In spite of recent rally, future still looks grim for equity markets
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Since the middle of April, the equity markets have made a nice upward move, amounting to about a 10% gain for the Nasdaq. Right now, many investors who have been sitting on the sidelines are looking at that rise and wondering if now is the time for them to jump back into stocks.
Among investing professionals, the type of move we’ve seen is sometimes called a “sucker’s rally.” In a bear market, investors sitting in cash get impatient–especially when the market starts to make an upward move. Afraid of losing out on profits, those investors get sucked back into the market only to have it make another downward move.
Below is a chart of the Nasdaq over the past six months. Notice the nice upward move over the past six weeks. You can also clearly see that in spite of the rally, the index is still below where it began the year. In this instance I’ve used a candlestick chart because it makes it easier to see a couple of other points. The red candles are down market days while positive days are marked by the open or white candlesticks.
From December through March, you can see that the red candlesticks are dominant. That changed in mid-April, but the advance has not shown a lot of strength. If this were a powerful rally, there would be periods of five or six days in a row of open candlesticks.
In addition to any technical analysis, economic fundamentals would indicate that this is not a great time to jump into the stock market. High oil prices, inflation, falling consumer confidence, rising unemployment: all of these things indicate that market weakness is likely to continue. Summer tends to be a period of weakness for stocks as well.
One market sector that is bucking the trend and generally doing well is energy. But there are indications that energy might be nearing a top. Below is a chart showing U.S. Oil Fund ETF (USO). Since mid-February, this fund is up about 50%. In spite of the recent run up in the price of oil, this would probably not be a good time to buy this sector.
The gold line is a 50-day moving average. Notice that the fund is trending well above that level. The middle section of the chart is a moving average convergence divergence (MACD) of the fund. This indicator is showing that the fund is at an overbought extreme and a downturn is probably at hand. Finally, the bottom portion of the chart is a stochastic oscillator. It is also showing that the fund is at an extremely overbought level and should soon correct.
The only caveat is that oil right now could be riding a speculative bubble. When that occurs, the investment can remain at an overbought extreme for an extended period. Under normal market conditions, we could expect a downturn in oil prices for the next three or four months as part of a traditional intermediate cycle.
There is a lot of seasonal downward pressure on the market at this time of year. Your safest bet is to remain on the sidelines for now, even though a few sectors are advancing.
Have a great Memorial Day weekend.
F.S.
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