Stocks Approach Ceiling of Magical Restraint

A while back I presented a historical study which looked at the behaviour of the S&P 500 relative to its long term trend line: what happens this far above the 200 day moving average? If you haven’t yet, go check it out for full details because what follows will make much more sense.

When the Dow broke 10,000 (for the nth time) in the middle of last month, I cautioned that stocks had risen into thin air (again). The S&P 500 meandered around 1090 for a few days and then fell back.

Now, once again, looking at the same technical metric, I would be remiss to not issue another cautionary note:

As of Wednesday’s close, the S&P 500 index is 18.8% above its 200 day moving average. That is very close the 20% ceiling that seems to exert an almost magical restraint on momentum.

In the days left in the week we could potentially move up to 1120, which would expand the distance between the close and the 200 day moving average to approximately 21%. That’s really the maximum distance that it has been able to roam away from its long term trend in the past. So that’s about +2% further gain in equities from where we are.

Also, remember that tops that form at the 20% ceiling tend to cluster. So just like mid October, we may see a few days where the S&P 500 hovers around the 1120 area before either dropping as it did before or simply plateauing (to wait for the long term average to catch up).

Although this message may appear bearish in tone, it is only in the short term. If my prediction is borne out, then the S&P 500 will have made yet another higher high (and higher low) - the very definition of an uptrend and a rather beautiful chart formation.

Finally, it seems that every time I write along these lines, someone comments to remind me that the “markets can do anything”. So allow me to nip that in the bud.

Well, yes, of course the market can do anything. I’m not under the illusion that I can restrain them or to make them do my bidding. I’m simply observing a pattern of behaviour that they have exhibited in the past and projecting from that a probability. So I hope that is crystal clear.

Comments

[jkh307:]

Babak;
Great analysis ... !! I went back on the links
you provided and you did some great work.
Thank you ...
Jim Horner

Nov 12 11:36 AM

[thiazole:]

Below are the 200 day SMAs of the S&P index along with monthly growth in the 200 day SMA:

Aug 12 874
Sept 11 887 +1.5%
Oct 12 906 +2.1%
Nov 11 928 +2.4%

As you can see, the 200 day SMA is growing and the rate at which it is growing is accelarating (although the rate of change of accelaration is declining). Assuming it is +2.5% for next month and levels off there, that would put the S&P 200 day SMA at 951 on Dec 11 and 975 on Jan 11. This moves the 20% ceiling to 1141 for Dec 11 and 1170 for Jan 11. This is something important to keep in mind. Obviously the stock market can't climb at the rate of 2.5%/month forever, so at some point this ceiling will no longer be a concern. I do suspect that we will be bumping at a couple more times over the next couple months, though.

Nov 12 12:55 PM

[Mr. Big:]

There appears to be a floor on relative values of the US dollar at which governments and central banks around the world are comfortable with before they actively intervene. Today was a clear indication that they are willing to act to strengthen the greenback. Perhaps this may trigger the unwind of the dollar carry trade....which, of course, will lead to a sell off in the stock markets and commodities.

Nov 12 05:21 PM