The best indicator for what an investment is likely to do is its long-term trend. Remember Isaac Newton’s first law of motion that says an object in motion tends to stay in motion. While stocks are not physical objects and therefore don’t really move, their price movements have momentum. The transitions between long-term bear and bull markets are infrequent so a trend tends to be a powerful force.

The early periods of those long-term transitional turning points are difficult to identify. They often look much like intermediate-term corrections that last only a few weeks. Such is the situation that recently confronted investors.

The chart below shows the New York Stock Exchange Composite over the past three years. Two years ago in March 2009 stocks bottomed after a bear market trend that had been in place since October 2007. Since that time, stocks have generally remained in an upward trend.  There was a sideways consolidation in summer of 2010, but stocks resumed their upward momentum in September and have staged a powerful advance since then.

A month ago stocks began to waiver and the political and economic events unfolding seemed to pose a threat to the two-year bullish trend. The past few days, however, stocks have recovered enough to turn most technical indicators back to positive and the long-term advance no longer seems in jeopardy.

There are lots of fundamental factors that provided an excuse for traders and investors to begin dumping stocks. The long list includes higher oil prices, Middle East tensions, Japan’s earthquake and the nuclear problems that followed. Those are just the global concerns. On the home front there has been continued high unemployment, ongoing weak housing numbers, U.S. involvement in military actions in Libya, and more. Just today the University of Michigan released its latest survey numbers showing that the March consumer sentiment was at its lowest level in a year. Consumer sentiment is an important leading economic indicator, yet the markets absorbed the number and continued to advance.

Of course stock movements are difficult to forecast and the unpredictability of the financial markets has been the downfall of many investors. But it certainly seems that if stocks needed an excuse to begin a new bear market, there have been abundant recent opportunities.

On the top portion of the above chart the gold line is a 50-day simple moving average (MA). The NYSE Composite dipped below its MA in March, but gains in recent days have it again trading above that mark. The middle portion of the chart is a moving average convergence divergence (MACD). The indicator turned downward at the end of February, but it never went below zero. Now the MACD has turned upward again, suggesting that the strong bull market remains in place.

Finally, the stochastic oscillator on the bottom portion of the chart indicates that the NYSE Composite is now overbought. But that is to be expected after the strong gains of the past few sessions. After a session or two of cooling down, it would not be surprising to see major indices advance to higher highs.

Flint Stephens

The easy answer is that the problems facing Japan should not have a significant impact on the U.S. economy. But right now, stocks are being driven by emotion, not fundamentals. It has been a week since the earthquake and tsunami struck Japan. Major stock indices were already in a corrective consolidation before the incident occurred. The result is that volatility has probably been much greater than it otherwise would have been.

In the past week there have been days when the Dow fell by triple digits and also days when it rose by triple-digits. The volatility experienced by major U.S. stock indices has not been as great as in Japan, where share prices fell by about 16% by Tuesday. Japanese stocks have since regained a significant portion of those early losses.

Below is a chart of the S&P 500 Index over the past year. The gold line on the top portion of the chart is a simple 50-day moving average (MA). Prior to the Japanese earthquake, the index was right at a technical support level and resting at its 50-day MA. Now the index has broken below that support and the big question is whether it will be able to break back above that support line or whether it will meet resistance that keeps it from resuming its advance.

Given the current situation, traditional technical indicators like a moving average convergence divergence (MACD), stochastic oscillator, or a relative strength index (RSI) are fairly meaningless. Fear, emotion and uncertainty are the major factors that will drive stock prices until the situation in Japan is stabilized. In addition, the market in Japan has already experienced significant intervention and will likely see more government involvement to maintain its integrity. That makes the impact on U.S. markets even more difficult to forecast.

Today the New York Federal Reserve Bank confirmed that along with the G-7 nations and European central banks it had intervened in the currency markets to drive down the price of the Japanese yen. The price of the yen rose sharply in the past week and there were fears that Japanese companies would sell dollar-denominated assets and buy yen to pay for quake recovery. There were also worries that a higher yen could reduce Japanese exports—something that would make it even tougher for the Japanese economy in the wake of this disaster.

For now the U.S. markets seem to be reacting as good as can be expected considering the extent of damage in Japan and the possibility of increased nuclear fallout. But it is important to realize that the situation could change in an instant if another major unexpected event occurs.

Flint Stephens

There isn’t much new to say about the markets right now. Stocks have been moving in a sideways pattern for the past several weeks and are likely to continue in that mode for another week or so or even longer if Middle East tensions result in continued uncertainty in the oil markets.

The chart below shows the New York Stock Exchange Composite over the past six months. The strong upward trend is clearly visible. The blue lines show the narrowing sideways channel that has persisted during recent sessions. Normally when stocks break out of a sideways consolidation they do so in the direction of the dominant trend. In this case that would mean stocks would resume their advance.

Of course when it comes to forecasting the markets, nothing is for certain. Right now oil prices are creating some uncertainty that has the potential to disrupt the market’s upward move. Another spike in oil could be the catalyst that would send stocks downward instead of resuming their advance. Under current circumstances it is difficult to predict what is going to happen with oil prices and consequently, how stocks are likely to react.

For the next couple of weeks the best course of action for investors is to keep a close watch to see which direction the indexes eventually move.
Flint Stephens

It must be time for a market correction. I can usually tell when one is about to occur because ordinary investors—like a guy a church or at the gym—start to tell me how much money they made recently in stocks. During powerful market advances it is easy to get the impression that everyone is getting rich by investing in stocks. It’s kind of like spending lots of time outside when the weather is good and the sun is strong—almost anyone with exposed skin will get tan.

The current stock market advance is now about two years old. The only significant period of weakness during that rally came during the late spring and summer of 2010. The chart below shows the performance of the S&P 500 over the past five years. This index is up about 25% since August 2010 with just a small pause in November. Now it appears that stocks might again be in a sideways consolidation. The only concern is whether it will last just a couple of weeks like the one in November or be more significant like the summer 2010 correction.

In spite of the impressive advance over the past two years, stocks still remain well off of the highs reached in the fall of 2007. As the green line on the chart shows, the S&P 500 is currently at almost the exact same level as five years ago. That means many buy-and-hold investors still have not recouped all of the losses experienced during the correction that began in October 2007.

The same is true for many businesses that were hit hard by the economic downturn. Earlier in the week Warren Buffett appeared on CNBC’s Squawk Box. He said he is still bullish on America in the long run, but admitted that the economy is just inching along. He noted Berkshire’s railroad business, led by Burlington Northern Santa Fe, is only about 60% back from the bottom.

The duration of the current consolidation in stocks is likely to be significantly impacted by oil prices. If oil and gas prices continue to climb, those rising prices could make it more difficult for stocks to resume their rally.  It is probably more than coincidence that the major market correction that began after the market peaked in October 2007 coincided with a steep rise in oil prices. The chart below compares the price of oil with the performance of the S&P 500 from 2007-2009. Stock prices did not begin a significant recovery until after oil prices stabilized in early 2009.

Obviously there were other significant challenges to the economy during the economic downturn. There was a banking crises as well as a meltdown in the real estate and mortgage industries. But it would be a mistake to underestimate the significance of oil prices on the overall U.S. economy. Virtually nothing else can fuel inflation as quickly as rising energy costs. And right now the price of oil could be the major factor in determining whether stocks can continue their long-term advance or they instead enter a lengthy corrective phase.