The market may be telling us something in the near future. Most of the senior averages around the world have peaked and may be in the process of reversing soon. The SPX measures from 1/22 lows almost to perfection with wave-1 and wave-3 equal to each other; wave-5 is 61.8% of both, a logical and in fact probable turning point for at least this upleg and possibly for a great deal more. The Nikkei and now the German DAX indices have turned down from wedge topping patterns as well, providing the coincidental correlation towards something that most big market corrections experience. While this may not be the ultimate high, because the SPX could still rise to 100% of waves 1&3, it does fit out methodology of spotting key potential turning points ahead of time.

In previous counts we have published the presumption was that the market had completed its final up leg out of a complex series of sub-waves stretching back to ’03 or ’02. Instead the market threw us a curveball that may have moved our count one wiggle to the right. At each of the last few possible turning points, the wave measurements and proportions were appropriate for a trend change. But our discipline requires a fast breakaway move to confirm potential turns in order to eliminate what amounts to head fakes. This happened recently when the conditions were ripe for change but the market failed to confirm its turn. The implications of yet another wedge top with latent reversals that would create major signals of change are that the market has confounded the majority of participants enough to now leave the bears (if any) on the sidelines. Just as a ship where people rush to one side to witness a whale sighting, once everyone is at the rail then there is no where to go but back to the other side. This is exactly what makes for market reversals and trend changes. 

With Asian and now European markets breaking down from topping wedge patterns, the suggestion is that the US too will reverse its throwover from yesterday as we anticipated in our daily technical comments. With the SPX at a crucial pivot point here and also possibly at 100% of waves 1&3 at 1440 and 1445 respectively, the time for change may well be upon us! If so this would be a key moment in time where the bulls and bears are fully balanced and even the slightest push could then influence the marketplace to begin what becomes a major shift in direction. If not then we would not be surprised to see stocks form yet another wedge formation just as has happened again and again. 

Momentum is another important indicator though one must recognize that it does not easily provide timing help, only directional guidance over time. The SPX has developed big negative divergences over the last couple years with the highs on RSI hitting way back in 3/04 and the current 6-yr highs failing to even top its own fall highs and remain below the peak readings for this bull run. The implications are that the up move is running out of steam, that each new high is coming with less and less steam behind it, and that coupled with the ST picture that also shows divergent momentum, the market becomes vulnerable to a whole host of risks that previously had been dismissed. 

LT Condo data on units for sale – rising rates an huge overhang could mean another down leg for prices

The housing industry is the Achilles heel of the economy and therefore the market. If home prices start another bear leg lower it will reverberate across the economy as consumers shudder and begin to retrench. With no viable means to raise money, the typical US household is cash flow constrained by mortgage resets affecting north of 7.5m borrowers. With interest rates breaking out to higher levels despite big overhead resistance dating back over 15 years or more, the refinancing game that fueled much of the last 5 years of consumption boom and home price rallies, not to mention stock market bulls has run out of steam as well. Refinancing numbers have fallen sharply since the enormous wave of refinancing and mortgage origination in the summer and early fall of ’03. Those loans were predominantly hybrids with floating rates, resets off below market teaser rates and flat disposable income stats. With jobs growing well below par for recoveries, and many of the jobs shifting away from high paying corporate jobs and into hourly unskilled positions, the ability of households to raise incomes is much more limited than in prior decades. Huge consumer debt and unsustainably high spending levels spawned by home equity funding have already become burdensome but may pose more serious problems soon if rates continue to climb.

Much of the securitized mortgage securities are sold abroad, pushing the dollar up relative to economic fundamentals and surging deficits. The key to MBS investments is flat to falling interest rates. Since the key mortgage rates float off Treasury yields, anything that precipitates higher yields will therefore have a negative impact on MBS prices. With default rates doubling over last year according to mortgage lenders, a fact that prompted a number of sub-prime lenders to fail in December and could affect a significant percentage of all such lenders, the risks are clearly rising that troubled consumers could be forced to default en mass due to the combined effect of mtg resets, relatively low jobs creation and rising inflation/interest rates. Default rates ran up to just off records in early ’05 only to back off for a time. Now they are rapidly rising towards records and perhaps well beyond with so many marginal homeowners who borrowed money to make down payments now falling into financial distress. Should MBS buyers conclude that inflation is not being adequately managed by the Fed or that defaults are likely to surge higher, they would be likely to liquidate at least some of the huge volume of MBS’ acquired over the last couple of years. With mortgage lenders being stuck with a put for roughly the 1^st 90 days of a securitization of loans, the surge in distressed players and perhaps even more so the large number of lenders that are currently up for sale tell volumes about what is happening to the business of MBS creation. The risks are growing that highly leveraged consumers could precipitate massive currency weakness plus higher rates should default rates jump high enough over a short period of time. The market seems to be gathering this.

