Markets Have Regained Strength on Fed Decision, but Is the Breakout Confirmed?

By Kevin A. Tuttle  SEP 17, 2012 9:05 AM

When a breakout of this nature occurs, there are additional mechanisms that have to come to fruition to ensure the move is not only fruitful, but also substantiated.


The capitalistic system is the oldest system in the world, and any system that has weathered the gales and chances of thousands of years must have something in it that is sound and true.  We believe in the right of man to himself, to his own property, to his own destiny, and we believe the government exists as the umpire in the game, not to come down and take the bat, but to see that the other fellows play the game according to the principles of fairness and justice.
-- Nicholas Longworth

Over the last week the global equity markets continued their bullish action as the tape persistently rolled higher. Fed Chair Ben Bernanke helped bolster the move with unprecedented action to not only continue Twist, but to begin purchasing mortgage backed securities in an effort to help swab up toxic debt which may be remaining, in turn providing further liquidity.  But let’s not forget that quantitative easing is meant to do one thing and one thing only: increase consumer confidence, and thereby business, in order for the economy to hit critical mass and become self-sustaining.
With global economic leaders easing policy in unison, the markets have regained strength and, in terms of the US equity markets, have finally pushed above the peak just before the Lehman collapse in 2008 (1,440).  The next stop for the broader market (S&P 500 Index (SPX)), technically speaking, will most likely be the 5- and 12-year highs (10/2007 & 3/2000) around 1,550. 
When a breakout of this nature occurs, there are additional mechanisms that have to come to fruition to ensure the move is not only fruitful, but confirmed (or better said, substantiated). In analyzing the cyclical trend (1- to 5-year) the additional facets begin with ascertaining the broader scope.  In our firm’s past articles we’ve discussed underlying strength beginning with our three favorite secondary indices: the PHLX Semiconductor Index (^SOX), the KBW Bank Index (^BKX), and the Dow Jones Transportation Average (^DJT).
With the Fed’s latest move it is obvious that the banks were first to initiate their advance higher and begin to overcome the latest resistance.  The SOX, yet to break above its short-term resistance, is looking extremely attractive if it can continue higher for a few more days.  With this said, it comes down to evaluating the transports.  In doing so we lean on Dow Theory because it is here where investors, if confident in economic expansion, believe in the growth of inventories and therefore the delivery of such.   Hence, one confirmation comes in the form of shipping orders.  Technically this index has only shown moments of strength over the last year.  If the index can break through the downward trend in place since July of last year, again on a sustainable basis, we believe this will be the first sign of confidence into the latest broader index advance.  

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On a purely technical basis we lean toward my firm's Cyclical Trend Index (or CTI).  Although it has recently given way to shifting from neutral to bullish, it remains in a bull ‘unconfirmed’ stance -- a step in the right direction.  Conversely it has yet to provide such confirmation to call it ‘bull confirmed’ (above 90%).   In analyzing CTI over the last 50 years (since 1962) it has directed, with absolute confidence, cyclical stages by identifying tops and bottoms within the larger secular (5- to 20-year) stances.  Nonetheless, until the CTI reaches a confirmed stance there remains a semblance of risk, possibly in the form of a false breakout as the market rallies toward the secular channel resistance (or SCR) in place for the last 12 years.

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Not to continue pontificating on the Fed’s decision and end this piece playing Negative Nancy, but this action, with all the QEs (1, 2, and 3), is meant to kick-start an engine which has seemingly stalled.  The question is really bifurcated in that many are asking whether the Fed’s action is doing nothing more than supporting the thought of regaining strength and simply buoying the ship; it's putting a Band-Aid on a broken arm.  In attempt to understand investors must look at a market which is pushing against the SCR as GDP is growing at 1.5% with 8%-plus unemployment, again, asking the aforementioned question. 
For as long as I’ve been privy to be in the industry we’ve heard the adage, “The market is the greatest leading indicator for the economy.”  I wonder if that is still the case considering where the market is in relation to where the economy is.  Last week my firm was in NYC speaking on a panel for family offices. We ended our market commentary by saying, “…there is reason to believe, based on a weight of evidence and probabilities, the market has entered yet another short-term bullish stance.  Yet, in this environment we would rather fly with a parachute strapped on our back than without.” For now, in our humble opinion, investors can plausibly go along for the ride as long as they are nimble enough to shift if signs change.
We hope this helps and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

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No positions in stocks mentioned.

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