Still Stuck in the Range

Includes: DIA, IVV, QQQ, SPY, VOO
by: Sean Hannon

Although my college studies focused on business and finance, I took as many history classes as I could. Some may have viewed these electives as unnecessary academic pleasures, but I felt they would provide perspective regardless of the career path taken. Believing that human nature rarely changes, looking at what once happened provides important clues as to what will come next. As Edmund Burke famously declared, “those who do not know history are destined to repeat it.”

Recent articles have taken a look at the past in order to discern the future. Two weeks ago the focus was on the economy and the odds of a double-dip recession. Despite the negative economic data and constant chatter over the possibility of another recession, historical data indicated the likelihood of such an event to be very low (a view the mainstream media is now recognizing).

Last week I turned my attention to September’s history as the worst month for the stock market and offered my opinion about where prices move over coming weeks.

This week I will continue looking toward the past to see what may come next. However, whereas prior articles examined decades of data, this week will examine a narrower time frame.

Since bouncing off the lower end of its trading range (1,040 – 1,130), the S&P 500 has finished higher nine of 11 trading days. In the process it has rallied 8%, moved to the top end of the trading range, and pushed above the 10-, 50-, and 200-day moving averages (MA). Such a move took an oversold market on the cusp of breaking down to overbought on the cusp of breaking out.

Yet the breakout has not occurred. This pattern is eerily reminiscent of what occurred between mid-July and early August. On July 16, the S&P 500 stood at 1,064. By August 2, it had closed higher eight of 11 trading days, moved to the top of the trading range, and had pushed above the 10-, 50-, and 200-day moving averages (MA). Then the rally stalled. Swamped by concerns over the economy, the market traded sideways for two weeks before collapsing in exhaustion.

A quick scan of the two proceeding paragraphs offers stark similarities. Simply, we have been here before. Those who caught the current rally have done wonderfully, but until we see a decisive breakout, there is no reason to expect the future to be different from the past. The low volume bounce has shuffled dollars between traders, but done little to inspire lasting conviction.

Having quoted Edmund Burke’s warning about understanding history, we should also look to another of his quotes for guidance—“You can never plan the future by the past.” Eventually the current trading range will break and volume will swell. This would mark an end to the stalemate and allow investors to allocate capital more comfortably. Whether that occurs tomorrow, when earnings season begins in a few weeks or months later, no one can tell.

Therefore there is no need to take excessive risks and make large bets on when this event will occur. Our strategy has never been to out think the market and capture every price swing. Instead, focusing on value, watching for trends, and effectively managing risks is essential. Having indentified key prices levels to watch, we will be prepared to act when the time comes.