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Equities look poised, but for a move up or down?

25 April 2008

The Macro Trader’s view:
Since the low made back on March 17, equities have defied gravity and despite one or two hiccups have staged a solid recovery, almost to a point where a new bull run seems possible. But with the US considered already in recession and after a poor 1st quarter reporting season, surely the S&P ought to be testing the lows?

Although several bell weather stocks have reported weak profits (GE springs to mind) and many US Banks and investment Banks reporting record write-downs and seeking new capital, traders appear to be already looking beyond the current slowdown in anticipation of the eventual recovery.

But is this too premature?

The Fed expects the economy to emerge from the current recession in the second half of this year, but they also admit that conditions are continuing to deteriorate with no bottom yet in sight for the housing market. They base their optimistic forecast on having aggressively cut interest rates in recent months down to 2.25%, with addition cuts expected, albeit by smaller degrees, and with the Federal stimulus package due to kick in by mid-summer, they judge the economy will recover.

There is a degree of logic to their hope, mainly arising from the fact that the worst hit companies have been mostly in the financial sector, together with industries with close connections such as technology, and some other segments of the economy continue to perform well.

But the modern economy is fuelled by credit, so how much longer can business continue if the financial sector is damaged?

The current view of investors seems to be that now all the bad news is out. And as Banks have begun replenishing their capital base, they calculate that business will continue as usual. After all, Banks make money out of lending money and memories are short. The next sure-fire bet arises and lending standards drop in the general stampede so as not to miss out.

Is that right?

This time things may be different. The Fed had to rescue Bear Sterns with the use of US$30Billion of tax-payers money, with the additional help of J P Morgan Chase. Until that moment the market feared several other venerable Wall Street institutions were at risk- the system was close to a shock never before seen in the post WW11 era.

Policy-makers will undoubtedly endeavor to implement new rules designed to prevent such a situation repeating, but too heavy a hand would blunt the US economy’s creativity and dynamism.

We judge it is by no means certain that the economy will recover in the 2nd half of this year, the tax rebates may be saved and if those areas of the economy previously unaffected begin to weaken, unemployment may rise further and prolong the downturn. We think this is a realistic risk as we judge the Banking industry, although inherently ‘greedy’, will initially, be more circumspect going forward.

The current rally may yet prove to be no more than a bull rally in a wider bear market. So for us, the jury is still out.

The Technical Trader’s view:

The failure of the market at the 1574 high - a double failure – drove the market down but it has found some support from the first clear prior High around 1331.20.

Look closer
The detail of the market shows how the complex Double Headed Head and Shoulders Top was formed and reached its minimum target on the down-side.

The Prior High support at 1331.20 was penetrated but not convincingly.

Are there clear structures within the consolidation.

Yes there are.
It has the potential to both be a Double Bottom (completion level at 1400) and a Bull Head and Shoulders Reversal (completion Neckline 1385 or so)

Indeed, the H&S Reversal may be on the point of completing today.

But all the bulls’ enthusiasm has to be tempered by the close and powerful resistance from the Head and Shoulders Neckline at 1430.

So we remain undecided.

Mark Sturdy
John Lewis
Seven Days Ahead

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