How goes the market? The past few weeks have been a mess! And the volume doesn't signal any conviction in Wednesday's 2.6% rally in the Spyders. Perhaps we'll see some confirmation during the remainder of the week.

Chris comments: Multiple bearish technical patterns are taking place for gold right now, a rising wedge, Fibonacci resistance, not to mention bullish sentiment above 90%.

Does this mean that the "Power of the Pattern" will win again? Odds say yes, yet rising wedges are incorrect 35% of the time and investors should have a plan if gold overpowers the patterns.

If gold breaks above this resistance, the Fiboncacci expansion price target for Gold would be around $1,800 per ounce, about a third higher than current prices.

Should this breakout take place, even though gold has done well for the past few years, we'd be looking at yet another new leg up for Gold.

Technical analyst Chris Kimble, a dshort.com regular contributor, takes look at the contrasting patterns of Base Metals and Gold.

Chris comments: Base Materials ETF (DBB) is breaking a lower support level of late, in what seems to reflect a softness in the global economy.

Gold continues to push higher, ever higher into a narrowing wedge that has to end soon.

Often times precious and base metals are on the same price road, yet since January of this year, they are heading in different directions.

Will they get back on the same road again? If so, which direction will that road take them?

Yesterday I received a BP update from Chris Kimble, a 30-year+ market technician and student of Sir John Templeton. The top chart his update of the second chart, which he sent a month ago. See his original commentary from May 3 here.

On May the 3rd, I shared a chart of BP showing it had formed a "head and shoulders" pattern — prior to the rig going down.

Attached is an update. "How brave are you?" If you think BP has gone down a ton, look where the next support is.

Sir John used to say you must invest at the "point of max Pessimism." Are we there yet?

About the only certainty in the stock market is that, over the long haul, overperformance turns into underperformance and vice versa. Is there a pattern to this movement? Let's apply some simple regression analysis to the question.

Here's a chart of the S&P Composite stretching back to 1871. The chart shows real (inflation-adjusted) monthly averages of daily closes. We're using a semi-log scale to equalize vertical distances for the same percentage change regardless of the index price range. The regression trendline drawn through the data clarifies the secular pattern of variance from the trend — those multi-year periods when the market trades above and below trend. That regression slope, incidentally, represents an annualized growth rate of 1.70%

The Bearish View
The peak in 2000 marked an unprecedented 160% overshooting of the trend — about double the overshoot in 1929. The index had been above trend for nearly 18 years. It dipped about 6% below trend briefly in March of 2009, but at the beginning of June 2010 it is 33% above trend. In sharp contrast, the major troughs of the past saw declines in excess of 50% below the trend. If the current S&P 500 were sitting squarely on the regression, it would be hovering around 845. If the index should decline over the next year or two to a level comparable to previous major bottoms, it would fall to the low 400s.

The Bullish Alternative

A critical factor for the reliability of a regression analysis of stock prices over many decades is the accuracy of the inflation adjustment. The Bureau of Labor Statistics (BLS) has been actively tracking inflation since 1919 and has estimated inflation rates back to 1913 using data on food prices. In 1982, however, the BLS began incorporating changes to the Consumer Price Index (CPI), which is used to calculate inflation. These changes have resulted in much lower "official" inflation rates than would have been the case if the method of calculation had remained consistent.

At his www.shadowstats.com website, Economist John Williams publishes an "Alternate CPI" employing the earlier BLS method. Here is a chart that illustrates the significant difference between these two calculation methods.

Now, let's take another look at the S&P Composite, this time adjusted for inflation since 1982 using Williams' Shadow Government Statistics. The change is astonishing. The adjustments to post-1982 data alter the slope of the regression and impacts the variance from the trend across the entire time frame, dramatically so in the last two decades. The slope drops from an annualized growth rate of 1.70% with official CPI to 1.32% with the alternate CPI. In this view, the S&P 500 has been below trend since the end of 2007. The 2009 bear market low saw the monthly average index price drop to 54% below the trend, which puts us in the territory of those secular market troughs. The current price is about 36% below trend.

My opinion is that the optimum method for calculating consumer prices is somewhere between the revised BLS method and the historic method preserved by Williams. But for a long-term regression analysis, consistency is essential, which may lend some credibility to the alternate CPI chart as an indication of the current index price relative to previous troughs. On the other hand, government policy and business decisions have been fundamentally driven by the official BLS inflation data, not the alternate CPI.

I generally avoid predictions at dshort.com, but a future trough somewhere between the bearish and bullish view seems a reasonable expectation.

Check back next month for another update. Meanwhile, see also this comparison of secular bull and bear markets using some simple regression analysis.

Chris comments: Last week, at 1,842 on the NDX 100 the following chart was published, reflecting a potential "Head and Shoulders" pattern, with the price zone to watch for between 1,870 and 1,190.

Shortly after noon central today, the NDX 100 reached 1,878, touching the 38.2% Fibonacci retracement level.

Are we there yet? Don't know for sure, yet the lower end of the "price zone" was reached.

For those looking to score on defense, the price has been reached to start putting positions in place.

Technical analyst Chris Kimble, a dshort.com regular contributor, takes look at the S&P 500.

Chris comments: When support is broken in any asset class, often times the asset rallies to test if the old support line, which is now resistance, is a valid or strong resistance line. If it is, often times you can kiss that assets price "good-bye" for a while.

The 500 index broke below its 200-day Exponential Moving Average (EMA) line of late, which was support, now turning the 200-ema into a resistance line. Last Thursday, the index closed right at the 200-EMA for the first test of this line as resistance.

Now comes the huge resistance test for the 500 index. If the 200-EMA does hold as resistance, it could be viewed as the "kiss good-bye" suggesting much lower prices to come.

Big test at hand right now: Is this the "Kiss Good-bye" or a "Good Buy Kiss?" The patterns suggested to SELL BEFORE the worst May in over a half-century. If the 200-day line holds as resistance, the idea of "Sell in May and go away" might look smart as well!

At the beginning of what could be another volatile week, let's review volatility the S&P 500. The top chart features an overlay of the index and the CBOE Volatility Index (VIX). When you click on it, you'll link to a series of charts that review the S&P 500 and VIX over two timeframes 1990-present and 2007-present. I've also included identical versions with the VIX inverted to facilitate comparison with the underlying equity index. The VIX is nicely explained by Investopedia:

VIX: The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge".... VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

The second chart was furnished by Serge Perreault, our regular weekend analyst, who makes the following comments:

The VIX appears to be traveling sideways between the support of 30 discussed by Chris Kimble in one of his previous charts [here] and the resistance of about 45. Looking at the attached chart, I wonder if it will "relax" as it did from December 2008 (leading to the rally from March 2009) or break out again and lead to another correction? Notice too how ROC3 led the index, ROC 13 and RSI4.

Here's the latest update of my preferred market valuation method using the most recent Standard & Poor's "as reported" earnings and earnings estimates and the index monthly averages of daily closes through May 2010, which is 1125.06. The ratios in parentheses use the May monthly close of 1089.41. For the latest earnings, see the table below from Standard & Poor's.

The "price" part of the P/E calculation is available in real time on TV and the Internet. The "earnings" part, however, is more difficult to find. The authoritative source is the Standard & Poor's website, where the latest numbers are posted on the earnings page. Click on the Index Earnings link in the right hand column. Free registration is now required to access the data. Once you've downloaded the spreadsheet, see the data in column D.

The table here shows the TTM earnings based on "as reported" earnings and a combination of "as reported" earnings and Standard & Poor's estimates for "as reported" earnings for the next few quarters. The values for the months between are linear interpolations from the quarterly numbers.

The average P/E ratio since the 1870's has been about 15. But the disconnect between price and TTM earnings during much of 2009 was so extreme that the P/E ratio was in triple digits — as high as 122 — in the Spring of 2009. At the top of the Tech Bubble in 2000, the conventional P/E ratio was a mere 30. It peaked north of 47 two years after the market topped out.

As these examples illustrate, in times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator. "Why the lag?" you may wonder. "How can the P/E be at a record high after the price has fallen so far?" The explanation is simple. Earnings fell faster than price. In fact, the negative earnings of 2008 Q4 (-$23.25) is something that has never happened before in the history of the S&P 500.

The P/E10 Ratio
Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market's value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by the 10-year average of earnings, which we'll call the P/E10. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the P/E10 to a wider audience of investors. As the accompanying chart illustrates, this ratio closely tracks the real (inflation-adjusted) price of the S&P Composite. The historic P/E10 average is 16.3.

The Current P/E10
After dropping to 13.4 in March 2009, the P/E10 rebounded above 20. The chart below gives us a historical context for these numbers. The ratio in this chart is doubly smoothed (10-year average of earnings and monthly averages of daily closing prices). Thus the fluctuations during the month aren't especially relevant (e.g., the difference between the monthly average and monthly close P/E10).

Of course, the historic P/E10 has never flat-lined on the average. On the contrary, over the long haul it swings dramatically between the over- and under-valued ranges. If we look at the major peaks and troughs in the P/E10, we see that the high during the Tech Bubble was the all-time high of 44 in December 1999. The 1929 high of 32 comes in at a distant second. The secular bottoms in 1921, 1932, 1942 and 1982 saw P/E10 ratios in the single digits.

Where does the current valuation put us?
For a more precise view of how today's P/E10 relates to the past, our chart includes horizontal bands to divide the monthly valuations into quintiles — five groups, each with 20% of the total. Ratios in the top 20% suggest a highly overvalued market, the bottom 20% a highly undervalued market. What can we learn from this analysis? Over the past several months, the decline from the all-time P/E10 high dramatically accelerated toward value territory, with the ratio dropping from the 1st to the upper 4th quintile in March 2009. The price rebound since the 2009 low pushed the ratio into the 1st quintile, and it is now positioned on the lower boundary at 20.6. By this historic measure, the market is expensive.

A more cautionary observation is that every time the P/E10 has fallen from the first to the fourth quintile, it has ultimately declined to the fifth quintile and bottomed in single digits. Based on the latest 10-year earnings average, to reach a P/E10 in the high single digits would require an S&P 500 price decline below 540. Of course, a happier alternative would be for corporate earnings to make a strong and prolonged surge. When might we see the P/E10 bottom? These secular declines have ranged in length from over 19 years to as few as three. The current decline is now in its tenth year.

Or was March 2009 the beginning of a secular bull market? Perhaps, but the history of market valuations doesn't encourage optimism.

In response to the occasional request I receive for a real P/E10 based on the ShadowStats Alternate CPI for the inflation adjustment, see this chart, which suggests that the current market is fairly priced. The first such request came from Theodore Keeler, Professor Emeritus of Economics at UC Berkeley. See this link for more details.

Yet another approach, one which avoids the question of the "correct" inflation adjustment, is to use nominal values for calculating the P/E10. The is the method of analysis favored by by Bob Bronson, a market historian whose research is occastionally featured at dshort.com. For Bronson's rationale, see this post from May 5th. Thus I'm now including a monthly update the nominal P/E10.

Was the March 2009 low the end of a secular bear market and the beginning of a secular bull? Or is there more downside to come? Without crystal ball, we simply don't know.

One thing we can do is examine the past to broaden our sense of the range of possibilities. An obvious feature of this inflation-adjusted chart of the S&P Composite is the pattern of long-term alternations between up- and down-trends. Market historians call these "secular" bull and bear markets from the Latin word saeculum "long period of time" (in contrast to aeternus "eternal" — the type of bull market we fantasize about).

If we study the data underlying the chart, we can extract a number of interesting facts about these secular patterns:

The annualized rate of growth since 1871 is 1.94%. If that seems incredibly low, remember that the chart shows "real" price growth, excluding inflation and dividends. If we factor in the dividend yield, we get an annualized return of 6.61%. Yes, dividends make a difference. Unfortunately that has been less true during the past three decades than in earlier times, a topic I periodically discuss here. When we let Excel draw a regression through the data, the slope is an even lower annualized rate of 1.70% (see the regression section below for further explanation).

If we added in the value lost from inflation, the "nominal" annualized return comes to 8.83% — the number commonly reported in the popular press. But for an accurate view of the purchasing power of our returns, we'll stick to "real" numbers.

Based on the real S&P Composite monthly averages of daily closes, the S&P is 45% above the 2009 low, which is still 40% below the 2000 high. The 2009 low measures about 6% above the average decline for secular bear markets. Of course, this number is a bit skewed by the bottom in 1932, which saw a greater decline over a much shorter period (three years versus nine).

Let's review the same chart, this time with a regression trend line through the data.

This line essentially divides the monthly values so that the total distance of the data points above the line equals the total distance below. Remember that 1.94% annualized rate of growth since 1871? The slope of this line, an annualized rate of 1.70%, approximates that number. The 0.24% difference is largely a result of the rally over the past year.

Regression to trend, as we've seen elsewhere, often means overshooting to the other side. The latest monthly average of daily closes is 33% above trend after having fallen only 6% below trend in March of last year. Previous bottoms were considerably further below trend.

