Option Investor
Market Wrap

The Market That Refuses to Drop

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The Market That Refuses to Drop

This was written one week ago--"For over a week now we've been in a relatively tight range that has worked its way slowly higher. Whenever we see price action chop its way lower or higher it's usually a sign that the move is running out of steam." Change the above to read two weeks now instead of one week. For the past two weeks each time it looked like the market was getting ready to roll over, we got a shot higher and then more consolidation. As of the end of today it again looks like the market is ready to roll over. We have lots of negative divergences on the 60-min charts, the daily (and weekly for that matter) oscillators are peaking or peaked in overbought and we are at significant resistance levels that have been like a big hand over the market and yet the market keeps pushing the big hand higher. That's a warning and it could go either way. The fact that price has been chopping its way higher and new highs are being met with negative divergences is a warning that this could tip over at any moment, and it could do so swiftly. Certainly it continues to be a time for those in long positions to keep your stops tucked up nearby. But these kinds of bearish setups, and dare I say slam dunk kinds of short setups, have been failing more often than not. That tells me to watch for a sudden flare up as the shorts gets squeezed once again. Tomorrow's early morning jobs numbers could provide the catalyst either way.

Another unknown is how the recent strength in the US dollar will have an impact on the equity markets. The aftermath of the French thumbs down vote on the EU Constitution has caused some pretty massive selling of the Euro and buying of the US dollar. Europe is widely viewed around the world as being in a political crisis, and of being on the verge of a major economic malaise, hence the selling in the Euro. Unemployment is pegged at 8.9% in the 12 nation block that uses the Euro as its common currency. Bloomberg reported that due to the slowdown in Europe and rising energy costs, the OECD has joined European leaders, including Italian Prime Minister Silvio Berlusconi, in calling for the European Central Bank to cut interest rates, this while the US is still contemplating raising interest rates. Europe may be leading the US and personal opinion here but I think our Fed should be listening to them. The resulting sell off in the Euro will likely have major repercussions around the world. The strength in the US dollar will continue to finance our massive deficits as many continue to buy the dollar and help us pay our huge debts. For China, it could bring another round of tightening as both the U.S. and Europe continue to put pressure on Beijing to bring its trade policies to a more even footing. These are interesting times, but the uncertainty of it all will only make it more difficult for the bulls to drive full speed ahead. Or will it be the wall of worry the market needs?

There are all kinds of theories about how the strength of the dollar will affect U.S. international corporations and their international businesses, or even the consumer and how it will affect their purchasing power. Generally speaking, when looking over weekly charts, one could say a falling dollar has been good for our economy and businesses (our equity market rallied while the dollar was falling) so we're now left to wonder if the opposite will be true as the dollar rallies. On top of that it looks like the pullback in oil could be over. If oil rises back up towards $60, and probably higher, surely that will scare the bulls (high energy prices being a drag on the economy, especially the consumer). And yet we had a week of solid gains in oil price and the dollar and yet equities still rallied. On top of that we saw this equity rally in a period when we should see selling (sell in May and go away). As I said above, we are either perched on the edge of a cliff ready for a beautiful swan dive or there are bigger and smarter players than I who are buying this market and we're about to get a massive short squeeze. It's certainly a time for Jack Be Nimble in the market right now!

I had discussed last week (Tuesday's Market Wrap) a potential Fib turn date window of May 25/26. It turned out to be a dud since we got no turn. The next potential Fib turn date is June 10th and then July 25th after that. The stronger Fib turn date isn't until September 16th so from a Fib standpoint we may not see much influence through the summer. The September 16th date is interesting since we often see major turns in the months of September/October. This Monday is a New Moon and these will sometimes influence traders' moods and cause a turn in the market. Other than that we'll continue to follow the chart patterns and try to identify support and resistance, trend lines that are influencing price and see if we can't identify where a potential turn is occurring.

One other tool I'll mention is Gann for those of you who follow this method (in which case you're a lot smarter than I am about the subject). There is a Gann "Square of Nine" chart that's very fascinating in its accuracy. You can google "Gann square of nine" and find some interesting sites to learn more but try xmlworks.com/gann (I have no association with this site) and click on Create Gann Square, select whatever dates you'd like, starting number of 1 and then at least 18 levels. You'll notice on the chart that's created that the 17th level includes the current SPX values (so use at least 18 levels to generate the chart). Find a high or low on the Gann chart and then look for values that are 90, 180, 270 and 360 degrees from that number (360 degrees takes you to the next level). These are numbers of "resonance" in the market and it's uncanny how they work. For example, the low of 1160 in August of 2004 and the high of 1229 in March 2005 are 180 degrees from each other. Half way between (90 degrees from each of those two values) is 1194. As long as the market holds above 1194 there's probably a good chance this market is going to rally to new annual highs--the next square, 90 degrees from 1229, is 1264 and this of course is near the 62% retracement of the 2000-2002 bear market decline at 1253. Will we rally to there from here? I have no idea but it'll be fun to watch what happens if it does. You can also play with the dates and see which dates "square off" the others.

I digress a little but I thought it would be fun to play with that on quiet days like today (to keep your fingers off the trade button). Not a lot has changed in the charts shown in last Thursday's Market Wrap except for some bullish breakouts, especially in oil and the housing market. But the broader markets are still essentially trapped under some stiff resistance. The Nasdaq in particular--it closed right under its 2100 resistance level. Let's see what the picture tells us this evening.

