The Long Awaited Interim Bounce

Includes: DIA, EFA, GWL, IEV, QQQ, SPY
by: Investment Pancake

It appears, at long last, we may be coming into the long awaited "bounce" phase. Equities are broadly higher this morning, and with luck, may stay that way through the day. The MACD is now flashing a short-term buy signal for the S&P 500, which could take the S&P 500 at least up to 1,100 - roughly the level where the index's 200-day moving averages currently rest - or even higher.

But before concluding a long position would be an attractive trade, now for a word of caution from our sponsors. First, look at several of the broader international ETFs trading out there: iShares MSCI EAFE Index (NYSEARCA:EFA), iShares S&P Europe 350 (NYSEARCA:IEV) or SPDR S&P World ex-US (NYSEARCA:GWL). We see here that since April, short-term selling momentum (marked by the 50-day exponential moving average) has dropped below longer-term buying momentum (marked by the 200-day exponential moving averages). Traders, who buy and sell with greater frequency than investors, are basically unloading positions faster than investors are willing to accumulate them. In plain speak, price momentum has become negative in these ETFs (and multiple others besides).

Now, glance back at the charts from 2008. We see there that multiple equities ETFs - notably EFA, IEV, GWL - had all suffered a recent plunge in value during the initial crash of January 2008. The 50-day exponential moving averages had dropped below the 200-day exponential moving averages, roughly during January of that year. True to form, the markets recovered during April and May of 2008, lifting the value of EFA, IEV, GWL and other securities, back above their respective 200-day exponential moving averages.

It appeared safe to get back into the water to some technical analysts, but all the while, the 50-day exponential moving averages on each security remained stubbornly below the 200-day moving averages. The bulls took their best shot, lifting prices in these issues nearly high enough to cause the 50-day exponential moving averages to break back above the 200-day exponential moving averages. When you take your best shot at the devil though, you don't want to miss. The bulls lacked the firepower, and events unfolded in such a way as to drive markets wildly lower throughout 2008 and well into 2009.

At the early stages of a bear market (the big kind, not those little 20% thingies), it is all too common for markets to stage significant relief rallies. They may do so this time as well - perhaps, they already are in the process of so doing. But until short-term momentum becomes price positive and overtakes long-term momentum, it is wise to view the relief rally with the eye of a skeptic and a quick trigger finger poised above the "sell everything" button. For some, this was a painful lesson from 2008.

As always, there are more than a few flies in the ointment. First, the global crash in asset prices that began in May of 2008 was not purely technical in nature. The banking system collapsed, and that's relevant. Who can say whether a comparable set of facts will crop up this time around. Second, technical analysis doesn't predict so much as describe market conditions. Simply because selling momentum is higher today than buying momentum, it doesn't follow that this will stay the case for more than a day, or week, months or years. In markets, momentum tends to last for "a while" - but how long can be more a matter of conjecture than precise science.

Third, international equities ETFs are non-dollar denominated, and the recently, the buck has taken off like a shot. Perhaps the technical posture of ETFs like EFA, IEV, and GWL has more to do with currency fluctuations than actual equities price momentum? Just how relevant is the surge of the US dollar? This question is open to large debate. Last of all, and perhaps more importantly, the 50-day exponential moving average for most US equities index ETFs (notably, SPDRs, or Diamonds Trust Series 1) remain ABOVE the 200-day exponential moving average. US stocks are still in a bull market, technically speaking, and so there is a very significant disconnect between US and non-US equities ETFs. One of these groups is comprised of lying liars... but which one is it.

Thus far, today is a welcome respite after a grim month and a half in the equities markets, but investors will be well served to remember the lessons of May 2008 and draw comparisons. Even in a rally, pessimism and terror can be far less expensive than hope and greed.

Disclosure: No positions