The financial markets continued to be under pressure yesterday in front of Secretary of State Powell's UN presentation. The tone and the person presenting it reinforce that unless Saddam decides to take a long overdue vacation, there is likely to be some military action in the next few weeks.
The real issue here is how much of the military action is factored into the financial markets. Obviously, we will only know that after the fact, but should look for signs as we progress toward some resolution to at least one of the geo-political situations. It seems apparent from the Cisco (CSCO) quarter and commentary that the fundamental backdrop hasn't changed that dramatically over recent months, so we must look again to the technical indicators for signs of a washout.
My view has been that the major indices and their components have reached pretty deeply into oversold territory creating an environment for a bounce. The problem is the equity market remains in secular bear mode and the intermediate-term indicators have not yet reached levels that have led to a significant countertrend rally in the past. As a result, I have continued to advocate focusing on waiting for the intermediate-term indicators to flash a green light vs. playing the near-term oversold condition for an upside trade.
The question is --- has the weakness over the past few sessions been enough to change the intermediate-term picture? The answer is "a little bit." The weakness has caused the indicators to move in the right direction, but they remain far from flashing a buy signal for a sustainable countertrend rally. As I mentioned in yesterday's article, there are two ways to get there; a sharp price decline and/or a grind lower over the coming few weeks.
Yesterday presented a pretty nasty day and brought the weekly stochastic indicator very close to oversold. If I go back to the initial stochastic oversold on the weekly charts of the S&P 500 last year (after dropping from an overbought condition), I find that the market dropped over 20% AFTER the first oversold extreme was reached in May. This is why I included the RSI, MACD, VIX and other indicators I look at in last week's column. The urge is to buy the first oversold indicator; the reality is that investors should wait for confirmation from the others before committing to anything more than a trade. So far the others are far from confirming.
The near-term oversold could lead to a bounce, but until the intermediate-term indicators confirm a deep enough oversold condition (washout) any rally should be fleeting and not trusted.
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