The Bullish and Bearish Cases for Stocks
The frustrating truth about technical analysis is that it requires interpretation. Ideally, a chart would shout "buy" or "sell" and could only be interpreted one way.
But as the saying goes, "If it were that easy, we'd all be millionaires."
The stock market is at an interesting juncture right now as an epic battle between Bulls and Bears has left the market volatile and range-bound since the "flash crash" in early May.
In essence, the Bearish fundamental-analysis case rests on the plentiful evidence that the U.S. economy is slowing: As the economy grinds down, corporate profits will suffer and thus so will stock valuations. Indeed, a number market observers have been suggesting that the market is setting up for a serious crash.
The Bullish case rests on much less abundant evidence that even as the economy slows, it won't slide into the widely feared "double-dip" recession.
Technical Analysis Looks Only at Charts
Technical analysts avoid debates about GDP, revenues and profit margins by looking only at charts. To technical analysts, all the important information is reflected in price and indicators. From this point of view, all the millions of investor opinions, convictions and data points are compressed into the market action as traders buy and sell stocks and options.
This makes a certain kind of sense, because the inputs of the U.S. economy and market are so numerous and complex that it is difficult to crunch them all into a coherent "story" about what the future holds. Everything from the yen-dollar currency trade to the price of crude oil to the percentage of S&P 500 corporations' profits that come from overseas sales bears on the economy and the market.
Just as the market crunches all this data and human emotion into price action, charts compress the market action into a visual display of price and indicators. Given the great economic uncertainty, it's unsurprising that the charts can be interpreted as Bullish or Bearish.
To show how this works, I've marked up two charts, one displaying the Bearish case and one with the Bullish case.
As many technical analysts have noted in the past few months, the Bearish case rests on a technical formation called "head and shoulders." I've indicated the left and right shoulders and the "head" -- the market top in late April-early May.
Technically, a head and shoulders is a topping pattern, meaning that it typically marks a major market top. In theory, now that price has formed the completing right shoulder, the market should fall significantly from here. This is basic technical evidence to support the Bearish "crash" scenario.
More Bearish Evidence: The Death Cross
But there is other Bearish evidence as well. The blue 50-day moving average line crossed below the red 200-day moving average, a Bearish signal known as "the death cross" because it shows that market momentum is declining.
Even more telling, price has fallen below the critical 200-day moving average level. Repeated attempts to regain that level have failed after a few days, a sign of weakness.
The market has also fallen under the shorter-term trend lines of the 50-day and 20-day moving averages -- more evidence of a market in decline. The range-bound trading since early May is thus seen as a period of what is known as distribution, another word for widespread selling by big players.
Key indicators are also signaling a weakened market. The moving average convergence-divergence (MACD) indicator has slipped below the neutral line, marking a bearish trend, and the stochastic has fallen from overbought to oversold, reflecting weakening demand for stocks.
There's Also a Little-Noticed Bullish Case
The Bullish case rests on a standard technical pattern that few commentators seem have discerned: a "reverse head and shoulders" in which the low point becomes the head and higher levels form the left and right shoulders.
While this reverse head and shoulders isn't very symmetrical, technical analysts refer to this type of action as a "complex" head and shoulders, in which choppy price action is resolved into a general pattern with these key characteristics: The "head" is lower than the left shoulder (previous low), and the right shoulder is higher than both the "head" and the left shoulder.
In other words, the "head" marks a definitive bottom, and the right shoulder is evidence of a new uptrend.
The classic definition of an uptrend is simple: higher highs and higher lows. Both are present in the chart. While Bears see a flat trading range, Bulls see a trading range with an upward bias.
Could Be Setting Up a Bullish Cross
Bulls concede that the moving average convergence-divergence (MACD) line is below the neutral level, but they note that it's flattening, which could be setting up a very bullish cross.
Even more telling for the Bulls is the positive divergence in MACD: even as price has traded up and down in a wide range, MACD is working its way higher. This is strong evidence of a market that is slowly working its way into a Bullish stance. While the stochastic has fallen into oversold levels, the lines have begun to rise, and there is some modest positive divergence.
Another source of technical evidence is the VIX or "fear index," which I have reported on several times this year.
Lastly, many observers use sentiment indicators to help identify trends. Right now, sentiment is generally bearish. Contrarians view that as bullish.
So is the market about to crash or is it setting up a new uptrend? There is evidence for both points of view, and every investor must weigh all the evidence and decide where the preponderance lies.
From www.ChartAdvisor.com here is their weekly report regarding the major indexes which I believe is important when tracking TSP funds……..
The Weekly Report For September 13th - September 17th, 2010
Commentary: The markets managed to push higher for the second consecutive week, which caught many bears flat footed and ended up leading to a three-day surge. The markets ended the week near their respective 200-day moving averages, which will likely act as strong areas of support/resistance and could have a major influence on the market direction over the next several weeks. As you can see from the charts below, the indexes remain in a trading range, and seem to be on their way for a retest of the July highs.
IN PICTURES: The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, respected the $104 level as support, making this a critical level to watch. The significance of this level is that it held above the July lows, showing that investors were willing to pay higher prices than they were a couple of months ago. This could be an important intermediate low, and would be confirmed with a break above resistance near the $113 level. Many bullish traders will now turn their attention to the nearby 200-day moving average because this could act as a strong area of resistance and reveal some cracks in the recent rally. Despite the show of strength by the bulls, SPY may still need time before mounting a serious assault to clear the $113 level. The markets are already extended in the near term, and are pressing into gap resistance near $112.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, also respected a support level earlier this week and ended up surging from those lows. The $100 level has become a clear level to watch, as bulls have aggressively defended it on a few occasions. Looking above, DIA is testing an important level near $105, which is the lower end of a bearish gap. The close above the nearby 200-day moving average suggests that the rally could last much longer than some are anticipating and reduces the probability of a double dip. Friday's close above this level could lead to a test of the more important level of $107.
The Powershares QQQ ETF (Nasdaq:QQQQ) pushed higher and remained above its 200-day moving average for the second consecutive week. Many traders will now set their sights on the August high of $47.19. The sharp rebound over the past few weeks may have trapped some bears and it should add to the upward pressure moving forward. If QQQQ breaks above the high, it could lead to a longer term trend higher.
We mentioned last week that the Russell 2000, as represented by the iShares Russell 2000 Index (NYSE:IWM), had been showing some relative strength and that it could be a valuable clue as to the next move in the markets. One of the potential catalysts for the strong move this week was an increase in jobs in the private sector and this could be hinting at an improving picture for the small cap sector. The small caps remain a key component to watch and the $59 level is the clear area to watch on the downside. Overall, IWM remains in a much larger trading range, and it could take some time before it is ready to clear either side.
Bottom Line
This week’s price action was very constructive as the indexes neared their respective 200-day moving averages. While this doesn’t guarantee a bottom is in, it is the first step in a possible bottoming process. The markets have quickly gotten ahead of themselves, and while they may ride the current momentum a little higher, the more likely scenario is a retracement of at least a portion of this week's rally. With summer practically over, the next few weeks should usher in an increase in volume and provide more clues as to the next move in the markets. Either way, it's looking like there could be a strong move in autumn.
Have a Great Day!
Casey Murphy
Senior Analyst, www.ChartAdvisor.com
