So. . .major indexes have reached back to the September lows while the stochastic is deep in overbought. Time to short for all it's worth? Not on your life! I know. It sounds weird that Fundamentals Guy has dawned horns over the last three weeks. Again, don't misunderstand. I'm only cyclical bullish; not secular bullish.
So why the optimism? Our outstanding editor, Steve Price, got his hooks deep in it last night in the Wrap noting yesterday's breaks of the major averages over their 50 dma's. Let me carry that a step further tonight. It all comes down to a simple premise: Oscillators oscillate and revert to their mean. Let's drill down on the chart to see what all this might be about. NASDAQ is the underdog in this case, and the Dow Industrial represents only 30 stocks, which are assumed by most to represent "the market". However, the pros watch the S&P 500 for their lead. So we'll do the same.
S&P 500 chart - SPX (daily from April 2000 to present):
The numbe rs here are not immediately important. What is important is to notice the pattern. Here, we see a descending trend line with three distinct low points, each lower than the previous. OK, secular bear market still intact. But at each of those bounces, there was a pretty solid rebound that provided solid cyclical bull action. But did you also notice the disparity between the wavy magenta and gray lines? Those are the 50 and 200 dma's, respectively. The candle rebounds following the major declines will eventually cause the 50 dma to bounce too in delayed action, which brings the disparity between it and the 200 dma much tighter.
Casually observing, I note that when the 50-dma strays far enough from the 200 dma, it tends to return to it. Yes, oscillators oscillate and return to their mean.
Here's another casual observance. Once over the 50-dma the candles were only about midway through their journey. Journey to where, you ask? Though I have not drawn it on the above chart, there is a descending line of lower highs too, creating an almost perfect declining channel since April 2000. But the candles have moved up through their 50 dma on their way to touch the upper part of the channel, as shown below.
S&P 500 chart - SPX (daily from April 2000 to present):
What is particularly interesting to me is that on each of these previous occasions when the candles moved through the 50-dma, and the 50 dma converged upward with the 200 dma, thus lessening the disparity with the 200 dma, the stochastic was already OVERBOUGHT. Yet the cyclical move still had legs. Such too is the case with the current conditions as shown on the right side of the chart: above the 50-dma, big disparity between the 50 dma and 200 dma, and overbought stochastic. I'm only guessing, but I'll bet the 50 and 200 dma's are about to shrink their difference again.
Should history repeat, as it often does, perhaps the upper channel line just under 1050 or the 200 dma, likely just under 1070 by then, would be the ultimate bullish target. For those looking at the bullish target on the point and figure charts, the target is 1095 (boy wouldn't that be nice!) on a current buy signal. Again, what about overbought? I'm willing to label that, "inconsequential" to the cyclical trend for now, but will certainly pay attention to it as a trader.
One more thing from the Twilight Zone - Anybody note that today's high at 965 was right on the money at September 11th's close at 965? Should we fear a rollover and instant death of the market under the "old support equals new resistance" rule? If so, it would only be temporary in my mind. Still, it was no accident that today's 965 high matched with September's 965 low.
Now to fine-tune the theory. Back to the charts!
SPX daily chart (near term):
Nobody can reasonably hold the notion that the markets will rise forever in a straight line from here. In fact, due to the overbought daily chart, traders can probably expect some pullback or consolidation from here. So where does support lie if that happens? Our best educated guess comes from noting the above daily chart, shrunk back to normal size from the two longer-term charts shown far above. Anyway, support would likely come in at 928-930 since that is where the 10 dma (blue wavy line), 50 dma (magenta), and the 38% retracement from the March 2002 high to July 2002 low. A guaranty? No, plus it may take a few days to get there. But it's pretty solid footing for the trader.
But just to be sure, let's look at another daily chart.
SPX chart with ascending trend line:
Take a look at the above chart. It's identical to the previous daily SPX chart except that we've dropped the 10 dma line and added the bullish wedge noted in last week's column. By definition, a bullish wedge has a series of ascending lows with resistance at a consistent high before turning down again. That wedge broke to the upside 5 trading days ago, though it was unconfirmed then. Note that the stochastic was overbought then too, and it didn't matter.
Anyway, if we focus in on the chart, we see the most recent pattern of higher lows define a rising support line. Again to make the case for support at 928, we can use that line. It supplements our analysis done from the previous charts.
Ready to put it all together for the bulls?
1. Secular bear; cyclical bull - see descending channel.
2. Oscillators oscillate and revert to their mean.
3. 50 and 200 dma's converge from wide disparity.
4. Candle move above the 50 dma.
5. Bullish wedge breakout.
6. History plus point and figure chart suggest bullish target north of 1050.
7. Interim support from the 10 dma, 50 dma, and 38% retracement at 928.
8. Series of ascending lows also at 928 lending support.
Putting this all together, if bears were going to take control today, they would have attempted major damage at the September low of 965 - not accidentally today's high. They couldn't pull it off. Selling pressure should have greater. There isn't just an absence of weakness, but based on the above charts, pillars of strength on which the market can build on in coming weeks.
But please. . .don't take this to mean that we ought to buy everything in sight. It's still a secular bear market until we see a successful probe of resistance then a break to the upside, which appears to be some time off. Also, remember to look again at the long term chart above. We are better than half way through this bullish cycle. We are not at the beginning that happened 185 SPX points ago.
We also have that pesky daily stochastic that looks like it may want to cycle down for a breather before daily candles go knocking on 965's door again. But if the stars converge, we might see a few more weeks out of this cyclical bull market. Bears appear currently sated after their most recent feast at the honey pot leaving bulls free to romp in the tall grass and enjoy the sunshine for now. Keep your eyes on the daily support lines for signs of the bear. For now markets are catching a bid at critical junctures.
That's it for this week. Trade smart and make a great weekend for yourselves!