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Has Stock Market Rally Run its Course?

I highlighted the short-term overbought nature of the stock market in my "Words from the Wise" review two days ago, saying:

"From a technical perspective, a primary bear market still exists as long as the major indices remain below the January highs and the 200-day moving averages. Many of the rally's leaders (indices and sectors) seem to be running into major resistance at these levels and look susceptible to retrace at least a portion of the gains since the March low. Further evidence of a short-term top in the making comes from a chart showing the percentage of S&P 500 stocks [90%] trading above their 50-day moving averages."

Not surprisingly, investors' lingering worries about the financial sector resurfaced yesterday, pulling the S&P 500 Index down by 4.3% and the Dow Jones Industrial Average by 3.6% - the worst losses since early March and in all likelihood a Lowry's 90% down-day.

While the short-term movements play themselves out, it is important to remember that the longer-term charts have not yet signalled a secular uptrend. Using monthly data, the graph below shows the multi-year trend of the S&P 500 Index (green line) together with a simple 12-month rate of change (or momentum) indicator (red line). Although monthly indicators are of little help when it comes to market timing, they do come in handy for defining the primary trend. An ROC line below zero depicts bear trends as experienced in 1990, 1994, 2000 to 2003, and again since December 2007. Having said that, the level of the indicator is grossly oversold, as confirmed by the RSI indicator (blue line).

The stock market will tell its own story over the next few days, but it is crucial that the lows of March 9 hold in order for base formation development to remain intact. Should these levels - 677 for the S&P 500 and 6,547 for the Dow Jones - be breached, it's "Katie, bar the door" (quoting from Richard Russell).

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