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The Path of Least Resistance

spx

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In the image above I’ve drawn in a dashed black line.  This is the graph that I presented to our investment committee last week to show what I believe to be the path to the 200 day simple moving average – so far, it has followed the path of least resistance:  down.

If you recall from recent blog posts, I wrote that we were headed for the 200dma based upon various indicators that I discussed.  I haven’t added those to this graph as I didn’t want to make the graph any more confusing.  However, this focus on the S&P 500 seems to be misplaced and we should be watching the NASDAQ.

qqq

This is the chart of the NASDAQ that covers the same timeframe.  I have drawn a blue box around where the NASDAQ appears to have taken over dominance in the market.  You can see how the past several days have had all of the action under the red 50 day simple moving average line.  This is key – the index broke below the line in a pretty standard 3 down days followed by two up days followed by a resumption of following the primary trend, down.

What we need to watch for is:

1.  will there be follow through with another down day tomorrow?

2.  will we see another attempt to break above the 50dma? or

3.  Will we trade sideways in a consolidation range, build a base as we wait for valuations to come down and/or earnings to firm up, then move back toward the all time highs.

If we have another down day, we will be watching to see how the pattern develops – most likely it will follow the same path down that the S&P is following to the 200dma.

A break above the 50dma would mean we may have put in the low for the correction – no guarantees – all trading would need to take place above the 50dma for three days for it to be considered support.  But if that were to occur it would give us a buy signal to increase our equity allocation back toward previous levels.

If we trade sideways in a consolidation pattern, we could be in it for some time.  Maybe not as long as Walmart and Microsoft were as discussed in the prior blog post, but certainly long enough for another area of the stock market to take off.  Banks and Oils are both significantly oversold and trading at near-historic low valuations – its possible that the deep value area of the market that has been left behind for so long starts to be the leader while technology experiences a reversion to the mean.

Stay tuned as we work our way through this correction and look for an investable bottom to put cash to work.

—Mark