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Tuesday, 27 July 2010

The Dow Theory Buy Signal

Something very interesting happened yesterday, though few people seem to have noticed. The Dow closed above the highest close made in June, and the Transports index did the same. We therefore have a new Dow Theory Buy Signal, one of the most venerable, and reliable, of trend change confirmations in the indicator universe.

Richard Russell, writing before the close yesterday said:


'If they both close above their June highs, it will be particularly noteworthy, because simultaneous confirmations imply a special power.'

As far as I am concerned, that has all but killed what remained of the summer bear case, we are just waiting now for long treasuries to break support and for the 13/34 EMAs to cross back on the weekly chart. 30 year treasuries look as though they may well break support today:


I was researching a weekend post on the 13/34 EMA weekly cross the other day, and while the post is still on the drawing board, I was very struck by the points of comparison between the look of recent market action and the pullback in 1998 during the dotcom bubble. Here's the chart of 19991 to 2000 with the dotcom bubble highlighted in yellow and the comparable period in 1998 circled:


In 1998, as now, there was a sharp correction on SPX, from 1190 to 923, and there was a 13/34 EMA weekly cross that then recrossed within a few weeks for a strong buy signal. The SPX then rose more than 50% within two years to top out in early 2000.

What relevance does that comparison have now? Plenty. We are in another bubble now, the dotgov bubble if you will, and there is only one way that a bubble based on an orgy of government spending is likely to end, and that is with a bond crisis. That bond crisis is not going to be about bonds on economic also-rans like Greece, it will be centered on the US and the likelihood that the US will be able to repay the ever-escalating tidal wave of debt being generated now.

Until we get that crisis we are in an expanding bubble, and valuations could increase a lot from here.

In the very short term I'm expecting to see a peak and a pullback within a couple of days and I have a possible rising wedge on ES indicating back to a retest of 1084.5 ES:


If we should make it back to 1084.5 ES, I will be regarding that as a very good buying opportunity.

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