“Double Top Breakout” Redux?

Quite an interesting situation here as we see a substantial divergence among some of the major indexes. I’ve excluded the NASDAQ from the discussion below because it is effectively mirroring the S&P 500. Our contention has been that over the past 3-4 weeks smaller cap stocks have lagged, and aside from 2 weeks ago speculators / computers (or fund managers) have been hiding out in the big caps. One can see this by looking through a lot of individual charts, and this is borne out by looking at 3 major indexes, from largest to smallest.

1) We rarely look at the Dow Jones Industrial Average as it is 30 stocks and this index is price weighted… meaning a company like IBM has countless more importance than a company like General Electric. Makes little sense to me, but that’s how they have always done it… whatever the case, the DJIA has broken to a new yearly high.

2) The S&P 500 on the other hand is in a position it has been repeatedly this year… it approaches recent highs. This sets us up for a pivot point near the old high – either we (a) form a “double top” (bearish) or (b) break through and create a “double top breakout” (bullish). By buying double top breakouts we’ve made a lot of money this year in the fund. Each time we approach one of these points I sound like your grandmother warning you to look both ways before crossing the street.. i.e. “this is so obvious, it should not continue to work – one of these times the bulls have to be trapped”. But it keeps working… the minute we get over a recent high all the computers on Wall Street go into overdrive and we surge. Until the pattern breaks, it will continue to be played, so this is what we’ll be watching in the coming day(s).

The way I play this is I sell into the resistance, assuming at least a failure on the first attempt and then buy on the breakout. It’s worked like a charm for the past 6 months. This seems like ‘extra work’ (why bother to sell at all!) when the market “only goes up” but it will protect gains the one time this pattern fails. Again, the obvious should fail spectacularly at some point… could be in a few days or in 2011, who knows. I never expected the obvious to keep working as it has almost the entire year. We’re about 7 S&P points away from shedding some of our long exposure.

3) The weakest of the 3 indexes has been the Russell 2000, which also has more of the smaller and mid cap stocks. Only yesterday did it break through (concurrently) its 20 and 50 day moving averages. In the “old days” this lack of breadth and participation would be a warning sign. I don’t know if in a liquidity driven market that it matters at this time. Nothing seems to matter other than the constant hammering of the US dollar. Surely lack of volume or participation has meant nothing during much of this rally.

So that’s our strategic outlook, if the past patterns continue we might falter the first time we get up to S&P 1100 but soon it will be sliced like swiss cheese on the way to new highs. We’ll see if its just the same old, same old yet again.

About Mark Hanna 542 Articles

Affiliation: Hanna Capital, LLC

Mark Hanna is President and Owner of Hanna Capital, LLC, a registered investment advisory firm. Mark has been a follower of markets since the late 80s, with a focus on individual equities since the mid 90s. He has been a well known commentator in the financial blogosphere for the past 5 years, following a career in corpoporate finance and accounting. Mark attended the University of Michigan where he graduated with a degree in Economics.

As an avid reader, Market Montage is the personal blogging site for Mark to share his views on economics, markets, and the like. Occasional cynicism and wit shall be deployed in his postings.

Follow Mark on Twitter @fundmyfund.

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