Stock markets: reversal time?

I indicated in Sunday’s “Words from the Wise” review that “the speed and sheer magnitude of the rally argue for markets to either consolidate or retrace some of the past nine weeks’ gains prior to moving higher”.

Is the rally is about to be reigned in? While most major stock market indices are encountering resistance at their 200-day moving averages and/or at the early January highs, a few other indicators also warrant our attention.

Two sectors that have been leading the overall market higher during the rally that commenced on March 9 – small caps and technology – have reversed their outperformance, as seen from the turnaround in the relative performance. The first chart plots the Nasdaq Composite index relative to the NY Composite Index, while the second compares the performance of the Russell 2000 Small Cap Index with that of the S&P 100 Index (large caps). A rising relative strength line indicates outperformance and a declining line underperformance.

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Source: StockCharts.com

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Source: StockCharts.com

I will keep a close eye on these two charts as relative weakness of small caps and technology will not be a good sign for an overall market that is overbought and looking exhausted after its monumental rally over the past nine weeks.

Another interesting-looking chart is that of the S&P 500 Index’s Bollinger Bands. Although a close below the 20-day moving average (dotted blue line) is required to confirm a correction, the fact that the price is touching the upper band indicates a short-term overbought condition. Also, the black line in the bottom section of the chart – measuring the width of the Bollinger bands – has turned up and is signaling expanding bands. This usually points to rising volatility and lower prices, similar to those experienced at the January and February lows.

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Source: StockCharts.com

For those who missed the item over the weekend on Adam Hewison’s (INO.com) technical analysis of the S&P 500’s most likely direction and important chart levels, click here to access the video presentation.

I still maintain that US and other mature stock markets are in the process of mapping out a base development formation which probably means toing and froing between policy tailwinds and economic headwinds. It is only natural (and necessary) that profit-taking should set in after the strong advance; a pullback should not be too much cause for concern, provided the levels from which the rally commenced on March 9 hold.


Originally published at Prieur du Plessis’s international investment blog and reproduced here with the author’s permission.

2 Responses to "Stock markets: reversal time?"

  1. Guest   May 13, 2009 at 11:16 am

    I thank you for your post good sir. The charts you so kindly posted ,(especially the last one) look like a dead cat bounce that is slowly but surely getting lower and lower , thus losing air each time. The problems that led us in are still there and I firmly believe from my reading and slight research that the economy will in fact in relation to the dow- hit 5,000 sometime later this year.We dont have industry of our quote own here in the USA. We need to do that but cannot be branded under protectionism.The numbers thus far are not sustainable given the current real life issues and circumstances that are in the majority of americans’ lives today.thank you