Indicators show current bear rally is losing steam
Forecasting the stock markets is like forecasting the weather but much harder. There are a wide variety of tools available to help us measure and assess market conditions. What makes it so difficult to accurately forecast the movements of the financial markets is the virtually unlimited number of variables that can impact stock and investor behavior.
Locally our weather forecast today is for a storm to move in this afternoon, dropping temperatures and bringing rain to the valleys and snow to the mountains. I can see gathering gray clouds out my window at this moment, so I am inclined to agree with that assessment. I’m sure if I looked at a satellite map or a radar image, I would receive additional confirmation that a storm is imminent. But all the sophisticated equipment does not guarantee there will be rain.
Right now most of the technical indicators we use to assess the investment markets are forecasting a significant downturn in the near future. A few weeks ago I wrote about bear market rallies that Wall Street sometimes calls bear traps. During the 2000-2002 bear market there were several such rallies and each time major indices gained about 20% before falling again. If the current market follows through and turns down over the next few weeks, this will be a classic example of a bear market trap.
The chart below provides a good visual representation of the current situation. We are in the fourth week of this rally and major indices have generally gained about 17% to 22%. The technology sector has lead this advance so tech heavy indices like the Nasdaq have gained the most.
We saw another bear market rally that lasted about six weeks beginning in November 2008. The current rally has been much steeper and stronger. The steepness of a rally is often an indication of its sustainability and this one appears to be too steep to continue much longer.
The middle portion of the chart is a moving average convergence divergence (MACD) of the Nasdaq. This is a very good indicators for identifying periods of overbought or oversold extremes. In other words, it is kind of like measuring how much a rubber band is being stretched. When a rubber band is pulled tight, there is a lot of tension trying to pull it back to a relaxed state. Right now the MACD is showing that the Nasdaq has moved up far and fast and now there is a lot of tension trying to pull it back in the opposite direction.
The bottom portion of the chart is a stochastic cycle oscillator. This indicator is designed to measure random cycles–exactly like those found in the financial markets. When this indicator reaches levels above 70, there is a high likelihood that a correction of some kind will occur. There was a strong one-day pullback on Tuesday and this indicator reacted by dropping slightly below 80, but it still remains in an overbought area.
If this is a classic bear market trap, over the next few weeks we should see the indices decline to their previous lows and then continue to reach new lows. On the other hand, if the market really has bottomed and the worst is over, we will probably still see a correction of about half of the recent gains before major indices regain their upward momentum.
Markets will be closed Friday in celebration of Good Friday and the Easter holiday. Have an enjoyable spring weekend.
F.S.