In part 1 of this 3-part
series on market technicals, Bruce Zaro takes a look back at 2006 and tries
to put it into perspective. Subsequent essays will deal with the outlook for
2007.
Looking back at 2006, the
break out of the Dow on January 6th at 11,000 may have ushered in a new era
for the US markets. With that move, the market's 6-year recovery seemed
complete and the subsequent follow-through breakout in May at 11,500 has been
impressive. Nightmares about the post-1990's collapse finally faded as the
realization sunk in that corporate profits have been piling up at double
digits rates for years now. Finally, equities were waiting for one event that
had been so illusive -- a pause from the Fed. Since the middle of 2005,
investors had been bidding up stocks prior to each Fed meeting in hopes that
this time the spell of higher interested rates would be broken; most times,
the market sold off as those hopes went unrealized.
I wrote on June 13th of 2006
in Delta Global's Morning Meeting notes titled "Market Reversals
Imminent" that it appeared the ugly market sell-off that had started on
May 10th was about to come to an end. Deeply oversold conditions and wildly
bearish sentiment led to this earlier than normal mid-term election bottom
(truth be known, I had expected a mid-term election bottom later in the year.
While the timing is always difficult to pinpoint, I have strong convictions
that the rapid 8% sell-off we saw this year, which bottomed in July, was a
very significant bottom, possibly the second such major inflection point --
October 2002 being the other -- in the post -911 market).
I believe chart based analysis
is valuable in confirming one's fundamental outlook. Personally, I developed
a very positive fundamental outlook to the markets late in 2005 and had
written on January 11, 2006 ("Will the Strong Start to '06 Last?")
that these positive fundamentals would unfold during 2006. In retrospect, the
November 2005 bottom may have been foretelling that the Fed's rate increases
would cease 9 month hence, the top choice on the wish list of most investors.
Front and center in this article was a prediction of Dow 12,400, some 1, 400
points above the current closing price. Meanwhile, the NASDAQ has so far
fallen short of my 2,700 price objective, but more on that later.
Outlook for 2007
Dow Jones Industrial
Average - (DJIA 12,423)
What we have experienced over the last few weeks has been predictable
volatility in uncharted territory for the Dow. I had thought a perverse mood
might surface as the Fed abandoned its rate increase campaign, and it has.
Are we facing recession? Plunging corporate profit growth? Now what?! It's
just so predictable...classic fretting as a result of the Fed's change in
policy direction.
I happen to expect the market
to make additional progress in 2007 as profits remain strong, although it
remains a good possibility the string of consective quarters of double digit
growth will be broken. Inflation may shrink a bit, contrary to what
yields on the inflation sensitive TIPS bonds are telling us, and while some
consolidation is in order and could hit at any time, it's unwise to be
bearish on stocks at this time of year. As we get to the end of the
seasonally favorable period - April - then I will likely take more defensive
capital preservation strategies. As of today, however, my target on the Dow
now stands at 16,500.
Nasdaq Composite - (COMP
2,418)
The one crowd that has not been made whole yet is the tech-crazed, post-'90's
bubble herd. Investors who were heavily invested here saw their fortunes play
out like Cabbage Patch doll collectors, yet they've gotten some relief in
2006. So, what's the outlook from here?
An encouraging sign that the
market rally has further to go is the growing appetite for risk. Indeed, from
the July bottom the NASDAQ is up 22% versus the Dow's 16% rise. Year-end tax
trading and lack of liquidity has resulted in a bit of lost momentum for the
NAZ, but with the January effect around the corner, NASDAQ out-performance is
likely to widen in the coming weeks. I would caution that the index and its
components are exhibiting some pretty brutal volatility right now.
Furthermore, additional short-term indicators I follow have reversed down to
signal more consolidation is near. Still, investors should generally look to
use pullbacks as opportunities to initiate positions, albeit in technically
healthy stocks which also have well-defined stop points. This remains a time
one should want to be pretty fully invested. My own NASDAQ target is 3,360,
but bear in mind that in the types of analysis I employ it often tends to be
timing that is most difficult to gauge, with my 2006 NASDAQ target standing
as one overly-optimistic example (although the direction was surely correct).
US Treasury 10 year
Yield Index - (TNX 4.59%)
The peak in rates was clearly signaled with the TNX unable to push yields
higher than 5.22% in July. In fact, multiple lower bottoms on this chart
preceded the Fed's August pause by almost a month and that downward trend in
yields continues, refreshed by each subsequent reaffirmation of the change in
Fed trend at later policy meetings. With a bit of recession worry and the
hope of numerous rate reductions coming, the yield worked its way down to 4.42%
in early December. However, rates have gone about as low, technically, as can
be expected for a while. While rates could consolidate and back up all the
way into the 4.82% range, 2007 could be quite boring on the interest rate
front, with the 10-year ranging generally between 4.5 - 5%.
More on specific sectors,
including commodities, in part II...
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