Market Technicals Are Becoming Clearer, Darker

Includes: DIA, EEM, EFA, QQQ, SPY, VT
by: Investment Pancake

Several widely followed technical indicators are now pointing toward a bleak intermediate to long term picture for equities. Specifically, the 50-day simple moving average has dropped below the 200-day simple moving average for all major US and broad international equities indexes, demonstrating that these averages are, indeed, behaving as trading resistance.

For instance, we see this posture shared by the SPDR S&P 500 ETF (NYSEARCA:SPY) and the Vanguard Total World Stock ETF (NYSEARCA:VT). At the same time, the moving average convergence divergence indicator for both these funds also shows strong negative momentum, with short term selling momentum having overtaken longer term buying momentum as of the second week of August, and dropping now into net negative territory. Similarly, the 50-day exponential moving average has broken below the 200 day exponential moving average for a number of broad based equities ETFs, or threatens to do so within the next couple of trading days.

On a longer term time frame, we now see that the 20-week simple moving average has sliced below the 40-week simple moving average as well, demonstrating that net selling momentum is gathering steam, and that both moving averages are now behaving as trading resistance. That posture is shared almost universally by some of the widest traded ETFs including SPY, VT, EAFE Index Ishares (NYSEARCA:EFA), and Ishares MSCI Emerging Markets (NYSEARCA:EEM).

The last time all these technical indicators were shared this universally by widely traded ETFs was January of 2008, nearly half a year before the 2008 credit crisis erupted with full force. It could be that equities markets are pricing in a new phase of the credit crisis, perhaps generated within the banking sector or perhaps within the public finance sector. Or it may simply be that equities markets are pricing in a next phase of the recession.

But the main thrust of technical analysis is not to ask WHY the markets are doing what they are doing, or to argue about whether the market is "correct" or not, but to simply observe WHAT the market is doing and to act according to that information. Technically speaking, what the market is doing is forming up a technical posture that is typically observed during the front end of a bear market. That fact alone is sufficient information to drive some traders to sell equities, which can be enough selling pressure to drive a self-fulfilling prophecy of lower equities prices going forward.

Technical analysis is like any trading tool, in that it is more descriptive than predictive. And technical analysis fails to provide much in the way of a very long term secular picture of what's actually happening in the markets. That is to say, markets move in very long generational cycles. At the front end of a secular bull market, we tend to see widespread investor apathy towards, or revulsion of, equities, such as we saw in the late 1970s. And at the front end of a secular bear market, we tend to observe an almost universal love of equities by a huge percentage of the population, bolstered by conviction and unshakable optimism, such as we saw in early 2000.

Long gone are the days when average people would mortgage their homes to buy internet stocks, or when IPOs were common topics of conversation on subway trains or at the gym. Today, we see growing evidence that an entire generation of investors is walking away from equities. From a near term perspective, that bodes poorly for equities prices; it's hard to move markets much higher without investor participation. From a longer term perspective, the stage is gradually becoming set for the next great secular bull market. Unfortunately, in the near term, the final pieces of this set may not be in place until the markets are dramatically lower than they are today.

In sum, while the technical posture of the equities markets worldwide appears bleak, at some point (perhaps even now), these technical signs will, in fact, be pointing in the absolute wrong direction. Investors should be positioned to take advantage of investment bargains going forward, and be prepared to do so at the very darkest hour when all conventional wisdom is screaming "sell at any price before it is too late!"

Disclosure: Author owns modest positions in VT