Is This the Start of "The Big One"?
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
As regular readers of my weekly update know, the OEXA200R (the percentage of S&P 100 stocks above their 200 DMA) is a valuable metric for accurately assessing the state of the market in order to make profitable trading decisions. That is, whether we are in a bull, a bear or transitioning from one to the other, as well as market volatility and risk within each of those situations.
Historically, when OEXA200R drops to the 65% level it has also given traders a clear early warning signal of impending market corrections. For instance, since the start of the Great Recession in mid-2007, the OEXA200R has dropped to the 65% line on 25 July 2007, 16 October 2007, 6 May 2010 and 15 June 2011. In hindsight, each of these dates turned out to be auspiciously timed exit points preceding major downturns.
On 15 May 2012, the OEXA200R once again closed out the day at the critical 65% level, taken to be the clear early warning of the next major correction. Several questions come to mind. How soon will the drop occur? Will there be any rebound in the market beforehand? How hard will the market fall? And what will the post-correction recovery look like?
If we examine the Monthly OEXA200R chart, notice that during each of the three market recoveries since 2009 the OEXA200R has spent less and less time in the optimal zone above the 65% line — roughly three quarters from July 2009 to May 2010, two from late 2010 to July 2011 and one in 2012. The OEXA200R peaks have also been trending downward.
The recent drop in the OEXA200R has been particularly steep: from 89% to 59% in just the past three weeks, accelerated by the Euro disaster. This leads me to believe that there won't be any cushy rebound in the OEXA200R before the final slide as we had in June - July 2011; the market is going to come in for a much faster, harder landing this time.
To address the final two questions, take a look at Doug Short's chart "The S&P 500 and Federal Reserve Intervention". It becomes very apparent how vital QE has been to each market rebound in recent years. It could be argued that QE was the only thing that prevented the market from going into headlong free fall on those occasions in the manner of the Athens Exchange, which did not benefit from any type of QE. QE isn't an ideal solution but, lacking solid underlying economic growth, it's the only solution we've got.
The problem is that with every QE rerun we get less bang for the buck. As illustrated on the chart, QE2 coincided with an S&P peak of 1363, 12% higher than the QE1 peak of 1217. Operation Twist coincided with a peak of 1417, just 4% higher than the 1363 QE2 peak. Operation Twist has squeezed the life out of Ten Year Treasury yields while the Fed Funds Rate is now close to zero. It seems that with each deal of the cards, Mr. Bernanke has a weaker hand to play.
He will play them, of course, in the next round of QE but what will the effect be? Imagine an arc tracing the S&P peaks on Doug's chart. In a normal course of events, the next S&P recovery would probably peak somewhere along that curve either matching or slightly below the recent high of 1417. But an anemic, exhausted QE strategy will have to try to counterbalance several very formidable negative forces, the most important of which is the collapse of the Euro zone. Also in the negative column we have a likely Israeli - Iran conflict and oil spike, weak GDP, continuing U.S. unemployment crisis, comatose housing sector, skyrocketing state and national debt and the business-chilling prospect of four more years of Barack Obama's uninspiring economic stewardship. And if that weren't enough, the S&P is doubly "top heavy" and ripe for a fall since it is above both its historic 140 year trend line and the trend line for the secular bear that began in 2000.
Not to doubt Mr. Bernanke's sincerity and determination but at times he must feel like Barney Fife staring across the boxing ring at Muhammad Ali. Considering all this, for the foreseeable future the most prudent course would probably be to just sit on the sidelines with your cash, watch and wait.
Note: Stockcharts.com offers free access to the $OEXA200R indicator on a daily and weekly basis. The monthly view requires a subscription.
(c) John F. Carlucci
John F. Carlucci is a regular contributor to Advisor Perspectives and the author of "Ashes to Riches: How to Profit Spectacularly during the Economic Collapse of 2012 to 2022", published by Endeavour Press Ltd., and also available on Amazon.com