March 2010 Technical Outlook for Stocks

“Profit Confidential” Column, by Michael Lombardi, CFP, MBA

The famed ability of the market to climb the proverbial “wall of worry” continues to be put to the test by yet another wall — the Greek debt default tragicomedy. But default by sovereign borrowers is nothing new.

Financial history has many examples of defaults by different countries, including a few by Greece. What makes it different now is that Greece is part of the Euro monetary block. Its monetary policy is dictated by the EU Central Bank, while the fiscal policy is merrily run by Athens.

As grim as the Greek situation is, there is an important factor Greece has on its side — the financial meltdown following Lehman Bros’ bankruptcy. Awareness of what followed after the U.S. government failed to bail out Lehman will convince Germany and France to bail out Greece, at least this time around. How effective the bailout will be in the long term is less certain. Complicating the situation is the dire financial condition of Euro-currency countries of the so-called “Club Med” (Italy, Spain and Portugal).

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Considering the risk of another financial calamity, one has to be impressed by the resiliency of financial markets. Rather than triggering a sizeable correction of the huge rebound from March 2009 lows, the majority of Western stock markets have been consolidating those gains within narrow trading ranges.

In the process, the market averages, such as the S&P 500, have formed trading patterns taking on the form of complex head and shoulder tops (H&S). The technical bible of Magee and Edwards states that the multiple H&S formation usually shows less power than simple H&S patterns. A decisive breakdown below the neckline would mark the completion of a top, while a rally taking the averages above the head would rescind the formation.

Admittedly, technical patterns are prone to subjective interpretation and revisions, not unlike earnings estimates for individual companies or entire market averages.

To add hard numbers to the art of chart interpretation, most technically leaning analysts use numerically defined models that can be objectively tested for accuracy. Reviewing the performance of my own market indicators, one indicator that has had a remarkable 12-year-long accuracy is the NYSE High/Low model, a concept made very popular by N.G Fosback some 35 years ago.

Though its latest buy signal at the October 2008 lows did not catch the eventual lower lows of the stock market of March 2009, this indicator has remained bullish ever since. Combined with the bullish rating of fundamental and monetary indicators I follow, courtesy of the loose monetary policy, these two groups of bullish indicators have continued to lead the market higher and to overshadow the bearish signals from various sentiment indicators.

Technically, I believe the strength of the NYSE High/Low Model combined with bullish fundamental and monetary indicators will continue to lead the market in the short term.