Will a Bull Market Break Out?

Includes: QQQ, SPY
by: Jeffrey Bernstein

Before I even get started, I will come clean and remind readers that a year ago I suggested that a new bull market could be born out conditions just becoming less bad (Introducing the Less Worse Bull Market). Major flub, total bonehead call, the market imploded 4 months later. The somewhat improving technicals were merely a head fake that kept complacent investors from bailing before the really heavy stuff came down.

So how do I feel about the current stock market action? Conflicted! I hate the economic outlook, both short and long-term, I hate what the government has been doing to capitalism, risk and reward and all that is fair about our flawed but egalitarian system by not letting banks fail. I believe that smaller banks are in for a world of pain along with the commercial real estate market, while large banks have been incentivized to sit on their festering stinky old loans and "kick the can" forward for as long as possible instead of recognizing losses. This suggests to me that debt capital for worthwhile new investments, at rational prices will be stymied - not what our system needs right now to re-invent itself. Need I mention that the states are bust, the government is bust and there is no next big thing for the U.S. economy to leverage off of....carbon credit trading anyone??

Now that emotions are out of the way. Let's go to the tape. Stock charts are made by real investors with real money, crazy, deluded, smart as a fox or not. The equity market is an incredibly powerful capital raising machine when it is in gear and there is no doubt that that is in fact the case today. The Wall Street Journal carried a quote from a bank executive saying "It's easy to raise capital now." We are seeing where all the TARP (and other liquidity programs worldwide) is starting to flow out of the banking system, into stocks and commodities. We must not ignore the power of "reflexivity", George Soros's concept, that markets often drive economic trends as opposed to the normally expected course of events.

The chart above is the Dow Jones Industrial Average getting ready to "go topside" in the immortal words of my friend Stan Weinstein. I have waxed poetic before about the importance of the 200 day moving average to markets and stocks (Where is The Stock Market Headed? 200 Day SMA). So suffice it to say, that when a stock or index is able to surmount it's 200 day moving average in convincing fashion, particularly if that moving average is no longer trending down strongly it is an important signal of future trading activity and for many students of technical analysis it is the only sign of the birth of a bull market. The logic being that If a market can sustain an upward bias for 200 days, it has had time to fully digest whatever news was making it go down, and vice versa. In other words time heals all wounds.

Now most technicians also want to see confirmation of a bull market turn in more than just one major market index. Dow theory actually requires that the Dow Transports be in a bull market along with the Dow Jones Industrials. The logic here being that goods being manufactured should be improving, along with increases in goods being transported to market. Today many technicians look at the NASDAQ composite (QQQQ) and S&P 500 (NYSEARCA:SPY) confirming a move in the narrower Dow Jones Industrial Average. You can see that both the Nasdaq and SPX here:

FYI the Nasdaq is about to also get a technical afterburner signal called a golden cross, when the 50 day (shorter term) moving average powers above the 200 day moving average, potentially signaling that the NASDAQ is the way to play for upside at least short-term.

Last time I was premature to suggest that maybe things were not going to get much worse and the stock market could start to recover. Of course the stock market has already had a huge move off the bottom and frankly with the extensive damage to the economy that has taken place and dangerous changes to the capitalist system my outlook is pretty bleak. In fact I am going to work on a piece about the Misery index soon, a subject that is relevant when jobs are scarce and inflation is booming. But the stock market doesn't care about my outlook and, contrary to my son's belief, I am not all knowing and all seeing. I'm not telling anyone to go long stocks here, or suggesting that the best returns off the bottom have not already been earned. I am just saying that if the Dow Jones breaks out above its 200 day moving average on volume and doesn't immediately roll over and crash, it's a new bull market. Like it or not, don't try to fight it. How long it lasts and how much of a return it produces I will leave up to the professionals. However, it will take a lot of unexpected bad news to turn it back into a bear. I still think there is lots of potential for unexpected bad news further out into the future, so I am a scale seller looking to redeploy capital into cheap, well positioned income producing property that others will be forced to liquidate because they paid too much for it.