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Stocks Rise Into Thin Air (Again) at Trader’s Narrative

Stocks Rise Into Thin Air (Again)

dow 10000 againEveryone is excited that the Dow Jones Industrial is above 10,000 - again. While that nice round number may be where most of the attention is, there is another level which we’ve hit that is more significant.

But before I get to that, it is remarkable that every single major index has reached a new high. That includes the Russell 2000 and important sectors like the Philadelphia Bank index (BKX), Semiconductors (SOX) and even the Dow Jones Transportation index managed to reach a new higher close (while not exceeding the intra-day high on September 19th 2009). Also reaching a new yearly high is the Mid-Cap S&P 400 index as well as the Small Cap S&P 600 index. All in all, it would be accurate to say that a rising tide has lifted all boats.

But while everyone is partying like its 1999, excuse me for being a kill joy. The S&P 500 index has once again risen so far above its own 200 day moving average that it gives us reason to believe that all these new highs have stretched an already exhausted trend to the breaking point. Or at least to the resting point.

I presented a historical view of what happens when the S&P 500 is this far above its long term moving average. You can find the details in the previous link but the concise version is that this is not a good time to be long equities.

This rally was launched in early March 2009 when the S&P 500 was almost 37% below its long term moving average. Now it has reached 20% above it. Twice.

The first time in recent history was last month (September 16th) when it hit 20.27%. Not long after we had a very shallow and short lived pull back. And with today’s close it is 20.46% - once again above that magical 20% mark.

By the way, the S&P 500 managed to eke out a +2% advance in the 30 days that followed that first signal in mid September. That’s slightly better than the -1.16% historical average.

Since 1950 to now, we’ve seen very few times that the S&P 500 index has traded 20% above its long term moving average. In fact, the market usually tends to bounce between +20% and -20% like a ping pong ball. To see a large chart showing this, check the link above.

So what we are seeing is rather rare. And the consequence has been historically that the market will have to go sideways or correct. What it can not do is continue to sustain the pace it has so far:

SP500 relative to 200 MA Oct 2009 topping

The tendency for equities to remain within a +/-20% band of their long term trend persisted even during the birth of the super-bull market in late 1982. Then, the S&P 500 was barely able to nudge past the 20% mark, reaching a high of 23.28% above its 200 day moving average in early November 1982. While the index itself reached a high of 143 at that point, it was only by February 1983 that it was able to leave that level behind for good. So during one of the most powerful rallies, the S&P 500 basically tread water for 3 months. That is a persuasive precedent demonstrating the power of this simple indicator.

The other insight from this indicator is that at the top we tend to see a clustering of instances at or near +20%. This is indicative of the nature of market tops as they take much longer to form than bottoms. So far we’ve seen 3 instances of +20% during 30 days. We may see a few more. But the message provided by historical patterns is the same. At best we pause to allow the turtle-like 200 day moving average to catch up to the hare-like S&P 500. And at worst (for the longs) we correct sharply lower taking price down to meet the rising long term trend.

Either way, this is not exactly the time to pass around the party hats.

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21 Responses to “Stocks Rise Into Thin Air (Again)”  

  1. 1 Rick Tee

    Good Article…Thanks
    Trading the Market now is high risk.
    Probability and Risk says be very careful, those HFT can wipe you out quick.

  2. 2 Babak

    thanks Rick

  3. 3 Tom Terrific

    The only mitigating factor is a big one. The Dollar is collapsing and I see nothing that will prevent if from further collapsing except for from a contrarian point of view. The sentiment on the Dollar is so bearish that it ought to rally but so far it has not.

    The weakness is the Dollar is inflating asset prices including the Dow and S&P and every market. (See Wall street Cheat Sheet blog) but Dow is only at 7567 in real terms in relation to the dollar purchasing power and only 6500 in relation to price of Gold, since 2002. Do not quote me on that so look up the figures yourself. In any event the market will continue to rise as long as the Dollar is weak because it is priced in Dollars as will Gold. Corrections will come and go and maybe severe but it will be onward and upward for prices, though maybe not in real terms. In other words the Zimbabwe effect.

  4. 4 Babak

    Tom, good point. However, don’t you think the dollar decline has reached a climax here? I mean looking at sentiment and other technicals.

  5. 5 DL

    I am a believer in regression to the mean. But given how far BELOW the 200 day MA that the SPX got in March, it stands to reason that the market could overshoot in the other direction, getting to perhaps 30% above the 200 DMA before reversing.

