Sunday, May 18, 2008

Time for a Pullback?

There's almost uniform agreement among technicians this weekend that, even though the market has grown more bullish, stocks are due for a correction.

Many investors looked to OEX this past week for the selling to pick up. However, the week after options expiration is actually far more famous for market tumbles. As a result, it's possible that the sellers finally show up this week, with downside acceleration into the long weekend. However, the market has made so many technical improvements over the past nine weeks that remorseful non-participants could be eager to buy any weakness.

Long-term indicators still say we're in a bear market, and broad economic conditions range from mediocre to awful. However, nothing is more bullish than a market that keeps going up. Most investors have been surprised by the tenacity of the current, nine-week rally, and a wide array of indicators show an ever-strengthening market pulse.

One of the more popular Bull Market/Bear Market Indicators involves the 65-week EMA. It's a reliable long-term indicator, and there's even a public chart list at Stockcharts called Above the Green Line which is based on the 65-week EMA.

The chart below shows that the SPX has now climbed back above its 65-week EMA, after spending the past six months below. Also, RSI is back above 50. However, it's worth noting that Above the Green Line isn't impressed, and views this as the last chance to sell before the market turns really bad.

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The reason for the skepticism is evident in the chart below. The 13/34 weekly EMA is one of the most commonly followed long-term bull/bear indicators. Until the blue line crosses back above the red, the trend is still down.

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However, things can change. In the world of Dow Theory, all three components bullishly broke above key resistance in mid-April, and have held above ever since. It's old school, but Dow Theory has a long history of reliability and has some high-profile practitioners.

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Another chart with longer-term bullish implications is the Cyclical Ratio. It's currently near an all-time high, even as the SPX lags far behind. Relative strength in the Cyclicals is positive for the market outlook.

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Market tops are difficult to call, and the reminder du jour is the energy market. Even though USO was throwing off important divergences two weeks ago, it moved even higher this past week -- on even more astonishing volume! It's a great lesson in market mechanics, and a cautionary tale about jumping in front of a moving train.

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The significance of what the market does from here depends on your time frame. While a short-term correction in the next few weeks is a decent bet, there are few indications that stocks are ready to collapse to their March lows.

One of the most compelling reasons for this is that stocks with the very best fundamentals have been breaking out to new highs en masse for weeks. The IBD100 has had a thundering performance since mid-March, and has seen an ever-widening group of stocks participating in new highs. This is rare behavior for a rally doomed to failure.

Eventually, the market will sell off, probably to a chorus of "told you so's" and epic QID trade. However, unless investors produce a crop of 4-5 distribution days in a two week span -- and the IBD100 falls apart -- participants will likely step in and buy the dip.

Good luck trading, and I'll write when I can.



The dk Report Charts

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