Thursday, March 12, 2009

Don't be fooled by this rally!

A market bottom?
Today's 239 point rally in the Dow and 29 point gain in the S&P 500 got many of the financial tongues wagging that this is could well be the holy grail we've been searching for: a market bottom. I don't think so. Before you let the bulls out of the pen, consider the following technical criteria that indicate a trend reversal.

1. Chart pattern violation. A bear market is characterized by a series of lower lows and lower highs. The weekly chart of the S&P 500 clearly shows this pattern. A bull market is indicated when this pattern is broken, i.e. when the new high is greater than the previous high and when the new low is higher than the previous low. This has not happened yet. (This point ties in with #3 below.)

2. A substantial increase in volume. At the start of every bull market, the volume of the new rally is substantially greater than that of the previous intermediate bear market rallies. This has not been the case for the DIA and the SPY (the Dow and the S&P 500 tracking stocks). Today's volume on the SPY was only 18% of its 65 day volume average (81 million shares versus 445 million shares) and 67% of that for the DIA (22 million vs 33 million).

The exception is the QQQQ, the Nasdaq 100 tracking stock, which has been trading slightly above its average volume (of 167 million shares). This could be due to its weighting in biotechs, a sector that is undergoing major consolidation. Still, recent volume is smaller in comparison to previous bear market rallies.

3. Price violation. A reversal in trend is indicated when the price retraces at least 80% of its previous decline, and the stronger the retracement, the more likely a reversal. Let's take a look at the S&P. It's last relative high was at 875 put in on 2/9/09. It hit a low on 3/6/09 at 678. An 80% retracement would mean that it would have to reach 836, and so far, it's only retraced about 37%.

4. The VIX must break support. The volatility index, the VIX, closed today at 41 and change, slightly above its major support level at 40. I firmly believe that we can't even begin to think bull market until the VIX not only decisively breaks that barrier, but stays below it. (Note: The VIX runs inverse to the market.)

Maybe this time the technicals will fail, but they rarely do. I just tuned into Cramer where he's espousing a change in market direction for fundamental reasons. I hope he's right because if this market takes another severe drop, I dread the consequences.

No comments: