With MOPO and MOCO being discussed by Buzz and Mark maybe the market setup for Monday morning should be called the MOSS. (mother of all short squeezes) Of course after Friday there may not be many shorts left to squeeze. The +324 Dow gain was the largest one day gain since last September and helped the Dow break its six week losing streak. Unfortunately the Nasdaq and the S&P-500 still posted losses for the week.
Chart of the Dow
Chart of the Nasdaq
There was no economic reason for the bounce Friday. The Jobs Report should have struck fear into traders but their minds were already made up. The Jobs Report showed that there were only 36,000 new jobs created in June when 104,000 had been expected. Unemployment rose to 5.9% and the new jobs created were mainly in health services not business services and therefore did not signal any upturn in business activity. Manufacturing actually lost -23,000 jobs in June. While this may not be exciting we will continue to take these small gains instead of losses as bullish. What was not bullish was the revision downward of the prior three months numbers. May dropped from +41K to only +24K. April fell from positive to negative -21k and March dropped from positive to -5K. Suddenly the economic recovery is recovering much slower than expected.
Bulls roared? Traders came back from the holiday, saw no negative terrorist headlines and rushed to buy stocks. Sorry, that is not the way it happened. With the volume very light it was not a new bullish sentiment taking control but simply short covering in light of no attacks. This brings up several interesting points. We all know the bears have been shorting rallies for months very successfully. They are shorting based on general market fundamentals, accounting concerns, falling profits, etc. Only one short covering rally in recent history has brought anything close to this rebound and that was the Cisco comments on May-7th. The following day the Dow gained +305 points to 10141 and that was on a Wednesday with three full days of trading before the weekend. The +324 point gain on Friday in only a half day of trading would suggest that many more traders were short than in May.
Were they short simply because the economic conditions were worse? I doubt it since they are actually improved from early May. Were they short because the market was setting new lows on Wednesday? I doubt that also. After seeing the market action on Friday I now suspect that the flurry of terrorist warnings leading up to the holiday had prompted a broader range of traders to short stocks. Remember the rise in the markets on Wednesday afternoon? I said at the time that I thought it was short covering by smart traders taking profits in advance of the holiday unknowns. I believe the action on Friday was simply the shorts expecting an event closing those positions. This is really scary since it shows how many traders really expected another attack.
I also believe it points out another problem. The economic fundamentals did not change but the number of people wanting to go long on Friday was amazing. I received over a dozen emails from traders wanting to go long even after a +200 point gain in the Dow. This makes me believe that there is still not enough fear in the markets. It is surprising when you consider the levels we hit last week. Some analysts have suggested we are undergoing a capitulation by breadth instead of depth. With the horrible internals the beginning of the week it appeared we were nearing a bottom. With the knee jerk rebound on Friday I am now not so sure.
Monday is shaping up to be volatile to say the least. The TRIN closed at .25, a level only seen four times earlier this year. On May-8th and April-16th the following day posted a sharp drop. On March-8th and 15th the markets trended sideways for a couple days before dropping. The VIX closed below 30 again and back at the same level it was just before the last drop. Obviously these are both overbought/oversold indicators and they are pointing to overbought. Extreme overbought in the case of the TRIN.
The gains on Friday were extreme because of the oversold and heavily shorted market conditions. The spring was completely compressed and when the rebound occurred in only a half day's trading the results were dramatic. This brings up the problem of what may happen on Monday. Have all the shorts covered? Did the stop losses get triggered on the ones who were not at their PC on Friday? Will institutions come back to work on Monday and decide that now is a good time to buy? I doubt it. Earnings warnings are still with us and new accounting scandals are likely to continue to erupt. Fundamentals did not change despite the positive comments about the chip sector. For instance, to illustrate the absurdness of the buying on Friday, AMD gained nearly +7% to levels near its last warning. After two warnings in the last two weeks for AMD did business suddenly explode? I don't think so. This is simple short covering with a compressed timeline. Investors are not flocking into the market. The TrimTabs.com weekly survey showed that another $10.8 billion in cash flowed out of equity funds for the week ended Wednesday. This was on top of -$9.2 billion the week before.
I looked at several hundred individual stock charts and almost without exclusion the buying propelled them to just under recent resistance or right at it. The bulls would make the case that an opening bounce on Monday could propel these stocks over that resistance and trigger an entirely new round of short covering. This is entirely possible and would simply mean we roll over at a higher level. The bears would hope that the buying was over after Friday and sell into any weak bounce on Monday. You can bet that the absence of hedge fund trading on Friday means they will be back in force on Monday. Since they are normally contrarian in direction it means they will be shorting heavily on any weakness. Obviously you can see from my comments I am directionally biased.
Since IBM and Intel have not warned (yet) the possibility of lowered guidance with their earnings is very strong. The economic outlook since their last guidance has slowed considerably. IBM announces on the 17th, Intel on the 16th. That is only seven trading days away for Intel. With warnings still flying I expect a flurry on Monday and Tuesday now that the holidays are over. Want more bad news? IBM warned before the bell on Monday April 8th with scheduled earnings on the 17th. Monday is July 8th with earnings on the 17th. A surprising coincidence! Don't be surprised if history repeats itself.
Technically speaking the resistance for the Dow is 9412, only 38 points away and then 9725. I would suspect the 9725 is the one that will hold. Resistance for the broader S&P is 1007, 19 points away and 1040, 52 points above Friday's close. The Nasdaq has strong resistance at 1475-1485 an as long as the opening bounce does not take it over those levels they should hold on a gradually rising market. All this resistance bashing means that if this IS ONLY a short covering rally it will fail quickly and not much higher than our present position. There is room for one more good day and then the market will have to go back to trading on fundamentals in order to break out. Without some positive earnings surprises and positive guidance this will not happen. Bottom line, if you are long calls keep those stops tight after any opening bounce.
We have a new writer this Sunday that I really think you will like. Check out his Options 101 article entitled "The Trading Wars" in this weekends newsletter.
Enter Very Passively, Exit Very Aggressively!
If you feel you have a specific trading style, technique, indicator, market view or anything that would benefit our readers, please email me and lets give everyone the benefit of your experience. Everybody has a different view of the same market and how to profit from it. We will review it and publish the best ones in the newsletter. They don't need to be pretty or professional, just well thought out with enough documentation to prove your case. If you are a successful trader in this market then others want to know your secrets! Email Click here to email Jim