FMX | Connect – www.fmxconnect.com - (Reported 6/16/2010)

The following is an excerpt from the Commodity Trader’s Chart Book by Dan Wantrobski.

We’re not making a huge deal out of the fact that the S&P 500 crossed back above its 200-day moving average yesterday.

In post-crisis / range-bound market environments (as we believe we have entered), longer-term moving averages can actually be a deterrent, generating false signals as the markets whipsaw within more muted boundaries. Take for instance the last two post-crisis secular bear cycles and how the 200-day MA faired during these times: 1937-1942 and 1974-1982.

The DJIA: 1937-1942

Above we chart the Dow Jones Industrial Average along with its 200-day moving average from 1937 to late 1941. This is an important window of market history to watch in our opinion, as it represents the post-crisis period of the last deflationary secular bear cycle in the U.S. 1937 proved to be a cyclical peak in the markets (after the 1932 crash lows, and equivalent to our recent 2007 peak): after the Dow (and S&P) hit new recovery highs during that year, another panic ensued which led to the formation of a cyclical bottom in 1938- followed by a huge rally that posted a 61.8% retracement of the entire decline within 12 months. The 200-day moving average worked well during the cyclical decline and the initial recovery rally (1937-1939)- but then became ineffective: the Dow settled into a very choppy trading range for the next several years, whipping around the 200-day line which remained flat for  a majority of the time. It wasn’t until mid-1940 (when it became obvious that America would be drawn into World War II) that the bottom fell out of the markets and rolled the 200-day back over for the next few years. This period of  time did not provide enough cyclical  trending power to render the 200-day effective, in our opinion.

We understand that cycles fuel rhymes- not repetitions- throughout history- and therefore, we do not expect our current path to be a carbon copy of the late-1930s. Still, the following chart provides a glimpse as to how this deflationary bear cycle has progressed within the last decade:

The S&P from 1928 to 1948 is shown in grey; the NASDAQ Composite from 1999 to present is shown in blue. The Great Depression was the last deflationary bear market cycle in the U.S.. During this period, stocks built a huge trading range from multiple cyclical bottoms formed post-crisis / panic. Against this landscape, interest rates remained very low, while commodity prices (some more than others) rose throughout the two decades. This scenario is very close to how the world is today in our view: volatile stock markets, low rates, and outperformance from commodities / hard assets.

The 50-day MA Still has us Neutral…

Our focus for the most part over the last year has centered around the shorter-term 50-day moving average. This indicator has done a good job (so far) of keeping us on the right side of the tape for most of our current cyclical trend:

SPX: 1107.91

The daily chart above shows the S&P 500 with its 50-day moving average (red line) since the March 2009 bottom. Only two times during our current uptrend did the 50-day signal a neutral position on the index based on a declining trend: Jan.-Feb. 2010 and April 2010-present.

Current conditions- a declining 50-day line not only on the S&P, but on the majority of sector benchmarks- still have us in neutral /weak territory, as recent oversold pressures have begun the process of mean reversion higher (aka a trading rally). We still believe that targets toward these 50-day lines are possible over the short-run. This implies resistance on the S&P lies toward the 1142 zone- a level which is decreasing slightly each day.

However, simply rallying back toward / above the 50-day will not be enough for resumption of the cyclical uptrend in our view. The benchmarks need to reverse these indicators upward to signal further strength (and the ‘all clear’) going forward.

This is especially critical right now because that declining 50-day line is close to crossing below the 200-day. This is a generally rare occurrence on the charts- and the last time it happened, it marked the beginning of the 2007-2009 bear market:

Strategies As we believe that the markets will trade within a more muted range going forward (not necessarily muted volatility per se), we continue to utilize relative strength studies to see what is working. The risk aversion / risk tolerance battle that is currently being waged points to which equity sectors are leading the charge when the markets rally, as well as when they falter: The resumption of a cyclical uptrend is a true rising-tide phenomenon in our view. Therefore, building a portfolio allocation that capitalizes on both cyclical and defensive sectors over the short-run may provide good insulation while the tape makes up its mind- since any resumption of the bull market will likely carry the majority of sectors and stocks higher (including the defensives, even though they may not lead the charge on a relative basis).

Full Credit to:

Dan Wantrobski, CMT

Janney Montgomery Scott LLC

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