How Long Can this Rally Last: One Must-See Chart Has the Answer

Like us on Facebook

Since then, the markets have made a sharp turnaround. The "fix" is in. It's earning fantasy season and companies are posting average earnings. In most cases they're not as bad as expected. Which means to some - buy, buy, buy.

Right now though with the herd solidly on the euphoria tangent, investors should be asking, "How long will it last?"

The chart below shows the answer may surprise you.

Getting Technical

Through many years of experience we've learned to be highly suspicious of charts and black box trading systems.

There are, however, some technical indicators that are very important if only because so many people follow them. One of those is the 200-day moving average.

The chart below, which tracks the percentage of S&P 500 components trading above their 200-day moving average, shows the downtrend could have made a sharp reversal  (Refer Top)

Since the markets turned around, the number of S&P components trading above their critical 200-day moving averages has surged to 52% from a low of 26%.

It's a critical turn because when stocks are below their 200-day moving average, they tend to go down.  Just look at what happened since the start of the bear market of 2007 to 2009. Stocks were below their 200-day moving average almost the entire time. Then the March 2009 rally started and pushed stocks above the critical 50% level and the rally lasted longer than almost everyone anticipated.

That's why, if the markets hold on for a few more days, we could be in for another sustained multi-month rally.

If It Bleeds, It Leads

Of course, there is no way to predict the short-term market movement with absolute certainty. We know enough to know we don't know anything about the short-term. But we can get in position for what's likely to happen. This indicator will help us do that.

As part of our "L-shaped" recession expectation, we expect the markets to remain very volatile. It's easy to expect a stock market which moves up and down 10% to 20% every few months as the economy dips into and out of recession.

So if we don't see a sustained period where most stocks are above their 200-day moving averages, it's a pretty safe bet the market's next move is down. Remember the old newspaper adage, "If it bleeds, it leads" and the vicious cycle of bad news begetting more bad news can really feed on itself during period of high uncertainty.

That's why now is a great time to review your positions, ensure you have enough cash on hand to take advantage of the opportunities when they come (being 20% or more in cash is certainly reasonable in this type of environment), and continue to look for the high-reward/low-risk opportunities.

So although the masses are succumbing to the idea of great earnings and are happy to take a break from the bearishness, we don't feel it will last too long. But the great indicators like the S&P 500 stocks relative to 200-day moving averages, we won't have to rely on feel and be able to take what the market gives us.