Technical Weakness Accumulates

NOTE:  This Market Commentary alert was originally emailed to subscribers at Ritholtz Research & Analytics on Mon 12/7/2006 4:34 PM;

This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.

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Even as the Market shows resilience, the signs of technical weakness continue to accumulate. Toward that end, we have uploaded our comprehensive Technical review of the NASDAQ Composite Index (download it here).

At present, conditional elements remain mixed: Price trend is bullish, while momentum, breadth and sentiment are now neutral. 

We need to see a trend break — confirmed by momentum and breadth — before we would decide to switch to an aggressively short posture. Although our individual recommendations have been long biased, they are quantitatively driven, hopefully staying in sync with the markets’ shorter term trend. However, enough indicators have migrated away from bullish readings to neutral to warrant increasing shorter term caution.

In driving terms, we are at a yellow light currently, down from a green – and waiting for the red to signal (unless we see a reversion back to green).

Anecdotally, this rally has as much to do with fund managers caught behind their benchmarks, and they are now playing catch up as it does with the strong seasonal factors. Additionally, we see evidence that, after many years on the sidelines, small investors are plowing back in, mostly due to the headline DOW numbers making new milestones. Directionally, the uptrend has not yet been broken.

Though the indicator evidence remains mostly neutral, we cannot help but note the low quality, low priced stocks bubbling up. As is often the case, these runs will likely end on excessive speculation.

Next up on the watch list: sentiment numbers, and volume leaders (to see the types of issues being sponsored). However, opinions and emotion often lead to troublesome decision making, so we defer to the unbiased, un-emotional indicators. They are now mostly indecisive, but we see a gradual shifting downward from previously more bullish levels.

This is another piece of evidence that is building the case for caution.

-Barry Ritholtz
December 7, 2007

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