For months we’ve been warning investors to stay out of the markets because risk was too high to warrant being invested. This week’s market action is forcing us to reconsider our position. That does not mean we are advocating jumping into the market with both feet. However, for some speculative or aggressive investors, it might be time to test the water with a toe.

From a fundamental perspective, risk in the economy and in the financial markets remains high. Although there have been a few highly publicized positive surprises, second-quarter earning reports so far have been mixed. Unemployment is high and is expected to go higher.

The reason we are rethinking our position is because of changes to the technical situation. The black line on the chart below shows the daily price movement of the S&P 500 over the past two years. The gold line is a 200-day simple moving average (MA). Notice that the index broke above this moving average at the end of May, but for all of June, it hovered right on the 200-day MA as the markets corrected. But in the past week, the S&P 500 has advanced strongly above the MA.

The pattern for other major indices is similar with the Nasdaq showing the greatest strength and the Dow looking almost identical to the S&P. The 200-day MA is a long-term indicator and it is often used to help identify changes in long-term market trends. The last time the S&P moved this strongly above its 200-day MA was in September 2007. It held its ground for about a month until the market peaked and rolled over–precipitating the bear market that has persisted ever since.

The middle portion of the chart is a moving average convergence divergence (MACD) of the S&P. About a week ago it crossed over and made a move into positive territory. Normally that would indicate that the market has enough positive momentum to sustain an advance.

The bottom portion of the chart is a relative strength index (RSI). During periods of market strength, the RSI usually trends above 50. In June the RSI had fallen well below 50. But again, over the past couple of weeks the RSI has climbed sharply and is now showing surprising strength.

Of course this could all change very quickly, which is why we must still advise investors to use caution–particularly conservative investors and retired investors who cannot afford to take any losses. But for more aggressive investors, we have reached a point where taking some carefully considered long positions again makes sense.
F.S.