The Stock Market Explodes: Now What?

Last week brought the biggest upside move in the stock market in more than two years, with the S&P 500 soaring over 7% for the week. The jump in the market caught most participants off guard, with the focus being on what seemed like a deteriorating situation in Europe. The sentiment over the Thanksgiving week was somber, with the markets declining steadily. However, a move by six major central banks, to lower the interest rate by .5%  and extend the dates on “swap lines”, offered a trigger for the upside move and a swift change in investor sentiment.

Swap lines are short-term reciprocal agreements between central banks to loan each other dollars in return for the foreign currency. The central banks then loan the money to their banks to help them meet reserve requirements. These lines are only used when things are very tight, so they hold a stigma. And the swap lines have not been used much this year. So the action by the central banks didn’t mean a lot, other than they were paying attention. And the move certainly does not address Europe’s fiscal woes.

That’s basically the story that sets up chart analysis I’m about to show you.

The conclusion I draw is that the stock market was just ready to explode upward; “anyone have a match’? I gave supportive evidence in my October 17 article in greenfaucet.com, “The Stock Market Spring”, that the stock market was just beginning a major advance. Somewhat prophetically, I suggested the S&P 500 would correct a bit, moving down into a range as low as 1165 before beginning the next upward leg. So here we are with a massive gain in a week’s time. Now what?

 

I want to compare two charts that are eerily similar to come to a forecast for the coming couple of months for the stock market. Below is a daily chart of the S&P 500 from July to October 2010. There several important aspects to note on this chart:

 

 

Charts courtesy of TD Ameritrade

Note that there is a 38 day period in July in August that separates two major lows (red vertical bars). This is how I find cycle patterns in the charts. The rally phase saw a gain of about 11%, with a correction of about 8%. Once that downside correction was over, the market soared, with the first week gaining about 5%, with no real correction in the market over the following two months. Also, once crossing the 89-Day moving average, the S&P 500 never neared it again, riding the 13-Day moving average upward. It was clearly a buying stampede.

Now look at the chart of the S&P 500 from October of this year to today.

 

 

Here you see nearly the same image, except the amplitude of the rising and corrective phases is greater now. The market rose about 17% and corrected about 11%, all in the same 38 days. Last week the market gained 7%, pretty much in proportion with the increased volatility this year. Also, this market soared will beyond the 89-Day MA; very bullish. So the picture is very much the same as mid-2010.

Technically, when a cycle ends higher than it begins; the odds of the next advance equaling or surpassing the previous high is about 75% to 80%. That puts the S&P 500 above 1292 rather soon. With a high percentage of fund managers underperforming this year, they are not about to waste one last rally. They know that the last three years have seen strong finishes. Thus, they are getting on board this one, spawning last week’s piling on affect.

So, I believe this will be an extended rally, with only minor one or two day corrections for the next few weeks. And I’m chomping at the bit to buy those dips. So I’m maintaining a strong bullish bias, expecting the S&P 500 rises above that 1292 level, with momentum carrying the market to the resistance at 1309 or slightly higher. 

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Commentaries Hi Steve, Just wanted to say hello and compliment you. I've been reading your stuff over the years and its always been interesting. Your call on aapl in Oct was great. I never knew you personally, I was a mm in the OEX from the early 80's through 1998 and remember you from your days in the beam. Good to see someone like yourself still successful and banging it out. As always, good luck and good health for that continuing. This market is brutal and a long ways from what we dealt with in those days. My Best, Carl mcLean Submitted by Carl McLean (not verified) on Tue, 2011/12/06 - 10:15am » reply |