Short term overbought last week - next 3 months could be range bound consolidation

From the last post I hinted the stock market could start to rally soon. But the following week there was an one day 2% sell-off before the rally I was looking for finally happened. I also followed up in the comment section of the post that a medium term oversold bullish setup could be occurring too. So since then the stock market has gotten an impressive two week rally especially the Nasdaq. But the medium term indicators has gotten close to overbought for the New York Stock Exchange while the Nasdaq exchange is between neutral and overbought. So caution is warranted here.

As current, the stock market is short term overbought. I would think this occurrence would be like the same situations of the past 6 months... grind a little higher before stalling on the 3rd or 4th week. The problem, which I been stating for the past few months, is the 200 day moving average is going need to be retouched which this hasn't happen yet since 15 months ago. In my Nov. 13, 2013 post I looked back the last 30+ years of the SP500 going beyond 12+ months without retouching its 200 DMA and most went up to 15 months before getting a quick sell-off back down. I also illustrated in the 1996 chart it went up to 18+ months before selling off over 8% intraday before recovering back higher.

So whether the stock market can continues to grind slower higher, any move higher will be temporary as a quick move down is expected and any move lower will also be temporary. I expect to see range bound consolidation for the next few months. Risk has risen and I had reduced my positions to less than 50% and into less volatile stocks. Will continue to reduce positions and go into short term and day trade modes if risk continues to rise. I anticipate the stock market will eventually move higher at the 2nd half of the year.

At short term oversold. Rally here as happened last several times or it's a plunge toward the 200 DMA?

Writing this new post while the stock market is still in session and down intra-day. Just wanted to note that I'm getting short term oversold readings from my indicators. The last three times this happened the stock market in the next day or so bounced back for a rally that lasted about three or four weeks before stalling. In recent posts, I did anticipate a quick strong sell-off to occur around January or February. This looks like what I was anticipating. The SP500 is now down over +4% below its all-time high of 1850 set seven days ago and about +4% above its 200 DMA. So will the SP500 continue to plunge down toward the 200 day moving average (at the 1700 level) I been worried about for the last few months? It could happen but I'm betting for a bounce in the next few days for another strong rally higher.

A look at bullish long term charts to go along with the usual short term overview.

Since the last post on a look out for a short term oversold rally, the SP500 had rallied +3% higher. Each of the previous two short term buy signals, I recalled on my last post, lasted about 4 to 5 weeks before stalling. The SP500 may had already started stalling last week given an overstretched price away from its 200 day moving average. It will be 14 months in mid January since the SP500 (along with the Russell 2000 and NYSE Composite) last touched its 200 DMAs. The SP500 is +8% above its 200 DMA so that's quite steep considering the index don't often go beyond 12+ months haven't touched its 200 DMA. The Nasdaq and Nasdaq 100 are 12+ months overstretched.

On rare occasions, the SP500 has overstretched up to 15 to 18 months before touching its 200 DMA again. Looking back, the years 1954 and 1994 comes to mind. Both have similar price patterns as 2013 and both continued to move higher the following year while stretching the streak to 15 to 18 months before touching the 200 DMA.

Like 2013, both 1954 and 1994 had big gains and the following years were up though about half of the gains of the previous year. Some of my quantitative work hints either or both of the 1st or 2nd quarter of 2014 could be a pause/consolidation phase before moving higher at the 2nd half of the year.

Now lets look at two long term charts I believe should indicate we are in a secular bull market that still have plenty of years to go on the upside.

The long term chart above shows three incidents of breaking above decade long resistance levels. This chart is from October 2013 when the SP500 was at 1695. It is now around 1830, already breaking higher two months later. In layman's term, this look very bullish long term. This is a technical view of a bullish price pattern.

The above chart, which has been circulated on the internet, shows the 10 year annualized return of the Dow Industrial index. The first 3 shaded green boxes indicates the stock market moving from oversold conditions at the beginning to overbought conditions at the end. If the 4th smaller shaded green box is just the beginning then it's likely there is many more years of upside to go. This is a fundamental view of a bullish return rate cycle.

Another short term oversold is near but risk is now very high

My last two posts were written after the stock market was coming off corrections and reversed the trend back up. Each of those two times, I was waiting for another percentage or so more drop further down from the major indexes before reaching short term oversold levels (which didn't happen.) So I'm jumping the gun a bit early here if the stock market tries to reverse the trend back up before the week is over. Note that these last two rallies lasted no more than 3 or 4 weeks before stalling. And given the last several posts, I have been concerned about the major indexes being overstretched above their respective 200 day moving averages. We are now approaching 13 months since the SP500, Russell 2000, and NYSE Composite last touched their 200 DMAs. As illustrated from the charts in the last post, this raises the risk of a sharp and swift sell-off back down toward the 200 DMAs. The SP500 is 7% and the Nasdaq is 10% above their 200 DMAs and that would be big sell-offs if that would occur this month. The seasonality of December tend to be minor weakness into mid December and then a Santa Claus rally into the end of the year. So if there is no further strong correction this month then January or February could be targeted for a possible large sell-off instead.

