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Economic Review

12/07/2009

Is the exuberant Stock rally a function of fundamental or technical forces?  Sure looks like technicals, baby.

The massive and unrelenting rally in the major US equity indexes that followed the abyss-like drop this past March has perplexed many well-respected analysts given the host of horrible economic fundamentals that continue to plague the US economy.  The Dow, S&P and NASDAQ are all posting over 15% returns so far in 2009 as massive unemployment, ballooning deficits, increasing foreclosures remain a reality.  So what’s really driving things?  Outside of the reflation trade….the main driver is good old technicals.  How so you say?  Well here’s how so.

The main index that initiated the bull move was the Dow Jones which formed a traditional head and shoulders bottom, where the break above Dow 9000 kicked the formation into gear implying an upside objective of about 12,000.   Now of course head and shoulders come and go, and sometimes end up merely sucking in speculators only to force them to bail out of positions after the technical formation fails.  However the presence of technical trading has been reinforced lately and this refers to the reason why the Dow has not been able to take out 10,500.  That level is roughly the 50 percent retracement zone from the Dow highs to the bottom put in back in March.

The real debacle now is the battle between technical bulls playing the head and shoulder upside objective and technical bears that are playing the 50 retracement resistance level.  Which will prevail?…let’s just say that given the momentum on the up-trade, the Doc is quite surprised that Dow 10,500 has held.  However, one key fact to remember, is that technical indicators without sound fundamental support create asset imbalances which eventually re-adjust.   Fundamentals support the fact that Dow 10500 should hold, while pure momentum supports the Dow breaking through the key resistance on its way to 12000.  Play all the bull technicals you want…fundamentals are seriously lacking that side.

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