  6. 6 Babak

    DL, certainly possible of course, but if it were to happen, it would be the first time.

  7. 7 David

    I am disturbed by the statement that the market “can not” do something. The market will do what it wants to do when it wants to do it and for however long it wants to do it.

  8. 8 Babak

    David, you’re right, my point was that historical precedent points to this or that.

  9. 9 Dave

    Babak or open question,

    This is an amazing sight to see the $VIX at its lowest point since March even when the DJI was still down 65pts.

    Any comments ?

  10. 10 Babak

    Dave, you mean the VIX is at its lowest since Sept 2008, right? In any case, low VIX readings don’t really correspond with tops - at least not the way VIX spikes do with market bottoms.

  11. 11 dacian

    David, you’re right; it just that based on past experience and statistics, we can look for what’s the most probable scenario; this is what Babak tries to show with his work. So while S&P can move 300% above its 200 DMA, the probability is quite low.

  12. 12 DL

    Dave @ 3:43

    I noticed that also. Sure doesn’t make me want to have any big bets on the long side.

  13. 13 Dave


    IF the S&P was 300% above its 200 DMA, Jack would be holding the other end.

  14. 14 Dave


    I wasn’t looking back that far; so thanks for the addt’l info. I was just struck by the dichotomy. The quuestion is what is the meaning or what caused it ? If i understand Pete Najarian, right now on Fast Money, there was an excessive amount of call buying today.

  15. 15 Wayne

    Not sure what to read into Vix. Vix over the last 10 years has averaged around 20ish and we are getting back to somewhat normal volatility. Two years ago, Vix of > 20 , would have been considered high.

    You can calculate what the statistical Vix should be based on a a trailing N day average and compare it to the “implied” statistical volatility priced into the Vix and get some insight into the fear factor priced into the options. Some software packages provide such. Normally options are about 10-20%% above what there statistical value is.


    Near the end of October, Ill try to update my 4th quarter odds based on October performa and pass along. We could also have our 8th up month in a row, but Curly could still kill somebody before the day is over.

  16. 16 Wayne

    I read Hulberts article on the Dow theorist that you referenced. Thank goodness the market is never crystal clear to everyone, else efficiency would dominate and opportunities would not present themselves.

    The Fed is a wildcard here. They probably should be taking rates back to 1% in the next 3 months, but will probably be behind the curve. The easy money in 02-04 helped contribute to the conditions that led to the crisis in 08. Let’s watch and see if they learned anything. Did you see where Volckler commented that they should be tightening, as well?

  17. 17 wayne

    Lead story in Barron’s Monday is calling for Bernanke to take rates back to 2% before inflation gets away from us

  18. 18 Dave

    Mkts have started to reflect a rise in interest rates. If one looks at a chart of LQD going back to March, you can see that the rock solid uptrend in corporate bond prices has been broken. The mkts are thus reflecting that a growth cycle in the economy is beginning accompanied by an interest rate tightening cycle.

    This normally spooks the stk mkt particularly if it’s earlier than expected. However, intermediate/long term it’s very good news because the Fed should not be willing to risk choking off the economy with monetary tightening unless it thinks that the economy is strong enough.

  19. 19 wayne

    Historically, rising rates have been shown to work against the markets. The old rule is “3 steps and a stumble”. The question I have is how should the rule be modified if rates are starting from near zero and the move up in rates is a sign that we are coming out of a recession, not necessarily overheating. Could it actually be a positive sign initially? One Percent Tbills are not exactly a lot of competition for investment dollars.

    My expectation, in this spot, is that a rate hike before yearend could give the market an initial excuse for a 5% correction before resuming higher and that I think the market is probably alright for the first 3-4 hikes over the next 12 months ??

  20. 20 dacian

    Rates won’t be raised before unemployment peaks; and that is 2011 eventually. FED doesn’t do what Barron’s says. Few people have access to 0% money; the truth is the FED doesn’t control rates, the (bond) market does. FED just follows that market.

  21. 21 wayne

    1-1.5% could probably be justified to deal with unemployment. rates went to unprecedented zero to deal with crisis, which is behind us.

    oil, commodities, market, gold, point to potential of inflation, unemployment dictates caution is warranted. Zero rates is not, at least not in my opinion.

    I would take friendly wager that fed funds rate is increased within 12 months.

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