MarketOwl is a totally FREE service. If you find the information beneficial and of interest, we invite you to encourage friends and acquaintances to sign up.

The past few sessions have produced a significant correction in major indices, but the long-term uptrend has not been violated. What that means for investors is that while this correction is uncomfortable, so far it is nothing out of the ordinary. I’ve included a three-year chart of the Nasdaq so you can see how the current downturn compares to recent corrections. 

The black line is the Nasdaq and the gold line is a simple 200-day moving average (MA). In this case I am using a 200-day MA because I think breaking it establishes the possibility of a change of direction in a long-term trend. For short-term trends I use a 50-day MA and at the end of yesterday’s trading, the Nasdaq was resting right on that mark. In today’s trading it broke significantly below that level.

Notice that the last time the Nasdaq broke below its 200-day MA was during the correction that began in May 2006. That correction ultimately went much lower, but it still took the Nasdaq only about 90 days to recoup those losses.  The two prior corrections in 2005 the Nasdaq quickly rebounded after breaking below the 200-day MA.

Stocks have sustained a fairly steep rise for the past year with a lone pullback early in 2007. Downside activity is inevitable. It is the nature of the markets. But so far the long-term advance has not been violated. I anticipate that the Nasdaq will not correct much below its 200-day MA. In fact, if you look at the red trendline that I added to the chart, I suspect that the correction will stop at that level. That would put the Nasdaq at about 2550. Today it closed at 2599.

Of course I have always said that no one has the ability to predict market movement, including myself. So if I am wrong and the Nasdaq breaks below its 200-day MA, I would then sell positions as a defensive measure and buy again when the index crosses back above its 200-day MA on the upside.

The bottom portion of this chart is a Moving Average Convergence Divergence (MACD). I wrote about this indicator a couple of weeks ago. At this point the MACD is still positive, but falling. If the Nasdaq breaks below its 200-day MA, I suspect the MACD will go negative.

The blue line on the chart shows the long-term trend that I believe is still intact. I think once this correction ends, the Nasdaq will rebound back to this trendline and we will see new highs again, probably in September.

What about other indices and sectors? The Dow is faring slightly better in this correction and so far the S&P 500 is doing slightly worse. International markets are likely to correct more sharply than the U.S. The old saying is that when the U.S. market catches a cold, the rest of the world markets get pneumonia. In general, any sector that has outperformed the Nasdaq on the way up will probably also lead on the way back down. That is the bugaboo of volatility and risk.

So as uncomfortable as this is right now, my best advice would be to hold tight unless you have positions that break decisively below that 200-day MA.
F.S.

I’m writing this on Wednesday–a day earlier than usual–because I am spending the next three days experiencing my pioneer roots. I’m the designated photographer for more than 300 teens who will be pulling handcarts across some high desert terrain near the border of Utah and Wyoming. I am certain it will help me gain a new appreciation of the hardships those early pioneers endured. And I suspect I’ll endure some of my own hardships since the broken ankle I suffered a few months ago is still not fully recovered.

Today the markets experienced some hardship as Federal Reserve Chairman Ben Bernanke told members of Congress that this year’s economic growth rate will be slower than anticipated. He also said that inflation remains the biggest threat to the economy. Those comments came a day after the Dow climbed above 14,000 for the first time.

I can vividly remember when the Dow crossed 3,000 for the first time. I was working for best-selling author and investment guru Howard Ruff at the time. People in the office were cheering as the Dow went higher. I wasn’t too worried about the Dow at the time, because my personal money was invested in a Japan mutual fund. The Nikkei had been the hot market for some time and was near its all-time peak of about 42,000. A few weeks later it had dropped to 19,000 and I was still holding my position. That was my first expensive lesson about investing, but far from the last.

Despite today’s pullback, investors don’t need to be too concerned about a similar slide in the U.S. market right now. The strong upward trend is intact, as the chart below shows.

The gold line is the Dow and the black line is the Nasdaq. Both of these indices are advancing neck and neck since the market’s last bottom in March. The red line shows the nice slope of this advance. Down days are to be expected but there is little reason for investors to be concerned unless the indices drop through the trend line. During this latest surge, the S&P 500 has not shown quite as much strength as these two indices and is consequently lagging a little more than 3% on its year-to-date performance.

The latest move that began in late June has carried these indices about 4% higher. That would produce an annualized gain of more than 50%. Obviously it seems unlikely that the market can sustain that type of pace for very long. I anticipate that this move will flatten out over the next few weeks. August tends to have some of the lowest trading volume days of most years as traders and investors use the last of the summer for vacations. That can lead to increased selling because traders don’t want to hold long positions while they are away from the markets. So don’t be surprised or worried if the major indices start moving in a mostly sideways direction.

For now there is nothing on the horizon that should cause investors undue concern or worry. The economy is still strong and corporate profits are still regularly beating expectations.
F.S.

