Market Outlook as at December 4, 2009

On November 23, I wrote a piece that points the danger lurking in a market after a pro-longed period of price gain (go here). To wit:

We have been fortunate that all the corrections in the current rally have been fairly mild. If you look at the monthly chart below, you will see that the absence of sharp correction in the current rally almost mirrored the condition in the super bull run of 1993. This is quite unlike the bull rallies of 1998-99 & 2006-7, where sharp corrections or significant consolidation took place during the rally.

I wish to add to the above observation by examining the following questions:
1) Why should we be wary of a period of prolonged uni-directional price movement?
2) Can we use more objective means of determining whether the market is in a period of prolonged uni-directional price movement?
3) When would such a period end?
4) How much would the decline or rebound be?

A period of prolonged uni-directional price movement leads to a sharp reversal. This happened at the end of the Bull run of 1993 & towards the end of the bear market of 1998. If we are positioned wrongly in the market, such as having large long positions in December 1993 or large short positions in December 1997, we could be badly hurt.

Looking at the Slow Stochastics %K (and, to some extend, the RSI), we can see 3 periods when the indicator stayed "overbought" or "oversold" for a long time (say, 8-10 months), without any movement towards the neutral 50 level. These 3 periods are denoted as 'A' for the present bull rally; 'B' for the Bull run of 1993; and 'C' for the bear market of 1998. The latter two periodic episodes ended in end of the year or the beginning of a new year.

In the case of the Bull run of 1993, the KLCI dropped back to the 40-week Simple Moving Average (SMA) line. In the bear rally at the beginning of 1998, the KLCI rose to the 40-week SMA line. Why the 40-week SMA line? Interestingly, the 40-week SMA line is about the same as the 200-day SMA line- a line that is generally regarded as a turning point in the market.


Chart: KLCI's daily chart as at Dec 3, 2009 (Source: Tradesignum)

To be sure, the market has not issued a clear-cut "sell" signal. Some negative signals were observed, such as bearish divergence between indicators & prices; MACD appears poised for a negative crossover; weak volume sponsorship; and, poor market breadth. For a clear-cut signal to base our decision to sell, I think the 50-day SMA line (currently, at 1250) is probably better than the linear trend line that I had drawn earlier. Some would prefer the 200-day SMA line for certainty, but that certainty would be purchased at a cost of much lower prices when the selling is finally carried out. In any event, we need to avoid a sharp correction, not amounting to a bear market, as much as we need to avoid a bear market.

Needless to say, our market is not an island and we are likely to travel in the same direction as other global markets. So, it is important to keep an eye on the global markets for further development, which of late has been rather discouraging.