I hate to admit this, but I might have been wrong in my recent bullishness. Two weeks ago I triumphantly compared news of coordinated central-bank money printing with the Germans' loss of Stalingrad in 1943. I said the bears would be driven back by a steady tide of strong economic news and improving headlines from Europe.
I am now acknowledging a mistake because the S&P 500 rolled over at well established resistance around 1268. My earlier column also said pullbacks would be "shallow in coming weeks"--something else that didn't happen.
There is nothing wrong with being wrong, per se. The important thing is to know when you're wrong--and then change your strategy.
So my plan now is to wait for support and let the market prove itself. The chart below shows how the S&P 500 has been forming a " wedge " pattern, which puts the next key level around 1185. We could bounce before then, but it will probably be difficult to trade.
The good thing about the wedge is that it provides a roadmap for trading. The downside support level helps us pick where to buy, and the overhead resistance tells us where to take profits. The pattern is also useful because we know that we can expect a big move in either direction once it's broken.
There are still a lot of reasons to expect a big rally: good earnings, an improving U.S. economy, and cheap stock valuations. The bad news is that we've been hearing this mantra for a long time now, and it's failed to bring capital to the market in a concerted way. So what's going on?
It appears that we haven't yet emerged from the structural bear market that began in the late 1990s. The basic issue seems to be demographic because pension funds and life-insurance companies have been piling into bonds for the last five years as they prepared for the wave of baby boomers hitting retirement age.
More than 4 million Americans were born every year between 1954 and 1964, which means that there is a bulge of people between the ages of 47 and 57 who will soon start collecting fixed monthly payments. The result is that fund managers have been shifting money into fixed-income securities that match those liabilities.
That brings us to the final problem: the bond market. In addition to the demographic issues, there is an unnatural demand for bonds now because of the Fed's commitment to keep interest rates low through 2013.
Fed Chairman Ben Bernanke has essentially given investors permission to buy Treasuries with impunity and without risk of loss. So, why should anyone want to own stocks, which carry some risk, when there's guaranteed free money in bonds?
It's not clear how much further this run in Treasuries can continue, but like all bubbles it very well could defy reason. The yield on the 10-year note is consolidating below its low from late 2008 and may fall even more.
Stocks also made a lower low in early October and a lower high at the end of the same month. The question at present is whether that signals the start of a downtrend or simply a period of consolidation.
For now, it's impossible to say. So for now, I plan to stick with the levels mapped out in the wedge pattern above, stay disciplined, and not think I'm smarter than the market.
(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Dec. 14.
(S&P 500 chart courtesy oftradeMONSTER .)
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