He Ain't Heavy, He's My Rally

So how long can it go? Now after the carnage of 2007-2009, it might be hard to believe, that the rally we called here (with the help of Mr. O'Neil and Mr. Cramer back on December 21, 2011) is 44 days long without a significant correction. At face value, that may not seem to be a lot until you read Michael Santoli's piece "Market Pull Back Watch." He quotes McMillian Analysis by saying this is the 5th longest running rally without the S&P 500 index touching its 20 day average. (We'll discuss technical indicators a bit later.)

Santoli suggests that the market is looking for reason to adjust or correct. Not to be confused with collapse. (That was for you Hutch, correct, not collapse.) Michael's points to the escalation in oil prices as the possible catalyst to a 2-5% correction. That makes sense to me if oil stays above the 105 area for any length of time.

He also points out that even though most equity markets have all the Euro scares built into current pricing, we might be underestimating the global impact of a Euro recession which seems inevitable. He is not one to say the sky is falling without showing us some of the ceiling tiles so he points to China's weak production report last weak. Chinese export growth stopped in January. You could also filter the new home sales number everyone was talking about last week with the chart below. It shows that the recent improvement is but a tiny step back to where we were.

If you don't get the connection between new home sales and the general economy, just walk around your home. (computers, TVs, washers, dryers, refrigerators, light fixtures, plumbing fixtures, vacuums, to name a few.)

Roulette and the Market

We will get to my prognostications for next week, possible tomorrow. We did want to talk just a minute about technical analysis and why it is important. Reading charts and technical analysis is useful for one purpose and one purpose ONLY. Let me demonstrate.

Here you have a crude chart of a stock showing very clear support and resistance lines. Once they have been identified, the casino managers who hire people that do nothing but look at charts and set computer trading parameters around things like resistance lines and support lines.

Here you got a great chart demonstration a double top, a clear resistance line followed by a break through and a strong upward trend line. The "chartists" love this kind of pattern and will tell their fund managers what levels to sell at or buy at, and as a result, the market reacts accordingly.

Here is another chart where even someone as lame as me can identify some common patterns like a W and a resistance line.

That is why you want to pay attention to technical details. WAIT A MINUTE. Those weren't stock charts. Any guesses of what they are? Go ahead guess. I'm waiting. Ok, I will tell you. They are charts of random flips of a coin heads or tails. All the statisticians did was to assign an irrelevant value to heads and tales and tracked the increase or decrease of the value.

DOW theory was developed by Mr. DOW more than 100 years ago. I won't bore you with all the detail, but he discovered patterns in the movement of the market. (We just proved there are patterns in very consistent statistical measurement.) All of that was good.

By the 1940s, historical evaluation of the these patters started to take on a more important role as a predictor of future value movement. (Keep thinking about the coin.) Now we know in our hearts and souls, that makes no sense. Knowing whether a coin was last heads or tales does not have ANY influence on the probability of the next coint toss. Now you folk who go to Vegas and say "No way because if I put my money on black on the roulette well after the numbers have been read for 30 balls, it is more probable that it will come up black on the next spin." You have just become a technical analyst to a hedge fund manager. Ya see each spin of the roulette wheel does not change the odds regardless if the ball dropped in to a red number 1,000 times. On each spin the odds are 50/50, right. (Not really because you have 38 numbers on the wheel 18 are red, 18 are black and 2 are green-0-00. So your actually odds are 47.4%)

So why is technical analysis important? Because it is now how fund managers and computer programs are making investment decisions to buy and sell and THAT is what drives the supply and demand for any stock or equity.

Take AAPL Apple. There are 932,000,000 coins out there flipping everyday. (outstanding shares) That collective wisdom will drive the stock up or down depending upon how the news of the day affects the coin flippers, how ever if enough coin flippers advance or decline the value, analysts and computer programs say, "Wait a minute red has come up 44 days in a row, the next flip has to be black". Ok what they would say is the stock is 20% over a clear buy point we should take some profit. The big casino managers would begin selling some of their holdings or their program selling will do it for them and take a bit of the profit off the top. The blind folded casino monkeys (you and I) would hear all the technicians saying sell sell sell the stock comes down about 10% and then we sell after the drop. Then the chartists see a support level and tell all the fund managers that black has come up about 20 days in a row and we think it is due for a red day. And a way we go.

That and ONLY that is a reason to understand the basics of chart patterns. Hope this helps.    

 Salve Lucrum