Near-term test now playing

After a strong bear market rally since March 9, world markets are looking pretty overbought. Not that they cannot continue overbought a while longer, but the probability of the next downside test is growing daily. Much of the recent fervour has been optimism about carefully dressed bank earnings which seem better than had been expected for Q1. But credit issues still loom and lasting health has not yet been restored to our financial institutions.
Lest anyone forget, so far we are still in a cyclical bear market, within a long secular bear market, and so defensive action is still key. Peeling off profits from big rallies is always prudent action in this type of market cycle. When markets are able to punch through the overhead of their 200 day moving averages with sufficient force, it will be a bullish sign for the next leg up. But in the meantime, we can't go broke taking profits and after an incredibly volatile first quarter 2009, we are grateful to take them.
As far as the next downside test goes, it is possible that markets could bounce somewhere around the November lows and not have to fall all the way back to the March 9 lows; only time will tell.
In the meantime, two charts offer ominous clouds to passionate bulls here. First is the fact that as of April 89% of stocks in the S&P 500 are trading above their 50-day moving average. This type of overbought reading has a historical precedent of setting up corrective pull backs.
And although sell in May is generally too trite to use as an effective timing rule in general, during other secular bear periods like the one we are in, negative returns in the May to November period have more historical weight.

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3 Responses to Near-term test now playing

  1. Anonymous says:

    Thanks Danielle,
    We had toed in and were beginning to worry that things like XFN,
    XSP and QQQQ were becoming too good to be true.
    Took some profits today.

  2. Anonymous says:

    In this market, I do do not feel like I am investing in stocks of a good company. To me, it feels more like gambling. Stocks are going up and down for any reason so it is futile to try and figure it out. Many now have become traders and try to guess which way the market is going and hop on for the ride and get off when it changes.
    Today, inverse ETFs make it possible to trade no mater what the market is doing.
    This recent rally is the result of traders and not long term investors. They are simply too afraid to invest in this bear rally. Just watch when the market turns and everyone sells. Those inverse ETFs will be just the ticket for the ride down again.
    I, like most, missed the rally of the century, so maybe I will be lucky and catch the ride back down but I am not counting on it.

  3. Anonymous says:

    From a recent article ('Smart money' starts to bail on stocks' rally), something else that gives me pause about the current rally:
    . . . the usual progression in stock rallies is for big institutions to provide the original fuel. By the time retail investors join the party, it's almost time for the smart money to pack.
    But this time around, anecdotal evidence — such a trading data from online brokers Etrade and Ameritrade– suggests that retail investors have been driving the rally from the start, while institutions have remained very cautious about the market, says Barry Ritholtz, CEO and director of equity research at Fusion IQ.
    “The 'dum' retail money is leading the gains,” he said. At the same time, while some institutional investors have remained cautious, some are afraid to miss the opportunity to make some money in the process.
    “After the strong gains we've seen over the past two months, you'd expect to see some sort of digestion of the gains,” Ritholtz said. “But while bull markets usually give you more than one opportunity to step in, bear markets usually don't.”

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