Here is a chart that overlays its performance on the legendary Dow Crash and Great Depression with the S&P 500 of the 21st century. Both are adjusted for inflation using the Bureau of Labor Statistics' Consumer Price Index (CPI). Dividends are excluded. As the chart illustrates, at the nine-year point, both major markets were registering similar staggering losses.

Most people, however, evaluate market performance in nominal terms with no inflation adjustment, as in the next chart, which obscures the true starting point of our 21st century downturn. Such charts also foster what economists call the money illusion — an unreal image of wealth based on nominal dollars with shrinking purchasing power. By the nominal comparison, the market performance during first decade of the 21st century has been significantly stronger than during the Great Depression.

But wait. Could it be that even in our inflation-adjusted chart, the current market gets a "money illusion" boost compared to the earlier Dow?

Let's look at the same chart — this time adjusted using the Alternate CPI maintained by Economist John Williams at his Shadow Government Statistics website. This disturbing chart suggests that, after a decade of nominal price volatility, the real value of the current market is dramatically lower than the equivalent point after the Crash of 1929.

The Alternate CPI preserves the algorithms in place before 1982, when the Bureau of Labor Statistics began introducing a series of modifications to their calculation methods. Those modifications have significantly reduced the government's official estimate of inflation, which has had a ripple effect throughout the economy. For example, Social Security Cost-of-Living-Adjustments (COLAs) are accordingly reduced — not a happy outcome for senior citizens. The chronic lowballing of inflation also facilitated the environment of low interest rates that have contributed to the inflated prices of assets purchased with cheap borrowed money — hence the twin bubbles in equities and real estate).

Here is a chart that shows the larger context for the two historical periods and the very different inflationary/deflationary environments.

For an extensive series of charts, including several that compare the differences between the CPI and Alternate CPI on key economic metrics, visit this amazing collection at the National Inflation Association website. I've now added a permanent link to the Association in the research section of my right column.

For a fascinating perspective on the adjustments to the official CPI calculation method, see these videos from ChrisMartenson.com.

Of the three market overlay charts, the nominal version is the least useful for comparing the decline is equity asset values. The real overlay based on the official CPI is flawed by the radically different calculation methods during the two periods. The overlay based on the consistent CPI calculation methods preserved by ShadowStats probably gives a more accurate comparison of the relative loss in value of these two vastly different timeframes — one deflationary and the other inflationary (although the degree of contemporary inflation is debatable).

The first decade of the 21st century is a vastly superior economic environment compared to the 1930s. We are not at this point in a Second Great Depression. Nevertheless, the similarity in the real deflation of equity asset values is rather stunning — and a fact that is poorly understood by the majority of investors.

Footnote on Dividends: The comparison of these two secular bears is based on index price only, excluding dividends. The inclusion of dividends would work to the detriment of the current secular bear. The average annualized dividend yield during the 1930s was 5.53%. For the 21st Century Bear, the annualized yield has been 1.84%.

Technical analyst Chris Kimble offers a weekend perspective on the Dow across two timeframes.

Chris comments: Is Dow 11,000 a big deal? It's only 7% away! Only two more days like Thursday, (up 3%) and the Dow will be there! The last time the Dow hit 11,000 I suggested that investors should harvest gains because of Fibonacci resistance and a rising wedge.

Yet from a long-term perspective are there any other reasons to apply risk management or harvesting strategies around Dow 11,000?

As the chart here illustrates, Dow 11,000 is important dating back to the 1990's and all the way back to the 1930's.

What was the famous line from the movie "The Gambler?" You've got to know when to fold them!

Keep this long-term chart in mind as an input for knowing when to "harvest" due to medium and long term resistance.

The S&P 500 closed a volatile week up 1.47%. It is 10.50% below its interim high set April 23rd, when the index was up 9.16% for the year, which puts is in traditional "correction" territory (a decline of more than 10% from an interim high). The year-to-date performance is now -3.85%.

The first chart is a weekly view of the S&P 500. The second chart is a weekly view of the Dow Jones World Stock Index.

The S&P 500 closed the month of May 8.2% below the April close. Two of the three S&P 500 monthly moving averages we've been tracking have signaled a sell. See the specifics here.

Since 1950 the S&P 500 10-month SMA has had 41 buy signals; 26 of them (63.4%) led to a gain before the next sell signal, 15 of them (36.6%) led to a loss. The 12-month SMA has had 31 buy signals, 21 (67.7%) led to a gain before the next sell signal, 10 (32.3%) led to a loss. These moving-average signals have a good track record for long-term gains while avoiding major losses. But they're not fool-proof.

Here is a table with the current signal for the 10-month SMA for the five ETFs featured in The Ivy Portfolio. I've also included a table of of 12-month SMAs for the same ETFs for this popular alternative strategy.

Buying and selling based on a moving average of monthly closes can be an effective strategy for managing the risk of severe loss from major bear markets. In essence, when the monthly close of the index is above the moving average value, you hold the index. When the index closes below, you move to cash. The disadvantage is that it never gets you out at the precise top or back in at the very bottom. Also, it can produce the occasional whipsaw (short-term buy or sell signal).

Nevertheless, a chart of the S&P 500 monthly closes since 1995 shows that a 10- or 12-month simple moving average (SMA) strategy would have insured participation in most of the upside price movement while dramatically reducing losses.

The 10-month exponential moving average (EMA) is a slight variant on the simple moving average. This version mathematically increases the weighting of newer data in the 10-month sequence. Since 1995 it has produced fewer whipsaws than the equivalent simple moving average, although it was a month slower to signal a sell after these two market tops.

A look back at the 10- and 12-month moving averages in the Dow during the Crash of 1929 and Great Depression shows the effectiveness of these strategies during those dangerous times.

For anyone who would like to see the 10- and 12-month simple moving averages and the equity-versus-cash positions since 1950, here's an Excel file (xls format) of the data. My source for the monthly closes (Column B) is Yahoo! Finance. Columns D and F shows the positions signaled by the month-end close for the two SMA strategies.

Timing works because of a basic human trait. People imitate successful behavior. When they hear of others making money in the market, they buy in. Eventually the trend reverses. It may be merely the normal expansions and contractions of the business cycle. Sometimes the cause is more dramatic — an asset bubble, a major war, a pandemic, or an unexpected financial shock. When the trend reverses, successful investors sell early. The imitation of success gradually turns the previous buying momentum into selling momentum.

Our illustrations from the S&P 500 are just that — illustrations. In actual practice, you should have a separate signal for each asset class that you plan to use for this strategy. For example, you wouldn't buy and sell a small cap index mutual fund or ETF based on an S&P 500 signal. The strategy is most effective in a tax-advantaged account with a low-cost brokerage service. You want the gains for youself, not your broker or your Uncle Sam.

In the past we've recommended Mebane Faber's thoughtful article A Quantitative Approach to Tactical Asset Allocation. The article has now been updated and expanded as Part Three: Active Management his book The Ivy Portfolio, coauthored with Eric Richardson. This is a "must read" for anyone contemplating the use of a timing signal for investment decisions.

The book analyzes the application of moving averages the S&P 500 and four additional asset classes: the Morgan Stanley Capital International EAFE Index (MSCI EAFE), Goldman Sachs Commodity Index (GSCI), National Association of Real Estate Investment Trusts Index (NAREIT), and United States government 10-year Treasury bonds.

As a regular feature of this website, I try to update the signals at the end of each month. However, my retirement flexibility and life's unpredictability preclude a firm commitment.

If you wonder what the US market is doing, what index do you first check? The Dow 30, the S&P 500, the Nasdaq or Nasdaq 100?

Chris Kimble takes a look at the world's largest index, the New York Stock Exchange (NYSE), affectionately referred to as the "Big Board," with over 8,000 companies listed.

The NYSE is much further below the 200-day exponential moving average than other major US index.

This broad-based index is something to respect and keep an eye on. The chart reflects again — when certain patterns present themselves, it's a good time to "harvest the fruits of a rally."

The chart below is a long-term look at gold sent earlier today from regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

Gold has been an awesome asset to own this decade. Since we are at the end of a month, I've annotated a monthly chart of Gold from 1979. The trend is up and the price is above all the important moving averages.

The one thing investors should be aware of is that monster of a multi-year rising wedge — often a bearish pattern.

Technical analyst Chris Kimble saw that I've now included the Shanghai Composite Index in my World Markets Overlay feature. Why am I'm not surprised to find the following in my inbox?

I've added a brief explanation from Investopedia for the Fibonacci numbers. It looks like Chris also marked a pennant that failed to resume the uptrend.

I had posted a "preliminary" preview on Wednesday because of number of changes to the monthly moving-average signals we've been tracking. Here now is the pre-market situation on the last day of the month. All three S&P 500 monthly moving averages are in the green, but two are close to signals. The 10-month (simple moving average) SMA gave a buy signal at the end of June 2009, and the 12-SMA and 10-EMA (exponential moving average) signaled buys at the end of July 2009.

The top table previews the 10-month SMA timing signals for the five asset classes highlighted in The Ivy Portfolio. See the Timing Updates for interim updates.

I'm also included the 12-month SMA timing signals for the Ivy ETFs in response to the many requests I've received to include this slightly longer timeframe.

At this point two of the Ivy ETFs are flashing a sell signal for the 10-month SMA. Two are signalling a sell for the 12-month SMA variant on the basic strategy.

The bottom line, as we've pointed out earlier, is that these moving-average signals have a good track record for long-term gains while avoiding major losses. They're not fool-proof, but they essentially dodged the 2007-2009 bear and thus far have captured significant gains since the buy signals after the March 2009 low.

Today's 3.69% rally in the Nasdaq 100 was good news. However, technical analyst Chris Kimble points out a not-so-happy pattern that could be taking shape — a head and shoulders top.

I have shared in prior posts that the NDX began a rally in 2008, well before the S&P 500, and it has greatly outperformed since the low.

NDX is currently above its 200-day Exponential Moving Average, while the other major US indexes aren't. Earlier this week (here) I suggested we keep an eye on this leader.

Is this leader now putting in the "scariest" technical pattern possible? Possibly. I've created target zones on the chart in case this pattern forecast is correct.

The S&P 500 rallied an impressive 3.29% — much more pleasant than the -3.90% selloff one week ago, although some additional volume would have been welcome.

Friday will be interesting. It's the end of the week, the end of the month, and the starting point for a three-day weekend. Today's close was fractionally below the 200-day moving average, which will also add a bit of drama to Friday's action. Will the 200-MA offer resistance? We'll soon find out.

Crude oil fell almost 20% after the suggestion to "harvest oil positions" (May 13 post). After the decline on 5/16, the suggestion was "its time to pick up cheap oil" in this May 18th post.

This update suggests that Crude held on support and is now breaking above falling resistance. Crude is now "feeling its oats" and, from a pattern perspective, has broken out of the starting gate.

Yesterday technical analyst Chris Kimble shared a chart that again showed the 20-year Treasury ETF (TLT) against stiff resistance where harvesting TLT gains is the logical trade, a case he made earlier in the week with The Time is Now! Here a snapshot of TLT a couple of hours into today's trading.

Harvest at resistance in TLT. Already, one day later, TLT has broken support and is being hit VERY HARD. Already down 2.5% from its high at resistance/double top. TLT has lost 25% of its one month gains in just TWO DAYS, which reinforces the benefits of "harvesting against resistance."

This is actually very good news for stocks.

With bond prices down, we expect bond yields to rise, which is exactly what we're seeing today in Treasuries (chart below).

Here's another chart from Chris Kimble, this one a triple look at commodities (COMEX High Grade Copper futures, Morgan Stanley Commodity Related Equity Index (CRX), and the Reuters/Jefferies CRB Index).

Should you invest in the "Jungle Book" trade (bare necessities), like copper?

Looks like the Jungle Book is losing to a Bear in the financial Jungle!

Here's a chart from Chris Kimble showing the CBOE Interest Rate on the 10-Year Treasury Note (TNX).

Yields on the 10-year note bottomed on December 18th 2008 — stocks a few months later. Yields on the 10-year peaked on April 5th 2010, and stocks hit their highs on April 26th. Perhaps we should view government yields a leading indicator of the stock market.

As the chart suggests, the current pattern resembles what we experienced in 2008, when stock values soon "deflated" like not seen in years.

Investors should be wary of what yields do RIGHT NOW!

Preface: The inflation-deflation debate is a favorite topic at dshort.com, one that today's guest contributor previously addressed in The 'Flation Debate. Today Edward Jaffe returns with a different analysis regarding inflation measures.

It is important to understand that many widely accepted metrics of current and historic economic and investment performance are flawed and lead to conclusions that certain parties wish us to arrive at. Like stepping on a scale that already has 73 lbs on it, proper calibration is essential to honest weight.

A quick visit to some websites of leading financial institutions lead us to calculators and other presentations where the viewer is told to utilize a "historic" number in order to project future inflation as best as one can. The numbers I have found range from 2.30% to 4.00%. Most sites use 3.00%.

A leading broker says that "inflation has averaged 3% over the past 80 years." Current financial panic aside, the last time inflation was honestly ~3% for any length of time was the 1960s. Are we really that in love with the idea of fooling ourselves?

