Consolidation is good, but…

It’s your weekly dose of TSP Talk.

Stocks were mixed on Friday, with the Dow and S&P 500 closing up on the day, while the small caps finished in the red – as did the I-fund after a rally in the dollar, which also helped bonds have a nice day.

As much as I have been expecting a pullback from this recent monster rally, you have to be at least a little impressed with the constructive consolidation we’ve seen over the last few weeks.

I am not yet falling for the “recovery” talk for the economy, but except for the recent rising wedge formation, the technical action in the indices has not been bad. It appears that the S&P 500 wants to break to the upside, to follow the action of the Nasdaq, which has already accomplished this. But then there is the Dow Transportation Index, which is lagging, and the S&P could always choose to go that way.

Some technical analysts use the 200-day simple moving average (SMA) as opposed to the 200-day exponential moving average. The SMA adds up the daily price over the last 200 days and gives us an average, while the exponential moving average (EMA) is more weighted by recent activity.

The reason to use one over the other is up to the individual but since many technical indicators can be self-fulfilling prophesies, you want to know what both are doing. We used both when the S&P was breaking below the the averages on the way down, so now that they are getting close to being broken to the upside, let’s see what they are up to.

You can see in the S&P 500 chart that the index is still finding some resistance at the 200-day EMA, while it has now broken above the 200-day SMA average. I believe this is why buyers are still stepping in. For some technical analysts, this is a bullish sign for the longer-term. You can also see that the 50-day EMA is flirting with the 200-day SMA (a move over the slower 200-day averages would be a great sign) but it is still below them and that is a still a sign for caution.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

Meanwhile, the Nasdaq is above both 200-day MA’s, and the 50-day EMA is now above the 200-day SMA, although not quite above the 200-day EMA. This is a good looking chart and a pullback to the 200-day SMA could be a good buying opportunity, using any move below it as a stop (sell signal).

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

Have I lost anyone yet?

The Dow Transportation Index is still trading below both the 200-day SMA and EMA, and the 50-day EMA is well below both as well. The chart appears to be leaning toward an upward breakout because of the strong consolidation, but it is a less encouraging chart. You would hope that it follows the Nasdaq’s lead, but you never know. This index is very sensitive to economic conditions and we’ll have to see where it heads next.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

So, while we are seeing improvements in the charts because of the recent consolidation, we still need to see a few things before buying – ironically a breakout AND a pullback. Long-term is a different story. I will need to see those moving averages all do the right thing (50 over 200, etc.) before getting comfortable.

If a breakout does not happen soon, the bears could eventually step in and finally take things down hard. These tight coil-like consolidations usually end sharply – but it could be up or down.

Thanks for reading! The TSP Talk Market Commentary is updated daily on www.tsptalk.com.