October 20th, 2009 by Prieur du Plessis, Investment Postcards from Cape Town

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On the 22-year anniversary of the 1987 stock market crash yesterday, stocks marched to one-year highs, with the Dow Jones Industrial Index reclaiming the 10,000 level and the S&P 500 Index breaking through 1,100 (although it then declined again to fall shy of this number by two basis points by the closing bell).

First, some comments from regular contributor Kevin Lane, technical analyst of Fusion IQ.

“The S&P 500, which recently broke above a downtrend line (purple line in the chart below), is closing in on its 50% retracement level from the 2007 peak to the 2009 lows near the 1,120 level. This level may cause some minor profit-taking and retracement; however, only a move below 1,000, which would put the S&P 500 back below its recently broken downtrend line and near-term support, would be viewed as a negative. So, until a break of 1,000 occurs, price trends remain up and pullbacks are to be viewed as minor market noise. Again only if 1,000 is violated does the trend turn more corrective.

“We continue to wait to hear investors embrace this rally as a clue it may be nearing a near-term exhaustion peak; however, the overriding theme remains that the market “needs to correct” or is “way overdue” to correct. To further that point we talked to two investors last week that were still “uninterested” and “not invested” in the market even after this large run-up. Our rationale for their apathy is that they are still scarred from last year’s collapse and made the assumption this rally was not real or would soon revert to the negative environment of 2008.

“Typically markets have this way of going to extremes to either scare all investors to the sidelines or seduce them to come back into the markets. The current run with its persistence is doing its best seduction routine to extract the last bit of capital from even the most ardent doubting Thomas.

“While we could be wrong we think the market will remain generally strong, defying consensus (as it has for the last three months), and entice the remaining sideline capital back into the pool. Only at that juncture when sideline liquidity or buying power is exhausted will we have a correction of any magnitude.”

Still from a technical perspective, Adam Hewison (INO.com) sounded a cautious note as explained in one of his popular technical analysis presentations. Click here to access the presentation.

The current rally that commenced in March has lasted for 32 weeks. Interestingly, when considering the 32-week rolling rates of return of the S&P 500 Index the amplitude of the current cycle resembles that of the cycles of 1932, 1937-1938, 1974 and 1982 as shown in the graph below.

Source: Ron Griess, Thechartstore.com, October 16, 2009.

The question that invariably arises is what happened to the returns subsequent to the highs of the four previous cycles. The table below shows that the market mostly worked lower, but the last period was an exception.

Source: Ron Griess, Thechartstore.com, October 16, 2009.

All said, I am still following a cautious approach in anticipation of the market working off its overbought condition and fundamentals reasserting themselves. I will bide my time while the fundamentals play catch-up.

Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.

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