For purposes of contemporary planning, looking at any pre-1971 data is absurd and misleading. Read more to see why. This is a short essay, not a book, so the time I can spend on the definition of inflation will have to be limited.

Oops! That last one is a problem. We are really using currency and calling it "money." This currency is not a storehouse of value; rather it is simply a medium of exchange. The popular notion that creating more "money" makes prices go up is generally valid — as is the idea that skyrocketing prices represent "inflation" even if the observer is not entirely sure what M1, M2, M3, MZM and TMS are up to lately (see the handy explanation here). We generally measure symptoms rather than look at the causes, which would be excessively painful.

There are a variety of "inflation" causes and much variation of "inflation" symptoms and manifestations. In a previous essay I focused on asset inflation and its connection to credit expansion. In this essay we are going to touch on studies of the general price level and other measures that relate to the "cost of living." The focus here is to determine how valid some of our "retirement" concepts and calculations are. There are countless plans, calculators, theories and promises that fundamentally rely on a level of inflation that bears little resemblance to our real history — despite their liberal use of the word "historic."

A casual look at the monetary aggregate mountain range should frighten anyone who has future obligations payable to him/her in nominal units of some currency (like an annuity). Once currencies are purely symbolic, central banks can create an environment of extreme expansion.

For someone seriously trying to determine future prices, an objective idea of past events and metrics would seem necessary. A good place to start is to ponder whether or not we are dealing with the same currency. After all, lots of things are called "dollars" including the currency of Zimbabwe.

From the end of the Revolution until 1873 America saw much volatility in prices but little cumulative inflation. The purchasing power of the "dollar" was similar in 1875 and 1914 despite substantial volatility in between. That 1914 "dollar" is worth pennies today — so it seems rather silly to consider it the same currency.

The United States was on a fairly consistent gold standard from 1873 to 1913. The Public-Private Federal Reserve Bank was created in 1913. There was some price inflation and much credit/asset inflation during the "Roaring Twenties" and by 1933 the world was in the midst of the Great Depression. While many prices had collapsed along with commerce, the dollar was debased further when the US — and most of the nations of the world — abandoned the gold standard. There was much sovereign insolvency at the time — a phenomenon we are starting to notice today. Winning — not fighting — WWII ended the depression for the US.

There are many people who think that official economic metrics (BEA/BLS/FED/other) do a poor job of matching objective reality and furthermore that there are obvious political motives and possible long-term savings of billions if not trillions if "inflation adjusted" payments and interest on government debt can be keyed to lower inflation numbers. In areas like unemployment there are more useful numbers available (U6 = ~17%). But somehow only the "headline" number (U3 = ~10%) makes the headlines [See footnote].

Fortunately there is a firm that has made a scholarly effort to generate corrected results using the same basic data — essentially economic metrics ex-manipulation. That firm is Shadow Government Statistics and their work frequently appears as an alternate metric on this site. It a a subscription-based website, but much of the content is available to non-subscribers.

If we are going to think about what inflation might be like in the future, the Consumer Price Index (CPI) from 1971 until today would be your best-case scenario. Averaging in CPI before 1971 is a non-case scenario — as one would be comparing a society on gold/quasi-gold standard to complete fiat money. Also it is important to understand how important making a low-inflation case is to the sell-side of the financial product sales world. How can you be convinced to buy all those mutual funds (with sales loads) if returns are not above inflation?

There are actually three key issues for thinking about inflation and the future. One is selecting the time period for "historic inflation." The second is the accuracy of the official CPI (we are trying to avoid compounding dishonesty). The third issue is that many credible people see very-high inflation in the future as the only end game to global sovereign debt issues. This last issue won't be addressed here, but it is worth keeping in mind.

We all know there was high inflation in the 1970s shortly after Nixon closed the gold window, ending convertibility between US dollars and gold. The Oil Embargo of 1973 exacerbated matters. We know that because the CPI was a reasonably reliable metric. According to SGS, statistical manipulation of the CPI began in the 1980s, making the issue of price analysis particularly confusing in the first decade of this millennium.

According to the Bureau of Labor Statistics (BLS), price inflation was tame during the first decade of the millennium. But SGS has another story to tell. When comparing these two metrics there a few things to keep in mind that don't reflect well on the conclusions offered by the BLS.

Increases in commodity prices were very substantial, especially energy (not shown). We import huge quantities of raw and finished goods in our mass-consuming economy. How could CPI price measures be so stable with commodity prices on such a tear? The drop in the value of the dollar and the updraft of commodity prices relate somewhat and make sense, but the CPI numbers don't. I invite everyone to review your check stubs and other costs from 2000-2010.

So official CPI 1970-2009 is around 4.5% (a long way from 2.3%) — but estimated SGS consumer price inflation for 1970-2009 is around 7.5%.

Now let's flash forward to 2030 and go shopping on a shopping trip with our ShadowStats currency calculator:

We are not going back to a gold standard from where we are now — not without a Total System Reset.

Here's an interesting chart from Chris Kimble featuring the 20-year Treasury ETF (TLT) and the Base Metals ETF (DBB).

Yields have been falling in sync with falling commodity pressures. Yields and Commodities both find themselves at VERY LARGE trend support and resistance. Bond prices are up against resistance and Base Materials are on support. The Power of the Pattern suggests buying support and selling resistance.

If Bonds break resistance and Base Materials break support, not only is the world slowing down, the DEFLATION horse is truly out of the barn and running hard.

The theme that has dominated the month of May is "Dollar strength and Euro weakness." However, the charts might be suggesting a reversal.

The Euro is creating a potential bullish falling wedge at support and the Dollar is creating a potential bearish rising wedge at resistance. Are the major themes/trends about to change direction — at least in the short-term? We'll see if the "Power of the Pattern" will win again!

Also don't forget yesterday's post showing that bond ETF (TLT) is up against critical resistance.

The second chart is another Bernanke "Kodak Moment" — the second is a probable series that started here two weeks ago.

What does Nixon (top chart) have to do with any of this? Flash back to August 9, 1974. Nixon knew it was time to leave.

Here is a pre-market Technical Tuesday chart from Chris Kimble, our guest market technician and student of Sir John Templeton.

The chart below shows what has happened since the previous posts. I'm glad Chris changed his metaphor from a waterfall to a roller coaster. At least the later can also rise.

Historically, when the 200 day EMA is broken to the downside, many investors see this as a signal to take money off the table. The decline of late has erased the last 7 MONTHS of market action.

The "Power of the Pattern" — rising wedge and Fibonacci retracements — prompted me to issue suggestions weeks ago to "HARVEST/RAISE CASH."

For investors still "longing" to conserve values, they must realize that this is where downside action can really pick up speed.

In the spirit of the be prepared posting of this weekend, I would point out that the bottom of the 10-year falling channel is still a LONG WAY DOWN!

Here's a new update on TLT, the 20-Year Treasury ETF that Chris Kimble has been tracking for us since his Price and Yield Butting Heads in late March. His email accompanying this chart reads:

TLT has rallied more than 10% in less than 60 days, not bad for an ol' government bond holding. It's now up against resistance that has been a quality time to "HARVEST" and take profits.

The game plan should be to take gains while up against resistance. The last time this ETF broke resistance was during the financial crisis of 2008-2009. If resistance breaks again, you will want to own the break out the ETF, because odds would favor stocks are under extreme pressure again.

If you happen to believe stocks are going to be challenged and don't own something like TLT, watch this line in the sand for a buy signal.

Here's a quick update on the Nasdaq 100 (NDX) from technical analyst Chris Kimble. He writes:

This index has been a clear leader. It bottomed in 2008, months before the S&P 500 index, and it has substantially outperformed to the upside.

The 500 index broke its 200-day Exponential Moving Average (EMA) last week, but the Nasdaq 100 continues its leadership role by remaining above the 200-day EMA and channel support. However, if the NDX 100 breaks support and the 200-EMA, the technical perspective suggests that investors should Be Prepared.

On Friday CNBC ran a curious piece entitled Buy on Friday, Sell on Monday — Then Go Away? The rationale for the title was an observation that Mondays have amazingly outperformed the other days of the week in 2010. The stats for the Dow are:

Well, that triggered a bit of weekend research. The two pairs of tables below allow us to compare the behavior of weekdays during two nasty S&P 500 bear markets and the rallies that followed. As we can see, Monday has indeed behaved strangely over the past decade. The key factor is whether we're in a bull or bear market.

The general view is that the Financial Crisis was triggered by the Lehman collapse in September 2008. But early warnings of the crisis predate the Lehman debacle by over a year. A not-so-subtle clue was the collapse of two Bear Stearns hedge funds in July 2007. Markets around the world peaked in October 2007.

During the 56.8% decline in the S&P 500 that followed the 2007 high, a frequent pattern was bad new over the weekend, a selloff on Monday, bounce on Tuesday, renewed selloff on Wednesday continuing through Thursday, and a relatively calm Friday. The recovery after the March 9, 2009 low saw a dramatic change in the Monday personality. Many weeks started with a Monday rally, a moderate Tuesday, stronger performance on Wednesday and Thursday, and a relatively flat Friday.

The pattern was rather different during the Tech Crash and recovery. Mondays were relatively flat with the big selloffs on Friday. The five-year bull market that followed saw a more even distribution of weekday gains with Wednesday as the leader with a 0.09% average gain and Monday close behind at 0.08%. Fridays are also in the green but take fifth place in the recovery table.

Now that CNBC has publicized the Buy on Friday, Sell on Monday concept, I wouldn't put much "stock" in this strategy going forward.

This weekend update from technical analyst Chris Kimble is a follow-up on his S&P 500 Be Prepared alert from April 13th, eight market days before the interim high on April 23rd. He also includes a six-pack of high-yield funds, which is a fascinating update on his March 16th post entitled A High-Yield Leading Indicator?

It's been nearly six weeks since my Boy Scout Be Prepared" email was published. I wanted to update that chart [top chart].

Since that time, the high yields have all broken 50 and now 100-day EMA lines [second chart]. This raises another reason to "be prepared" since the last time the high yields broke both the 50/100 EMAs was back in 2008, at the top of the trading range.

The S&P 500 has now put in the classic 10% correction that bullish analysts often view as buy signal. But every bear market drops below 10%. The behavior of high-yield funds suggests a continued posture of preparation.

I've received some additional comments from Serge Perreault, reflecting on the S&P 500 over the past month. He writes:

Charts told the story again as weakness started to show as far as my Apr.23 charts:

The S&P 500 closed the week down 4.23%. It is 11.97% below its interim high set April 23rd, when the index was up 9.16% for the year, which puts is in traditional "correction" territory (a decline of more than 10% from an interim high). The year-to-date performance is now 2.46%. The chart is a weekly view of the S&P 500.

Here's the latest from technical analyst Chris Kimble (doing his best impersonation of Inspector Clouseau). The subject of his investigation is Hyperinflation. His evidence? Commodities. Inspector Kimble comments:

Falling interest rates. Falling CRB Index. Falling Crude Oil. Falling Grain Prices. Falling Base Materials. All of these indexes have broken below rising wedge support lines and critical 200-Day exponential moving averages — hardly a precursor to hyperinflation.

For weeks I've have pointed out that Copper and interest rates were suggesting that the economy was slowing down (e.g., May 4th). Hyperinflation concerns at hand right now? I suspect many investors would be glad to see a little inflation in their investment accounts!

Here's a quick gold update from technical analyst Chris Kimble. Gold is a topic he has addressed in several previous charts. See for example The Monster Test for Gold from ten days ago and yesterday's Gold Watch. This time Chris compares short-term gold performance versus the iShares 20+ Year Treasury Bond ETF (TLT).

How does the current Dow recovery compare with major recoveries in the past? Let's take a look. The first chart overlays the first 500 days of sixteen recoveries in the Dow Jones Industrial Average since its creation in 1896. I'm counting market days, so each recovery is truncated to approximately two calendar years. As of yesterday, we were 303 days beyond the March 2009 low.

The second chart is based on Dow daily closes with the sixteen rallies highlighted. Since the first chart is limited to 500 days, this chart can be used as a cross reference to get an idea of the ultimate length and gain of the rallies and also when they occurred in the larger historical context.

My initial selection criterion was to overlay all the Dow rallies following a 30% or greater decline. Using the traditional 20% decline associated with bear markets would have made the chart too busy, and it occasionally runs against conventional wisdom. For example, the Tech Crash in the Dow consisted of 3 baby bears (if you round up the 19.91% decline in January-March 2000) separated by two rallies over 20%. I consider it a single bear market with a decline of 37.85% and thus included the rally that began in 2002. I also treated the Crash of 1929 as a single bear decline, even though the 20% rule would have divided it into six bear markets with five intervening rallies. Likewise, and more to the point for the overlay, I treated the rally after the 1932 low as a single rally, even though the 20% rule would see it as an oscillation between three bull and bear markets.

Another liberty I took in selecting recoveries for the overlay was to include two rallies after declines of less than 30%. In both cases, they marked the beginning of a new economic era. One is the recovery that began in 1949 after the 23.95% post-war decline. The 12-year, 355% advance that followed warranted inclusion. Likewise I added in the first 500 days of the 250% rally that started in 1982 after a 24.13% decline. The 1982 recovery brought an end to the decade of stagflation and launched the great Boomer bull market. Here's a larger view of the overlay.

