Tuesday, December 06, 2011

About Your "Guaranteed" Santa Claus Rally....

Will Santa Claus arrive in time to deliver his usual year end rally, or has he decided to trim his largesse to Wall Street this year and instead deliver lumps of coal to Bernanke, Geithner & Co.?

A lot of punters are awfully confident that Santa Claus will deliver his usual year end rally this year. A glance at a few charts calls that confidence into question.Let's take a look at a daily chart of the S&P 500. (Those of you who loathe charts, please scroll down and enjoy the pithy conclusion.)

While charts are as much a reflection of the reader as the market, several things pop out of this chart to me. One is the bullish flag in September. The On Balance Volume (OBV) was rising while price declined, a classic example of bullish divergence. Given this and some other clues (sentiment hit an extreme of bearishness, VIX spiked,etc.), then the rally in October was not exactly "out of the blue."

But when we turn to recent action, the indicators are bearish. OBV climbed to a new high, but price did not even make it up to the previous high--a bearish divergence. Now OBV has plummeted while price has skyrocketed higher, an extremely ugly divergence.

Meanwhile, stochastics are already overbought and VIX (not shown) punctured the lower Bollinger Band, and sentiment by some measures is either neutral or moderately bullish, all of which suggests complacency is once again the dominant emotion.

All these bearish signs have appeared just as price ran into the buzzsaw of strong overhead resistance: the 200-day moving average and the top line of a gigantic wedge formation, which typically breaks big up or down.

Given the lower highs--a classic sign of a weakening market--and the indicators suggesting this last manic rally has run out of steam, then we might reasonably conclude that the big break out of this wedge will be down--and perhaps in a major way.

Consider this chart of the 2007-2011 period from my Chartist Friend from Pittsburgh (who has shared both bullish and bearish charts with me). Notice the remarkable similarity of the pattern that preceded the 2008 waterfall crash and the current price action. Coincidence? Perhaps.

Perhaps the general blithe confidence in Santa's delivery of a rally is misplaced;perhaps he's decided to trim his largesse to Wall Street this year and instead deliver lumps of coal to Bernanke, Geithner & Co. It's something to consider.

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