If you would like an investment strategy that attempts to minimize risk but still provides the opportunity for solid growth, check out the Foundation Strategy from Strategis Financial Group.  This actively managed strategy is designed to take advantage of the experience and expertise of some of the nation’s best mutual fund managers. To learn more, call me, Mark Sumsion or Scott Garbutt at 800-279-3377.

You requested this MarketOwl free e-newsletter. Please add support@marketowl.com to your e-mail address book to ensure prompt delivery.

This week the major indices shook off a sharp down day on Tuesday and by today had surged to an all-time high for the Dow and a new multi-year high for the Nasdaq. Today’s advance was largely supported by better than expected June sales by WalMart. Many investors and professional money managers are starting to express concern about the the continued staying power of this bull market run. But economic fundamentals remain strong so there is no reason to anticipate an immanent market downturn.

Right now most technical indicators remain positive, which isn’t surprising since virtually all technical indicators lag the market. In other words, most technical tools used by market analysts are not predictive. In fact, it is somewhat amusing to watch money managers create varying combinations of lagging indicators in the hope that somehow the right combination will generate a signal that becomes predictive.

One of the common mistakes most analysts make is that they fail to understand the limitations of the tools they use. A pipe wrench is heavy like a hammer, but it would not work well for someone framing a house.

One of the tools I commonly watch is a Moving Average Convergence Divergence (MACD). Created by Gerald Appel in the 1960s, it shows the difference between a fast and a slow exponential moving average of closing prices. The standard periods recommended back in the 1960s by Appel are 12 and 26 days:

    MACD = EMA[12] of price - EMA[26] of price

A signal line is then added by smoothing this with a further EMA. The standard period for this is nine days:

    Signal = EMA[9] of MACD

The difference between the MACD and the signal line is often shown as a solid block histogram. You can see this displayed on the chart below. The top portion is simply a daily price chart of the Nasdaq over the past year. The bottom portion is the MACD. The blue line is the 26-day EMA minus the 12-day EMA. The brown line is the 9-day EMA signal. The divergence between the two is shown as the black portion on either side of the zero mark.

Here is how Wikopedia describes this tool:  “The MACD is a filtered measure of the velocity. The velocity has been passed through two first order linear low pass filters. The ’signal line’ is that resulting velocity, filtered again. The difference between those two, the histogram, is a measure of the acceleration, with all three filters applied. The ‘MACD crossing the signal line’ suggests that the direction of the acceleration is changing. ‘MACD line crossing zero’ suggests that the average velocity is changing direction.”

Like many tools, the MACD fell out of favor when the tech bubble burst in 2000. Analysts that relied on this tool for a trading signal lost money in the correction, just like everyone else. Others who have relied on this tool for trading signals have learned that it is subject to whipsaws, just like almost every other technical indicator.

The real purpose and value of the MACD is to identify changes in trend. In that capacity, it is best used in conjunction with other tools such as Relative Strength Index, Advance/Decline Lines, stochastics, etc.

Notice on the chart above that right now, the MACD is not signaling an impending trend change. In fact, it appears to show that the Nasdaq could advance higher from this level. The MACD was at this same level in September 2006 and the Nasdaq followed with three months of significant gains. That doesn’t mean the same thing will happen this time. After all, we just acknowledged that this is not a predictive indicator. But used in combination with other technical and fundamental indicators we get a picture of a market that is still healthy.

Have a great weekend.
F.S.

First let me apologize for last week’s lack of a report. We had a baby that arrived a couple of weeks early. It was an adopted first child for my oldest daughter and it was my second grandchild. The new baby is named Harvey Creed Nielson and he is doing great.

In the meantime, major stock indices are still plodding along in a mostly sideways pattern. In the past I have mentioned that when it comes to making investment decisions, the primary factor I look for is a long-term trend. But a short-term view is a helpful tool in trying to identify what the market is likely to do next. Take a look at the chart below, for example.

What you see is a comparison of the Nasdaq (black line) and the Dow (gold line) over the past three months. The Dow peaked early in June and has been unable to exceed that high in the weeks since then. The Nasdaq, on the other hand, has twice exceeded that early June mark and a couple of days ago reached a new, multi-year high. 

Over the past two-plus years, the Dow outperformed the Nasdaq by a few percentage points. But recently the Nasdaq has been gaining ground. That is significant because from a historical perspective,  investors make their biggest gains when the Nasdaq is dominant over the blue chip indices. While it is far too early to declare that the Nasdaq and the tech sector are stepping back into a long-term leadership role, it is one step in the right direction.

For the past three months, energy remains the strongest sector, followed by Latin America, and select large cap funds. But the technology funds have been rising and some have produced double-digit returns during that period. For example, IAH, an Internet ETF, is up 14.4% over the past three months. PTF, PowerShares Dynamic Technology, is up 11.68% for the same time. XLK, Technology Select Sector SPDR is up 11.28%.

This surge in tech funds is a move worth watching. If this sector can gain and maintain a leadership role for several months, it should produce a great opportunity for investors to make sizeable gains.
F.S.