What Do the Stock Charts Suggest for February ?

Barron’s

U.S. stocks had their best January in 15 years. But technical indicators are sending mixed signals about whether the rally can continue.

Even intermediate-term bears such as yours truly can see that stocks have been in short-term rally mode for nearly two months. And now with the Standard & Poor’s 500 notching a so-called golden cross, the mood of the market remains positive. New highs here we come? Not so fast.

Chart 1

STANDARD & POOR’S 500

[GT1-0201]

Your market outlook may just depend on which index you analyze and which technical indicator you employ. Such inconsistency across market segments does not provide an environment conducive to taking lots of risk. That means it’s best to keep your powder dry.

Much has been written about the golden cross, which occurs when the 50-day moving average crosses above the 200-day average (see Chart 1).

Last month I wrote about a version of this indicator using exponential, or geometrically smoothed, moving averages (see Getting Technical, « A Tarnished Sign for Bulls, » Jan. 5). Theoretically, it signals a confirmation in an emerging bullish trend. And before the financial crisis of 2008, I would have agreed with the theory.

Golden crosses and their bearish counterparts, called « black crosses, » are not supposed to happen close together. Each occurrence is supposed to signal a trend that should last for one to two years or more. However, for the second time in less than two years, we have seen a black cross and a golden cross only a few months apart. When a signal produces a lot of whipsaws, we have to take it with a big grain of salt.

Making it even more questionable, only some of the major indexes have their golden crosses in place at this time. The Dow Jones Industrial Average crossed in December. The Nasdaq and the Russell 2000 small-capitalization index have not had their respective crosses yet.

Which one represents the market?

I would argue that small stocks must join big stocks with golden crosses before the signal has real meaning.

There are other signs I still see that make this year’s performance to date questionable as a bullish signal. The most important, in my view, is how individual stocks react to earnings.

For every Seagate Technology (ticker: STX) jumping higher on good earnings news, there seems to be an Alkermes (ALKS) giving up huge premarket gains to close lower on the day. Seagate makes disk drives and computer storage devices. Alkermes and partner Amlyin Pharmaceuticals (AMLN) both jumped Monday on news that their latest diabetes drug was approved by the Food and Drug Administration.

And for every Apple (AAPL) jumping on solid earnings, there is an Amazon.com (AMZN) getting clocked on a revenue miss.

In bull markets, good news is rewarded handsomely with price gains while bad news is shrugged off. In bear markets, the opposite is true so the presence of both together suggests the market is conflicted and not really as healthy as its January performance would lead us to believe.

Finally, there is one indicator, called the « January Barometer, » now getting press for its bullish forecast. But I have to dismiss it as being meaningless. The theory is that a strong January leads to a strong year but studies have shown it to be little better than a coin flip.

For starters, most years are up-years. And most Januaries are up-months, in part because they are in the middle of a seasonally strong winter. Investors familiar with the « sell in May and go away » mantra will know that the flip side is to buy in November and sit tight through April.

Indeed, the last three January Barometers in 2009, 2010 and 2011 did not work as advertised.

So, while golden crosses and January Barometers are great stories, their reliability is questionable, at least in the market today. The current rally may indeed continue a bit longer but not because indicators say it will.

I’ve written before that low trading volume thanks to a disengaged public leaves the market at the mercy of news generated outside the market and specifically from Europe. More than ever, relying solely on indicators is a bad idea.

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