Clean up time

Hi there, and welcome back to CRI's S&P 500 blog.

Amid all of the 'end-of-the-world' talk out there the broader stock market (as measured by the S&P 500 stock index) has worked its way back to the 50% rule and begun to consolidate in a very orderly (if not swift) fashion. Currently, the market is doing nothing more than cleaning up the excess's of the past year's bull run. We have made a very natural 50% correction of that move and shall now need some time to confirm that this is indeed nothing more than a healthy correction within a massive bull market.

As has been previously stated, this correction comes on the heels of US federal political instability rather than poor economic fundamentals. As a result, one is left with the feeling that if only Washington could just get it's act together the market would stabilize and resume its previously well established up-trend. Make no mistake, the 135 area (on SPY in this case) shall now act as considerable resistance to the upside but given that the two primary drivers for stock valuations (earnings and the yield curve) continue to be supportive, a resumption of that uptrend would seem likely upon a resolution. The big 'if' now is indeed Washington (or more succinctly - US Federal political leadership) and given the current extreme polarization of the US Congress (and now the US Fed's insistence that any solution must be fiscal in nature and not monetary) that much needed leadership is in serious question.

So lets review how our two primary market participants ought to be positioned.

Investors: As has been the case now for several weeks, cash is king! Investors were given a very clear 'exit' signal when our time tested trending indicator (that being the relationship between the weekly 13 EMA and the 30 SMA) crossed bearishly 5 weeks ago. That exit should have come on a break of key support in and around the 125.70 level (or about 6% higher than where we are currently). Until the moving average relationship turns back up, investors are well advised to sit on the sidelines and watch the fireworks. Ironically enough, this camp is cheering for further price deterioration which would make their exit look all the more significant.

Traders: This camp was well advised to begin shorting the market in earnest through the final week of July and again when the important 125.70 level was breached. Those that were fortunate enough to get short should have been more than happy to take profits on those short positions as we approached our well established downside target zone (119.15 - 111). The fact that the market has basically oscillated around the 50% level (for the past four weeks) suggests that the market is trying to relieve the oversold condition that developed on the initial downward move. The recent consolidation in price has both relieved that short term oversold condition and may be laying the ground work for the next leg lower. Should the 110.27 level be taken out, one would have no choice but to look for another move lower equal to or greater than the previous. This bear flag formation would imply a price target of 96.65 [(134.82-110.27)-121.20]. Conversely, should the 121.20 level be taken out, one ought to look for a counter-trend rally that would imply an initial price objective of 122.935 [50% retracement; (135.6+110.27)/2]. Should that breakout occur, one could also argue that the 13 EMA shall act as resistance and it ought to be in and around that level as well.

So in summary then, the market needs political leadership in order to continue the expansion that was established last fall. The US Federal reserve has stated that it will be very reluctant to initiate a QE3 program and that in its opinion, fiscal stimulus is what is needed. Couple this with extreme political polarization in Washington and there appears to be no quick resolution on the horizon. All of this suggests that the market will have to take some more time to clean up this mess and that if one were to suggest a general direction for price in the coming weeks/months, that direction continues to suggest down rather than up.

That's all for this week,

Brian Beamish FCSI

The Canadian Rational Investor

the_rational_investor@yahoo.com

the-rational-investor.com