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Stocks closed lower on Tuesday with the S&P 500 losing 5.74 index points or .45% to close at 1270.92, with the DJIA down 59.95 index points at 11,125.73 and the NASDAQ falling 29.28 index points or 1.40% to close at 2062.19. What is striking about the stock market behavior in recent weeks is the inability of badly oversold stocks to find any kind of a trading rally, and in many cases, any type of solid bottom. Even more to the point, is the fact that selling within the broad market has been indiscriminate in that virtually every major stock sector has seen its shares of disasters, or what I call “airpockets” stocks just blowing up in one day. Last week, on a modest EPS miss, healthcare insurer Aetna Life collapsed 20% in one day, and since then has not managed to find even a single advancing session. Along with Aetna, Omnicare, Varian, Healthnet and Coventry have all experienced frightening declines. Even more telling, all of these supposedly “defensive stocks” sell at very low P/E and PEG multiples, at levels where they should be viewed as bargains. I start this with the obscure discussion of healthcare stocks to make a larger point, namely, that selling pressure appears to be gaining ever increasing control within the market. Just look at Tech leaders --- Qualcomm, Motorola, EBAY, AMZN or YHOO. What do you see on these charts? In one word, carnage. How about EMC, JBL, SANM, TXN, INTC or AMD in the broader tech space? Again, carnage.
Over and over, I pour through sector after sector and see the giant hand of the bear reaching out to pull stocks down. Yes, there are exceptions, and to date, still a fair number of exceptions. But the pattern of progressive deterioration is unmistakable, implying that “net, net” the bear is gaining traction. To those of have never lived through a stock market “bear” – the outcome is usually pretty horrible. In the case of today’s stock market, major averages like the S&P 500 have actually held up very well despite widespread damage on the broad tape. Looking at the broad A/D Line, we see that despite the recent relatively decent percentage recovery by the S&P, the A/D Line has hardly bounced and is still just barely inside its declining 200 day lower band. This is not a good sign for the primary trend of the market. Want some additional evidence of the broad based weakness? Just look at ACI, FDG, MEE or BTU, some of last year's darling Coal companies… again, carnage…even with a small bounce in the last few days. In the case of Fording Coal the stock has maintained a nearly 15% dividend yield over the last 12 months and still investors have been ravaged giving back all of the return via downside action in the stock. Elsewhere, Homebuilding (KBH, NVR, DHI, RYL, TOL, PHM), Media (BLC, CCU, ETM, XMSR, SIRI, NYT, WON) Medical Equipment (BMET, ZMH, SYK, SNN) Generic Drugs (TEVA, WPI, BRL, MRX), Hotels (CHH, HOT, HLT, IHG, FS), Restaurants (CPKI, PFCB, DRI, LNY, APPB, EAT), Entertainment & Advertising (PLA, LAMR, ERTS, ATVI, THQI) Semiconductors (LSI, AMD, AGR, TXN, ZRAN, INTC) Materials and Construction (CX, FRK, VMC, URS, TIE, JOYG, AG, GVA, JLG, NC, ASTE, KMT, CAT, DE), Manufacturing (MMM, IR, ITW, TN, PLL, PNR, GGG, BGG, ITT, APCC), Auto (GM, F) and especially Retailing (TGT, COH, JWN, CHS, CLE, URBN, TLB, ARO, DBRN, CHRS, PSUN, HOTT, SHLD, PBY), all of these sectors have been in sustained declines, and in some cases, have had huge explosions to the downside over the few weeks. Names we all know and love like Target, Whole Foods, PF Changs, Coach, and Netflix are way down, as are some of last year's biggest gainers like Joy Global (JOYG), Titanium Metals (TIE), and Florida Rock (FRK). In my view, the action of the broad market speaks to a strengthening bear market environment, and the kind of environment which could soon hasten a full scale break down in the major averages. When looking at the daily chart of the S&P 500, the key level is still the 1220 low seen back in early June. Yet, as time has passed, the movement of this index has increasingly come to resemble that of a potentially powerful Head and Shoulder Top. In the realm of a Head and Shoulder pattern, it is not uncommon for the right shoulder rally up to reach a price level equal to that seen on the left shoulder. For the S&P, this means the Right Shoulder could rally as high as 1285 to 1290, although with today’s decline that prospect is diminished. Going forward, any close below 1220 on the S&P 500 would almost certainly signal a “breakdown” from this potentially large distribution top. The implication of this kind of pattern first developing and then, potentially breaking down would be far reaching as normally very large declines follow the completion of this type of top. To date, and just to be clear, we are only looking at a wide spread trading range with the S&P between 1220 and 1300. A Head and Shoulder Top is truly not activated until the pattern breaks down, which would require a close below 1220. Therefore, despite the carnage in the broad market, we really do not have a full scale bear market signal in hand until the S&P actually breaks down. That said, with the action of the broad market being as poor as it is, the odds have to be rising that a major breakdown is likely in the weeks immediately ahead.
