Friday, December 23, 2011

The Market's Technicals - Get back In The Water ?

The current condition is, in a word, seductive. We have drifted back up from the volatile, scary days of August. Europe is taking measures, albeit can-kicking measures. The US recovery is bumping along, albeit a grossly sub-par recovery. If we are to believe the government's figures (a big if) unemployment is going down.

But there are disturbing signs emerging that the main horror show is yet to be. Before I get into the charts, consider this basic fact. We have been in a "recovery" for going on four years now. In this day and age, four years is actually more like the lifespan of an expansion and a bull market. As I pointed out in my last post about the fear roller coaster, there is a striking similarity between the end of the 2003 -2007 four year run and the 2008-2012 version. If we are in a post debt bubble adjustment period, maybe 4-5 years is all the shelf life we should expect from a bull move - like the 1932-1937 five year bull phase.

Now to the charts. And they certainly agree with this notion of an expiration date of a four year run. In the roller coaster piece, I outlined the larger scale fractal nature of the 2003-2007 period and the 2008-2012 approaching period. Now let's zero in on a more detailed technical view of now compared to 2008 (click on image, right click on image then select "view image" then click to magnify)

As you can see, there is an astonishing similarity. This similarity takes on more significance when you consider that it is in response to very similar market dynamics. In 2008, it was the US banks and their ability to function. Now it is the very same thing with the European banks, who throw around about four times the money of the US banks. But then, these banks are so interlinked, that distinction may be muted.

The main technical feature of 2008 was the large head and shoulders top that was put into place, then the intense, VIX spiking selloff coming off the right shoulder of the top. As we technical types like to say "volume tells the truth" and this selling told no lie about the future direction of the '08 market. We had the very same ultra-high volume with the August selling, and it moved us through a critical break of the neckline of the head and shoulders top.

That in and of itself often can be misleading, as in the case of the mid 2010 weakness where everyone was watching the head and shoulders formation there, and we got a break of the neckline and massive shorting, followed by much covering. But this break was not accompanied by the kind of volume increase in the above charts, and it also did not lead to the 140/200 crossover, which doesn't happen that often and most usually has much follow through in a major trend change. We have seen both of these conditions with the 2008 neckline break and the current one.

What we have going now is a critical test of the broken neckline as resistance. This is typical and it took place in 2008 in May through June. It is happening now starting in November. Note how closely the two above charts match in the time frames involved. This means that we are now at the June '08 juncture and we're beginning to walk through the valley of the shadow of death - a time span of about three months. We will either break away from this course soon or complete it.

Until we know which it is, a very defensive portfolio makes sense. This could be a huge overweight in cash, with a core holding of gold that you don't trade, and not much else, except maybe a little VXX, the volatility ETN, which would go ballistic in another '08 style event. Or, it could mean a line-up of mainly very high yielders, the natural gas pipelines, utilities, and such. But keep in mind that these will get hit in another steep selloff - they just recover more quickly and more surely than the other stocks, but they will get hit. A large cash stash waiting to buy these brief low points would be better.

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