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Market Momentum Suggests Pause Ahead at Trader’s Narrative

Market Momentum Suggests Pause Ahead

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The market started weak in the morning and spent the whole afternoon trying valiantly to paddle back upstream. It was futile as the stream of positive earnings news was not enough to scare away the bears. On that note, while the majority of companies have reported and of those many have brought in positive surprises there is reason to be skeptical.

According to a recent study covering 500,000 firms over 27 years, there is ample massaging of the numbers to “beat” expectations. According to one of the co-authors, Joseph Grundfest:

“Managements will exercise accounting discretion to try to make their numbers look better for Wall Street… in a number of subtle ways”

While accountants are usually portrayed in popular culture as nerdy and about as creative as a celery stalk, the reality is very different. Having taken advanced accounting in university, I can tell you that the discipline could easily be moved under the auspices of Arts Departments.

The surprising part of this is just how little money is required to be shuffled around to provide a nudge over estimates. According to the study, just $31,000 in quarterly net income is enough to beat estimates by a tenth of a cent (per share). See complete article at the WSJ: Afflicted by Quadrophobia.

Again, this should not surprise anyone familiar with the extreme pressure imposed by Wall Street on quarterly performance and the cat and mouse game involved in managing their expectations. Also not surprising is the corollary of the findings: that companies which engage in such shenanigans repeatedly have a higher probability of “having an accounting issue”. I suppose that’s what Enron had, “an accounting issue”.

Putting aside such fundamental concerns, after catching the market’s bounce from the recent correction, I don’t really feel like pressing the long side. Especially since a simple market momentum gauge like the annual rate of change is hinting that we are headed for either a pause or possibly another tumble:

Click to open larger version in new tab:
S&P500 index comparison 250 day rate of change

As you can see from the chart of the S&P 500 compared to its 250 day rate of change, when we hit a high like we have (twice) recently, the market either plateaus or corrects. By the way, I chose the 250 day rate of change because that is approximately the number of trading days in a year (give or take a few days for leap years and holidays and such).

What the graph is showing visually is the concept that is inherent in all organic systems. To use an analogy, while a very fit person can sprint for a few hundred meters, they can’t keep the pace up in the long term. They would need to pause and refuel before setting off again. So with the market. It has periods of expansion and contraction in all time frames.

Earlier this month I already touched on how momentum is waning as the market loses its afterburners. I think this is another indication of the same theory.

It also dovetails with what we’ve learned from Lowry Research, in that we are entering the last stages of this cyclical bull market. The momentum thrust, which lifted the market with a ferocity to befuddle almost everyone, is now over. The S&P 500 is now sputtering and while it may still have a few points left in it for the bulls, I don’t think this is the time when you want to press it.

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2 Responses to “Market Momentum Suggests Pause Ahead”  

  1. 1 chaitanya

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    good post. nice analogy comparing market with sprint.

  2. 2 Babak

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    chaitanya, thanks [pant, pant…] gimme a sec

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