At Pinnacle Advisory Group, technical analysis is one of the three pillars of our investment process (Macro Fundamentals, Valuation, Technical Analysis) that help us shape our forecast and set portfolio allocation. Technical analysis is a very broad term and we will define it loosely as anything non-fundamental. Some examples are following intermediate term trends (like the 200 day moving average), analyzing sentiment in the market place, and monitoring measures of investor fear (options volatility (VIX) & put/call ratios). One technical indicator we monitor is called Fibonacci analysis, which is based on the mathematical theory of Leonardo Fibonacci. It is used in practice to try and identify trend changes, and entry and exit points in markets undergoing countertrend retracements. Based on Fibonacci’s work, most counter trend retracements will peak somewhere between 50-61.8% before the retracement stalls and the major trend again resumes. If the countertrend retracement exceeds 61.8% it is usually assumed that there has been a trend change from bull to bear or vice versa. Utilizing this technical tool seems particularly valuable right now to help analyze a market that has recently seen a vicious long term down trend give way to a rip roaring rally.
Below is a chart of the value line index, which is a broad index that consists of 1650 equally weighted stocks. When looked at from a top to bottom basis the index has currently retraced more than 76% of the decline off the last market top. This chart would imply that we are currently in a new bull market, and not a bear market retracement. But hold on, depending on which index you look at (the S&P 500 or the Russell 2000, NASDAQ, Emerging Markets etc.) and what time you use to run the Fibonacci numbers (some might use a timeframe closer to the Lehman collapse in 2008 to present, others like the top of the market in 2007 to present) the retracement level may give an entirely different message. After running through a number of markets and different timeframes, the general message I’m seeing is mixed and muddled, which simply means this technical indicator is providing a non-conviction forecast. But one indicator does not make a market, and Fibonacci analysis aside, there area two different technical takes that appear to be more clearly defined. Number one is that the market appears to be overextended in the short term and is vulnerable to correction at any time now. Second, and more important, is that the weight of technical evidence seems to be improving on an intermediate term time frame. That won’t make a correction feel any better when we get it, but right now we are viewing any correction as a healthy consolidation within a bull market, not the beginning of the next bear market.
