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Dow Breaks Through 13,000

S&P 500 Index Annotated

Yesterday, the Dow closed above 13,000 for the first time since the stock market crashed at the end of 2008.

There are lots of varying opinions on what is happening – whether we are at a top and set to correct (I’ve heard predictions between 3% and 9%) or whether this is the beginning of a new bull market that will be driven by peak corporate earnings and P/E expansions.

As I always do, I like to see what the market is telling me and act accordingly. To that end, I’ve included a chart that should be vaguely familiar to readers of this blog. I’ve annotated it to show various stages, levels, indicators and turning points.

I’ve started the graph last September (on the left) to show you the progression from the bottom of the correction to today. You will see that I’ve drawn some green circles/elipses around strong up-trends in the market. You will note that the MACD indicator below also has green circles drawn on it – the MACD is my favorite trend indicator as it tells me that a move has sustainability as long as the black line remains above the blue line.

If you look to the right side of the graph, you will see that where we are now in this part of the advance higher is not showing the same sort of trend – I’ve drawn a red box around it on the MACD graph. In fact, it is drifting sideways, fairly trendless and in fact is starting to drift down. That concerns me.

You will notice a number of red boxes on the graph, none of which I would describe a particularly healthy indicators of where the market is at the current time. Of note, look at the historgram at the top of the page. You will see that we have started to see some black bars appearing above the gold ones. This means that we now have more companies trading above their 200-day moving average than above their 50-day moving average.

By the shape of the histogram, you can see that the black bars are fairly flat (meaning that the companies trading above their 200-day moving average have remained flat) while the gold bars have started to trend down (meaning that stock prices for those companies have fallen but remain above the 200-day moving average yet they have dropped below the 50-day moving average. That concerns me.

The other red boxes show you various overbought readings or below average trading volume readings while the market advance has moved up to a 100% recovery from the selloff as measured from the 2011 high. All of that concerns me.

But that does not mean we are due for a major correction in and of itself. Overbought situations, particularly in a trendless market, can move sideways for an extended period of time while investors either determine that:

1. there is some economic or geopolitical issue that would work to either derail the economic recovery or shake consumer and/or investor confidence and likely send the market lower – or

2. that economic fundamentals are strong enough to provide for growing corporate earnings and P/E expansions to send the market higher.

The economic news continues to improve in the US – today, the Chicago PMI came in above expectations, yesterday the the Dallas numbers were better, Consumer Confidence readings are better, bank lending is expanding – all signs that the double dip recession that cause the market to correct into the September time frame were wrong just as we wrote about at the time here on the blog.

But, given the indicators in the red boxes, and my adage that you invest what you see not what you believe to be true, here in the short-term, I think getting cautious is warranted.

Here is our plan:

1. We are going to raise cash out of the pure beta section of client portfolios, booking profits on the SPY ETF we purchased earlier in the year. The goal will be to redeploy that cash into either SPY again if the market pulls back or to add to current positions that have not rallied as much as some other positions.

2. We are going to increase the stop loss orders we have for companies that have performed significantly greater than the market overall year-to-date in order to protect the gains we have.

Given the strength in the US economy as noted by the improving economic indicators, the easing in monetary policy in the developing world, and the slow progress forward in Europe, I don’t anticipate a major move lower. However, I see in the indicators I trust weakness in equities so i don’t want to be caught in a corner not having taken the appropriate action.

If we see that the market can move above the 1370 resistance level of lat year’s high and successfully complete the Rule of Three (see earlier blog posts) then we will move that SPY back into the market for a fully invested position once again.