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S&P 1250

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But it's all good!

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I have not seen his latest letter, but I understand Richard Russell, a market veteran for whom I have tremendous respect, has a piece out featuring a point & figure chart of the S&P 500 using a long-term 25x3 scale.

Would a move to 1250 be extraordinarily bullish for the SPX? Let's consider the context.

S&P 500 25x3 scale
Chart courtesy
Dorsey Wright.



The problem I see with this potential new buy signal, which traders are increasingly regarding as a given in this market, is simply that if it does occur, it requires some sort of context.

Buy and sell signals fail all the time. By "fail," I mean they describe present price action, but do not necessarily predict future price action. This is an important distinction, description versus prediction. In my view, description of the present action is critical since it is impossible to know where you are going unless you understand where you are.

It's as if each and every day financial markets drop us off in a strange location, and it's our task to map out a path for where we would like to end up. Importantly, since we never arrive at our destination by the time the market we trade closes, and because markets are non-linear, we must begin anew the unique process of mapping out our destination with great frequency.

In my experience, many market participants look for a map in the beginning, especially one that seems easy to follow, and then they hope the market allows them to follow that particular map until they arrive at their destination. But, as we've learned, markets requires more flexibility than that.

So we need to understand the context of the potential SPX buy signal that may occur at 1250. Presently, the contextual bullish percent indicators are showing that risk is high, but the conditions are not outright negative. In other words, the risk is high, and the indicators are declining from their peaks, but they have not yet reversed down from a column of Xs.

In order to arrive at our present context, let's go back a bit. On January 16, 2004, the contextual bullish percent indicators (according to Dorsey Wright data) were at 86% for the NYSE and 74% for the Nasdaq. Today those indicators are at 68% and 52%, respectively, and have been making lower highs - even as the Dow and NDX have remained almost flat, and even while many indices have posted large gains; the Russell 2000 is up more than 14% over that period, and small caps are up about 25%.

What this means is that the percent of stocks participating in the upward price action (by definition, giving new point & figure buy signals) is diminishing, while the percent of stocks contributing to the downward price action (by definition, giving new sell signals) is increasing.

That is descriptive of churning, not basing, and new buy signals are more powerful when generated from bases, than from extensions of moves that occur within the context of high risk.

Compare this to the "basing" action, which occurred in July 2002, October 2002, and March 2003. On July 31, 2002 the NYSE and Nasdaq bullish percent indicators were both at 24%; on October 31, 2002, they were at 36% and 32% respectively, and by March 31. 2003, they were at 36% and 34% respectively. That was basing action.

The SPX may indeed generate a long-term new buy signal at 1250, but the conditions for that buy signal, and the overall context, are quite dangerous. This does not mean one must avoid all stocks and avoid all risk. Rather, by understanding the context it can help one choose how one would like to participate (or not - which is, believe it or not, and despite what the Fed's actions say, a legitimate financial plan for some) in a manner that best suits one's risk tolerance, style and financial condition.




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No positions in stocks mentioned.

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