approximate low seen March 2009—7200 to be a bit more precise). The red line is the median point in the trend channel (not to be confused with a linear regression line). It seems that the Dow finds support at that line when trading in the top half of the channel, and finds resistance there when trading in the lower half. Thus, in the near-term, the Dow could find neartermed support where it hits the midpoint at around 10,000. The test of the median line may signal the end of the current lost decade, and this could occur fairly soon. As you will note with prior sideways periods, when the Dow met the median line or bottom of the channel, the sideways period ended.

My thoughts are that the markets will trade sideways through the median line based on the likelyhood of current macro-events (global deleveraging) taking several more years to work themselves out. The forward downside projection when using this trend channel might be around 7500 or less for the Dow, and 700-ish for the S&P 500 (not shown) if the markets trade sideways into the lower quadrant of the trend channel. The upside for the Dow in the longer view would bring us back to the red median line or 15,000-ish, which neatly corresponds with the top of the current sideways trading range. This projection provides an estimation of the potential length and depth of our current market currents, should the sideways market continue until 2020 (i.e a total of 20 years since beginning). Its a great unknown as to how much longer the markets will remain range-bound – but the above chart provides food for thought, if nothing else.

A few thoughts on the intermediate term:

-When S&P broke a rectangular top at 1260 support this fall, it entered into a new bear market/downtrend — despite a potential for a brief rally to 1300-1350  (which may or may not even happen- see “Santa” below)

– The S&P 500 level of 1400-1500 has been the ceiling for this decade. It hit 1366 in the spring of 2011—close enough to the top of the decade-long trading range to suggest “that may be it”  for this cycle, until we complete a test of the bottom again. Note — the Dow didn’t get quite as close to its 2007 top as the S&P did this spring, but it did penetrate the more significant resistance level of 11,500 established in 1999 only to fail yet again and fall from that level. The last time it blew through 11,500 and failed was at the 2007 peak.

-Next year is the 4th Pres. Election year. Although it is usually thought that the year following an election is weakest,  it is worthy to note that some of the biggest single year draw downs have occurred during the 4th year of the Presidential election cycle such at 32% in 1917, 23% in 1929 and 33% in 2008.

Will Santa deliver ?

Will the market have its Santa Clause rally or an early-year rally in 2012?  Here are some positive and negative factors that will help answer that question, as applied to the S&P 500 stock index. Personally, I give it a slight near termed upward bias, but a bearish bias later in 2012:

Bullish

  • Some sentiment indicators such as the NASDAQ and S&P “Down Pressure” indicators are oversold
  • Some encouraging signs of economic growth coming from the US (unemployment, retail sales, consumer confidence)
  • Seasonality should be bullish until spring 2012
  • QE3 is thought to almost be a certainty. An anouncement, or hint of such action, will likely trigger a strong  (although likely short) rally.
  • Tax loss selling ends at the end of next week. Thereafter, there is a tendancy for stocks that have been sold off to rally into the first 2-3 weeks of the new year as bargain hunters buy.

 Bearish

  • No sign of cracking the 200 day MA and 1265 overhead resistance, and once again we’re testing support at 1215 – 1220
  • S&P is below 200 and 50 day MA’s
  • Seasonal factors like the thanksgiving rally are not working so well lately
  • Gold, which has a high market correlation, is weakening (broke its 2-year trendline and 200 day MA)
  • Momentum is rounding over for some of the leading sectors and for the broader S&P 500 (MACD, RSI)

 

2 Comments

  • I specialize in channel analysis. Your channel is drawn incorrectly. You can’t draw channel boundary through the prices, lines always have to be drawn as boundaries, unless it is an internal line (which is usually a median line since channels are fractal). You should draw a line from the high in 1929 to the high in 2000, then you replicate this line in parallel to match the low in 1933. Now you have the channel.
    The common pattern is to do a double hit into the channel line and then retrace to another boundary. If this is the case, the other line passes at around 2500 , so the DOW can drop so much and still be inside this uptrend channel.

    Reply
    • Hi Ker
      Channels, in my view, (which are defined as “The technical range between support and resistance levels that a stock price has traded in for a specific period of time” according to one source) should be drawn with lines that touch support/resistance most often (usually at least 3 tests). For example, if you look back a few comments ago on this blog- you will see that I mentioned I was selling gold at the top of a chanel around $1800. If I had used the extreme high of the $1900 area that gold hit August/September as the top of my trend channel, I would not have sold at the true trend channel top of $1800 and would be licking my wounds right now. In the end, I try to take in the best representation of the channel and eliminate those few movements that fall outside of the greater trend. So for the Dow, drawing lines incorporating the 1929 peak and 1933 trough wouldnt allow one to draw upeer and lower channel lines that would incorporate the majority of trending peaks/troughs.
      Whatever the case, my view has always been “whatever works for you”. Text book definitions take a back seat to pragmatic trading systems. If you have found success in trading with incorporation of the wider swings, then by all means continue to profit by your chosen methodology! Thanks for the input.

      Read more: http://www.investopedia.com/terms/c/channel.asp#ixzz1h5LF7GaH

      Reply

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