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August 8, 2010

Time Bandit

The summer rally in equities seems to now be mired in a topping process. Regular readers know that ever since the February yearly low gave way, I've been proclaiming that any impending rally would fail to better the April high. As this rally progressed out of the July 1 low, I have therefore been watching intently for signs the market would either exhaust itself or negate my interpretation by setting itself up for a surge to new highs. Indications are mounting that this rally will not be as fruitful as many traders may have hoped or imagined.

Let's begin with a quick view of the S&P 500:

S&P 500 technical analysis

Don't be surprised to see one more push to get price above that June pivot before the correction sets in... nothing like hammering all those buy stops before taking the market down.

Circumstantial evidence for this potential correction abounds...

NDX divergence from S&P 500

A laggard tech sector is a typical precursor to a market turn, but certainly no guarantee of one.

Small cap stocks lag

technical indicator stock market

Now before anyone goes shorting their boots off, keep in mind that once the impending correction completes, price should recover to new rally highs... the rally out of July, that is... before rolling over to resume the secular decline. (The reasons for such expectations are based on cycle analysis, which is covered in the Member letter). Even then, this is likely to be a tough market to short. If history is any guide, the decline is apt to be a slow, grinding process rather than a relapse into crash mode. Furthermore, desperate attempts to halt the process by the powers-that-be will induce a series of violent rallies along the way. If I trade such a market at all, you will most likely find me selling OTM calls into those rallies... time becomes a strong ally and steadily converts itself into cash. In any case, the window for maintaining a generally long stance in the market seems to have passed.


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