No Quick Cure for These Summertime Blues

Barron’s

This week’s stock-market decline broke several important chart levels. Time to take on more cash?

Wednesday’s 280-point drop in the Dow Jones Industrial Average was more than just an occasional big down day. The market’s sentiment changed from bullish to bearish, and that means the summertime will likely see further selling pressure. In bull markets, the strategy is to buy dips and let the rising trend take care of the rest. After nearly a month of gentle corrective declines, investors remained true to form and returned from the long holiday weekend with wallets wide open. Tuesday, stocks started strong and finished strong.

Indeed, volume was the heaviest it had been in two months and various technical levels on the charts were breached to the upside. So far, so good. But when prices headed south the next day, all of these positive changes were instantly negated. For example, the Dow climbed back above 12450 on Tuesday’s rally, which was the level from which it broke out to the upside in April (see Chart 1). At that time, it represented a victory for the bulls after a three-month stalemate, and the market seemed to be in very good shape.

DOW JONES INDUSTRIAL AVERAGE

In what seemed to be a normal decline within the ebb and flow of a bull market, prices eased in May. The decline took the Dow below 12450 but within an acceptable margin for error. In other words, the dip was not big enough to overrule the upside breakout. Stocks responded with a four-day rally. With Wednesday’s selling, we now have a larger violation below 12450 and that suggests the breakout failed. In technical analysis, failed bullish signals become bearish signals. The Standard & Poor’s 500 offers a different look but sports a failure of its own. Currently, it is sitting below the rising trendline that guided it higher since August 2010 (see Chart 2).

STANDARD & POOR’S 500

It first dipped below that line last month for a preliminary technical breakdown. After several rally days ending in Tuesday’s surge, it was unable to move back above the trendline. Chart watchers call this a « test » of the breakdown. The S&P 500 rallied to kiss its now-broken trendline from below, and when it did the sellers returned in droves. What was recently thought to be cheap was now perceived to be expensive. Market psychology shifted for the worse. To be sure, a trendline breakdown does not necessarily mean a bear market is coming. Prices can drift sideways to lower for many weeks, so this is not a call to sell it all. However, investors may find it difficult to find stocks with good technical charts. Investors may be better served by sitting with a higher-than-normal portion of their portfolios in cash for a while.

Over the years, the summertime has not been kind to investors. This year does not look to be an exception.

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