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April 18, 2008

Bears Back in Hibernation

Bears have got to be seriously worried at the moment. Stocks have seen two high-volume rallies in three days, and the SPX is challenging 1400 once again. As you can see in the chart, the last three times the SPX tested the 1390-1400 area, it was turned down, and did so with RSI5 (thanks, Gary) showing a very high short-term overbought condition.

stock chart

The SPX is once again short-term overbought, and in fact moreso than the previous three ocassions. I suspect we will now see 2-3 days of pull-back / consolidation followed by a solid punch above 1400. The consolidation will have the effect of shaking out weak hands on the long side and drawing in impetuous bears who still expect an imminent collapse. But the pull-back should betray itself by occurring on low volume.

The reasons I believe 1400 will be breached this time have more to do with a psychological read than a technical one. I get the sense that people are generally not believing this rally. We have also yet to work off some extreme bearish sentiment readings in indicators such as the put/call ratio and bullish percent indexes. In other words, there is a lot of bearishness already built into price that needs to be beat out before the market can head lower in a meaningful way. I don't know when such an inflection will occur, but I would be surprised if it occurred before the elections. In the meantime, I expect stocks to take a very choppy and tortuous path higher.

How high? For the technicians out there, a punch through 1400 would complete a head and shoulders pattern that projects the SPX to 1540. Wow. I have no bets on this outcome, however. My strategy for this market will be to execute hit-and-runs whenever I see a setup I like (such as the triangle mentioned yesterday). Perhaps when Tim Knight writes a tortured piece of dismay and anguish with threats to discontinue his blog out of sheer disgust with the markets, I'll call my broker and load up on SPX puts.

 

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