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SPX and IBM: Market Overbought, but No Divergences Yet


While a short-term correction would not be unreasonable, history suggests higher prices are still likely.

MINYANVILLE ORIGINAL Last night, in an attempt to keep up with the Fed and ECB, the Bank of Japan announced an increase in their monetary stimulus programs, and the yen reacted accordingly. The "race to zero," as countries devalue their currencies against each other so that they don't end up priced out of the world economy, is a spectacle to behold. Somewhere down the road, it seems there will be an ugly endgame here, but these things can go on for much, much longer than seems reasonable. I remember I felt the same way about the housing bubble back in 2005. I felt quite certain by mid-2005 that things would end very ugly, but housing just kept ramping higher anyway. Eventually, of course, it did end ugly... but it first ran much farther than I thought it would.

Most know the old John Maynard Keynes quote: "The market can remain irrational longer than you can stay solvent." My personal twist on that is: "The market can remain insolvent longer than you can stay rational." In any case, no matter what the endgame looks like (and who really knows what that will be), things can always keep plugging along in the meantime.

Bears are hoping for a turnaround here, and I've heard a lot of bearish theories floated recently -- on everything from "QE3 is out now, so there's nothing more to fuel speculation and drive stocks higher" to "bullish sentiment is too high." I'll admit, the contrarian (and the long-term bear) in me wants to jump on that bandwagon. But there is the issue of central bank liquidity, and since everyone who has access to an inkjet is printing more money, it's hard to imagine that liquidity won't find its way into equities.

I haven't completely capitulated the bear case just yet, because the ending diagonal pattern I've been outlining would look really good with a whipsaw here, and oil has suddenly started diving lower. But it seems the bulls have to be given the benefit of the doubt unless the bears can demonstrate some level of equities selling pressure. The approach I'm taking is basically, "Let's stay aware of the bear argument and watch the signals, but right now the trend is still up."

The market is overbought, and a correction would be reasonable. Yet the momentum which got us here was strong -- and that suggests there are still higher prices coming, either before or after said correction.

I want to lead off with IBM (stock symbol: XYZ. I'm kidding... it's (IBM).), more for educational purposes than anything. This chart demonstrates RSI and MACD confirmation vs. divergences, which is an aspect of what I'm discussing above regarding momentum. I haven't marked every single instance, but you'll get the idea. IBM and the S&P 500 (SPX) are both showing confirmation of the rally. While there are always instances when the market turns on a dime, that isn't the rule -- so it has to be considered as lower probability.

Click to enlarge

Next are two looks at the daily chart of SPX.

Click to enlarge
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No positions in stocks mentioned.
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