Market Technicals: Indices Break Above 200-day MA, Momentum Indicators Rebounding

Upcoming US Events for Today:

  1. Housing Starts for October will be released at 8:30am. The market expects Starts to show 836K versus 872K previous. Building Permits are expected to reveal 865K versus 894K previous.
  2. Ben Bernanke Speaks to the Economic Club of New York at 12:15pm.

Upcoming International Events for Today:

  1. German Producer Price Index for October will be released at 2:00am EST. The market expects a year-over-year increase of 1.7%, consistent with the previous report.
  2. Japanese Trade Balance for October will be released at 6:50pm EST. The market expects -¥337.0B versus -¥558.6B previous.

The Markets
Markets bounced strongly higher to open the week as investors embraced risk assets following the reversal patterns that became realized across the major equity benchmarks on Friday, attributed to optimism pertaining to the fiscal cliff. The S&P 500 and NASDAQ Composite both accumulated gains around 2%, helped by the stellar performance of Apple, which gained over 7% on the day as the stock bounced off of a significant multi-year rising trendline. The long-awaited bounce is upon us, correcting the significant oversold state of equity indices. The question now becomes, is this a bounce or the continuation of the longer-term positive trend?

Of course gains during this week, from a seasonal perspective, are typical as traders take time off for the Thanksgiving holiday and significant negative bets are kept to a minimum. The strongly seasonal trend even follows through to the beginning of December as a profitable holiday leads into a positive month-end. Following that, the notorious Santa Claus rally is know to provide a seasonal bump to stocks during the week following Christmas as well as the week after. Gains for the S&P 500 average 2.1% between December 15 to January 3rd. So seasonal tendencies tend to provide a positive bias through the remainder of the year.

Technicals are also looking interesting. With the bounce achieved on Monday, the S&P 500 traded back above its 200-day moving average, breaking through this level that has historically provided strong support and resistance characteristics. Breakouts through levels of resistance, such as this, are conducive to a positive trend. A look at the daily chart shows that the breakout occurred convincingly near the close of the session, within the last hour of trade, at a time when the smart money is getting in. Prior to this last hour, the market resisted the breakout, waiting for the end of day volume push to suggest conviction to the move.

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Momentum indicators for equity markets are rebounding from deeply oversold levels, a scenario which typically takes at least a month of trading to resolve. The 14-day relative strength index had recently crossed below the 30-line, indicating severely depressed trading activity. A cross back above the 30-line, as was realized on Monday, typically results in short-term bottoms from which the market seeks to correct the negative imbalance. The degree to which the market became oversold was also evident in the percent of stocks in the S&P 500 trading below 50-day moving averages. Last week we noted that bottoms typically occur when the reading reached 25% of stocks or lower. The indicator hit a low of 21.8% at the end of last week, rebounding to 34.2% on Monday. Gains over the past three years for the S&P 500 from the low to the following high upon a rebound from this extremely oversold reading have averaged 13.7%, the bulk of which was achieved in a one-month period following the bottom. So technicals are providing an encouraging backdrop for a positive move between now and year-end.

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Sentiment indicators also suggest a buy signal following last week’s overly bearish results. The AAII reported last week that over 48% of sentiment survey respondents indicated that they were bearish of the market for the next six months, well above the long-term average reading of 30%. This was the highest bearish reading since August 2011, when the market found a low following the substantial plunge attributed to the downgrade of America’s debt rating. Significantly bearish sentiment is typically a contrarian indicator to buy stocks. So sentiment is also providing merit to a rally attempt; as the old saying goes “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

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Fundamentals remain the wildcard. Investors continue to debate whether a solution to the fiscal cliff will be achieved. They also remain skeptical regarding the recessionary impacts of Europe on the worldwide economy. On a positive note, economic indicators in the US remain quite strong. On Monday, the National Association of Homebuilders reported that its housing market index (now at 46) is at the highest level in six and a half years. A recent report on Industrial Production noted that activity in October remained strong, held back only by Hurricane Sandy, which distorted results for the month. Significant fundamental news is expected to slow into the last half of this week as investors take the time off for the Thanksgiving holiday, which could allow the markets to drift higher on lower volumes, particularly on Wednesday and Friday.

Sentiment on Monday, as gauged by the put-call ratio, plunged from last week’s overly bearish high of 1.24 to 0.75 yesterday. Investors showed a dramatic shift in sentiment, moving from an overly bearish stance to a bullish stance as investors reduced negative bets and protective hedges. This can lead to portfolio vulnerability, if the correct conditions are met (eg. significant news events), in the short-term given that protective put options are falling out of favour. This vulnerability does present a risk as a short-term trend for equity markets attempts to establish, but the concerns are not presently overwhelming.

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S&P 500 Index
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Chart Courtesy of StockCharts.com

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TSE Composite
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Chart Courtesy of StockCharts.com

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