The Huge Rally, and My Current Outlook

So over the last couple months, we’ve had an absolutely phenomenal rally in equities.  The SPX index has recovered from its lows around 870 to its current slot at 1007.  So what happens next?  A huge pullback; the typical suckerpunch to the novice investor? A continuation of this historic rally?  Or possibly a small pullback, before the market takes off yet again?  The first thing to consider is the long term trend, as shown by moving averages.

The averages most people use are the 50 and 200 day.  As a rule of thumb, if the 50 is above the 200, long term uptrend.  If the 50 is below the 200, long term downtrend.  I myself prefer to use the 17 and 43 week moving averages, with the same rules in terms of short average above long average, or vice versa.  This gives us the following picture:

The 17 week moving average is above the 43, so that indicates a long term uptrend.  Essentially, this is telling us that the bear market has ended.  The question then becomes, is now the time to buy, or is waiting for a pullback a better call?  If a pullback were to start tomorrow, I’d estimate it goes to around 900, because that’s where the last low was, and as such, the strongest area of support.  If you’re a long term investor, the difference between getting in at 900 and 1000 is more significant then it may sound.  If it goes to 1600 over the next 5 years, then getting in at 1000 means a 60% return, getting in at 900 means a 77.8% return.  Annualized over 5 years, the difference is getting 9.8% annually, vs. getting 12.1%.

So for long term investors, what’s the move… buy or wait for a pullback?  The first thing i look at here is the short and intermediate term trends.

The 20 day EMA is above the 50 day EMA, so the intermediate term trend is up.  The 20 day EMA has an upwards slope, so the short term trend is also up.  What does this tell us about a pullback?  It tells us that we’re not partway through one - if we were, waiting till it ends would be the correct move.  Yet at this very moment, the market is moving up.

In terms of how this affects our long term investment choices; buy or wait for a pullback, it comes down to these options:

1.        If we wait for a pullback, the market will most likely continue rallying for another 2 weeks, and the pullback may not even take it to the current levels.  If we get in even higher, our returns will be lower.  Waiting is the higher risk move; either we get higher returns if the pullback comes sooner, or lower returns if the pullback comes later, and doesn’t bring us beneath today’s levels.

2.       Long term, we’re almost assuredly profitable if we buy here, based on the long term trend.  Buying now looks to be a safer move then waiting for the pullback.  In a long term uptrend, almost everything goes up, and now’s the time to be buying.  We may be buying at a more expensive price then is absolutely necessary, but now that the market has shown itself to be up trending again, it’s time to be buying equities.

So that’s my analysis for the long term portfolio.  What’s the right move for traders?  I’d stay long as long as the market is above the 20 day moving average, and exit if the market spends 2 days under the average.  Best guess at holding period with that scenario is a week to a month, if the market continues its current trend, there is definitely the potential for significant profit; if the market decides to pullback, the fairly tight stop should get you out without big losses.