The Dow closed yesterday (May 20th) 53.8% above the March 2009 low after reaching an interim closing high up 71.1%% on April 26th. Compared to the other 15 rallies at the equivalent point, the current rally is in 9th place. The volatile recovery after the Crash of 1929 leads the pack by a wide margin. Second and third place date from yet earlier periods, as does the fifth place.

Where do we go from here? Some of the historic 500-day rallies went on to substantially higher gains — the launch of the Roaring Twenties, the Boomer Era that started in 1982 and resumed after the Black Monday misadventure in 1987. Even the recovery from the Crash of 1929 falls into this category, although the Great Depression would eventually lead to some significant retracements.

On the other hand, several of the earliest rallies (1903, 1907, 1914) would soon falter, a fate that later befell the rallies in 1962, 1970 and 1974. If we look at the Dow chart adjusted for inflation, the failure of these recoveries is more obvious. The chart below is adjusted for inflation using the technique popularized by Robert Shiller, namely adjusting with a spliced index based on the Consumer Price Index for Urban Consumers (CPI-U), which dates from 1913, and the Warren and Pearson's price index for the pre-1913 inflation estimate. In my real version I've chained the daily prices to the May 1896 dollar value.

The question is whether the rally of the past 14 months is the early stages of a secular bull market. Or will the future resemble something closer to the early 1900s, the late 1960s-1970s, or something in between?

Here's an updated gold chart from technical analyst Chris Kimble. Gold is a topic he has addressed in several previous charts. See for example The Monster Test for Gold from early last week and Chris's comments on today's chart. For the behavior of Palladium, check out this post from earlier today.

Here's a snapshot of the S&P 500 about 30 minutes into the market day. Technical analyst Chris Kimble highlights the relationship of the index to the Fibonacci 61.8% retracement and the 200-day exponential moving average following the intraday "flash crash" of May 6th.

Here are some important "Power of the Pattern" illustrations from technical analyst Chris Kimble. He comments:

Have another look at Monday's Fork in the Road chart. Another apt metaphor is a "Line in the Sand" or "walking a tightrope" — both of which are particularly appropriate ways to think about many of the lines in technical analysis.

Indexes at Resistance: The 200 day exponential moving average (EMA) was touched by the S&P 500 index yesterday, and it held yet for two other major indexes, the 200-day EMA didn't hold. For those who didn't harvest at the top of the wedge and at Fibonacci resistance, the 200-day becomes a critical line in the sand.

Palladium: This metal illustrates the importance of using support and resistance levels in the investment decision process. In a volatile market, bad things can happen quickly when support fails.

Here's an updated "Power of the Pattern" chart from technical analyst Chris Kimble (first posted here). For those of us who like the larger context, this is an amazing perspective. It also gives a technical basis for some of the gloomy Dow crash forecasts that have been in the news of late.

Chris comments: These lower numbers are NOT predictions. They are possible price points that the markets could test as "pattern support!"

I received this Blackberry message from regular contributor Chris Kimble a few minutes ago: 200-day ema is 1102, wonder where the index stands right now? The timestamp on the email was 11:57. I pulled up Stockcharts and did this screen capture:

The April 2010 Consumer Price Index for Urban Consumers (CPI-U) is 218.009. The annualized inflation rate computed from this number is 2.24%, which marks the sixth month of mild inflation after a streak of 8 consecutive months of deflation. The annualized inflation rate of the last five months, however, is well below the 4.1% average since the end of World War II.

The Bureau of Labor Statistics (BLS) began calculating the CPI in 1913 (BLS historic data). Our chart now shows inflation back to 1872 by adding Warren and Pearsons's price index for the earlier years. The spliced series is available at Yale Professor Robert Shiller's website. This look further back into the past dramatically illustrates the extreme oscillation between inflation and deflation during the first 70 years of our timeline. Click here for a larger version.

The chart below (click here for a larger version) includes an alternate look at inflation without the calculation modifications the 1980s and 1990s (Data from www.shadowstats.com). The Alternate CPI puts the annualized inflation rate at 9.46% for April 2010.

Here's a new "Power of the Pattern" chart from technical analyst Chris Kimble, a 30-year+ market technician and student of Sir John Templeton. Chris takes a look at the SSE Composite (Shanghai) Index and highlights a pennant ("caution flag") within a rising channel.

Here's the latest "Power of the Pattern" chart from technical analyst Chris Kimble. Talk about resistance! And with that helmet, there's no chance of a face mask violation. Does the dollar make a first down?

Here are two more "Power of the Pattern" charts from technical analyst Chris Kimble:

S&P 500: Will the S&P 500 index continue to repeat the pattern of the past year? The chart below highlights a rising channel, within which are a couple of rising wedges. Sellers dominate at the top of those rising wedges and buyers have been lured in at the rising channel. Lately Copper has been soft, and high yields are giving a sell signal (The Scent of Copper and High Yield Bonds). See the chart for Chris's recommendation.

The Bank Index: The chart below shows a year-long rising wedge and broken support. It probably doesn't help the industry that yesterday Meredith Whitney has urged investors to avoid banks at all costs. As Chris points out: "So go the banks, so goes much of the market."

Here are the latest "Power of the Pattern" illustrations from technical analyst Chris Kimble:

Euro and Dollar: The "Euro" has been in the news of late, for all the wrong reasons, weakness being top of the list.

Nothing moves in one direction forever (AKA 3 steps forward, 1 step backwards). As investors have fled from the Euro, other investments have become safe havens.

No doubt the flight from the Euro has benefited the Dollar and Gold. If the Euro finds temporary strength, the Dollar and Gold could both move lower. Other assets that might benefit from this? The hard hit Oil and Basic Materials complex.

See this link for more info on a possible "turn around" in the Euro and Basic Materials.

Light Crude: In a previous post I suggested harvesting oil positions at the top of a rising channel. Crude Oil has declined about 17% since that time.

Now Oil finds itself at the bottom of a trading range at the same time the Euro looks to be at support. This may provide an opportunity to pick up some cheap Oil.

If Euro support fails, assets that have been challenged of late will be put under even greater pressure!

Last week I analyzed the Nikkei 225 monthly closes since 1970 to back-test several monthly moving average strategies versus buy-and-hold (see here). Now let's make a similar analysis of the S&P 500. The index was created in March 1957. But I'm also including the spliced S&P Composite monthly closes from January 1950, the starting point for my data source, Yahoo Finance. By including these earlier years, we get a more complete view of the post World War II bull market that began six months earlier in the summer of 1949. See this monthly update for more on secular bull and bear markets.

Like the Nikkei study, this is a purely hypothetical exercise since there was no mechanism for investing in the S&P 500 until the first Vanguard index fund was launched in 1976. In addition, the Yahoo Finance S&P 500 data excludes dividends. Similarly, I've excluded interest earnings when the SMA strategies signal a move to cash. Finally, this approach doesn't factor in trading costs, which will impact SMAs, especially the shorter ones with more buy/sell signals. Despite these limitations, the analysis should still provide a general idea of relative performance for passive buy-and-hold (B&H) versus active management with the various monthly SMAs.

The bar charts that follow show the nominal value of one dollar invested using B&H and fourteen monthly SMA strategies. I've divided the 60-year timeframe into the four secular bull/bear markets illustrated above. The boundaries are determined by peaks and troughs based on monthly-close highs and lows and thus don't correspond to the specific intramonth dates. They are November 1968, July 1982, August 2000 and the most recent close. Thus we will examine two secular bull markets (1950-1968 and 1982-2000) and two secular bear markets (1968-1982 and 2000-?). The chart for the last cycle extends to the latest S&P data. But one day we conclude that the cycle really ended in March 2009.

The first chart shows us the big picture. Over the past 60 years, B&H outperforms two-thirds of the monthly SMAs, including the 10-month SMA, which is the system highlighted in the The Ivy Portfolio. However, the authors, Faber and Richardson, point out that the 10-month SMA, as illustrated by their data from 1973, significantly minimized the downside risk (psychological and financial) of bear-market declines.

This chart covers most of the postwar boom that began in the summer of 1949, six months before the earliest data available from Yahoo Finance. However, since the index gained over 20% in the last half of 1949, a chart understates the returns for the entire post-war boom.

The nearly 14-year span in the next chart saw the combined effect of consolidation from extreme overvaluation in 1968, when the cyclical P/E10 was in the top quintile of market valuations (see the P/E data here), and the relentless erosion caused by the decade of stagflation.

The B&H performance was just shy of break even, returning 99 cents on the dollar, excluding dividends. Twelve of the fourteen monthly-SMAs outperformed B&H, especially the longer ones, and they dramatically reduced losses during the three cyclical bear markets during these 14 years (declines of 36.1%, 48.2%, and 27.1% illustrated here).

Side note: That 2-month SMA is a curious outlier that worked surprisingly well during the recessions of this period (see this chart).

The most interesting chart in this study is the amazing 18-year Boomer bull market — probably the most favorable extended period in US history for passive investing.

I use the "Boomer" label because this period coincided with the financial coming-of-age of the Baby Boomer generation. The 401(k) plan was introduced in 1980 and IRA rules were liberalized the following year. The US saw the massive growth of a new investor class with a limited understanding of markets and risk. The bulge of Boomers became a windfall for Wall Street, the oldest having just turned 35 in 1981. Stagflation was replaced by the Great Moderation. We entered an era of optimism and investor confidence, we and witnessed the emergence of the Boglehead philosophy of B&H passive investing with low-cost index funds. The crash of 1987 was a minor blip for the passive investor, but it gave a nasty whipsaw to many of the monthly SMAs — further insuring their underperformance and validating the strategy of passive investing.

The Tech Wreck of 2000 marked the beginning of a massive secular change in the market, one that was confirmed by the more recent Financial Crisis. In less than nine years, the S&P 500 suffered two staggering declines — 49.2% and 56.8% from peak to bottom. Compared to B&H, the monthly SMAs showed their superiority for capital preservaton and risk management.

Like my study of the Nikkei SMAs this is another back-test of investment strategies in a hypothetical environment. It is based on authentic, but partial, data — monthly closes excluding dividends, interest on cash, and trading costs. Naturally it would be foolish to cherry-pick a single monthly SMA strategy based on these charts, intriguing as the results may be, especially since the results for the various timeframes demonstrate that no single strategy is a consistent winner.

What we can conclude is that in secular bull and bear markets, passive management (B&H) is a successful strategy on the way up, but it is a losing proposition on the way down. The reverse is true for active management with SMAs. It's has reduced odds to outperform B&H on the way up, but outperformance on the way down is a virtual guarantee.

Unfortunately it's impossible to pin-point those secular tops and bottoms and change strategy on a dime. For example, more than a year after the March 2009 market lows, it's still impossible to say for certain that we're in a new secular bull market.

Here are two more "Power of the Pattern" illustrations from technical analyst Chris Kimble:

High yield bonds (often called junk bonds) have done extremely well since the lows of late 2008 to early 2009. Some call them "Stocks in Drag" because of the way they "imitate" the price action of equities.

Copper and High Yields are both leading indicators, and the price action of late might be "sniffing out" a new direction for the economy.

I asked veteran market technician and regular contributor Chris Kimble what major asset classes have patterns that warrant watching this week. He responded with a number of suggestions, many of which he has already highlighted for us.

Today regular contributor Chris Kimble, a veteran market technician, revisits gold:

A few days ago I featured a comparison of the gold and the US dollar (see this post). Since then, gold has broken above the short term resistance and the dollar likewise has broken above the long-term resistance of an 8-year falling channel, an event explored in this post from yesterday.

The chart now shows gold up against a wall of resistance. It is simultaneously colliding with three longer-term levels — Fibonacci 1.618% dating from the late 1970s, the top of a rising wedge, and the top of a rising channel.

In addition to the technical hurdles gold faces, the extreme level of bullish sentiment could be a contrarian indicator. On Friday CNBC's Squawk on the Street presented a a gold bull-bear debate, with Robert Prechter of Elliott Wave International presenting the bearish view (watch video). A cornerstone of Prechter's argument is the 98% bullish sentiment on gold as tabulated by TradeFutures.com, the organization Elliott Wave International uses for such polling. This is the level of sentiment that has often accompanied major turning points.

As the chart above shows, the gold rally is long in the tooth. Does that mean it's about over? No. However this is the point where the "Power of the Pattern" signals the possibility of a reversal. The next few weeks could be crucial for gold.

Regular contributor Chris Kimble, a veteran market technician, had provided some thoughtful observations on the dollar:

Earlier this week I highlighted the fact that the US dollar was testing the upper level of an 8-year falling channel (see this post).

As the first chart illustrates, it looks like the dollar has succeeded, at least for now, in breaking this 8-year resistance. For any asset, a falling channel of this length, once it gives way, has the potential to signal a MAJOR CHANGE OF TREND.

What's next for the dollar? The second chart suggests the beginning of a rising channel. The top of the channel is currently around 91, which represents a gain of 5.5% from the latest close.

