August 2010’s Monthly Stock Market Commentary

Market Ends August & Year In the Red:

The major market indexes ended lower last month and are down for the year. As the US dollar has recently advanced, fears of a global economic slowdown have been escalating. For the year, the Dow Jones Industrial Average has shed -4%, the S&P 500 Index is down -6%, an the tech-heavy Nasdaq Composite is leading the major averages lower, down -6.8%. The confirmed rally that began on the July 7, 2010 follow-through day (FTD) ended on Tuesday, August 24, 2010 however, a new FTD emerged on September 1, 2010 which confirms the latest rally attempt.

Before we address the current market outlook, it is important to step back and put the recent action in proper context. Since the March 2009 bottom, the major averages have experienced explosive gains on the simple premise that the global economic recovery will be robust. That notion helped the benchmark S&P 500 Index rally +83% before reaching a near-term top of 1,219 on April 26, 2010. Since then, notions of a robust recovery have come into question, especially due to the ominous debt levels in several European nations and the major averages are each down –11% to -17% from their 2010 highs. The euro, which has also enjoyed healthy gains since March 2009, topped out in December 2009 and has steadily fallen during the first half of 2010, then rallied smartly in July, but lost ground in August. Looking ahead, it is imperative to monitor the direction the euro is heading in order to better gauge investors’ world-wide collective appetite for risk.   

Bullish Case:
History shows us that most bull markets last between 18-36 months before they fail. Therefore, the fact that we are only beginning our 17th month bodes well for this bull market. It is also somewhat encouraging to see nearly every government across the globe step up and unanimously infuse an unprecedented amount of capital into the global economy and more recently, reiterate their stance in recent weeks to infuse more capital if needed. This unified action saved the global economy from entering a deeper recession and laid the foundation for this massive bull run. On average, central banks around the world are still keeping rates near historic lows to help spur economic growth, while a few have begun raising rates. As of this writing, the major averages continue to find formidable support near their 2010 lows. As long as these levels hold, the intermediate and longer term picture remain somewhat positive. However, if these lows are breached, then all bets are off.  

It is also somewhat encouraging to see the bulls show up and continuously defend support. Since the April 2010 highs, the major averages have pulled back a handful of times, each somewhat mild, not exceeding the -20% level which technically defines a bear market. Therefore, until the major averages pullback over -20% from their recent highs this could be interpreted as a temporary correction, albeit a steep one, before the bulls again return and resume this powerful uptrend that began in March 2009. A characteristic of this bull market and others is that every time the market pulls back the bulls promptly show up to quell the bearish pressure and defend support. That said, until support is breached, the bulls deserve the benefit of the doubt. 

Bearish Case:
Each of the major averages appear to be tracing out an ominous large head-and-shoulders topping pattern. There are two ways for this scenario to ultimately play out: for the market to break down below the neckline of this large pattern (near July’s lows), or rally to break out above resistance at the highs of the right shoulders in their respective patterns. The first case will likely have bearish ramifications while the second is bullish.

Another bearish concern is that sovereign debt woes and tepid economic growth continue to be the bane of this rally. Since the April 2010 highs, several popular rating agencies have downgraded a slew of European nations and financial institutions’ debt. Not surprisingly, this corresponded with a steep sell-off in the euro which sent it down to fresh 4-year low earlier this summer.  Italy, Hungary and Iceland are the three nations which analysts believe are also dealing with onerous debt levels. All of this helped the US dollar, gold, and bonds to be able to rally smartly as a so-called “safe haven” play. Since November, the greenback has rallied smartly and jumped above its 50-day moving average (DMA) and 200 DMA lines. As expected, the stronger dollar sent US stocks and a slew of commodities (i.e. dollar denominated assets) lower as investors continue to debate our economic future.

The bears believe that the effects of the massive worldwide stimulus packages from 2008-2009 are beginning to wane and the future of the global economic recovery may not be as robust as initially expected. The bears also claim that technically this rally is done and overdue for a serious intermediate-term correction. Since the March ’09 lows, the major averages have retraced (rallied back) a little over +50% of their 2007-2009 bear market decline, which is a fairly typical bounce before a new down leg ensues. Only time will tell exactly how this plays out.

Market Action:  Price & Volume C
As we know, the major averages topped out in October 2007 and then proceeded to precipitously plunge until they put in a near-term bottom in early March 2009. Since then, the market snapped back and enjoyed hefty gains which helped send the major averages to one of their strongest 17-month rallies in history. The small cap Russell 2000 Index was the standout winner, surging a whopping +117%. The tech-heavy Nasdaq Composite is a close second, having vaulted +100% before reaching its interim high of 2,535 on April 26, 2010. The benchmark S&P 500 Index raced +83% higher before hitting its near term high of 1,219 on April 26, 2010, and the Dow Jones Industrial Average soared +74% before printing its near-term high of 11,258 on April 26, 2010.  

This data indicates that Monday, April 26, 2010 appeared to be a very important day for the market because that is the day that most of the popular averages printed their near-term highs and negatively reversed by closing lower from new recovery highs. In addition, after such hefty moves, a 10-18% pullback, if the indices can prove resilient enough to hold their ground near current levels, would be quite normal before the bulls return and send this market higher. However, if the 2010 lows are further breached, then odds will favor that even lower prices will follow. In addition, the downward sloping 50 DMA line undercut the longer-term 200 DMA line for many of the indices which is known as a death cross and is not a healthy sign. Trade accordingly. Never argue with the tape, and always keep your losses small.

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