Recent reports point to potentially serious problems in the tech industry and beyond. Several weeks ago the wireless handset makers reported sharply lower margins despite robust unit sales. Then hardware companies reported weak demand and falling prices, which in turn took the stocks down. The software vendors have been reporting last week and this week that margins are week and forward demand is considerably weaker than last year’s 1Q. Service vendors have also had problems with missed numbers and weak forward guidance coming out of both outsourcing firms and Big Blue. The latest news hints at more disturbing news relating to tech stocks. One of the big wireline players has said it will cut CapEx spending. That flow of dollars had been expected to be akin to a tidal wave of new money that would fuel many a hedge funds high hopes for a big rally in tech stocks. Instead early indications suggest that consumer weakness is affecting the willingness of big telco stocks to spend on IT projects. If this were true then we would expect a great many tech stocks to experience unexpected slowdowns in deal closures despite strong pipelines as well as outright misses. With many stocks at or close to highs, any weakening of fundamentals will likely be greeted with rising concerns and heavy selling.

The spate of recent sell signals includes our pattern wave counts, Supply/Demand models, momentum indicators, price/volume analysis, sentiment measures, New High/Low models and volatility divergences. Interestingly some indicators have signaled change from bullish conditions while others have continued to call for higher prices. We tend to follow an eclectic group of indicators that include LT trend analysis of economic measures and statistics to identify emerging trends and potential turning points. After the conditions are set it is up to the market to confirm the action or to revert to watching for the next significant pivot point. Currently the market is reacting to a number of issues that play on the three big concerns for stocks: inflation, interest rates and the dollar. Inflation relates to monetary conditions as well as pricing concerns. The interest rate picture delves into economic conditions as well as Fed policy. The dollar reflects economic trends plus the net attractiveness of US assets and securities to foreign investors. Right now inflation is clearly a problem, rates are quickly becoming an issue as they rise through heavy resistance and the dollar is important in terms of money flows into the economy and the financial markets. We think the rising rates and surging defaults in part signal a distressed consumer, something that will be reflected in IT spending plans. With misses in hardware, services and software plus mortgage lenders and telco players, indications are growing that a slowdown may be in effect, one the market may anticipate.

RTW

SPX ran to a new high throwing over a big wedge – it has subsequently reversed – now a fast down move is needed to confirm!

SPX count puts the 5^th and final wave at 61.8% of wave-1 – next probable stop would be 1465 at 100% of wave-1

SPX count could be complete if the 5^th/5^th/5^th ends at wave-1 to wave-5 equals 61.8% - note LT divergence at prior highs

China broke down a ST wedge in what could be a topping movement

The NKY broke down a ST wedge as well – ahead of the US for a change!

DAX turned today as well signaling a global reversal often seen at the start of big declines…

Oil prices signaled the big decline with months of divergent RSI readings – new lows were confirmed by RSI

The HGX is on key support – But look at RSI on the highs – it made a lower high which is a bearish signal !

Hourly Sell signal from 1/10 is still waiting for confirmation from price – a sustained break of SPX 1430 would do it

VAP is holding up so far but RSI is really weak - suggesting a turning point soon!

Home prices may be poised for another down leg – rates are rising and supply is huge

S/D is still on a Sell signal – confirmation will come from sustained prices below 1425 and again at 1415

VAP has backed off – RSI tried to catch up – But failed to recover, issuing a big sell signal

Rates broke out of heavy resistance – TYX also has RSI confirmation! Targets 5%-6%

Work hours give a telling indication of what is going on in Mfg – could this be whats behind all the misses lately?

Weekly S/D needs only a fast move lower to become operative below SPX 1390

VAP is rolling over and Momentum lagged badly before turning lower itself – a correction is indicated

MZM has broken out indicating the Fed is back in the money printing business once again !

The bulls have run up to a relative high and then pulled back – declines often follow such moves…

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© 2007 Richard T. Williams, CFA, CMT
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