By Michael Kahn at Barron's
If ever the old saw that “market bottoms are events and market tops are processes” were applicable, it would be now. Stocks have been trading in a range for nearly two years, albeit one accented with several tradable trends, both higher and lower.
The question is whether this is an actual topping process or simply a large pause in an ongoing bull market. Given that bull market trendlines drawn from the 2009 low are broken to the downside on all major indexes, I’ll easily side with the former.
Still, with the sharp rally from the February low breaching several resistance levels, it is easy to get swept up in the action. Breadth has been good. There was a huge three-day surge to kick things off and a short-term double bottom pattern was broken to the upside.
We’ve even seen surges in all four of my key sectors — retail, technology, home building and financials. Retail stocks have led the advance.
And now we can add extreme bearish sentiment to the mix, which actually sets the stage for more upside. Specifically, the American Association of Individual Investors just released its February Asset Allocation Survey showing that equity allocations among individual investors declined to a three-year low while they boosted their cash allocations to a three-year high.
That is so bearish that it is actually a contrarian bullish indicator. It tells us that the supply of shares for sale is low and, of course, available cash to buy shares is high, at least among retail investors.
Chip Anderson, president of StockCharts.com, wrote in a recent newsletter to users that current “emotional short-term reactions are really just part of a larger pattern.” According to his analysis, “The market has topped and is generally moving lower based on a rounding top pattern and the downward movement of the 40-week (200-day) moving average” (see Chart 1).
As we can see in his updated chart, which was originally created nearly two weeks ago, resistance on the Dow Jones Industrial Average at 16,500 was broken to the upside. Anderson said that he expected the Dow to move toward the 200-day moving average. “At that point,” he wrote, “the market will feel more pressure to move lower.”
I concur. This still feels like a countertrend rally and volume confirms it (see Chart 2). Switching to a shorter-term chart of the New York Stock Exchange composite index, we can see that volume contracted during the beginning stages of the rally last month and only spiked higher on the day when the market closed down following a sizable intraday reversal to the downside.
Indeed, cumulative volume studies on all the major index exchange-traded funds including the SPDR S&P 500 ETF Trust (ticker: module article chiclet SPY ) were flat, suggesting no real inflows of money or any urgency to buy. It is almost as if the market is rising because the bears are just taking a few weeks off.
Anderson concluded, “The most important thing to remember at this point is that we are currently in a downtrend and we need to respect that downtrend until it is decisively broken. This will be true at least until the Dow climbs back above the 200-day moving average.”
Again, I agree. And even if the Dow and other indexes do break their averages the thickness and quantity of overhead supply — chart resistance — would be formidable. It would be an uphill battle for the bulls, so investors should treat all opportunities as short term for the time being.