Friday, January 1, 2010

S&P500: Long Term Technical Outlook

Looking out over the next 12 months, my outlook for the S&P500 is bullish. This may surprise many of you as I have had a cautious bent for the better part of six months now, and I have been writing about selling something, anything for the past 6 weeks.

Make no mistake about it, this market needs a correction, and with the market looking toppy, I believe we are nearing the point that a correction will begin. So despite my 12 month bullish outlook, I would not make an out sized allocation to equities until investor sentiment (as measured by the "Dumb Money" indicator) turns bearish (i.e., bull signal). How deep should the correction be? I don't have a clue. Any pullback will likely find willing buyers - especially when investor sentiment turns bearish (i.e., bull signal). This much is a given. The correction will not be the end of this bullish run that started in March, 2009; it will be a buying opportunity.

While it seems obvious that any meaningful correction will lead to a buying opportunity -as it usually does - the longer term perspective suggests that markets won't roll over so easily, and to understand why this is so, we need to look at a monthly chart of the S&P500. See figure 1.

Figure 1. S&P500/ monthly

The red and black dots on the price bars are high and low pivot points, respectively. If we draw a trend line from the two most recent pivot high points, we note that the S&P500 broke this trend line back in November (see the blue up arrows on the graph). This is bullish. How bullish? This price behavior - a break of a down sloping trend line - is bullish enough to suggest that we will not have a market top of significance until there are a clustering of negative divergence bars (see pink marked price bars with ovals on price chart at 2000 and 2007 tops) or there is a close below a pivot low point. (Of note, this price behavior is fairly consistent across decades of price data when looking at the S&P500, Dow Jones Industrials, NASDAQ, and Russell 2000.)

The clustering of negative divergence bars implies slowing upside momentum, and we are at least two months away from possibly developing our first one. One negative divergence typically implies a trading range. While several negative divergence bars implies the strong possibility of a market top. In addition, as the market has gone straight up since March, there are no pivot low points, and the bounce following the first pull back (if and when it comes) is likely to create one. If the markets were to close below this pivot low point, then it will be another bear market.

All this is going to take time. So my bullish "call" is more like I cannot get too bearish on this market in the long term. If we are going to have a market top of significance that leads to a bear market, then that top, which leads to a rollover in prices, is going to take months to develop. It is that simple.

By the end of the year, the S&P500 may not be higher, but it is unlikely to be too much lower. At some point, there will be a correction, which should be a good buying opportunity. To me, a good opportunity means that risk will be well defined and reward or upside potential will be worth playing for. And if history is any guide, we should have about 2 good buying opportunities next year.

For equities, I cannot see the secular bear market resuming without a prolong period of discourse.

7 comments:

D-man said...

very nice analysis

we have 2 posibilities

- develop a cluster of negative divergences (takes months)

- develop a low pivot point and see how the market behaves relative to that point.

And because the next correction will be buying a opportunity, the second scenario (a close below that lower privot point) is unlikely in the coming months; more, new highs are likely after that correction. Which leaves us with the cluster of negative divergences to look for a market top. Correct?

thanks

D-man said...

I will have also a personal comment on the correction (if it's coming). As we saw many times in last months that every time there was a small dip buyers quickly stepped in (without moving prices substantially higher) there is no reason not to expect the same at the first phase of the correction. We saw here that in order to have a "buying opportunity" (low risk), we need "dumb money" to turn bearish; in order for that to happend, we need much lower prices. So in the firs phase of the correction these "dip buyers" need to be washed out and make them turn bearish, probably with correction going on (second phase).

So how large a correction? Last correction in this bull was 9% back in July. I would speculate this must be well larger in order for dumb money to become bearish (and get a buy signal). 15-20% is not out of the question.

What do you think Guy?

Anonymous said...

CRASH BIG IS GOING IN JANUARY,YOU SHOULD HAVE TERROR OF THIS.RUN RUN AND SELL STOCKS¡¡

Anonymous said...

I think January 4th will begin little bearish, but if it comes back, S&P500 will touch 1143, and then come back to 955.

The other possibility is touching 1193, where the lower pivot point would be the same than before or 1139.

It's just my opinion, but have to see what happen 2003.

Javier

Guy M. Lerner said...

Dacian:

Happy New Year!

1) I am not prone to make wild predictions like a "big crash" is coming; I don't think it is useful; I am presenting data that suggests the most likely outcome

2) the trendline break I speak of in the article is bullish and because of that it is highly likely that the market won't rollover without a long period of consolidation; this will be manifested by the appearance of multiple negative divergences.

3) confirmation of the resumption of the bear market will likely be a close below a pivot low--this is the "M" type top

4) these are just price patterns most often seen at market tops

5) so my rational for my "I cannot too bearish" call is that a bullish trend line break typically doesn't end by just rolling over

6) with regards to the correction or how things might play out, I could conjecture: a) first we get a mini - correction that is bought but the bounce fails to materialize; b) more selling ensues with folks throwing in the towel

7) I guess the correction has to be such that the old pattern is broken and people start thinking that a new pattern is upon us

8) lastly there is the thought shared by many that the market is just going to go straight up from here--anything is possible; it is not the high odds play and this would just require one to keep their investment horizons short term in nature

Anonymous said...

Great Work GUY!

A question regarding the calculations of the pivot points used in your analysis. I see the Tradestation code of (3,3,CLOSE,1,0)....What does this refer to? What is the actual signifgance of these Pivot Points?

Also I am curious if you still offer a subscriber service for your Market timing model?

Tank you for your wonderful analysis. Yours is one of my favorite sites around!!!

Kingsley

Stas said...

One thing I`m not understand in this market - who is buyers at this levels? Retail investors don`t anticipate - they sell all year. So - short covering + hedge funds+ wild speculators? :)) Can they alone push market to the 1200? When retail is selling... May be this is FED games in markets? I simply don`t understand what participants expect - 5% GDP in 2010\? :) Or now in market is only technicall players and they don`t know why economics have influence on markets? )))