Monday, February 25, 2008

More on the Range Bound Market

From the WSJ:

The past four weeks may be a glimpse of what could be in store. The broad market indexes have been trapped in ranges since the market indexes hit their recent lows on Jan. 22 near 1270 on the Standard & Poor's 500-stock index and 11508 on the Dow Jones Industrial Average.

Aside from the week of Jan. 22, stocks have spent the past month and a half between 11953 and 12866 intraday on the Dow and between 1312 and 1418 intraday on the S&P 500. Last week was the narrowest band this year for both indexes.

Despite those tight ranges, it hasn't felt like the market was going sideways. Since the lows of Jan. 22, both the Dow and the S&P 500 have had only one day with an up or down move of less than 1% and, in fact, only one other day all year with a sub-1% move. In contrast, there were only four days with swings greater than 1% by this time last year.

Behind this choppy, rangebound trading is the considerable uncertainty about the economy's fate. Many players say the January selloff in stocks reflected the expectation that the economy is likely to be in recession sometime during 2008, if it isn't already. In other words, much of the bad economic and financial news now hitting Wall Street is priced into the market.

But at this point, there are few willing to make big bets that the next big move will be a rally. Among the major uncertainties is the extent to which home prices will decline this year, as a bigger-than-expected drop could prompt a new wave of losses among big banks and brokerage houses. And even though news of a potential bailout of struggling bond insurer Ambac Financial Group Inc. could remove one question mark, other troubles in various parts of the bond markets continue to result in uncertainty on Wall Street.

Short version: the Federal Reserve has put a floor under the market for now. Whenever a bad economic number comes out -- a number that says we're either in or very close to a recession -- it bolsters the perception the Fed will lower rates again. However, the bad news also keeps the market from rallying in a big way. Hence, we arrive at a range bound market.

Let's take a look at the year to date charts to see what they say.

On the SPYs, notice the year started with the market in a clear and strong downtrend. The market fell from about 147 at the beginning of the year to 127 -- a drop of 13%. Then the Fed started to aggressively lower rates, leading to a strong rally at the end of January. However, notice the market action from the end of January to now. There are a lot of candles with large bodies, indicating prices moved strongly on that day. Also note that many candles have long wicks, indicating the trading range for that day was wide. But notice the price direction is decidedly sideways -- there is no up or down trend.

Notice the short term SMAs -- the 10 and 20 day SMAs -- are also level and have been for about a month. Finally, note that prices and the SMAs are tangled together in a bunch around 135.

Below are the same charts for the QQQQs and the IWMs. Notice the exact same analysis applies to each chart. There was was a sharp sell-off at the beginning of the year, followed by a trading range characterized by high volatility.