The Trouble with the Charts

05/16/2012 11:45 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

When everyone is watching the same ones in a market starved of fresh money, it’s a recipe for getting whipsawed, writes MoneyShow.com senior editor Igor Greenwald.

Bear with me for a moment, please, while I impersonate a technical analyst. Because technical analysis is the only kind anyone trusts these days.

That’s only logical in the wake of all the black swans that have bitten us where it hurts most in recent years. Clearly, the economic and social realities are not as amenable to straight-line extrapolation as most people thought in 2007. Whereas the charts don’t lie and don’t cheat; they merely change in ways that often mirror past patterns.

So: the level at which the market stalled and then failed yesterday approximates a 38% retracement of the December-April rally—the 38%, of course, being a key Fibonacci number. Moreover, that level lines up neatly with the neckline of last year’s head-and-shoulders top, and as every market hobbyist by now knows, old resistance becomes new support, and vice versa.

The stock market has spent a good deal of negative energy to get to this worrisome juncture, dropping 6% in two weeks amid aggressive distribution. So we’re still overdue for a dead-cat bounce. Thereafter, once the market breaks decisively below current levels, you should go to your safe room and gnaw on survivalist jerky pending Rapture.

I’m not making fun of technical analysts. Our own Tom Aspray is among the best in the business, and is deservedly popular because he has been money. And that success is really the point here.

It’s not technicians’ fault that fundamental analysis has produced so little value in recent years amid the wild and largely indiscriminate price swings treating the entire asset class as a single ETF. But that’s the reason the technicians are more widely followed than ever, with the result that most market participants are staring at the same charts.

And most market participants can only be right at the same time if there’s an influx of new money into the market, as hasn’t been the case for stocks in years. Alternately, we can all rush to sell in response to some obvious prompt, like the S&P breaking below its 50-day average.

Today’s market is dominated by speculators and machines that have become adept at triggering sell stops and messing with the widely watched technical levels. The percentage of trading based on market technicals is almost certainly at a historic peak, with the likely consequence of more traps and fake-outs than ever, the entirety of yesterday’s action providing only the latest example.

That’s the market hinting that fundamental analysis has become undervalued, and I’m seeing plenty of attractive fundamentals out there.

Tomorrow I’ll go over some specific names, mostly profiling as small-cap growth. This category is out of favor at the moment, which is the right time to buy it.

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