In my view, the August 8th Fed Meeting is going to be a key event to measure market sentiment. In all probability, with the ISM data today showing an uptick along with the recent reports on Consumer Confidence, the Fed will probably raise rates another quarter point in August but could also announce a “pause” at the same time. Whether the Fed pauses in August or September, I am convinced that the economy is slowing enough so that they will pause soon. The key thing to watch for will be how the stock market reacts when the Fed announces the pause. In my view, there is now a very high probability that at this point, a pause could be greeted by a brief 15 minute or 1 hour rally followed by a serious downside reversal in the S&P. In other words, what should be “good news” for the market (i.e. the Fed pause) will end up failing to generate a major rally and instead will see institutions ‘sell the news.’ Driving that decline would undoubtedly be a resumption in the US Dollar bear market wherein the dollar has been quietly weakening over the last few weeks. If the announcement of a Fed pause in the rate hiking cycle rekindles the bear market in Dollars, chances are very high that it will be a falling dollar that will start to force up long term interest rates --- which are presently fairly oversold with the 10 year Bond having recently declined from 5.25% toward 4.99%. Rising long-term interest rates would then accelerate the decline in the US Housing sector and put more downside pressure on US Consumer spending. The combination of slowing spending and a weakening housing sector would then push the US economy past the brink of a slow down and into a full blown, and likely very deep recession. For the stock market, rising long-term rates and a weakening currency would be the last straw and would kick start a bear market of epic proportions. That’s the message the market is flirting with right now, and the message we could be seeing with the conclusion and break down of a Head and Shoulder Top in the S&P. Another element I have been watching is the relative strength of the NASDAQ versus the S&P 500. From the June 13th low on the S&P at 1223.69 to the recent high at 1278.55 seen on Friday, July 28th, the S&P rallied 54.86 index points or 4.48% which represented a recovery or nearly 54% of the previous decline from 1325.76 (the May 5th high to the June 13th low).
Now, over the same period of time, the NASDAQ Composite barely squeaked out a gain moving from a low on June 13th of 2071.48 to a closing high on July 28th of 2093.11, a gain of just 21.63 index points or only 1.04%. Even more telling, the NASDAQ was not able to retrace any of the decline seen between its May high and its June 13th low. This tells me that something is seriously wrong in Techland and with Tech stocks being cyclical in nature, probably means that the Fed has already gone too far in its rate hiking cycle. For highly cyclical Tech Stocks, the message of the charts is recession ahead and that has manifested itself in steadily declining relative strength. Over the last 10 days, the relative strength ratio of the NASDAQ to the S&P 500 has continued to tumble and is now pressing the lowest readings seen since June 2003 – a three year low. That is not a good sign as the stock market is normally at its best when the NASDAQ is leading the way higher. For now, what “leadership” remains in the stock market is grounded in highly defensive area’s such as Energy, pockets of Healthcare, and Consumer Staples such as Food and Beverages. If the history of bear markets is indeed repeating, the normal pattern would be to see only the Energy and Gold Stocks holding up into the next phase of the bear (the breakdown phase for the S&P) and at some point down the road, possibly only the Gold Stocks holding up, as Gold Stocks have a decent history at doing well in bear markets. We will look at the history of Energy Stocks and Gold Stocks in bear markets in more detail in next week's update while duly noting the S&P’s preliminary reaction to next week's meeting. The lack of a sustainable rally from here will be very telling. Frank Barbera
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