As I've discussed in prior posts, should people view the dollar as a safe haven in the troubled world economy, several asset classes, especially commodities, could see considerable pressure on prices. More about this in a future post.

Here's a weekend look at the Dow, S&P 500 and Nasdaq 100 and their relationships to two key crossings, the 200-week moving average and the Fibonacci 61.8% retracement.

All three indexes posted weekly gains in an atmosphere of high volatility. Both the Dow and S&P 500 remain below their 200-week moving averages and Fibonacci 61.8% retracements (retracements based on weekly closes). The Dow needs a gain of about 6% and the S&P 500 8% to start a breakout above the two levels of resistance. The Nasdaq 100 has a comfortable distance above both, which means that they could play the role of support in case of a decline from here.

Despite the sharp Friday selloff, the S&P 500 actually rose 2.23% for the week, which puts the index 6.70% below its interim high set April 23rd, when the index was up 9.16% for the year. The year-to-date performance is now 1.85%. The chart is a weekly view of the S&P 500. Here Serge shows that the index the two momentum indicators he's been tracking appear to be bouncing off their supports. See his annotations for additional details.

This chart arrived earlier today from regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

Chris raises an interesting, if disturbing, question about whether the Euro/Yen trade is acting as a leading indicator for the direction of the US market, as it appears to have been since the escalation of the Financial Crisis in 2008. See the chart for Chris's comments.

Earlier this week I reviewed Japan's historic equity bubble in comparison to the US market, and I posted a daily chart of the Nikkei 225 showing the metrics of the post-bubble rallies and declines.

Now let's now use our Nikkei 225 data to back-test some monthly moving average strategies versus buy-and-hold (B&H). This is a purely hypothetical exercise, but it may cast some light on the larger context of monthly moving averages to supplement my monthly timing update for the S&P 500 and the Ivy Portfolio.

First a word about the approach used to generate the bar charts below. I've used two sources for monthly close data: Yahoo Finance for the numbers since 1984 and Wren Investment Advisers for the earlier years. Since I don't have the Nikkei dividend yields and don't include interest on cash, the charts below understate actual returns. And I do not factor in trading costs, which will impact SMAs, especially the shorter ones. However, the comparisons should still be reasonable approximations for our purpose of comparing B&H and active management with monthly simple moving averages (SMAs).

The first chart is a reminder of what we've seen in the earlier articles — the classic shape of a major asset bubble across four decades. The peak on December 29, 1989 is almost dead center of the chart, with 20 years each of secular bull and bear markets.

Now let's compare the nominal value of an investment (no inflation adjustment) of B&H and 14 different monthly SMAs. The unit of value I've used is the dollar, but since our illustration is nominal and doesn't consider currency valuation, the choice of a dollar is simply an arbitrary unit of measure.

Across our forty-year timeline, all the SMA strategies beat B&H except the 2-month SMA, and the 3-month SMA would probably lose a real competition with B&H because of transaction costs. The top-performing 13-month SMA return is about 290% higher than B&H.

Now let's split the first bar chart into its two halves. First up is the secular bull market from 1970 to the close of 1989. Anyone who has studied monthly moving averages knows they generally underperform in a bull market, as this chart illustrates. B&H outperforms the best SMA (13-month) by about 38%.

The bear half shows the opposite result. Here every SMA handily beats B&H, with the 6- and 7-month SMAs giving the best results. The 6-month tops B&H by 528%.

To paraphrase my opening remarks, this is a thought experiment, one that back-tests some moving average strategies against buy-and-hold in a hypothetical environment based on authentic, but partial, data — monthly closes excluding dividends and interest on cash. Naturally it would be foolish to cherry-pick a monthly SMA strategy based on this data, intriguing as the results may be.

What we can conclude is that in epic secular bull and bear markets, passive management (B&H) is a successful strategy on the way up and a disaster on the way down. The reverse is true for active management with SMAs. You've got to be pretty savvy to hold your own on the way up, but outperformance on the way down is a virtual guarantee.

Of course it's impossible to pin-point those secular tops and bottoms. But one thing is very clear in our chart of the Nikkei: Cyclical volatility is minimal in epic bull markets and savage in secular bear markets.

Let's finish off with a snapshot of a Nikkei-S&P 500 overlay using the S&P 2000 high.

The US is not Japan, and time-shifting also reduces the broader economic parallels. But a couple of things are clear:

Note from dshort: Regular visitors to this website know my preference for long-term market perspectives and may recall this article on Robert "Bob" Bronson, who has spent decades analyzing market history and merits a link in dshort.com Favorites. Below is an email Bob sent earlier today. See also his previous discussion of unemployment here.

The Disconnect Between the Jobless Data and Nonfarm Payrolls
More on not-so-bullish payroll employment
and continuing bearish initial unemployment claims.

Excerpted from permabull Dick Greene's Briefing.com update on initial unemployment claims:

Note also that initial unemployment claims as a leading economic indicator, and thus a very important coincident indicator for the stock market, troughed on Feb 6. Both its four-week moving average and a polynomial best-fit of all 59 weeks of data troughed March 27, 11- and four-weeks, respectively, before the Supercycle Winter dumbed-down, and thus lagging, stock market peaked on April 26.

Light Crude: Mixed signals continue in the ongoing "inflation/deflation" debate.

Let's "drill down" into one asset that often has a big influence on the direction of prices in our lives.

If this pattern is correct, bullish oil and bullish oil stock holdings could be challenged. This might not be good for some investors, but if the "Power of the Pattern" is right, it would appear that oil won't be adding much to the inflation side of the equation.

Remember, "Harvest at the top of wedges and at the top of rising channels until resistance is taken out!"

Baltic Dry Index: This is a good index to measure pricing pressure and the economy on a global basis.

Baltic finds itself struggling against Fibonacci retracement levels and may have created a pattern that says a good deal about future commerce.

The latest Japanese Consumer Price Index (CPI) shows the fourteenth consecutive month of deflation. The charts in this article have been updated through the May 12th close.

The left sides of the two bubbles are remarkably similar. More conspicuous, however, are the dissimilar contours of the post-bubble declines. A key difference is the fact that Japan experienced nearly simultaneous bubbles in equities and real estate; the former peaked in December 1989, the latter in early 1991. The equity and real estate peaks in the US were separated by approximately five years, and the 2005 peak wasn't generally recognized for another year or two because of the highly regional nature of the real estate market.

Inflation or Deflation?
Many economists and market experts predict high US inflation as a result of the massive government intervention in the current financial crisis. However, over the past year, the US economy slipped into an eight-month period of deflation unparalleled in nearly 60 years.

The decade following the Japanese twin bubbles was accompanied by mild inflation averaging around 1.4% with occasional brief periods of deflation. Thereafter, the Japanese economy has tended more toward deflation (see the circled area).

The daily peak for the S&P 500 came in March 2000. However, in both real and nominal terms, the S&P 500 monthly close peaked in August 2000, which is the reference point of overly for the two charts. Following the 2000 high, the annualized rate of inflation averaged 2.8% until March 2009, when the economy moved into an eight-month period of deflation.

To some extent the widespread predictions of high inflation in the US have a political bias. Opponents of government intervention often point to excessive inflation as the inevitable outcome of bailouts, incentives and monetary easing. The Japanese government also played a strong interventionist role in the wake of that county's twin bubbles. As the chart shows, accelerating inflation has not been the result.

Of course the two countries differ in many respects. Both experienced stagflation during the 1970s, but the inflation charts during that period do not mirror one another. Likewise Japan's long-term post-bubble struggle with deflation does not preordain a similar fate for the US. The charts and commentary here merely constitute an observation that severe inflation is not the inevitable outcome of government efforts to manage the US financial crisis. Deflation may be a greater threat than is commonly thought. It's worth noting that deflation didn't become a significant issue for Japan until near the end of the decade following the 1989 peak. Our recent bout with deflation occurred nine years after the top of the Tech Bubble.

Mike "Mish" Shedlock's Global Economic Trend Analysis has been an excellent source for explanations about the deflation risk. Here are links to three of his many posts on the topic:

For a more detailed view of the Nikkei performance, see this analysis of post-bubble rallies and declines.

Preface from dshort: Yesterday's article Inflation, Deflation or Both? prompted an email from Edward Jaffe, President of ENTROPY Investment Advisors, Inc. in Bennington, VT. Regular visitors may recall his previous guest contribution Bubble Dynamics and Dividends. Here is Edward's email from last night.

Second, the cycle of commodity inflation and some other visible cycles, including equities and inflation itself, are highly levered to monetary causes. This is pretty much my point in my previous contribution.

Back to the 'FLATION debate — inflationary or deflationary — I think the answer is: Distortionary. Creating new symbolic "money" and credit causes ebbs and flows to different sectors through different channels. Right now the channel is:

In the 1970s the flow was out of equities and into commodities. What makes some of these flows function the way they do could no doubt be the subject of 20 lifetimes of discussion.

I think everyone in the 'flation debate is a little bit right and a little bit wrong. We DO have debt deflation, which is strangling the real economy and should pull down equity prices. But too many market participants can borrow for free and speculate.

In Japan, I think the Japan Central Bank *COULD* create inflation if they wanted to destroy the savings of their citizens. But they stop short (maybe), assuming they have a clue. (Problem: their economists were educated at US Ivy League schools). At some point they will stop being able to fund government debt with on-island savings, and then it is game over. One thing the Nikkei bubble tells us is that post-bubble problems border on hopeless.

Here's an updated chart that gives a close-up view of the cyclical rallies and their duration during Japan's secular bear market, now in its 20th year.

I've been posting weekly updates of a mega-bear market charts (here and here) that include Japan's Nikkei 225. In addition, every few months I update an inflation-adjusted overlay of the Nikkei 225 and S&P 500 bubbles (which I see is about due for an update).

The table below documents the advances and declines and the elapsed time for each cycle.

For the sake of comparison, the S&P 500 interim high thus far is 79.9% (set April 23) above the low in March 2009. I update this statistic each business day in this chart.

I've been an avid student of inflation since 1973, when the oil embargo kicked off a decade that included three recessions and four years of double digit inflation (1974 and 1979-1981). Peanut butter became a staple in our household diet.

The top chart is one I update monthly with the announcement of the Consumer Price Index. I even include a second version based on the alternate CPI from the ShadowStats.com website, which preserves the Bureau of Labor Statistics pre-1982 calculation method. (The next inflation update will be May 19th; see my April commentary here).

In recent years, however, official inflation has been quite moderate. In fact, the 2009 average rate was negative (-0.34%) for the first time since 1955 (-0.28%). We have to go back to 1949 for deeper deflation (-0.95%).

On the other hand, many costs have continued to rise dramatically (check your health-care insurance over the past five years or the cost of college tuition). The ShadowStats.com alternate CPI puts the 2009 rate of inflation at 7.03%.

Adding to the confusion is the perennial debate between the inflationists, who expect severe inflation as an outcome of the skyrocketing Federal debt, and debt deflationists, who point to the opposite aftermath during the two decades following the Nikkei bubble, which triggered even more aggressive government debt assumption. For a scholarly perspective on cycles of inflation and deflation, see Bob Bronson's Revealing Supercycles: BAAC and Economic.

So which is it — inflation or deflation? Market technician Chris Kimble (second chart) suggests we're getting a bit of both:

At heart, I'm drawn toward market fundamentals, but there's plenty of evidence that the market can ignore fundamentals for very long periods.

The rally resumed today. The S&P 500 intraday high was just shy of the 50-day moving average. Will it become resistance? We'll soon know. Volume has declined inversely with the price. And of that below-average volume, I wonder how much was high-frequency and proprietary trades?

As we watch the major indexes in the aftermath of their rising wedges, here's a reminder of how similar the patterns have been. Also, as Chris Kimble points out, the 200-day exponential moving average appears to be providing support now as it did during the previous pullback in February.

Gold seems to be a theme today. Here's another gold chart (the GLD ETF) with some interesting analysis from Chris Kimble.

GLD finds itself at one of the most unique and technically important price and pattern points it can ever create.

I suspect many will look back and say "Why didn't I take advantage of this price situation!"

If I were an options player I would straddle this puppy and say, "I don't care which way you go, just run Forrest run!"

Note from dshort: Regular visitors to this website know my preference for long-term market perspectives and may recall this article on Robert "Bob" Bronson, who has spent decades analyzing market history and merits a link in dshort.com Favorites. More recently he shared his thoughts on P/E Ratios here. The text below arrived in a email today, which I've reformatted for presentation here.

What Gold is Telling Us
Gold's monetary value, rather than its inflation-hedge value,
is very bearish for the stock market over several time horizons.

In the first chart below, we've added a high-low volatility channel (blue dashed lines) and another mean-reversion bottom projector (green dashed line) that is parallel to the solid green best-fit line.

Gold typically leads the stock market as it did most recently by peaking in late March contributing to our call on the April 26 peak in the SPX at 1220. See the second (daily) gold vs. SPX relative strength chart below, along with the third (weekly) chart signaling the last major stock bear market several months in advance of its October 2007 high.

