Two April 13 stories may help the market hold near some key levels. The bears have been in control for almost a week now, but the bulls got some good news from England and President Obama is scheduled to describe his ideas to reduce the deficit on Wednesday.
With the markets jittery about the end of QE2 and Federal Reserve Chairman Ben Bernanke due to participate in his first press conference on April 27, any news that decreases the pressure to reign in extremely loose monetary conditions is a positive for stocks. According to Bloomberg:
Bank of England Governor Mervyn King won respite from pressure to end record low interest rates as soon as next month after inflation unexpectedly slowed and retail sales plunged.
Deficit reduction also can reduce pressure on long-term interest rates. According to the Wall Street Journal:
In a midday speech in Washington, Mr. Obama will propose a plan that includes cuts to entitlement programs such as Medicare, limits on military spending and an overhaul of the tax system designed to bring in more revenue.
While the bears picked up the pace of selling on Tuesday, the market (SPY) has been basically asleep since April 1 with tight trading ranges and low volatility. Periods of low volatility are often followed by periods of higher volatility.
Welles Wilder developed the Average Directional Index (ADX) to measure the strength of a trend, without regard to the trend’s direction. In the chart below, Wilder’s ADX is at the top and the S&P 500 Index is at the bottom. The thick black ADX line rises as a trend strengthens and ADX falls as a trend weakens. When the red ADX line is above the green line, as was the case at the close on April 12, the bears have the upper hand. When the green ADX line is above the red line, the bulls have the upper hand.
Our description of the chart will move from left to right. Notice how when the ADX black line moves up from low levels (see orange arrow left), the stock market often makes a sharp move (see orange line bottom left). Similarly, when the black ADX line moved up from low levels in the middle of the chart (see green arrow), a strong uptrend followed. The takeaway for us today is near the blue arrow; ADX is at low levels, which is often followed by a “pop” in the market. The fact that the red line is above the green line does not necessarily mean the “pop” will be down – it is too early to tell.
How does all this help us? In case the big move is down, we took some profits off the table before the close on April 12, cutting back on energy (XLE), utilities (XLU), and technology (QQQ) – we still own all three positions, just not as much. If the big move is up, we are fine with that since we still have significant exposure to the markets. Our next move will use the incremental approach; if the bears regain control we will continue to step away from risk. If the bulls remain in charge we will consider redeploying some of our cash depending on how strong the advance looks and what type of news we get on the inflation, growth, and interest rate fronts.
As outlined on April 8, we remain tentatively bullish, but we are concerned about the approaching end of QE2 - a relatively rare circumstance that does not have much in terms of historical precedent. We are also concerned about recent sentiment readings which have come in excessively in favor of the bulls, which can be a contrarian indicator for stocks. Earnings are facing high expectations which can lead to disappointment.
Disclosure: I am long XLE, XLU, QQQ.
Disclaimer: Chris Ciovacco is the president of Ciovacco Capital Management, LLC (CCM), a Registered Investment Adviser with the SEC. Chris Ciovacco and CCM and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. This commentary does not constitute individualized investment advice. We have no way of knowing reader’s goals, risk tolerance, or financial situation. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
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