Those expecting the markets to offer clear, decisive answers are destined for frustration. At times markets react to events in rational ways, but often they seek to frustrate us at every turn. Consider the movement of the Dow Jones Industrial Average (Dow) since January. Weakness early in the year led to a sharp decline (red line) as people feared the economy was descending into the abyss. Just as quickly, the market determined this view was incorrect and a sharp rally (black line) completed a classic V-shaped rebound. As this process was unfolding, economic and company-specific information dictated the ebb and flow of prices.
Since the Dow topped out nearly three weeks ago at 8,575 (black arrow), less concern has been paid to news and more to the market’s technical patterns. Recently, prices have bounced in a tight trading range (black dotted lines). As I mentioned on my recent appearance on Canada’s Business News Network, the rising 50-day moving average (MA) and falling 200-day MA are setting up a key inflection point. Just as a coil that gets compressed for too long will eventually spring loose, we should expect stock prices to come unbound shortly. If the Dow can rally above both the recent high and the 200-day MA (8,779) we should expect the market to eclipse 9,000 as the rally continues (black box). However, a break below the 50-day MA (8,088) would open the door to 7,400 (red box) with a likely retest of the March low (6,547). Investors will be well served to watch these price points and take action once the trend becomes clear.
Monday looks to offer an important test of the trading range. Pre-market futures are above the recent high. If that strength maintains, we will see the topside of the range violated and higher prices lie ahead. Were the initial strength to fade, the reversal would be bearish and the future uncertain. Facing a week which features important economic data, we should receive an answer to this question in the near future.