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August 6, 2009

Bear Essentials

Tomorrow is going to be an important day in the life of the largest bear market rally of our generation. For the first time since May, the S&P 500 saw volume acceleration on a bearish day coming off a price peak rather than after a modest decline. In May, the bearish candle was reversed in the very next session, though one of those modest declines followed. I would very much like to see some immediate follow-thru this time, and on even bigger volume.

stock index chart

Oscillators also remain exttremely overbought, thereby supportive of a bearish turn of events. Even if the next bear leg is not planting roots, one could at least anticipate a back-test of the 65DMA, which may be conveniently hitting the SPX 950 pivot by the time the meeting occurs. If the 65DMA fails, I suspect we will see an even faster retreat to 875 before a bounce unfolds. Were this latter scenario to play out, I would then consider any bounce to be corrective and would position for a larger decline to new bear market lows.

On the flip side, the 5-point decline in the SPX was meager given the half percent rise in the dollar index.

us dollar index graph

Perhaps traders share my view about the back-test. Nevertheless, I believe the next big surprise for large and small traders alike will be the dissolution of the inverse correlation between equity prices and the dollar index. I expect this fifth wave of the dollar's current bear leg to be accelerated by some sort of minor crisis... maybe the Federal Reserve will follow the BoE in announcing further monetization efforts... and the ensuing panic will drive equities down as well as witness traders flee the buck.

Once the fifth wave of the dollar decline is complete, we should see a larger corrective rally in the DX. The corrective rally may put even more pressure on equity prices, but let's take this one step at a time.

I'm a little concerned about the reversal we saw in silver today, but at this point, the most I expect is a back-test of the $14 pivot. On the other hand, gold looks like it is forming a crawl under an important trend line:

gold price chart

Despite the ugly candle on silver's chart, I still favor a breakout in precious metals. Such action would jive with expectation for an accelerated dollar decline.


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