Notice that gold is clearly signaling that the Supercycle stock bear market is still ongoing since both the March 2000 and October 2007 highs, which is consistent with our other Supercycle technical and fundamental indicators in our forecasting models.

Perhaps the Lone Ranger rides again, and we all know his means of transportation. Here's a chart of the silver ETF from technical analyst Chris Kimble.

Silver is facing a "crossroads of resistance" at current prices. Twice in the past two years the Silver ETF (SLV) has peaked at the price it reached today.

So caution is the name of the game right now. With Gold setting all-time new highs, should Silver break resistance, the upside action could push SLV to the highs reached back in March of 2008, around 8% above current prices, in short order.

Game plan... understand that "harvesting at resistance" is a good risk management tool. Should Silver break resistance, "hop on board Ole Silver" and hang onto the saddle.

As the second chart shows, SLV is up almost double over GLD in the past 90 days.

Before the market opens on what promises to be another interesting day, let's take a quick look at the dollar and gold, courtesy of regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

Currencies are a front-page story of late, thanks to the credit crisis and instability in Europe. Gold seems to be benefiting from this global uncertainty.

The dollar has been declining for years, creating a falling channel. Since the lows in December, the dollar rally has taken it to the top of this falling channel. The explanation is probably as simple as the old saying: "The dollar may be the worst currency in the world, except for all the others."

The dollar will likely be the key to how stocks and commodities perform going forward. The "crowded trade" seems to be based on the assumption that the dollar can't move any higher. However, should it push through resistance, the move could be pretty large and swift, since it's been trapped in a falling channel for eight years.

I post a monthly market valuation update based on the cyclical P/E ratio using the 10-year average of as-reported earnings. I use As Reported earnings because it factors in write-offs and restructuring charges and it is consistent with the historical data popularized by Yale professor Robert Shiller's research. My source for the most recent earnings is the Standard & Poor's Excel file maintained by Senior Index Analyst Howard Silverblatt and available on the Standard & Poor's website (free registration required). The numbers I want are in column D on the ESTIMATES&PEs tab.

The quarterly earnings for the most recent completed quarter are adjusted several times a month, and there are as-reported earnings estimates for the next several quarters (currently through 2011), also subject to frequent revisions. My monthly update includes a table showing the earnings for most recent quarters and the estimates for the rest of the year. I also include monthly earnings numbers using a linear interpolation for the two months between the quarters.

This morning I took a look to see the latest Silverblatt numbers, dated May 5th, and I noticed a change in the as-reported earnings estimates from the previous spreadsheet posted one week earlier. See the table below for a comparison of the two (note: each number is the sum of the current quarter and the previous three).

That 4.7% reduction for Q3 was a bit surprising. To put that into context, based on today's close, the P/E ratio based on the trailing 12-month (TTM) earnings for Q3 is the difference between a P/E of 17.97 (latest estimate) versus 17.13 (last week's estimate). Incidentally, the average TTM P/E for the S&P Composite since 1871 is 15.48.

If you're interested in market valuation updates, you should bookmark this link to valuewalk.com. Jacob Wolinsky, a devoted value investor, does a monthly valuation update that features several metrics for the market: Current P/E TTM, the cyclical P/E10, Price-to-Book Value, Dividend Yield, Market Cap as Percent of GDP, and Tobin's Q Ratio. Here is a link to Jacob's May update.

I have a link to the website by its title, Value Investing, in my dshort.com favorites in the right column.

Today's rally was encouraging, but it needs to be sustained for several weeks before it's safe to write off last week as a blip. The top chart revisits a topic I explored in more detail here, the 200-week moving average. This level proved to be powerful resistance last week. We need to see it become support.

But let's think in shorter timeframes. The second chart takes another look at the 50-day moving average, previously discussed here. Can the index move decisively above the 50, or will it become resistance?

The third chart is another look at Chris Kimble's Fibonacci levels created 20-minutes into today's session. Little Fib held (see Little Fib or Big Truth?). That certainly needs to change — soon if this rally is to continue.

The fourth chart is probably irrelevant. In this new age of HFT (high-frequency trades) and "prop" (proprietary) trades, volume isn't the indicator it used to be. Still, for us old-school types, it would be nice to see higher volume on advances in rallies — like is was before the days of black-box showdowns.

A few minutes ago Chris Kimble sent me a chart that puts Ben Bernanke's trademark pose in a meaningful context. Chris writes:

The "power of the pattern" really rings true for Goldman Sachs (GS). Crossroads of resistance came into play at (1), long before the fraud charges hit the front page last month.

Ben's wishes had best come true at (2) or GS could turn into a "waterfall" pattern and quickly spatter his crown!

I couldn't resist the title. Chris Kimble has charted a little Fibonacci retracement on the S&P 500 based on the April 23 high and Friday's low. The 61.8% retracement is 1162.

While we watch today's market action, let's have a look at a pair of charts from technical analyst and frequent contributor Chris Kimble. The top chart gives a close-up of the rising wedge and resistance in the New York Stock Exchange. The second chart is the equivalent view of the S&P 500 with the addition of the 61.8% Fibonacci resistance. Chris comments:

Remember the game show "To Tell the Truth?"

No doubt the Trillion Dollar loan in Europe is going to push our markets a ton higher this morning. Key will be what the market does up against resistance levels that turned the market lower two weeks ago.

In my recent posts on the surge in market volatility I've examined the S&P 500 and the VIX over a couple of timeframes:

Now let's look at another measure of market volatility, this time with a historical perspective dating from October 1928, the month the Dow Jones Industrial Average expanded from 20 to 30 stocks. Here's a chart of the Dow with an overlay illustrating intraday volatility (intraday high divided by the low minus one).

The rows in the table above are in chronological order and labeled to facilitate grouping by historic market periods: Crash of 1929, Great Depression, etc. The first column shows the rank order in the range of intraday volatility. Most noticeable is the astonishing numbers for Black Monday and the following Tuesday in the Crash of 1987.

I've also included a column showing the percent gain or loss for the day. Even though most of the 28 days occurred during bear markets, there were more up days (15) than down days (13).

The few high-volatility days occurring in bull markets — using the popular definition of a 20% gain — were all in proximity to a bear market (except the most recent?):

The peak in intraday volatility occurred with the first leg down in the Crash of 1929 and a second major spike with the fourth leg down (of which there were a total of six). Otherwise the volatility generally moved inversely with the market price through the crash and initial phase of the Great Depression. Noteworthy are two later spikes — above 10% in October 1937 and near 9% in May 1940. Both were associated with sharp price declines.

The Crash of 1987 makes the record book in a couple of categories. The back-to-back spikes in volatility were by far the largest in the history of the Dow. And the first spike is associated with the single largest percent decline in Dow history (22.61%). It's clear that program trading played a major role in the crash, but overvaluation, illiquidity, and market psychology were additional factors.

Intraday volatility during this historic episode (which I believe is still ongoing) is reminiscent of the Crash of 1929, at least in the number and clustering of high-volatility days. The most dramatic spike in volatility occurred during the weeks following the Lehman collapse on September 15th. The volatility subsided as the year end approached, but a smaller wave of volatility appeared at the beginning of 2009 and peaked around the March 9th bottom and the initial weeks of recovery.

I've created these charts over the weekend following the sudden spike in intraday volatility on Thursday, May 6th. The immediate question is where we go from here. Major spikes are often associated with major turning points, as the chart below illustrates (Click for a wide version).

Whether the volatility continues will depend on many factors — black-box trading, market psychology, market valuation and, most of all, the ability of the European Union to avoid a cascading sovereign debt crisis.

The next few weeks should prove interesting — perhaps even historic. As I post this article the pre-market futures are up dramatically on the combined efforts of the EU and the Fed to avert market panic. The initial response will probably be above average intraday volatility and a surge higher in major markets. But a final verdict will likely take weeks or even months to determine.

This chart is one of my personal favorites from contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton. Chris has taken a step back to give us a long-term view of the Dow Jones Industrial Average since the year the index expanded from 12 stocks to 20 (expansion to 30 would happen in October 1928). In previous charts Chris has frequently pointed out rising wedges and Fibonacci levels, as in this example. In this latest chart he highlights a 70-year channel in the Dow. Here are Chris's comments:

Not only is the Dow up against Fibonacci 61.8% resistance and rising wedges, the index is also up against a rising channel line that has been important for OVER 70 YEARS!

Will it be different this time?

If they are long this market (?), the one thing investors hope will be different this time is that the mid-range or bottom support of this epic rising channel doesn't come into play!

On April the 13th I posted this article from technical analyst and frequent contributor Chris Kimble showing a crossroads of resistance (top chart) annotated with the Boy Scouts motto "Be Prepared." The following comments from Chris accompanied the second chart:

Attached is an update to my April 13th chart showing that nearly a month later the crossroads have held. The decline, after hitting resistance, has now erased the gains the 500 index had achieved in 2010.

Some say the reason the markets declined is the situation in Greece. How long has Greece and their debt problems been in place? Months? Years?

News events become the "excuse" after patterns have been created. Don't say it's all Greek to me! Let technical analysis and the "Power of the Patterns" be your investing friend.

The S&P 500 declined 6.39% for the week, which puts the index 8.74% below its interim high set April 24th, when the index was up 9.16% for the year. The year-to-date performance is now -0.38%. The top chart is a daily view of the S&P 500 since the 2009 low. Here Serge shows levels of support below the current price. See his annotations for additional details.

The second chart is Serge's monthly view going back ten years. Here he points out some similarities with March 2004 and January 2008.

On March 9th, the anniversary of the index lows, I featured a chart from technical contributor Chris Kimble in response to a CNBC good news piece about stocks and the dollar moving in tandem (see Technical Tuesday: The Dollar Dilemma). Chris's new chart suggests a return the non-correlation.

For the majority of the past 7 years, "so goes the dollar, the 500 index heads in the opposite direction." The past few months have seen a high correlation, until the past couple of weeks. Is the non-correlation about to pick up again as the dollar is hitting new highs for 2010?

Here's another chart from technical analyst Chris Kimble. This look at Base Materials is an interesting follow-up on two earlier articles, where he warned of a potential pullback:

Have been sharing to harvest commodities, Base Materials for a couple of weeks.

DBB has declined over 15% since mid April. Now Base Materials is setting on a short-term support line.

Base materials suggested an improving economy in November of 2009, by heading higher, over 100 days before stocks started heading higher.

Base materials forecasted this downturn in stocks, before it happened. Continue to keep a close eye on what this good forecasting tool does from this price point forward.

Here are a couple new charts from Chris updating his earlier work posted April 20. The top chart is a six-pack of high-yield bond funds and their 50-day exponential moving averages. The second chart is an overlay of the S&P 500 and a sampling of high-yield bond funds.

The last time we looked at these charts, we saw that high-yield funds have occasionally been leading indicators of tops and bottoms in the S&P 500. This week the two seem to be simultaneously suggesting a top — at least in the near term.

This chart is just in from regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton. This morning Chris looks at the big picture in gold, which has been in a 10-year rising channel. But there's much more to this pattern. Here's the commentary that accompanied the chart:

Was the 1,000 point intraday decline due to an accident?

The rally in gold has been anything but an accident, since the lows reached in 2001.

Could gold skyrocket from this price point? Anything is possible. Three small hurdles need to be taken out for this to happen.

Fibonacci 161%, top of the rising channel and a rising wedge, all three need to be broken to the upside before gold could grow wings.

Will the "Power of the Pattern" win again?

Nonfarm payroll employment rose by 290,000 in April, however the monthly unemployment rate rose to 9.9% — an increase over the 9.7 rate during the previous three months. The peak for the current cycle was 10.2% in October 2009. The chart here shows the pattern of unemployment, recessions and both the nominal and real (inflation-adjusted) price of the S&P Composite since 1948.

Unemployment is usually a lagging indicator that moves inversely with equity prices (top chart). Note the increasing peaks in unemployment in 1971, 1975 and 1982. The inverse pattern becomes clearer when viewed against real (inflation-adjusted) S&P Composite, with its successively lower bear market bottoms. The mirror relationship seems to be repeating itself with the current and previous bear markets.

The second chart shows the unemployment rate for the civilian population unemployed 27 weeks and over. This measure gives an alternate perspective on the relative severity of economic conditions. As we readily see, this metric is significantly higher than the peak in 1883, which came six months after the broader measure topped out at 10.8%.

I now show the latest recession as having ended in June 2009, following the lead of the Federal Reserve Bank of St. Louis. The "official" end will be a rear-view mirror call by the National Bureau of Economic Research (NBER).

The third chart is one of my favorites from CalculatedRisk. It shows the job losses from the start of the employment recession, in percentage terms (as opposed to the number of jobs lost).

The start date of 1948 was determined by the earliest monthly unemployment figures collected by the Bureau of Labor Statistics. The best source for the historic data is the Federal Reserve Bank of St. Louis.

Here's a Chris Kimble quartet that clearly illustrates a point Chris has been making in several previous posts. His comments:

As noted in this article from last week, rising wedges favor lower prices for any asset class in which the pattern appears.

I have suggested for a few weeks to "Harvest" or take protective action.

