Does Anyone See A Pattern?

Jun. 13, 2011 9:27 AM ET
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Macro

Contributor Since 2009

Tom Feeney began his work in the investment industry in 1969. Clients have included cities, states and major corporations, as well as numerous religious, charitable and other not-for-profit organizations. In his early career Tom served as Executive Director of Stewardship Services, Inc., Washington, D.C., and as a Senior Vice President of Atalanta/Sosnoff Capital Corporation, New York. He established Thomas J. Feeney & Co., a financial consultant to tax-exempt organizations, in 1978. Feeney & Co. initiated investment management services in late 1985, and Marathon Asset Management Co., Mission’s predecessor, was incorporated in early 1987 to separate those investment management services from Feeney & Co.’s consulting work. Tom served as Marathon’s Chief Investment Officer since the firm’s inception. In 1997 Tom assumed the roles of Managing Director and Chief Investment Officer of Mission Management & Trust Co., located in Tucson, Arizona. Prior to his investment career, Tom served on the faculties of the University of Santa Clara, St. Joseph’s College and Guadalupe College, all in California. In more recent years, he has lectured on investments at the University of Notre Dame and Georgetown University. His own academic background includes a B.A. in economics from Boston College, an M.B.A. from the University of Santa Clara, studies at the Stanford Law School and additional post-graduate work at the University of San Francisco. Over the years Tom has been interviewed on CNBC and frequently on local business TV shows. Similarly he has been interviewed and written about by such national publications as The Wall Street Journal, Barron’s and Investor's Business Daily as well as local papers throughout the country. Away from his desk, Tom enjoys his all too infrequent time on the golf course. In earlier years he ran two dozen marathons or ultra-marathons including the Boston Marathon and the New York City Marathon three times each. The highlight of his competitive career was winning a relatively small field marathon in Carpinteria, California.

Dow

The graph above shows the progress of the Dow Jones U.S. Total Stock Market Index from 1994 to present. This capitalization-weighted index is comprised of all U.S. equity securities with readily available prices, essentially the entire U.S. stock market. I have added the horizontal and slanted trendlines. No graph shows conclusions, but rather presents a picture of the past from which the technically-oriented may choose to draw conclusions.

Each vertical line represents the extent of the monthly price progress of the index. The two descending lines in the upper right hand corner of the graph depict the 7½% decline that the index has traced out since the beginning of May. Because of the steepness of the slope of the trendline connecting the March 2009 and mid-2010 lows, the index is rapidly approaching that trendline just six weeks after hitting a new high for the current rally. While there is no certainty that prices will continue down to or through the trendline, it is instructive to note how aggressively prices fell after penetrating the trendlines supporting the two prior multi-year rallies.

So persistent has the selling been over the past six weeks that most short-term measures are substantially oversold and in need of a rally to relieve that oversold condition. Intermediate and long-term measures are not oversold and could certainly accommodate lower prices. The lack of any meaningful rallies over that six week span has produced short-term bearish sentiment readings that also normally spawn a recovery rally. Those bullish factors notwithstanding, when markets don’t rally when such conditions are in place, there is a danger that investors panic and throw stocks on the market at any price, creating waterfall-type declines. So while a short term rally is the more likely prospect, the danger exists that the rally might not materialize until prices descend far lower. This week should provide a resolution for this short-term tension.

A look at the graph illustrates that the two prior major market tops in 2000 and 2007 took several months to develop. One could argue that the current market has been building a topping formation since February, but it certainly looks less well developed than its predecessors. Because so much of this rally has been based on confidence that the Federal Reserve would not allow the economy to fall back into recession, the rally’s durability is probably dependent on that confidence remaining high. Should the deteriorating global economic condition undermine that confidence, market declines could unfold rapidly.

For those who look for technical patterns on graphs, it is easy to see this as a possible developing giant head and shoulders pattern. I’ve drawn horizontal lines connecting what could be both shoulders and the neckline. There is considerable symmetry in the pattern with the 2007 head clearly at the top. Obviously there is no necessity that prices decline beneath the neckline, but this would certainly form a classical picture, should that pattern unfold. With numerous countries on the verge of bankruptcy and governments and central banks taking huge financial risks to keep them from default, almost any kind of market response remains possible. While it is conceivable that central planners will yet keep economies and investment markets afloat, the risks remain extremely high.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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