Climbing the Wall of Worry

The old cliché sure is correct: Stocks do climb a wall of worry. At yesterday's open, everything seemed to point to the downside. Overseas markets had been falling all night, futures were lower and the U.S. and China had just fired the opening salvos of what could become a "dangerous" trade war.

The S&P 500 opened lower as we all expected, but the selling quickly ran out of energy. Less than 10 minutes into the session, the index put in a base at a support level established last Thursday and then proceeded to close a new 11-month high.

This is exactly the kind of price action we saw during the staggering run between July 13 and Aug. 4, when the S&P 500 fell only four sessions -- and even then the declines were diminutive and short-lived.

As the saying goes, the trend is your friend. I feel like I am getting to know this bullish trend as an old buddy now, and one thing I know well about it is that it keeps the pullbacks to a minimum. As I have highlighted in previous columns, stocks remain broadly underowned and cash funds remain crammed full with investor capital. Money-market assets totaled $3.5 trillion last Wednesday. That's down less than $400 billion from the height of the panic on March 11, and is still about $400 billion above where it stood in early 2008, according to the Investment Company Institute. Given that the Fed has created an ocean on money since early 2008 and the economy has gone from being at the start of a recession to the start of a recovery, cash will continue flowing into equities.

30-day vs. 50-day

Another reason investors shouldn't expect any pullbacks soon is that the upward trend is accelerating as more stocks find support at their 30-day moving averages rather than their 50-day moving averages. This trend can be observed over the past month on the charts of market-leading stocks such as such as Halliburton, 3M, Honeywell, Occidental Petroleum and Simon Property Group. (I know it's an unusual list of names, but they're all making new highs along with the market.)

This tendency to find support at the 30-day moving average rather than the 50-day reflects an intensification of the uptrend, and appeared several times on the S&P 500 during the market's recovery in 2003. (See daily chart at the end of this article.) And it happened with the S&P 500 earlier this month.

Another extremely bullish sign in my view is the collapse of the euro/yen currency pair as a leading indicator for market direction since early August.

This is good news because it means the market is no longer living on panic. During a time of crisis, all assets tend to correlate inversely around their funding source. This is what a margin call, or forced deleveraging, is all about: You sell anything you can to pay back your creditors, regardless of its underlying quality. That's why so many great stocks and corporate bonds were put on sale in the first place. Furthermore, the unwind of the yen carry trade first emerged as a major negative force in February 2007, when the cow chips first started hitting the fan in the mortgage-backed market.

Another way of thinking about it is like a restaurant. Imagine the number of diners plunges by half after the credit-card companies cut everyone's limit. That would reflect an underlying weakness for the restaurant's business because people would be relying on borrowed money. But now after more than two years of this happening, people have enough cash in their pockets to afford a meal with or without the plastic. This suggests a deeper return to normalcy and a healthier environment than we've seen in a long time.

When one considers stocks are climbing despite continued credit contraction and the relentless pace of foreclosures, it's clear that the markets have had enough time to quarantine the problem areas and find new avenues to upside. It's a lot like a tree that suffers a broken limb, but then grows new bark to seal off the wound and grows even bigger in a new direction.

Next stop: 1,100 - 1,150

While I am a little uneasy making such a bullish prediction, I think the S&P 500 could make a very sharp move in coming weeks. Later this year, I suspect we'll be looking at a green smear of candlesticks going up the chart the same way we saw an ugly red smear down last October.

I expect the rally will run out of steam somewhere between 1,100 and 1,150, and then move sideways or pull back for several months. If we proceed through that area then, we'll be looking at a new bull market. If we fail, the whole recovery might prove to be nothing more than a bear-market rally, as some esteemed technicians including Elliott Wave's Robert Prechter maintains.

Why do I chose the 1,100 - 1,150 area? Two reasons. First, it was an intraday support level on Sept. 18, 2008, shortly before the real calamity hit last year. Secondly, it's the rough location of the 500-day moving average -- a seldom-used indicator that I find highly useful. (Some analysts do cite the similar 20-month indicator.)

At every major recovery since the early 1960s, the 500-day has served as a point of resistance and consolidation for the S&P 500. For those of you interested in looking back, I'd flag these periods as instances of when the 500-day moving average presented resistance on the S&P 500:

• January - February 1967
• April 1975
• December 1970
• May - June 1978
• September 1982
• November 1987 - December 1988
• December 1990
• June - August 2003

If the market reaches this level quickly as I expect, it would be hugely overbought. And given the index's tendency to halt at the 500-day moving average, investors should not expect stocks to keep on moving through this area without significant consolidation first. We'd probably have several months of chopping sideways to lower as we wait for the 50-day or even the 200-day to catch up.

The chart below shows the 500-day moving average in orange and the 30-day in purple. As you can see, we bounced off the 30-day earlier this month, and the 500 is looming down on use like a ton of bricks.

For those of you who are interested, these are times when the 500-day moving average has served as support:

• February - March 1968
• October - November 1969
• November 1971
• June - August 1984
• April - June 1994
• September - October 1998