Remaining Bullish in the Long Term

 | Oct 07, 2011 | 4:00 PM EDT
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As longtime Real Money readers probably know, I am a big fan of many of the old Wall Street adages. Consider "sell in May and go away," which was pretty darn accurate this year as the market topped out on May 2 and then the Dow plunged almost 2,500 points. Generally, these adages make for pretty good advice.

I also like the Santa Claus rally pattern, which is good for the end of December and early January. Then there is "sell Rosh Hashanah and buy Yom Kippur," which I have also followed pretty closely for years now.

In 2005, when the market was selling off into Yom Kippur, it seemed like a particularly good idea and, as noted, that one marked a multi-year low. But now, it's a very different story as we have just had one of the sharpest three-day rallies on record. In fact, I heard this morning on CNBC that in the Nasdaq, the past three days have produced the sharpest percentage gain since the March 2009 low. Along similar lines, the Russell 2000 has exploded for better than a 12% pop off of Tuesday's lows in less than three days. Now some think all of this action is really bullish. But I don't. That's not the kind of thing I buy into -- ever. I leave that for the permabulls.

Anyway, Yom Kippur begins this evening at sundown and many observant Jews will be unavailable to the market until Monday. But, in deference to that pattern, some folks will attempt to get in front of the pattern and buy today. Normally, I might do that, and certainly, if the market were trading near Tuesday's lows, I would be buying aggressively. But that's not the situation, and I won't be adding to my positions at all -- not now. Maybe I will next week if the market pulls back.

As I discussed in Wednesday's column, the Russell 2000 helped to telegraph the rally as it held near unchanged levels at 3 p.m. EDT on Tuesday when the Dow was off 200 and the S&P 500 (SPX) was trading near the morning lows, off about 20. At that point, the Russell 2000 (RUT) began to go positive and, soon, the other averages were joining in. As noted above, the RUT has popped 12% off that day's new 13-month lows. That's the kind of thing one might expect after a bullish key reversal session of the kind we had on Tuesday (see the chart below). That was great, but now what? This morning, while the Dow was up about 100 points, the Russell barely moved into positive territory. Then as the market began to dip, the RUT began to sell off hard. Off 1.5% before the Dow ever turned negative. The Russell 2000 is again leading the market and, this time, it's to the downside. That's one thing keeping me a bit circumspect at these levels.

Russell 2000 -- Leading the way in both directions
Source: optionsXpress

Something else of note is that some upside targets have been satisfied. Not only did the Russell 2000 easily fill its Sept. 30 gap at the 662.80 level but so, too, did the SPX. As I discussed in a Columnist Conversation post yesterday, I was selling some positions as that gap was probed in the SPX at the 1160.40 level. Also said I would take some profits in my Energy Services positions at Rydex at the close as that sector had surged sharply higher since Monday's close (that early notice, yesterday, was especially designed for those among us who can't seem to find a gap on a chart).

SPX -- Filling its Sept. 30 gap and then some
Source: optionsXpress

A bit longer term, we may have some good news to look forward to: The Fibonacci numbers ar estill pointing somewhat higher. As you can see in the longer-term chart below, the 0.382 retracement of the massive 296 point plunge in the SPX from the May peak to Tuesday's lows comes in at 1187.78. This morning's high at the 1171.40 level was in the ballpark, but still well shy of that initial upside objective.

SPX -- The 0.382 retracement suggests still higher
Source: optionsXpress

Similarly, the Dow has as its initial upside (Fibonacci) objective a level not too far from today's highs. That's the 0.382 retracement of the 2,472 point drop from the May highs to Tuesday's lows, which comes in at 11,348. At 11,232, today's high was close.

DJIA -- Closing in on its .382 retracement
Source: optionsXpress

So these Fibonacci retracement targets have bullish implications as the targets, even the initial ones, haven't been met. That keeps me interested in the long side. But short term, as noted, it's stretched and I am not buying after such a sharp rebound. Not now, not ever.

The McClellan Oscillator is now marginally overbought, as it settled Thursday at the +103 level. And sentiment, while far from the recent frothy extremes, is no longer reflective of all that angst that we saw at Monday's close and Tuesday's intraday lows.

Market Volatility Index (VIX) -- Not as bullish now as it was on Tuesday
Source: optionsXpress

So longer term, I remain bullish. But have cut back to a maximum of 65% invested and will only add to positions on weakness.

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