Anyone of us with kids knows that "Catdog" refers to a cartoon about the trials and tribulations of an animal that is a cat at one end and a dog on the other - both with separate and opposite personalities going in two different directions yet needing each other. That sure feels appropriate given the struggle between the bulls and the bears in the current trading range. Maybe we should start a cartoon based on the tightest multi-week range in years called "Bullbear." Now wouldn't that be interesting...pull together the most optimistic bull, and pessimistic bear and see what kind of animal you get.
Meet "Bullbear." My guess is that "Bullbear" would be a market with such feelings in opposite directions that nothing much happens. Maybe a range would develop so tight that traders would successfully sell overbought and buy oversold within the range, while longer-term investors wait for some sign of the direction of breakout. In the current "dog" days of summer, traders are buying oversold near support and selling overbought near resistance - and it is working. Guess where the market is now (Exhibit 1)? The good news for the polar opposite camps is that ultimately the range will be broken one way or another. Unfortunately for the bears, history continues to suggest even a downside break of the range may only be a temporary win.
Exhibit 1 - The forces of "Bullbear" at work
First of all, let's take a look at whether a breakout of a range works or if it is another one of those misused market pundit phrases. The most obvious break from a range that came from high valuations, too much optimism and limited fundamental improvement (until Friday) was the PHLX Semiconductor Index (SOX).
"Bullbear" in SOX? The forces of our cartoon character "Bullbear" were forcefully at work on the SOX at 410. What we found interesting was the argument that these technology bellwethers were overbought, overvalued and overextended, yet it didn't matter. Intellectually, buying the semis didn't seem to make sense at any time after the initial surge off the low, but the market really didn't care. Once the SOX broke out past prior resistance (on a closing basis), the next likely target was the spread of the consolidation pattern that it broke out from. As Exhibit 2 shows, that would have yielded a SOX target of roughly 460 - right where it reached before falling back. While most would consider the failure to close at the highest levels of the day, near 460 would be a natural place for a pause. In a financial world watched so closely, that natural pause (or anything else for that matter) can come very quickly.
The aspect of Friday we found so interesting was the reaction the intraday reversal brought about. There was talk of failure, "reversal day," and an overall tone of disappointment. The fact remains that nothing, either the market or its leadership go up in a straight line...but there are very few signs of a true intermediate-term negative reversal.
Exhibit 2 - Near-term Sox paused at natural place
Patience "Bullbear," patience. From a near-term view, throughout this consolidation period in the markets, we have taken the view of patience. If you are looking to buy, with a trading range of less than 5%, it makes sense to wait until more buying enthusiasm presents itself. Increased buying enthusiasm should come one of two ways; (a) the fear of missing out (greed) kicks in on a break to the upside or (b) those wishing they had bought lower get that opportunity on a meaningful break to the downside. Until sustainable buying enthusiasm returns, there is no need to "buy the next tick."
Stepping back yields a more favorable view. From a more intermediate-term view, we continue to focus on the basing pattern the S&P 500 (SPX) emerged from when it made a sustainable move over 950ish. If you use the same concept of taking the spread of either a basing or consolidation pattern (just as you would in reverse during a topping pattern or a downtrend), and add that amount to the breakout point, the next identifiable target would be nearly 1100 on the SPX (Exhibit 3), which is right where meaningful overhead resistance lies.
Exhibit 3 - the SPX breakout should yield a target of 1100
Talk of disappointment may be premature. Even the disappointment in the recent action of the Financials as measured by the PHLX Bank Stock Index is in the context of a near-term range that has developed after a longer-term breakout (Exhibit 4). In our view, the key in this environment is to step back and view the environment from an intermediate-term standpoint rather than the tick-by-tick, which has not been very rewarding over the last few months. Much like the market as a whole, a break above or below the current trading range is likely to bring in more interest. Even a nasty break would only likely retest the more significant range breakout point, while a move above the current range would break multi-year resistance.
Exhibit 4 - The BKX looks a lot like the market
Leadership and longer-term momentum. In sum, the leadership areas of the market - Financials and Economically Sensitive issues may be taking a temporary break based upon superior relative performance over recent months. "Taking a break" in the context of the current broad market range, does not mean "about to get crunched." It simply means that a rest before another internal conflict for our old friend "Bullbear."
One of the reasons we continue to believe that one way or another more buying enthusiasm is likely vs. the resumption of the secular bear is that whenever this kind of momentum presents itself, it becomes extreme. As gauged by the monthly SPX price and oscillator chart since 1980 (and before), the momentum has yet to even become extreme (Exhibit 5). Waiting for the buying enthusiasm makes sense, but preparing an action once it presents itself makes even more sense.
Exhibit 5 - The SPX monthly oscillators argue for further upside.
source: FTN Midwest Research, Reuters, Baseline
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