As the chart shows, Fibonacci and the rising wedge were suggesting just what would take place, BEFORE IT DID.

Let the "Power of the Pattern" become your friend.

I was traveling today when all the market excitement was happening — no computer, not even a radio until shortly before the close. Later, after sifting through my email, I discovered this chart sent by Chris Kimble around mid-day when the S&P 500 was at 1155 and the VIX at 26.53. I've placed X's on the chart to indicate the closing numbers. Chris's comment: "Once the VIX broke this resistance, the 500 index went into a "waterfall pattern."

Conditions that might cause one to ponder (Joe Friday from the Dragnet show would often say "just the facts!")

Here's a quick take on today's market action in the S&P 500, courtesy of regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

I have been highlighting the dangers of the rising wedge and the need to harvest values at the highs.

As one can see, the wedge broke and in a flash, a "waterfall" pattern starts unfolding.

All in a days a panic. The 500 index found short-term support around the time the Dow was down almost 1,000.

Several of Chris's previous charts have highlighted a rising wedge — as in this example and more recently here.

The 50-day moving average is frequently a level of support and resistance, a topic I examined here yesterday. Today the index opened just below the 50-MA and closed further below after reaching an intraday high six points above the indicator.

During the correction that began in January, the 50-MA failed and a month later became resistance for a brief period before the rally resumed in earnest. The current correction stands at -4.22% since the interim high on February 23.

This morning I received a fascinating email from Robert "Bob" Bronson (Principal, Bronson Capital Markets Research) questioning of the value of inflation adjustment in calculating the cyclical 10-year P/E ratio. See my recent articles on this metric using the official CPI for inflation adjustment and a variant using the Alternate CPI. Over the past few years I've focused exclusively on the inflation-adjusted cyclical P/E, which dates from the early 1930s (devised by Benjamin Graham and David Dodd) and popularized in recent years by Yale professor Robert Shiller.

Since the S&P Composite has inflation intrinsically included in it, dividing by earnings, averaged of course, which also has inflation intrinsically in it, cancels inflation out of the P/E result. This is what the most thoughtful economists do, largely because it eliminates the need to find/argue about the "right" inflation index since what investors and companies priced it at the time is what is important, which ends the debate.

So let's take another look at the P/E10 ratio — this time using nominal values for both the price and earnings:

Click the links above the chart to compare the three P/E10 versions. Instead of a quintile analysis as in the two real charts, for the nominal chart I've followed Bob's example and drawn a "best-fit" channel using the first two peaks for the upper boundary and a parallel lower boundary at the 1932 low. The dotted line shows the channel bottom if the 1932 low is excluded. The blue line is an exponential regression through the P/E10 data. The slope is equivalent to a 0.47% annualized rate of growth.

With the nominal P/E10 analysis, the current value is just above the regression trend line. The nominal P/E10 at the time of the 2009 low was well above the low in 1982 and dramatically higher than the 1932 low.

In his own P/E10 analysis, Bob Bronson uses intraday highs and lows for calculating the peaks and troughs. I've used monthly averages of daily closes in my nominal version to be consistent with my two inflation-adjusted versions. To the naked eye (at least to mine), the differences between Bob's version and the one above are not apparent. However, as you might expect, the actual ratios at the peaks and troughs are slightly different. I came up with 48.9 for the nominal peak in 2000. Bob's number is 49.9 using the intraday high on March 24, 2000. The March 2009 low of 15 in the chart above would slip to 14.5 using the intraday low on March 6 instead of the March monthly average of daily closes.

As I mentioned earlier, I've been accustomed to thinking about cyclical P/E10 strictly in real terms. But I find this nominal version quite intriguing. I plan to include it as a part of my future monthly valuation updates.

Meanwhile, I highly recommend a close reading of Bob Bronson's Revealing Supercycles: BAAC and Economic. Bob periodically updates this report, and I'll alert readers here when those updates are available.

Here's a new quartet of charts from regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

The dollar is the worst currency in the world, except all the others...

The dollar made a new HIGH for the year yesterday. The ripple effect? Copper and Base Materials (DBB) are breaking support. These two assets are very sensitive to the direction of the economy.

Crude oil has made a monster multi-year rising wedge at (1) in the attached chart.

Should the Dollar continue to rally, if you are long commodities, you could get very frustrated.

Last night, in response to my latest update on the valuation of the U.S. market, I received a an email from a reader who asks:

How would the use of the ShadowStats "Alternate CPI" affect the graph of the P/E10? My guess is that it would push the P/E10 down to lower values because using a higher inflation rate would reduce the ratio of the current price to the average of the past earnings.

Good question, and one that I've received before. In my monthly regression analysis of the S&P Composite, I post a pair of charts showing the impact of the changes to the method of calculating the Consumer Price Index (CPI) introduced by the Bureau of Labor Statistics (BLS) in 1982. On his Shadowstats.com website, Economist John Williams calculates an "Alternate CPI" using the original BLS methodology. I use the Alternate CPI for the second chart in my regression commentary. My "Bullish" and "Bearish" labels characterize the striking difference between the two.

So let's take another look at the P/E10 ratio, an inflation adjusted measure, this time calculated with the Alternate CPI.

The standard P/E10 chart I post uses the official CPI for the inflation adjustment. The chart above shows a radically different contour to the post-1982 S&P Composite and a significantly different market valuation. This alternate version shows a much cheaper valuation, one that hit single digits in March 2009. The Tech Bubble peaked in 2000 at about the same level of over-valuation as the 1929 peak. And our 2009 valuation low was closer to the secular lows of the past, although 9.5 is still above the lows in 1921, 1932 and 1982.

My opinion is that the optimum method for calculating inflation is somewhere between the revised BLS method and the historic method preserved by John Williams. But for a long-term analysis, consistency is essential, which may lend some credibility to the alternate CPI for creating a chart of the real index price. On the other hand, government policy, interest rates, major business decisions and so much more have been fundamentally driven by the official BLS inflation data, not the alternate CPI. So it's difficult to believe that a simple substitution of the abandoned methodology would provide a more trustworthy version of the P/E10. What we have in these two versions of the P/E10 is yet another point of conflict in the perennial debate between the bulls and the bears and the inflationists and deflationists.

The last time I posted an version of the Alternate CPI adjusted P/E10 was in July 2009. Henceforth I'll make it a part of my regular monthly valuation update.

The 50-day moving average is frequently a level of support and resistance. The S&P 500 intraday low today tapped the 50-MA and bounced a bit before the close (see the inset on the chart). During the correction that began in January, this level failed and became resistance, briefly, a month later before the rally resumed in earnest.

After the previous charts were posted this morning, Chris Kimble sent in a comparison of the copper futures and the S&P 500, which nicely illustrates some occasions when copper led the broader market.

Here's are a new pair of charts from regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

Basic Materials and the yield on the 10-year note are both very sensitive to growth — or the lack thereof. These two often exhibit a great deal of correlation, and sometimes they can serve as leading indicators.

Both started turning higher in late 2008, suggesting that we would see an improvement in economic conditions. A few of months later the stock market made a low and began a major recovery.

Investors might watch both of these sensitive indicators because both are breaking support lines that date back to the lows 2008-2009. Interest rates and Basic Materials both suggested something that was hard to believe a year ago, which was an improving economy. Don't lose sight these to see if they are tipping their hat to something different again!

Latter Chris sent the second chart, a ten-year look at copper futures. It too bottomed in late 2008 in advance of the broader economy. And it too is now, at least in the short term, breaking support.

We will definitely keep an eye on these as possible leading indicators. All three are very much driven by the economy and all three are acting the same of late.

Here's a clever chart from regular contributor Chris Kimble, a 30-year+ market technician and student of Sir John Templeton. His accompanying email, which I quote verbatim below, is basic justification for technical analysis. Please read before clicking the chart for a larger version:

Technical analysis can be very beneficial, by seeing patterns and understanding risk, prior to news events.

The chart attached reflects a "head and shoulders" pattern being formed, with the head hitting the 61% fib retracement level. This setup was suggesting a high risk situation that investors should either "harvest" (store some current values/take some money off the table/reap the gains of the rally) or start putting protection in place.

Have any idea what stock I am discussing?

Did the pattern know an oil rig would collapse and create one of the largest spills in history? NO! Does that give you a clue?

With the broad indexes up against fib 61% and creating year long rising wedges, does it mean some major news event could happen? The patterns aren't suggesting that. They are suggesting that "harvesting" or applying some risk management strategies are something to consider at this point in price and pattern.

Here's the latest update of my preferred market valuation method using the most recent Standard & Poor's "as reported" earnings and earnings estimates and the index monthly averages of daily closes through April 2010. The ratios in parentheses use the April 30 close of 1186.69.

Where does the current valuation put us?
For a more precise view of how today's P/E10 relates to the past, our chart includes horizontal bands to divide the monthly valuations into quintiles — five groups, each with 20% of the total. Ratios in the top 20% suggest a highly overvalued market, the bottom 20% a highly undervalued market. What can we learn from this analysis? Over the past several months, the decline from the all-time P/E10 high dramatically accelerated toward value territory, with the ratio dropping from the 1st to the upper 4th quintile in March 2009. The price rebound since the 2009 low has now pushed the ratio into the 1st quintile — quite expensive!

Or was March 2009 the beginning of a secular bull market? Perhaps, but the history of market valuations doesn't encourage optimism.

Last week I posted an article with charts of the Nasdaq 100 (NDX), Dow and S&P 500 showing their encounters with the 200-week simple moving averages (SMAs) and 61.8% Fibonacci retracements. All three indexes lost ground for the week. NDX, of course was already well above both technical indicators, but the Dow and S&P 500 gave the impression of an initial failed encounter with dual resistance.

As we start the trading week with the futures pointing higher, these weekly charts illustrate the relationship of each of the three indexes with their retracements and 200-week SMAs. I've included insets for the Dow and S&P to show more clearly the closeness of the encounters.

The Bearish View
The peak in 2000 marked an unprecedented 160% overshooting of the trend — about double the overshoot in 1929. The index had been above trend for nearly 18 years. It dipped about 6% below trend briefly in March of 2009, but at the beginning of May 2010 it has risen 42% above trend. In sharp contrast, the major troughs of the past saw declines in excess of 50% below the trend. If the current S&P 500 were sitting squarely on the regression, it would be hovering around 845. If the index should decline over the next year or two to a level comparable to previous major bottoms, it would fall to the low 400s.

The Bullish Alternative

I generally avoid predictions at dshort.com, but a future trough somewhere between the bearish and bullish view seems a reasonable expectation.

Check back next month for another update. Meanwhile, see also this comparison of secular bull and bear markets using some simple regression analysis.

Was March 9th 2009 the end of a secular bear market in the S&P 500, or is there more downside to come? Without crystal ball, we simply don't know.

If we study the data underlying the chart, we can extract a number of interesting facts about these secular patterns:

The annualized rate of growth since 1871 is 1.96%. If that seems incredibly low, remember that the chart shows "real" price growth, excluding inflation and dividends. If we factor in the dividend yield, we get an annualized return of 6.64%. Yes, dividends make a difference. Unfortunately that has been less true during the past three decades than in earlier times, a topic I periodically discuss here. When we let Excel draw a regression through the data, the slope is an even lower annualized rate of 1.70% (see the regression section below for further explanation).

If we added in the value lost from inflation, the "nominal" annualized return comes to 8.85% — the number commonly reported in the popular press. But for an accurate view of the purchasing power of our returns, we'll stick to "real" numbers.

Based on the real S&P Composite monthly averages of daily closes, the S&P is 54% above the 2009 low, which is still 36% below the 2000 high. The 2009 low measures about 6% above the average decline for secular bear markets. Of course, this number is a bit skewed by the bottom in 1932, which saw a greater decline over a much shorter period (three years versus nine).

Let's review the same chart, this time with a regression trend line through the data. This line essentially divides the monthly values so that the total distance of the data points above the line equals the total distance below. Remember that 1.96% annualized rate of growth since 1871? The slope of this line, an annualized rate of 1.70%, approximates that number. The 0.26% difference is largely a result of the rally over the past year.

Regression to trend, as we've seen elsewhere, often means overshooting to the other side. The latest monthly average of daily closes is 42% above trend after having fallen only 6% below trend in March of last year. Previous bottoms were considerably further below trend.

The S&P 500 declined 2.51% for the week, which puts the index 2.51% below its interim high set last Friday. The top chart is a daily view of the S&P 500 since the 2009 low. Here Serge shows that the index has fallen to a recent support level, and it appears to be following a pattern similiar to one seen twice before during the recovery off the 2009 low. Both occasions were followed by declines — 7.1% in July 2009 and 8.1% in February 2010. See his annotations for additional details.

The second chart is Serge's monthly view going back ten years. Here he points out some interesting similarities and differences between the current recovery and the one in 2002-2004.

The S&P 500 closed the month of April 1.5% above the March close. All three of the S&P 500 monthly moving averages we've been tracking continue to favor equities.

A look back at the 10- and 12-month moving averages in the Dow during the Crash of 1929 and Great Depression shows the effectiveness of these strategies during those dangerous times.

