Wednesday, December 10, 2008

Breaking the Cycle of Lower Highs

Two add on points re yesterday's commentary.

First, it is always constructive when a market rallies in the face of bad news. This point was most recently noted by Barton Biggs (formerly of Morgan Stanley fame). Such action suggests that a psychology corner has turned as investors have begun to look passed the valley of FUD (fear, uncertainty, and doubt).

Second, an important dynamic to the bottoming process is the helpful price pattern of breaking the downward cycle of lower highs and lower lows - that corrosive process of a ball bouncing down the stairs: each drop to a new low, each bounce below the previous one. A careful look at yesterday's chart shows (see chart below) that this pattern was finally broken with the move above 900. However, it must noted that the 900 level is not as significant as the 1000 level, not because it is a nicer, more round number but due to the fact that during the decline the lower high of 1000 was set on two occasions - Oct. 13 and Nov. 4, versus the one time at the 900 level. Therefore, breaching the 1000 lower high would be more significant.

Investment Strategy Implications

I am not so sure that yesterday's market decline is the short-term breather the blog title refers to as the shorter time frame of Slow Stochastics has touched the 80 zone but has not crossed over its longer time frame cousin. Given the very positive strength in near term indicators - Momentum and MACD - plus the two points noted above, I would watch for a Slow Stochastics move more strongly into the >80 zone and then the crossover. It appears likely that this would occur right around the 50 day moving average, giving the false impression that it and not the short=term momentum aspects of the market was responsible for the subsequent breather.

Should all go as described, an assault on 1000 would be in the cards.


Scott Schmittel said...

I've been holding my nose and buying my way back in over the past six weeks. But Nouriel Roubini's words give me pause. He's calling for worse than expected (is this is possible) Q4 and Q1 earnings driving the equities markets to new lows in March/April? Was curious as to your response to his assertion.

Vinny Catalano, CFA said...

Sorry for the delayed response. Was traveling.

Given the discounting mechanism for stocks (6 months into the future), worse than expected earnings over the next 4 months (4Q08 and 1Q09) does not equate to lower stock prices today.

Rather, I would focus on projected earnings over the next twelve months and multiply that by the appropriate P/E. For more on this point, pls see my Oct. 30 blog posting on Minyanville - PEs for a Volatile Time