Sunday, May 23, 2010

Big Picture Update

I presented the above chart last month to show the important levels in the SP500 that have been created over the last 10 years. I calculated what I am calling the Decadal Pivot at 1160.75. In March we broke above the Decadal Pivot on the second approach only to fail back below it dramatically in May. Many are interpreting this severe decline as the beginning of the resumption of the secular bear market, and we certainly have to give strong consideration to that view. However, looking at the big picture we see that so far the SP500 is still trading within the same congestion zone that developed in 2004 and 2005. Therefore, I believe it is premature to be calling this a resumption of the bear market.

It may well be, but until we see a confirmed weekly close, preferably two or three weeks, below 1060.75, which is the bottom of the congestion zone, we should probably view the recent action as the work of consolidation, however violent, in preparation for the next move higher.

There are really on three outcomes from this point for the rest of the year: 1) the market continues to break down below the congestion zone confirming the bear market, 2) the market rallies to the decadal pivot and then turns down, or 3) the market rallies to the upper end of the congestion zone at 1260.75. After 2) or 3), the market could still fall below 1060.75, but until that happens we should expect many months of base building rather than an immediate decline. Remember, the market consolidated sideways for almost 20 months in 2004 and 2005. It doesn't have to repeat that action now, but it is a more likely outcome after the historic rally that we have just experienced.

At the moment, I personally think the probability of the 3 outcomes are about equal, which means the probability of a substantial rally into mid July to late August outweighs the probability of a continuation of the decline. The conclusion is that this is not the time to be heavily short this market, but rather to be looking for confirmation that a new short term to intermediate term rally is underway to initiate new long positions, with conservative allocations, or to be waiting for an opportunity to sell existing positions at higher prices. Only a sustained break of 1060.75 will alter that point of view.

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