As a regular feature of this website, I try to update the signals at the end of each month. However, my retirement flexibility and life's unpredictability preclude a firm commitment.

Before the market opens on the last trading day of the month, we can safely assume there will be no monthly-close surprises in our S&P 500 market timing signals. All three monthly moving averages we've been watching continue to signal an equities position. The 10-month (simple moving average) SMA gave a buy signal at the end of June, and the 12-SMA and 10-EMA (exponential moving average) signaled buys at the end of July.

The top table previews the 10-month SMA timing signals for the five asset classes highlighted in The Ivy Portfolio. See the Timing Updates for interim updates.

I'm also included the 12-month SMA timing signals for the Ivy ETFs in response to the many requests I've received to include this slightly longer timeframe.

One of the ETFs in the Ivy Portfolio, iShares Barclays 7-10 Year Treasury (IEF), is close to a signal, hence the yellow highlight, likewise in the 12-month variant of the standard Ivy Portfolio system. This ETF has by far the worst record for whipsawing investors in and out of the market. The Ivy Portfolio book mentions several variants of the monthly moving-average strategy, one of which is to exclude bonds. With a history of 23 signals in the past 7 years, this asset class would seem to be a poor choice for monthly timing.

Earlier this week I posted an item, Market Volatility in Context, which examined the inverse correlation between the S&P 500 and the VIX since 2007. I received several requests for a longer timeline, one that would show their relationship during the previous bull/bear cycle.

These two charts show the pair going back to 1990, the date of earliest VIX data available from Yahoo Finance. The first chart has the conventional overlay. The second chart inverts the VIX values, which helps us see more clearly the greater degree volatility and the fact that the VIX occasionally leads the S&P 500. See the earlier post for an explanation of the color-coded left axis.

I should point out that the VIX has undergone some important changes since 1990. The details are too complex for this brief update, but an excellent overview can be found in the Wikipedia VIX entry. The changes made in 2003 and beyond no doubt contributed to the dramatic increase in VIX volatility during the Financial Crisis of 2008.

Note from dshort: For those of you who share my interest in Robert Bronson's theory of supercycles, below is a reader's question and Bob's response. If you're unfamiliar with the Bronson Asset Allocation Cycle (BAAC), see my overview from last month.

[Question] Have you considered whether the US drives and dominates the global cycle or if other economies follow your BAAC Supercycle but are currently in different cycles?

Could it be that developed economies (US, Europe) are working through the "Deflationary Winter" while emerging economies and others (Asia?) are into the "Inflationary Summer"?

[Bronson] Very good question. Obviously they have been substantially different in timing historically, and always different in magnitude due to economic maturity and socio-political differences. But trade globalization has caused them to overlap and eventually they will much more completely morph into one another, much like the 40-month Kitchin inventory cycle morphed into the 48-month election cycle, as we discuss in A Forecasting Model That Integrates Multiple Business and Stock Market Cycles. See especially footnotes #4 and #14.

The key to inter-country timing is the Kondratieff Wave (K-cycle) in inflation and interest rates (bond yields), where interest rates, the "inflation" price cost of credit/debit, are the leading indicator of the two. In fact, the spread between the two is the driver of the macro trend in commodities, as an asset class.

Keep in mind that Supercycle Winters, when inflation and interest rates (bond yields) are declining from below normal (below the historical average, equilibrium or most appropriately, the natural rate) to a mean-reversion extreme trough due to deflationary economic conditions, and Supercycle Summers, when inflation and interest rates are the exact opposite — rising from above normal (above the historical average, equilibrium or most appropriately, the natural rate) to a mean-reversion extreme peak, have the same attendant Supercycle Bear Markets in equities per the following:

Here's an especially interesting quartet of charts from regular guest Chris Kimble, a 30-year+ market technician and student of Sir John Templeton. His topic is the standard rising wedge formation. For a quick overview, see this Wikipedia entry. Here's the key excerpt:

"The rising wedge pattern is characterized by a chart pattern which forms when the market makes higher highs and higher lows with a contracting range. When this pattern is found in an uptrend, it is considered a reversal pattern, as the contraction of the range indicates that the uptrend is losing strength."

Chris calls our attention to similar rising wedges in the Dow, S&P 500, the NYSE Composite, and the Dow Jones World Stock Index. Moreover, each is nearing the 61.8% Fibonacci retracement off their lows from last year. He elaborates:

As these charts show, rising wedge patterns have taken a year to form. Soon the patterns have to be broken — one way or the other. With the major indexes up against Fibonacci retracement levels, risk management surely needs to be in place if line (1), support, is taken out.

Historically rising wedges are bearish about two thirds of the time. The trend at present, based upon moving averages, is up. However, should the markets break to the top of the wedge and take out Fibonacci levels, demand for these major indexes should pick up in a large way!

Here's a chart sent earlier today from Chris Kimble, a 30-year+ market technician and student of Sir John Templeton, along with this explanation:

The U.S. Dollar has found the 79 to 81 price area, a zone of support and resistance for the past 20 years.

Currently the Dollar is attempting an upside breakout, as it is hitting highs for the year.

Should the upside breakout continue, if history is a guide, stocks and commodities could find themselves under some pricing pressure.

For an illustration of Chris's remark about the inverse relationship between the dollar and stocks & commodities, see this post from a March 9th.

Before the market opens, let's review yesterday's volatility in the S&P 500. The first chart features an overlay of the index and the CBOE Volatility Index (VIX) since 2007. Yesterday the VIX rose to 22.81, a gain of 30.6% over the previous close. The VIX is nicely explained by Investopedia:

As the top chart illustrates, the correlation between the S&P 500 and the VIX is inverse but imperfectly so. The lower low in the summer of 2008, when the index nearly dipped to 1200, came with a lower VIX in the upper 20s. More significantly, the unprecedented surges in the VIX above 80 in late 2008 predated the actual index low by over three months.

A key to understanding the VIX is to realize that it is far more volatile than the index to which it is attached. The second chart inverts the VIX values, which helps us see more clearly the greater degree volatility and the fact that the VIX tends to lead the S&P 500.

The 30.6% spike in the VIX yesterday is a bit worrisome. The triangles at the bottom of both charts identify days on which the VIX spiked by more than 25%, something that's happened on four previous occasions during the current recovery. However, the last time the VIX rose by more than 30% was the 31.1% spike on October 22, 2008, the week after the Lehman collapse. Of course the VIX was already above 50 the day before, and the daily range of volatility during that period was astonishing.

Perhaps yesterday's VIX action will prove an anomaly — a reminder of past market anxiety rather than the beginnings of a new episode.

Tough day in the market today. But a couple hours after the market closed, I snapped this shot from our balcony. I didn't have the nautical gear to go for the pot of gold, but perhaps the market will cooperate.

Here's another pair of charts from technical analyst Chris Kimble. The first chart revisits the 10-year note yield, a follow-up on this post from last week.

The second chart takes another look at what commodities might be telling us about the inflation-deflation debate, which Chris previously discussed earlier this month.

Yield on the 10-year note hit a 16-year resistance line and looks like in the short-term resistance won. At the same time yields are breaking support. I find this very interesting — when the 500 index is hitting the Fibonacci 61.8% resistance line and the spread of the VXN and Nasdaq is the biggest in 10 YEARS!

Commodities may be weighing in on the great Inflation-Deflation debate. The Base Materials ETF (DBB) may be one of the first clues to this big question. Not only is DBB breaking support, but also bond yields are breaking support at the same time.

Hmm, two pieces to the puzzle fitting together?

Here's our latest pair of charts from Chris Kimble, a 30-year+ market technician and student of Sir John Templeton.

The first chart shows the remarkable outperformance of the retail ETF (XRT) over the broader market, starting its recovery over three months before the bottom in March 2009.

Statistics show we are a "consumer led economy." With that in mind how are stocks in the retail area performing?

Well, the retail ETF (XRT) is back at the highs reached in 2007 and has been an outperformer over the last two years by a good margin.

Another sign of a growing economy? If XRT can get past resistance, investors might consider putting this ETF in the shopping cart!

The Tech-heavy Nasdaq, devastated by the 2001-2002 Bear, has led the recovery following the great Financial Crisis of 2008. The first chart shows the Nasdaq 100 (NDX) weekly closes since 2005. Without the financial exposure of Dow and S&P 500, this index broke above its 200-week simple moving average (SMA) late last year. Likewise it has risen above the 61.8% Fibonacci retracement off the March 2009 weekly low — first in early November and in a sustained fashion in early February.

How about the Dow and S&P 500? At the end of last week both indexes were encountering their 200-week SMAs and Fibonacci retracement levels. The S&P 500 is fractionally below both indicators. The Dow is above its 200-week SMA and a mere 36 points shy of a 61.8% retracement (calculated on weekly closes).

Will these two broader indexes enjoy the success of the Nasdaq 100? Yesterday Art Cashin, director of floor operations at UBS Financial Services, told CNBC viewers that the rally is "long in the tooth, but we're getting new high readings and new 52-week highs and so even if the rally's a little old, the market technicals are quite strong and nowhere near signaling that you're near a top" (CNBC Stock Blog).

Here's an intriguing chart just in from Chris Kimble, a 30-year+ market technician and regular contributor to dshort.com. Chris explains:

Is the Nasdaq 100 (NDX) index very far from its 2007 high? Actually it's less than 8% away, around 150 points. Without a doubt the trend is up at this time, outperforming both the S&P 500 and Dow.

Is being this close to the old highs something to embrace or fear?

Speaking of fear, the VXN (Nasdaq Fear index) is reflecting one of the largest spreads in years, while the NDX is pressing up against price resistance.

Fear can remain low for years, as it did from 2005 to 2007, while the NDX made sizeable gains and the same can take place again. But resistance needs to be taken out.

Over the past few days I've seen several references to the fact that both the Dow and S&P 500 weekly closes are in the vicinity of their 200-week simple moving averages (SMA). I've spent some time studying this indicator in both indexes, and I've extended my investigation to the Nasdaq 100 and the Nikkei 225.

S&P 500
Since its creation in 1957 until the top of the Tech Bubble in 2000, the S&P 500 has generally trended above the 200-week (SMA). The bear market declines are responsible for the few occasions when the index dipped to or below the 200-SMA — most notably in 1968-1970 and 1973-1974.

Here's a chart of the index weekly closes since 1950 with the 200-SMA (the S&P 500 is spliced with the earlier S&P Composite). I've highlighted bear-market declines and recessions, and I've given a "real" alternative view to indicate the amount of nominal performance that is inflationary illusion:

With the Tech Crash and Financial Crisis of the 21st century, the S&P 500 has spent extended periods below the 200-SMA. After nearly two years below the indicator, the latest weekly close brings the index within a fraction of the 1225 level of the current 200-SMA. Will it break to the upside or encounter resistance?

Dow
Here's a comparable chart of Dow weekly closes, where the 200-SMA is similar to what we saw in the S&P 500:

The Dow generally trended above its 200-week moving average until the mid 1960s. From that point until the 1982 low, the index seemed to oscillate around the 200-SMA, which had essentially flatlined. In fact, the real (inflation-adjusted) Dow had entered a savage decline, as the lower area chart illustrates. Since the 1982 secular bottom, the Dow remained above the 200-SMA until 2001, when it again began oscillating around the SMA. The latest (April 23rd) close at 11.204.28 put the index fractionally above the 200 weekly SMA, which is around 11,134.

Nasdaq 100
Over the past several months, the Nasdaq 100 (NDX) has offered an upbeat variation from the S&P and Dow. Because of the shorter time line for this index, I've switched to a linear scale, which rather dramatizes the Tech Bubble and crash:

NDX had been above the 200-SMA for over ten years until the Tech Crash submerged it for 187 consecutive weeks (3.6 years). It finally surfaced in September 2004 and remained above the indicator for four years until September 2008. The Financial Crisis put NDX below the 200-SMA for nearly a year (51 week). It ultimately surged above the 200-SMA in late 2009, but not without a few weeks of struggle. The arrows in the inset show some close encounters with the 200-SMA over the past few years, and the weekly closes intersected the SMA five times in eight weeks to achieve its current position above the 200-SMA.

Nikkei 225
Now let's see how the 200-SMA looks on the Nikkei 225 over the same time frame as our snapshot of the Nasdaq 100. This index also experienced a severe bubble, and twenty years later it remains more than 70% below the 1989 high. This scenario is precisely what U.S. policy makers and investors around the world are hoping to avoid.

The Dow Since 1900
Finally, let's have another look at the Dow, this time all the way back to 1900. The ovals show extended periods when the 200-SMA flatlined on a nominal chart. With the Dow now fractionally above the 200-SMA, the question is whether or not the rightmost oval is soon to be closed. For the Nasdaq 100, the latest encounter with the 200-SMA was an eight-week nail-biter. So it's probably too soon to break out the Champagne.

The S&P 500 gained 2.11% for the week to set a new interim high. The top chart is a daily view of the S&P 500 since the 2009 low. Here Serge shows that the index is squeezed between its uptrend resistance and up cycle support on above-average volume and rising momentum but near overbought territory. See his annotations for specific details and the next support should the up cycle be broken.