Tuesday, August 9, 2011
This morning's editions of The New York Times and the Chicago Tribune presented the front pages you see above this post. Just as it did this past Friday the stock market has made it into the headlines. Generally speaking big rallies start a day or two after headlines like these appear in the newspapers. Today's 6% rally from yesterday's close is probably only the first stage of a bigger move which should take the S&P (daily chart above this post) back above the 1200 level.
Aggressive contrarians still have above average long positions which were increased from average levels while the S&P was in the 1250-1290 range. This latest break has dropped the average nearly 20% from its May 2 high on an intraday basis. Frankly, this is a much bigger drop than normally appears in the context of an ongoing bull market.
For this reason I think it makes sense to adopt a defensive strategy even though the 200 day moving average of the S&P 500 (red line in the chart) has yet to turn downward by 2%, the mechanical method I prefer for signalling a bear market. I think the thing to do now is to hold on to long positions for the time being, but to adopt the strategy of dealing with bear market rallies which was described on page 133 of my book. Wait for the S&P 500 to close 1% above its 50 day moving average (the black wavy line on the chart) which currently is at 1293 but falling rapidly. When this happens reduce stock market exposure to below normal levels.
The blue arrow projects this drop in the moving average linearly into the future. It looks like the market is likely to meet its 50 day moving average somewhere in the 1200-30 range.
My best guess is that the drop from the May high at 1370 is only the first wave down in a bigger decline. I estimate that the low of this decline will develop somewhere in the 950-1000 range.
Conservative contrarians are still carrying a normal stock market long position. I think this is the appropriate strategy until such time as the 200 day moving average drops 2% from its recent high.