Indexes holding up better than stocks and are we at a momentum driven bull market?

From last post I commented above the pending high risk of a correction because the major indexes normally retest their 200 DMAs (200 day moving averages) within 12 months. So the 12th month should be about the mid to late November but thus far no correction as I had anticipated. I did initiate some long positions (40%) and short positions (about 20%) but with the market not doing much and the risk involved I had reduced my positions to 20% long. While the last four weeks the major indexes had consolidated or pause at current levels, individual stocks had underperformed with stronger corrections.

Surprisingly, last Thursday's sharp sell off came close to setting a strong short term (and modest medium term) buy signal if the SP500 dropped +1.5% further down (like in early October had the SP500 also dropped another +1%.) So with today's strong rally, it could be another move higher like the rallies of late August and early October. The risk could still be there as I warned from my last post but I'm warming up to the fact that this long term bull market has strong momentum behind its back.

In the charts below I will look at the times when the SP500 have gone over 12 months without retesting their 200 DMAs and what were the outcomes. Most of these occurred in the midst of the bull market run from the early 1980s to 2000.

The chart above has the SP500 go nearly 15 months before a sharp correction in October 1997 to eventually retest (touched) its 200 DMA and then make a quick bounce rally back up. A note, the SP500 did not go beyond 12 months during the parabolic dotcom bubble of 1999 to March, 2000. The Nasdaq bubble burst in March, 2000, after going nearly 18 months without retesting its 200 DMA.

The chart above shows two strong rallies that lasted nearly 15 months each before quick sharp corrections and in both cases they both recovered to continue the momentum trend higher (though the 1st correction was followed by a long consolidation/pause.)

The chart above again saw a quick sharp sell-off below the 200 DMA and then a recovery before moving higher.

The last chart above, was the rallies that started them all for the secular bull market of early 1980s to the eventual top of 2000. The first 2 rallies lasted nearly 15 months and the last two lasted less than 12 months before they retested the 200 DMAs. The Crash of 87 halted the five years of an exceptional rallies and return for investors.

My conclusion from the charts, is that an eventual retest of the 200 DMA will likely be quick and sharp... and will spook the investors. But the fact that this type of market behavior of strong lasting momentum rallies have occurred during long term bull markets.

Oversold rally last week but downside risk still high

Heading into the start of last week the stock market was quite short (and close to medium) term oversold which was I was looking for a downside move from my last post. I did entered some leveraged long positions last Tuesday and Wednesday and got out on the strong rallies of Thursday and Friday. The two day rally was much stronger than I anticipated. Could the near medium term oversold hinted last week warrant an uptrend rally for several weeks? I am inclined to jump in on the long side but with less risky positions and limited allocation (less 20% of my portfolio with very close stop loss.) I am still worried about the downside risk due to the current overstretched 200 DMA (see last post) as the SP500, Russell 2000, and NYSE Composite indexes approach their 11th month since last touched their 200 DMA (the Dow did touch it last week and which could had launched the two day rally.) There were several cases in the last 25+ years where the stock market has gone as long as 18 months but that is very rare and pushing the extreme cases. The chart below illustrates the last time the Nasdaq was a few weeks from its 11th month without touching the 200 DMA and overstretched. This was in 2010 which the stock market crashed due to the 'Flash Crash.' The red ring/circle in the chart indicates the 11th month since last touched 200 DMA in 2010. Not that it'll happen but the government shutdown and the debt ceiling crisis concerns this week could make a good excuse despite the big rally last week.

Overbought and could be more risk this time as the 200DMAs are stretched for the major indexes

From the last post, the stock market rallied higher after making a short rally and brief correction lower as forecast. Short term overbought hints were alerted last week. As stated in past posts this year, the stock market ignored this short term signal and continued to rally for several more weeks before finally turning down. But this time it could be different. As I looked at the charts I noticed that the 200 day moving averages of the major indexes haven't been touched in over 9+ months. Rarely do the indexes goes beyond 12 months without touching their 200DMA. Not only it's being over 9+ months but the indexes are quite overstretched away from the 200DMA so the risks have risen greatly. The stock market can continue to move higher for a couple more months but that will also raise the risk of a possible larger sell off later. So for now is advised to start to take off majority of positions (or even prepare to completely scale out of all long positions) and wait for the indexes to come back down toward the 200 DMAs.