This week has provided a measure of relief from a bear market rally that was overextended. Of course it is too early to tell whether this week’s downward move will continue, but several technical indicators show that major indices are at a crossroads.

We’ve remained on the sidelines for the past three months while the market advanced, because we believe that risk of a renewed decline remains high. So far that has not occurred–perhaps because of the steps taken by the Federal Reserve and other government entities to try to stabilize the economy. But while there are some very slight glimmers of hope, such as a decline in the number of people filing for first-time jobless claims, there are also plenty of indications that the economy remains in peril.

In today’s Tech Ticker on Yahoo! Finance, Henry Blodget wrote: 

“So far, the collapse of the world economy since April 2008 has actually been worse than the rate of collapse in the Great Depression. 

“The main difference between now and then is that most economists expect the world economy to recover more quickly than it did in the 1930s.

“The cause for this optimism has been that the government policy response this time around has been much more aggressive. Most major countries have cut rates and ramped up spending to unprecedented levels, which some economists believe will stop the pain.

“Of course, other economists disagree. In fact, we’re actually all now participating in a sort of lab experiment that will prove or disprove one of the major economic conclusions of the past 70 years: That the original Great Depression was not an inevitable outgrowth of the wild speculation of the 1920s but was caused by ‘policy errors’ after the collapse.

“If the 1930s was the result of policy mistakes, we should emerge from our current swoon relatively soon.  It if wasn’t, the new economic conclusion will be that there is simply no way to avoid economic catastrophes after a financial bubble the size of the one we just had.”

Blodget referenced some research by Professors Barry Eichengreen (Berkeley) and Kevin O’Rourke (Trinity) who compared the current economic downturn  with the Great Depression. You can see their charts at this link: http://www.businessinsider.com/henry-blodget-tracking-the-second-great-depression-2009-6/tracking-the-depressions-world-output-1

As indicated above, we do not know the direction the market will take in the next few weeks, but based on research like this and on our own analysis, we still believe caution is warranted when putting retirement assets at risk.

The chart below shows the price movement of the S&P 500 Index over the past six months. Right now, the index is nearly even for 2009. The gold line on the top portion of the chart is a simple 50-day moving average of the index. You can see that the index is resting almost on that line. Although I have not included it on this chart, the index is also right at its 200-day moving average. If the index bounces off of this level that would be a positive sign for additional upward momentum. If it breaks below this level, we could see it move quite a bit lower in coming weeks.

The next section of the chart shows a moving average convergence divergence (MACD). It is showing that the index has been trending at an overbought level for nearly three months. Under normal conditions, this indicator would be signaling that a downturn is imminent. 

The next section below is a relative strength index. It has been trending above 50 for several weeks. This week it dipped back below the 50 level. Usually a drop below 50 is a sign that momentum is failing and additional weakness can be expected.

Finally, the bottom portion of the chart shows a stochastic oscillator. This tool is used to measure random cycles. It is currently negative and is forecasting additional downside weakness for the S&P 500. However, it is approaching an oversold extreme meaning the index could also rebound in a fairly short time.

 
The upshot of all this is that the technical indicators are reflecting mostly negative market conditions, but they are not definitive. For now, we must continue to err on the side of caution.

I will be out of town next week visiting family in Texas. As a result, there will not be an update until the following week on July 2.
F.S.