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Relief Rally Not Sustainable.

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    August 17, 2011

    To paraphrase my posts of last week there was good news for the short term. Technically, the market was short-term oversold again, a condition that should produce another short-term rally, and have investors breathing a sigh of relief.

    And that has come to pass, with the Dow up 7.1% from its low last Thursday. It may have further to go as it is still somewhat oversold short-term.


    But don’t be made too complacent by the rally. As I also said last week, like the rally in July any oversold rally that develops is likely to be another opportunity for investors to take some risk off the table by selling into the strength, rather than being the end of the overall correction.

    I based that on a number of conditions. And they seem to also be unfolding.

    They included that intermediate-term the technical picture remains negative. Important intermediate-term support levels, like the 20-week m.a., were broken by the sharp decline since the April 29 top, and the longer-term trend looks to be down.


    Additionally, investor sentiment has not reached the level of fear and pessimism usually seen at market bottoms. For instance, the latest poll of its members by the American Association of Individual Investors last week showed 33.4% still bullish and only 44.8% bearish. In market corrections, the AAII poll almost always reaches a level of at least 55% to 65% bearish, and bullishness drops below 20%, before the correction ends. Given the rally of the last three days the poll this week (to be released late Wednesday night) is likely to show even more bullishness and less bearishness.

    Then there is the market’s seasonality. Historically, August, September, and October tend to be the most negative three-month period of the year.

    However, an even larger problem is the worsening condition of global economies, and increasing signs that we may be sliding into another global recession.

    In the U.S., the ‘soft spot’ in the first half was much worse than previously thought, as indicated by the shocking GDP revisions of a few weeks ago.

    Then the rebound that was supposed to take place in July to begin the 2nd half did not take place. Indeed the economic reports for July mostly showed more significant deterioration.

    And now we have the first reports coming in for August and they mostly show the economy sliding further.

    Yesterday it was that the Fed’s Empire State (NY) Mfg Index not only remained in negative territory in August but deteriorated further to –7.7 from –3.8 in July. Within the report the New Orders Index fell to negative –7.8. And the NAHB reported its Housing Market Index, which measures the confidence of the nation’s home-builders, remained unchanged in August, mired in the pits at just 15 (on a scale of 1 to 100).

    This morning it was reported that new Housing Starts tumbled 1.5% in July and previously reported starts for June were revised down.

    And outside of the U.S. it was reported that euro-zone GDP growth slowed to just 0.2% in the 2nd quarter, barely above negative growth (recession). And inflation in the U.K.accelerated to a 4.4% annualized rate in July, from 4.2% in June, and more than double the U.K. central bank’s inflation target rate of 2%. Meanwhile, after three days of rally most Asian markets were down last night on continuing economic and inflation concerns.

    So nothing has changed our expectation that although the short-term oversold condition would produce a short-term rally, the correction will resume to lower lows when it ends.

    I was confident enough of a rally that I and my subscribers temporarily took our profits from the ‘inverse’ exchange-traded-funds I recommended at our sell signal on May 8. They were substantial, an average of 20%. But with the rally of 7% so far, as we thought we would have given too much of them back if we had held the downside positions through the expected rally. Just as holding onto upside positions through corrections and giving back previous gains, holding onto downside positions rather than taking profits can be just as costly.

    But again, don’t be made too complacent by the rally, as we still expect our short-term indicators will turn negative again, perhaps very quickly, and we’ll be re-taking the ‘downside’ positions.

    To read my weekend newspaper column ‘It’s Time For Some Relief!’ click here!

    Which Way Next For Bonds?

    We also took our profits (13.8%) from our last buy signal on bonds (via TLT) last Thursday. For bonds it was because they had become so overbought, to a level that was likely to result in at least short-term profit taking and a pullback to the 30-day m.a.

    But so far bonds have only pulled back fractionally. In spite of Standard & Poor’s downgrade of U.S. debt, and the overbought condition, U.S. bonds are still attracting buying as a safe haven in the midst of all the global uncertainties.




    Images Flickr (licence attribution)

    About The Author

    Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!