Sunday, January 14, 2007

Correction Coming?

Regular readers of this Blog know that I don’t dwell on the gloomier side of the market such as corrections and such and that I’m usually pretty upbeat about the whole situation. I did write a post back in December that suggested that a correction was due and I’m going to follow that up today with yet another post along the same idea.

I’m a great believer in regression to the mean (duh) and I believe that the best view of any stock, index or otherwise is the 90-period EMA applied to the weekly charts. Here I show a picture of the SPY, which I use as a proxy for the S&P 500 index since it kind of is the S&P 500 index. The diagram shows clearly that the SPY weekly bars stay well in touch with the 90-period EMA. And whenever it pulls too far away it hurries back again. Now “too far” is a relative term and I normally just eyeball it and watch the highs and lows and it looks to me on this chart at least that the SPY and therefore the S&P 500 is flattening at the top. It could be that we will have another decline like last two years and then explosive growth through the remainder of the year – but I’d be careful right now if I were planning any really long-term relationships with stocks. I’m not saying don’t get involved (remember rule 1) but be watchful and don’t let your portfolio on autopilot.

Here is the IWM, which is the proxy for the Russell 2000. It isn’t as graceful as the SPY and that probably reflects the fact that the small caps are more volatile than the S&P 500 large caps. But the effect is the same and if you were to overlay the two figures you would see that the corrections occur about the same time. In other words small cap, large cap is meaningless in the context of the larger market. This one looks like it is already rolling over at the top (highs and lows lower than previous highs and lows). If we take the past as prologue (and what else can we do) then we could probably expect a 7 to 10 point drop before the correction is over. And that would be about 10%. Do I expect more? Expect - no – is it possible – yes.

Last but not least here is a picture of MSFT on the same baseline (weekly with 90-period EMA). Note Mr. Softy’s love affair with the EMA and note how very, very far away Mr. Softy has run from its anchor. I leave the rest to your fertile imaginations.

1 comment:


Corrections must always happen.