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LATELY, THE BEARS HAVE been saying, "heads I win, tails you lose" to the bulls.
Good earnings have not moved prices higher. Falling commodities now signal economic weakness rather than cheaper input prices. Even a Wednesday bounce in the sickly euro was an excuse to sell stocks.
Technically, the trend in the U.S. stock market is now down.
In a previous column, I wrote that the key 50-day moving average on the Standard & Poor's 500 was now confirmed to be broken to the downside (see Getting Technical, "Stocks Can't Find a Footing," May 17).
Many investors are familiar with another market signal based on the relative positions of two major averages -- the 50-day and the 200-day. When the 50-day crosses above the 200-day, a "golden cross" signals an important buy signal. The last time that happened was in June 2009 and it worked well.
Conversely, a cross the other way, called a "black cross" or "death cross" is a sell signal. So far, that signal has not happened.
However, a shorter-term version of this system has signaled a short-term sell. A crossover of the 20-day average below the 50-day average is not as powerful as the death cross, but it does tell us that something is indeed wrong. For the S&P 500, the downside crossover happened this week (see Chart 1).
Chart 1
To be sure, a short-term system such as this one is prone to false signals, so it cannot be used to time the market by itself. However, as part of an arsenal of indicators it adds to today's bearish argument for stocks.
Another reason to be very wary of the stock market now is the age-old mantra of "sell in May and go away." This refers to the seasonal tendency for the stock market to struggle in the summer months and rebound in the winter. Over the past century it has been a useful strategy.
As with all stock-market cycles, there are exceptions and, indeed, May was not a good time to sell in 2009. But even last year, the market did face a steep correction in June so we cannot dismiss it. We have to give the bears the benefit of the doubt.
Another argument against stocks is found in the commodities markets. With such economically sensitive commodities as copper and crude oil breaking down, we can surmise that the markets are having doubts about the economic recovery. I'll leave the formulas and fundamentals to the economists, but when forward-looking markets are weak we can take the hint. Stocks are also starting to sense pending economic problems down the road.
Aside from commodities themselves, currencies of countries considered to be commodities dependent are falling hard, too. Specifically, the Australian dollar just crashed through an important support level. Using the CurrencyShares Australian Dollar Trust (ticker: FXA) as a proxy, we can see prices falling sharply below the bottom of an eight-month trading range (see Chart 2).
Chart 2
The chart of the Australian stock-market benchmark ASX-200 index shows a similar breakdown. Prices are not only below an eight-month range but also below the 200-day moving average. There may not have been a death cross in the averages but this is a bearish development in its own right.
The question now is how far this correction will go. For the S&P 500, there is important support from the February low near 1050 (see Chart 3). It would represent a 14% decline from the April peak and when spun by the bulls, would be a "healthy" correction in a bull market. That does assume a bull market is still operating.
Chart 3
There is no doubt that the market tone has changed quite a bit over the past month. Good earnings news is ignored and bad news is soundly punished -- both conditions found in bear markets. Emerging markets are lagging the domestic market. And the Chinese market, home of the world's growth engine, is already officially in a bear market with a greater than 20% loss from its 2009 peak.
Right now, it seems that the only indicator in the bulls' camp now is the Chicago Board Options Exchange volatility index, aka the VIX, with its current level in the high 30s. In the past, this signaled enough fear in the market to call at least a temporary bottom. However, its chart now looks eerily similar to that of September 2008 just before it took off for the heavens.
I am not saying the market is heading for a 2008-style crash, but for me, preservation of capital is the best strategy now.
Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com
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