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Technically speaking

Yola Edwards

TORONTO (GlobeinvestorGOLD) — Every day there's speculation that the markets are near a bottom or forming a bottom. Well, that could be true this time.

Canadian economic data continues to support a strengthening economy, and employment is growing at a torrid pace, averaging nearly 50,000 jobs per month this year, with 40,700 jobs created in September. Added to that, confidence appears to be swelling, as Canada's work force participation rate for September was 67.2 per cent, the highest rate in 12 years. So is the bear market over and will the stock market finally turn higher to confirm the positive data?

The technical chart below should shed some light on the situation.

A four-year weekly chart of the S&P/TSX Composite Index (TSX-I) indicates that a bearish head-and-shoulders formation, a negative technical pattern, appears to have been completed when the index traded to an intra-day low of 5,678.28 on Thursday, October 10, 2002. Though the technical measurement of the pattern suggested a possible final target of 5,500, being within 3.2 per cent of the downside target is considered acceptable as the pattern forecast the lion's share of the decline.

Is that then the end of the bear market? According to Dow theory, the primary trend, which in this case is a bear trend, can only be considered to be officially over if the market exceeds the previous high of 11,400 set on Sept. 9, 2000. Any rally up to that point would be termed a trend reversal.

The stochastic indicator, a technical measurement that tracks closing price trends, indicates the TSX has rallied off of an extremely oversold level. An oversold reading would mean that prices have tended to close near the lower end of the trading range week after week and have become so depressed that some buying may occur.

On a weekly basis, as the market rises, the first point of resistance will be encountered at the 10-week moving average (ma) at approximately 6,300. The moving average measures the average price level that an index or equity has traded at over a given time frame. However, due to the oversold magnitude of the index, the 6,300 level should not pose much of a problem and a rally to the 20-week ma at 6,550 is likely.

Though the TSX may pause to catch its breath, meaning share prices could fall somewhat, it should continue to rally to the 6,800 to 7,200 levels where it will be met with heavy overhead resistance. The 50-week ma at 7,200 will definitely pose a challenge so you might expect the market to consolidate or trade in the resistance range before it makes its next move. If the market follows the prescribed course then it is quite possible that a bottom has been put in place and higher prices are ahead.

However, the weekly moving average convergence/divergence oscillator (MACD), a trend signal that uses two exponentially smoothed averages that cross above and below a zero line to indicate whether a buy or sell signal are confirmed, still suggests the market is in sell mode. Once the oscillator's faster exponential average, the blue line turns up and crosses through the slower red line average, an initial buy signal will be issued, forecasting the possible trend change ahead.

S&P/TSX Composite 1-Year Chart with MACD

The S&P 500 index, a broad measure of the U.S. stock market, has rallied over 100 points from its low on October 10. That equates to over 1,000 points on the Dow Jones industrial average, yet investor sentiment indicators and the CBOE put-to-call ratio, which are measures of investor psychology on the market, suggest there is still a lot of concern and fear in the market. Advisors who are bearish suggest investors sell into the strength of the market.

In addition, there is still the threat of war with Iraq, which could have a negative impact on stocks. Now earnings season is upon us and naysayers suggest that even if earnings come in ahead of analysts' expectations and the market could climb, caution is key as the market is still too richly valued.

However, November, December and January are traditionally strong months when stocks advance. There is also a mid-year election and that too is usually bullish.

What do you do? A look at the technical chart below might help.

Technical indicators usually focus on future events and the market makes its move in advance of actual events. The technical chart below suggests that the S&P 500 Index has made a key reversal. A true key reversal day marks an important turning point, rather than a temporary pause in an existing trend. Although the turning point cannot be correctly identified as such until well after the fact, it does appear that a bull rally could be underway. At the very least we have a strong trend reversal. A very bullish "W" technical pattern has also emerged lending support to the bullish theory.

The S&P 500 will likely run into overhead resistance, a technical ceiling where prices will have difficulty in advancing past, at the 10-week moving average (ma) of 870. Once past this level the S&P 500's next resistance point would be at the 20-week ma of 900. Although the index won't rally in a straight line, the technical measurement of the bullish "W" formation suggests that it should ultimately reach 1,154 over the next few months.

The MACD supports a theory of a higher market. Though the index registered a lower low in October than the low in September, the MACD did not dip lower than the September low suggesting a positive divergence.

S&P 500 Composite 1-Year Chart with MACD

It appears that there is more reward than risk ahead and investors could consider committing funds to the market.

Yola Edwards is a contributing writer and technical analyst for Bell Globemedia Interactive, providing options and technical analysis research on a variety of North American equities.

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