Monday, October 10, 2011

Another Day, Another Opportunity… to Fade the Rally

Memo to the momo lemmings: It’s more than the Eurozone that’s the problem.

Applying simplistic analysis, the momo crowd has unleashed yet another round of risk-on trades this morning. Jacking stock prices back near their 200 day (exponential) moving average – at least when it comes to developed markets. Emerging markets (remember them, the global economic sector where all the growth is supposed to come from?), however, are lagging the party thus far.

Yet, beyond the short-term wiggles and squiggles that the momo crowd tends to heavily influence, the longer-term picture paints a rather different story. As the accompanying chart** shows rather clearly, the Mega Trend* is decidedly in bearish mode. Moreover, both MACD and RSI are hardly exhibiting robust support for the rally, with MACD yet to crossover to the positive side (when the blue line crosses the red).

As the chart shows, the past is fairly clear what happens when the Mega Trend turns negative. Moreover, only when MACD and RSI register an internal non confirmation (as it did so significantly in the winter of 2008 into the spring of 2009) is there cause to believe the establishment of a negative Mega Trend is at the point of reversal.

To be sure, RSI did register a modest divergence last week but MACD did not. And while one indicator is fine, two is always better.

Investment Strategy Implications

The momo crowd is enthused that another round of inadequate political action will save the Euro day. And perhaps the movement they have fostered these past few days has some lasting power to it resulting in the aforementioned reversal conditions. However, with earnings season starting this week, there is every reason to expect the optimistic bottom-up projections will follow the macro economic forecasts for the third quarter, which were well below economists’ expectations. And that reality may trump the momos rationale du jour. Yet, when it comes to the momos, here's something useful to remember:

Being agnostic when it comes to the longer term and the real world of earnings and economics, they will follow whatever short-term trend they manufacture. That's what lemmings do.
*use search function on the top left to read about the Mega Trend.
**click image to enlarge.
Note: the above chart is a weekly chart in which the 50 and 200 day daily moving averages are converted to the equivalent 10 and 40 week moving averages.

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