Time For a Rally? Technicals, Sentiment Point to Relief

Time For a Rally? Technicals, Sentiment Point to Relief

Time to buy the market?  It’s at least time for a relief rally to sell into, says Sy Harding, based on his technical analysis of current market conditions…


Sy Harding

Being Street Smart

Sy Harding

It’s Time For Some Relief

August 12, 2011

We’ve had enough bad news in recent months. It’s time for at least some temporary relief.

The economic news has been awful. The ‘soft-spot’ in the first half that was supposed to be temporary turned out to be worse than previously thought. GDP growth, previously reported as having been around 2% in the first half, was recently revised to being up only 0.8%.

The return of strong growth that was supposed to begin in July did not show up. Consumer and business confidence, which was expected to produce the improvement, instead deteriorated further in July, accompanied by unexpected further declines in both the manufacturing and services sectors.

The increasingly bad news has economists now saying that rather than the first-half ‘soft spot’ being temporary, the odds are 50-50 that the economy is sliding into another recession.

Globally the reports are similar, news of slowing economies, and serious government debt problems. The success of the additional bailout plan for Greece a couple of weeks ago is already being questioned, and Europe’s debt crisis is apparently now spreading to Italy and Spain, countries considered too big to bail out.

For investors, stock markets around the world have seen their bottoms drop out in serious corrections, some exceeding declines of 20%, which is the level that marks entry into a bear market.

Investors in the U.S. have seen $2.8 trillion disappear from the value of their stock market holdings in just over three months.

In my last column I said it was too soon to buy, that more declines were in store. And so they were. The Dow lost another 1,400 points, or 11%, in the first 10 days of August.

Enough is enough!

And there is at least some good news for the short term.

Technically, the market is short-term oversold again. That was a condition that created a brief but significant rally in early July.

It’s a condition that should produce another short-term rally, and have investors breathing a sigh of relief.

Unfortunately, like the rally in July, it’s likely to be another opportunity for investors to take some risk off the table by selling into the strength, rather than being the end of the correction.

I base that on a number of conditions.

Based on technical analysis and charting, the major market indexes like the Dow and Nasdaq are short-term oversold beneath their 50-day moving averages to a degree that almost always brings a rally back up to the moving average. That would be a rally to roughly 12,000 on the Dow.

But intermediate-term the technical picture remains negative. Important support levels were broken by the sharp decline since the April top, and the longer-term trend seems to be down.

And investor sentiment has not reached the level of fear and pessimism usually seen at market bottoms. For instance, the latest poll of its members by the American Association of Individual Investors this week shows 33.4% still bullish and only 44.8% bearish. In market corrections, the AAII poll almost always reaches a level of at least 55% to 65% bearish, and bullishness drops below 20%, before the correction ends.

Then there is the market’s seasonality. Historically, August, September, and October tend to be the most negative three-month period of the year.

And in the background, with consumer and business confidence declining to new lows in July, it’s unlikely the economy is about to reverse to the upside anytime soon, which is what the stock market needs to see to support a sustained rally and return of the bull market.

Meanwhile, the nerve-wracking up and down volatility is likely to continue.

Next week will bring a number of potential market-moving economic reports from the housing industry, and on inflation, two areas on which there have not been reports in the last several weeks.

So summing up, the short-term oversold condition makes a short-term rally likely, but with the correction likely to resume to lower lows when it ends.

I’m confident enough of a short-term rally that I and my subscribers took our significant profits on Thursday from the ‘inverse’ exchange-traded-funds I was recommending at my sell signal on May 8. But I think it’s likely our indicators will turn negative again and we’ll be re-taking the ‘downside’ positions when the expected rally ends.

But meanwhile there should be some relief, at least temporarily, from the relentless selling that seemed to have the stock market in freefall.

Sy Harding is editor of the Street Smart Report, and the free market blog, www.streetsmartpost.com.