In late September, after markets rallied above the summer highs there was a period of digestion. In that time, the sentiment was pervasively negative amongst market participants and in the news. Europe troubles resurfaced after a brief hiatus. At the time, the S&P had just regained its 200-day moving average for the first time since mid-May in the aftermath of the Flash Crash and at the depths of the European woes.
Let’s take a look at the chart of the SPYs (NYSE: SPY):
The first circled area in late September/early October saw the indices swing around violently within a tight range. All of the action stayed above the key 200-day moving average, which indicated the markets inclination to remain in Bull territory. The second circle area in November represents the last week and a half of trading activity. We can see that since the post-QE2 rally, markets pulled in 4% from their high point and found buyers lurking right above the 50-day moving average.
This recent action around the 50-day is very similar to what transpired around the 200-day and gives us a clue as to market momentum. The most impressive element of the digestion stems from the fact that the pull-in remained very tame and mild compared to the nature and extent of the worries standing in the way of any upside action.
While moving average are not to be used as fine line indicators in and of themselves, they do provide a great rough guideline for market momentum. With the market holding up at the 50-day moving average now, we have a clue that the short-term momentum is strongly in the Bull camp. At the moment, many hedge funds and mutual funds have underperformed the major indices on the year because so many were left underexposed to the long equity side. These managers now have no choice but to chase to the upside. Clearly many would have loved a deeper pull-in to accumulate more positions but after yesterday’s gap up that was not in the cards.
Dr. Copper, a leading market indicator which helped presage a short-term momentum top in early November gave us the first clear-cut sign that the next leg would be higher when it rallied strongly positive on Tuesday despite markets opening lower. Watch copper over the next few days to see if this important commodity breaks into new 52-week high territory.
To an extent, momentum begets momentum, and when the trend remains up in the face of bad news, once the good news really kicks into gear, the stage is set for an explosive rally. That’s exactly what we’re setup for right now.
Disclosure: No relevant position in SPY or Copper