Monthly outlook by regression trend analysis

A tale of three regressions

For this Sunday, we take a longer term look at the market. Presented here, for your approval is a monthly chart of the Dow going back seven years (click on the chart to enlarge):

In it, I have drawn three regression trend channels. Recall that the RTC defines the limits of a trend to a given statistical probability. If a candle goes outside the upper or lower trend limits, then there is a 95% chance (according to the parameters I set) that the trend is over. The lower panels are, top to bottom, volume, RSI, momentum, money flow, stochastic, and OBV. These are my favorite indicators.

Let's start with the RTC's. The first is the bull market that ran from 2005 to the all-time market peak in late 2007. The second is the bull run from the post Great Recession crash in March 2009 to the peak in May of this year. The third is a descending RTC that began at the May peak and continues to this day. The other lines on the chart are the Bollinger bands (in blue), Bollinger center line (black), 20 MA (red) and 200 MA (dotted orange).

I don't know about you, but I am struck by the similarites to today's chart and the 05-07 RTC. Notice how both rising RTC's ended with candles dropping from the upper edge on down to the lower edge, where a hammer was put in. Compare January '08 to August '11.

This leaves us at a crossroads. In February '08, the market continued lower, falling out of the RTC and causing a bearish trigger. And you can see how that ended. Right now, the half-baked September candle still has a chance to end up looking like February '08. If so, then history would suggest that we might see a one or two month rally. That dovetails nicely with the historical strength of the fourth quarter.

Right now we're in two RTC's: a rising one from '09, and a shorter descending one from May of this year.  We're on the verge of falling out of the rising one and a long way from exiting the descending one.  That's all bearish.

On the other hand, note how the monthly indicators have all traveled far from their overbought peaks. The RSI and stochastic in particular are near levels from which the 2010 rally started last July. Combine this with strong support at 11,000, I think we have more chance of going higher between now and the end of the year than we do of going lower. However, I'm fairly pessimistic about 2012.  It's possible to have a few months of gains while still remaining inside the third RTC.

There's a limit to how far and how often you can kick the can down the road, and it seems like the world has been kicking a whole recycling center's worth of cans lately.  Everything depends on how much you think now is like 2008.  There are certainly plenty of opinions on both sides.  Personally, I don't think it's that bad, but it's still pretty bad.