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Being prepared for a bear market is certainly prudent but a technical analysis review of the Canadian and U.S. market indices suggests that a bear market may yet be a few years off, perhaps in about 2010 if my analysis is correct. Of course we'll have corrections along the way but the path of least resistance is up right now, so don't get in the way of the freight train, as the saying goes.
Speaking of freight trains the Dow Jones Transportation Index is at record highs and has been leading the charge with the Industrials finally confirming in April. One of the basic tenets of the Dow Theory, the granddaddy of technical analysis, is that “no important bull or bear market signal can take place unless both averages give the same signal and both averages have to exceed a previous secondary peak in order for a bull market to begin.” Though we have been rallying for the past four years, it appears that the latest bull market signal was posted in April thus we are actually in the early stages of the U.S. bull. It appears that the Dow traced out a 6-1/2 year inverted head and shoulders pattern and broke out to the upside in September 2006. The pattern's technical measurement suggests a target of 15,500 over the next two-three years.
In my previous column I suggested that the TSX should reach 14,196 in May and that record was achieved on May 23 with an intraday high of 14,213. What's next?
Well, it appears that the TSX Composite index is in a third wave advance. Third waves are usually very powerful and usually one of the longest waves. In the case at hand it appears that the wave may be subdividing suggesting thus it may be the longest wave. Temporarily however, the index is overextended and the moving average convergence/divergence oscillator (MACD) has issued a sell signal. With summer on our doorstep and anticipated lighter market participation the index is likely to experience weakness. A pullback to the daily lower Bollinger band at about 13,700 should alleviate the overbought condition. Once the correction is out of the way a rally to 14,600 could be expected. However, final wave five could reach 21,888 over the next three years before we experience a significant bear market.
The positive technical outlook is further supported by fundamentals as Statscan's first quarter economic data revealed that the economy soared by 3.7 per cent, as compared to the last quarter of 2006 which grew by a revised 1.5 per cent. The growth in the current quarter was fueled by the energy and retail sales sectors. That's a mixed bag as retail sales growth is indicative of early expansion and energy sector growth is late expansion.
The U.S. economy on the other hand nearly stalled with growth of just 0.6 per cent, but most economists think that although growth will continue to be sluggish, “the first quarter will be the low point for the year. The National Association for Business Economics predicts the economy will expand at a 2.3 per cent pace in the April-to-June quarter.”
So do you look to take a defensive or an aggressive approach? With the bear a few years away for both markets I would personally get aggressive. However, let's assume I'm wrong and we'll go defensive. Defensive stocks are ones that aren't highly dependant on the larger economic cycle and the consumer staples sector would be an example. The Coca-Cola Company looks extremely interesting, but you must keep currency risk in mind. The stock's share price appears to have traced out an 8-1/2 year saucer bottom and it broke out to the upside in May. However, temporary caution is advised at current prices of $52.99 (U.S.) as the stock appears to be developing an evening star top, thus a pullback may be expected. First support is seen at the 10-month moving average at about $49, which would offer your first buying opportunity. Further support would be found at the 20 and 41-month MA's at about $45.25 and further accumulation would be suggested at that level. Once the advance resumes and the stock closes above $53.65 on a monthly basis it should rally to about $69 over the ensuing two years.
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.