Listening in to the chatter on CNBC and reading other technical analysis articles there's a general consensus that despite the oversold nature of this market we haven't had fear or a climactic sell-off to confirm a bottom. Panic or climactic selling is a plus when sniffing out a bottom, but the true source lies in an exhaustion of selling, whether that occurs in a short amount of time during a panic or slowly in a base. Did we have climactic volume at the May top? No. It was a slow process as buying pressure became exhausted. Price needs to move down enough to encourage demand and many investors and traders are looking at the 200-day moving average or the March low for that indication.
The market is oversold. That much has been made clear by the percentage of stocks (in the S&P 500) above their short and intermediate term moving averages. I'm referring to the 10-day and 50-day moving averages respectively. In addition the RSI and MACD are low for the major indices. The VIX has broken out above 20 and is spiking as it did in March as fear finally steps in the hearts of traders and investors. The sentiment indicators that were discussed when the market was overly bullish in Q1 have greatly moderated. The percentage of bullish newsletter advisors in April peaked at 57.3% and is now currently 37%. Bearish sentiment has steadily advanced from 15.7% in April to 26% currently.
We have just entered into the extreme demand zone I discussed last week near the March low. Today the S&P 500 bounced off the 200-day moving average currently at 1257.88. Should buying step in, this is the logical area from a technical stand point and considering the day's mixed economic indicators, technicals seem to have played more of an importance.
Discussing the Long-term
There is no question that some technical damage has been done to this market. The percentage of stocks (in the S&P 500) trading above their 200-day moving average have dropped from overbought levels above 70% down to 57%. New 52-week lows on the New York Stock Exchange have been on the rise. Best performing sectors are defensive ones: healthcare, utilities, and consumer staples. Large-cap stocks are outperforming small-cap stocks. Both commodities and equity stocks have the look of topping formations.
With the exception of the Nasdaq Composite and the Nasdaq 100, it's still positive that all of the major indices are trading above or on their respective 200-day moving average. The Nasdaq Composite closed below the 200-day moving average today by 5 points. The Dow Jones Industrial Average is holding up like a champ trading near 350 points above its March 16th low close while other indices are already testing those grounds.
As far as Dow Theory signals are concerned, Dow Theorists disagree on what determines an actual reversal signal. Some would argue that a break below the March low before we place a lower high is the reversal signal, while others would argue we first need a failure swing below the April high. A drop below the March low would be a technical blow to this market, but you can officially call it “down and out for the count” if a rally fails to breach above the April high and then confirms with a lower close as was the case in the 2007-2008 top in the Dow Jones Industrial and Transport Averages.
(For a purely academic look at the 2008 decline, notice that the Transport index did in fact create a bullish reversal with a higher low and a higher high in the 1H of 2008 (also formed a head & shoulder bottom)? However, because the industrials never formed a higher low, the buy signal in the transports was unconfirmed by the industrials; therefore, the previous reversal signal still held in January.)
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Discussing the Short-term
To say the market has been whippy over the past week and a half would be an understatement. Since May 31st, there have been four 90% down days and two 90% up days. Buy! No Sell! No Buy! While the short-term has been whippy, there are a few items to discuss that aren't so flip-floppy. The first item I want to talk about is copper. Copper turned down in February ahead of a market correction in May and has formed a long-term top formation. Currently, copper has put in a short-term bottom within the downtrend, hugging the 200-day moving average. This may only be a short-term reprieve, but it's something that should be watched ahead of an equity bottom, and it is certainly a divergence with the equity market trend from May.
Divergences
Momentum indicators are rising on hourly charts for the Russell 2000 and the S&P 500 since June 6 while the index's price has fallen. This is called positive or bullish divergence.
Another short-term divergence can be shown on the daily chart of the Financials Select Sector SPDR (XLF), an area of the market that has lagged since the beginning of the year.
Another short-term plus is the higher low on the hourly charts for the Dow Jones Transport Index.
In discussing sentiment, I've already discussed the bullish and bearish newsletter reading in the Investor's Intelligence report. Another sentiment indicator that is widely followed is the put-to-call ratio as recorded by the CBOE. As Phil Roth, a former president of the Market Technician Association mentions, “The rule on the total CBOE put/call ratio is 1.0 and over is bullish, under 0.6 is bearish. You rarely see put activity equaling call activity. There is almost always more call activity…(due to hedging) I have had to raise my trading rule over the years. Right now, the rule I am using is on a 10-day basis, 1.30 and above is bullish; under 0.9 is bearish.” Technically Speaking by Chris Wilkinson. The put to call ratio has now entered bearish extreme levels with yesterday's reading at 1.36.
Conclusion and Small Rant
The equity markets have suffered a heavy blow in the two months of May and June with whippy signals all along the way. Long-term charts look heavily damaged and some companies, like Cisco Systems (CSCO), have had their own little bear market. The bull market since the 2009 is intact in my eye; however, the damage lately has taken my long-term view down to neutral since the ISM non-manufacturing number decimated investor confidence; so much so, investors completely ignored the non-manufacturing survey later that Friday, you know the other 80% of the economy that's doing well. Interestingly enough, a poor number from the Philadelphia Fed Survey was ignored by the markets with a positive close on the day for the major indices excluding the tech-heavy Nasdaq.
Something that has bothered me a lot since the manufacturing numbers have skewed the model-driven macro picture for many investors is the lack of common sense from other professional investors and analysts in the business.
Number 1) the economy (including service, consumption, as well as manufacturing) is growing.
Number 2) LEIs rolling over are not an indication of the top in the economy. Recall that the LEIs rolled over in 2004, yet the economy continued growing into 2008. The leading economic indicators are not the end-all-be-all magic economic indicator. They rolled over last summer too.
Number 3) Traders, analysts, and investors aren't digging into the manufacturing numbers nor are they hitting the bricks to see how the economy is really doing. Go to a Toyota dealership to find out if there are any Prius vehicles for sale. There probably are very few to none. The problem isn't demand, it's with supply. Additionally, prices have jumped due to the supply constraints. Toyota two week ago said they expect 90% capacity by the end of June up from very dire announcements in May and April. They expect full capacity by the end of summer and heavy production in the second half to equal last year's production.
In April, a lot of economic numbers were hit by supply problems due to the Japanese quake as well as weather related issues such as tornadoes and flooding. Housing starts picked up for May as well as permits. Jobless claims dropped last week and the 4-week average has begun to decline again. Better weather as we step into the summer should help construction, especially in flooded and tornado devastated areas of the south and central U.S. as they begin reconstruction.
Go to an Apple store and there aren't any iPads available to buy. I read a recent story today from Bloomberg that Ford is having trouble selling Mustangs; not for lack of demand, but because they can't supply enough 305 horsepower V-6 engines. Like the Prius, when the problem is with supply and not demand, that's not the typical recipe for a recession.
There's no question that the unemployment rate has been sticky. We bailed out the recession with short-term policies to boost consumption (cash for clunkers, housing credit, tax rebates, etc.) nothing structural or long-term to fix problems. The only thing we did to help with the long-term problems is fix low interest rates. China's still doing our manufacturing, or now that wages are going up there, other peripheral Asian countries. Now that the Fed has clearly said they're stepping out of the stimulus equation for now, the fiscal government is being looked to for another handout. Either way, you want to watch the tape. The market indices will regurgitate all of the economic, Greek, and political headlines to decide on the direction for equities, bonds, and commodities. That direction has been sideways since February. The true test is around the corner near the March low and around the 200-day moving average.
