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Risk On!

 November 27, 2012 02:03 PM

(By Cam Hui) Last Monday I speculated that equities were on the verge of a Santa Claus rally (see Waiting for a Santa Claus rally) and what a rally we've had in the week!

Since then, the news backdrop has turned more positive. Mark Hulbert reported that insiders are buying again, which is a signal of a sustainable intermediate term upswing in stock prices. China's PMI has moved into expansion mode and Pragmatic Capitalism noted that China's leading indicators continue to improve and Nomura is turning more bullish on the Chinese economy (China bulls may be interested in my post A better way to play a China rebound).

[Related -Oversold Airline Ready For A Quick Rebound]

One of the key indicators I said to watch is the stochastic on the NYSE Summation Index:

I have been watching the slow stochastic of the NYSE Summation Index, which is shown below in the top panel, with the SPX shown in the bottom panel. In the past, cross-overs in the stochastic have marked good entry points to get long the stock market and this indicator has only failed once out of six in the past two years.
As the chart below shows, we have seen the crossed over in the stochastic and, if history is any guide, this market should be good for a rally of 4-6 weeks. This pattern is consistent with a Santa Claus rally lasting until year-end.

[Related -What Is Your Sell Criteria?]

Nearby resistance a sign of pause?

What could possibly go wrong?

In the short term, the market is approaching overbought territory. As well, I see numerous signs that major indices are approaching resistance levels, either minor or major, which could cause the market to pause and consolidate its gains for one or two weeks. For instance, take the chart of the SPX below and note how it's in a uptrend but approaching a nearby resistance zone, marked in yellow.

The SPY/TLT ratio, which measures the relative returns of equities against long Treasury bonds as a proxy for the risk-on/risk-off trade, is also nearing an overhead relative resistance level.

This pattern of risky assets rallying and nearing technical resistance levels is not just confined to the United States. Across the Atlantic, the Euro STOXX 50 will bump its head against technical resistance should it rise much further.

Hong Kong's Hang Seng Index is in an ascending triangle and likely to test resistance soon.  

I could go on, but you get the idea. Given the proximity of nearby overhead resistance, the most likely scenario is for stocks to fail the first time it tests those levels. We will then see some sort of pullback and consolidation period for one to two weeks.  

Bottom line: The bulls have seized the initiative and markets are likely to continue their rally, but may pull back and consolidate their gains in the next 1-2 weeks. Traders may wish to view any weakness as opportunities to add to their positions.        

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.  

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.




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