Technical Analysis Market Letter October 2013 from Ralph Acampora

An article by New York Institute of Finance Technical Analysis instructor Ralph Acampora.

So much has happened over the past two months; for example, no sooner did the Dow Industrial and Dow Transportation averages score all time new closing highs on September 18th and 19th respectively, confirming Dow Theory's definition of a primary bull market, the DJIA fell precipitously, retracing its entire August/September rally. That's the bad news. The good news is that none of the major indexes, including the DJIA, broke below their June lows. Thus, the 'summer rally' that commenced on June 24th is still in force. Historically, the longer the summer rally, extending into the September/October period, the greater are the odds that we will witness a strong year-end. And as of this writing (October 18th) the DJTA is now at another new all-time high while its sister average is a mere 2% away from making its comparable new all-time closing high. When one thinks about what we all went through because of the shenanigans in Washington D.C. over the debt ceiling, it is really amazing that the market did as well as it did. An old Wall Street adage: "During a sell-off, those that go down the least are the new leaders in the next up move", see Table 1.

Table 1. Performance During The September 18th Thru The October 9th Market Decline

As you can see, the worst performing average during the Sept/Oct decline was none other than the Dow Jones Industrial average itself; note that the secondary's (mid-, small- and micro-caps) outperformed the Dow's large-cap components on the downside. Europe, especially France and Germany, did exceptionally well versus the US while some developing markets also did better than the DJIA. I am glad to report that ten of the twelve indexes in Table 1 are making new highs as I write this letter; the DJIA and the FTSE 100 are lagging, but due to the market's breadth and momentum during this current advance, they too are expected to catch-up and make new highs.

I believe that the March 2009 low was a generational low similar to the August 1982 bottom, commencing a secular bull market that ended in early 2000. Thus, I believe our current secular bull market still has many years to run. But, of course, it will not be a straight line up - there will be many pitfalls on the way which will precipitate cyclical bear markets. Having said this, one of the overriding positives for me is something I call, structural sentiment. Unlike the weekly Bull/Bear statistics, the AAII polls and the Put/Call ratios, which are very helpful in identifying near-term shifts in investor sentiment, I take a much longer-term view, see Figure 1.

Figure 1. Three Phases of Investor Sentiment During Classic Secular Bull Markets
Source: “The Fourth Mega Market”, Ralph J. Acampora, CMT

Phase One. At the end of a typical bear market, investors are froth with 'fear' after having experienced a serious sell-off; but, this time the 2007 thru 2009 debacle was anything but typical: investors saw the leading averages drop 50%; some large, well respected, money center banks sold down to low single digits; and once, highly regarded brokerage firms had to be taken over or simply go out of business. Not only were investors traumatized by their own losses but they found themselves disbelieving the system, starting with the rating agencies that haphazardly slapped AAA ratings on just about everything, especially subprime mortgages. In this kind of environment investors feel that they have no choice but to buy safety: quality large-cap blue chip stocks, with a long history of paying dividends. The public remains on the sidelines, underinvested in equities. Today is a classic example of this: they still have trillions of dollars in bonds and money market funds despite the fact that the S&P 500 is up about 160% over the past four and a half years, see Figure 2.

Figure 2. It Took Years for The 1982/2000 Secular Bull Market to See a Shift from Bonds into Equities

Phase 2. Those professionals who have participated in the stock market and have gleaned handsome profits to date will feel that now is the opportune time to broaden-out their holdings; as their comfort level increases they begin to lighten-up on some of their blue-chips and reinvest in secondary issues. This is exactly what Table1 is reflecting today - mid-cap and small-caps are outperforming large-caps over the past few months, see Figure 3. Why? Because investors, both institutional and retail, are starting to believe that things are getting better. They've seen the market absorb some real bad news, only to regain its momentum and move higher; e.g. the US downgraded by S&P; the 'fiscal cliff', the Arab Spring and most recently, the government shut-down. They trust that things will get better.

Figure 3. The Russell 2000 Is At All-Time New Highs relative To The S&P 500

Phase 3: This is a time when everyone thinks that making money in the stock market is easy. They now get their advice from friends at the Saturday night cocktail parties. Who needs research, they shout, as their arrogance increases. Over time these speculative 'stock tips' make them serious money which further increases their self-inflated egos. There is nothing like rising stock prices to lure in the unsuspecting. The last time we witnessed anything like this was in the late 1990s - 'The .Com Bubble" period where complacency and greed reigned supreme. So far this is not the case - money is only slowly flowing out of bonds and into equities these days - therefore, a surge in reckless public buying is not apparent at this time. Thank God!

Conclusion: The relief from the government shut-down, the historic implications following a strong 'summer rally', the broad-based leadership, especially in secondary issues and in the impressive performance of most global markets supports my belief that the fourth quarter will be a very impressive time for investors. The new high in the S&P 500 reinforces my near-term target of 1800.....a secondary objective of 1850 is also a strong possibility.

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