DOW chart, Daily

The DOW continues to press against the highs of late March/early April and the broken uptrend line that runs from March 2003 through the October 2004 low. Based on resistance and overbought indicators I'm showing a pullback but as stated above, if we get some short covering from here, we could see a big run past resistance as all those who are "sure" this market is going to drop suddenly run for cover.

SPX chart, Daily

The SPX and DOW continue to mimic each other. SPX is pressing above its broken uptrend line and if it can get back above this line and stay there, that would obviously be bullish. If the daily stochastics manages to flatten out in overbought here it would indicate a solid up trend is in place. Overbought can always get more overbought.

Nasdaq chart, Daily

One look at the Nasdaq gives me the immediate impression that I had better have my stops close by if I was long. The resistance level at 2100 is likely to be strong. So here again, we could get a quick burst of buying energy that propels us across that line of resistance and then it could act as support, or we'll start to see the sharp rally finally get corrected. Tomorrow's jobs numbers could be the key.

SOX index, weekly chart

The weekly chart of the SOX is either bullish or potentially bearish depending on what you're looking at. The fact that it has closed over its 200 weekly moving average, something it hasn't been able to do since early 2002, is bullish. The fact that it's approaching the downtrend line from December 2004 (443), only 3 points above where it closed today, causes one to wonder if it has enough energy to break that line of resistance. See the Nasdaq above.

BKX banking index, daily chart

The banking sector looks relatively week as compared to the broader market and bulls don't want to see this. Bulls like to see the banks and brokers leading the way. Other than a brief break above the 200-dma, including a spike above it yesterday and then a close below, the banks look weak here by their inability to capture this significant moving average and the daily oscillators looking ready to head back down.

This morning's economic numbers included the weekly jobless claims and productivity numbers. They were a mixed bag and left the market with a ho hum response. I think the market is simply waiting for the bigger numbers tomorrow morning. Weekly jobless claims rose 25K to a two-month high of 350K, above forecasts of 325K, due largely to temporary automobile-industry layoffs, lending further credence to arguments about slowing economic growth. Q1 Productivity was revised upward to 2.9%, versus consensus of 3.0% and a prior read of 2.6%, but unit labor costs, which are a key inflation measure, rose 3.3%, versus estimates and a prior read of 2.2%. It's the inflation number that will keep the Fed on course of raising rates (note that the bond market strongly disagrees with the Fed since the rates have been on a tear to the downside). A negative sign in the employment area was the U.S. Challenger report saying layoffs were up 42% to 82,283.

The durable goods orders numbers were also mixed and neutral for the market. April factory order rose 0.9% versus +1.1% expected, which was the fastest gain in five months. Shipments of factory goods increased 0.7%, while inventories increased 0.1%. The inventory-to-shipment ratio fell to 1.24 from 1.25 in March. Economists were expecting orders to rise about 1.1%. Orders in March were revised up sharply to a 0.7% gain from 0.1% previously. Orders for durable goods rose 1.9%, unchanged from last week's estimate. Orders and shipments for nondurable goods fell 0.2%, on a drop in petroleum.
The oil inventories numbers were also released today which caused the price of crude to pull back some today. The release of weekly crude supply data showed a build in inventories in the latest week. The Department of Energy said crude supplies rose by 1.4 million barrels in the week ending May 27, and remained well above the upper end of the average for this time of year. Gasoline supplies rose by 1.3 million barrels, while distillate supplies rose by 700,000 barrels. Separate data from the American Petroleum Institute showed crude supplies up by 1.3 million barrels, distillates up 783,000 barrels and gasoline down by 1.4 million barrels. Trading and research firm Fimat was expecting an increase of 1 million barrels in U.S. crude inventories, while IFR Energy Services expected a decline of 1 million to 2 million barrels. Makes you wonder who really knows.
Oil had a very bullish week, having broken its downtrend from March. It may be ready for a pullback now, but the chart looks bullish.

Oil chart, June contract, Daily

Traders got a little anxious to buy the pullback (or to cover their short positions). Price got close to the uptrend line and 200-dma, near $47 at the time, but didn't quite make it, getting down to $48.05. From there it blasted higher and barely hesitated at its downtrend line. The bullish descending wedge portends a rally to a new high above its last high of $58.94 (July contract). Watch for a pullback soon (if not now) that retraces 38-62% of the recent rally to set up the next run higher.

Oil Index chart, Daily

The oil index also broke its downtrend and like oil looks ready for a pullback. If it pulls back to the downtrend line now, I would watch it for support as a signal to test the long side in the oil stocks.

Transportation Index chart, TRAN, Daily

The Trannies, while overbought, look like they're going to head for at least a test of the 62% retracement at 3863, closing at 3850 today. The boost in airlines helped the index today. Continental Airlines (CAL) reported late yesterday a 10.8% jump in traffic in May. The news, together with a pullback in spot crude oil prices overnight, set a bullish tone for the sector today.

U.S. Home Construction Index chart, DJUSHB, Daily

Those who have been trying to short Google hopefully haven't been trying to also short the housing market. Neither one care to accommodate the bears. This index has climbed to new all-time highs and shows no sign of letting up. Thanks to significantly lower interest rates, the home construction industry is still feeling bullish. It's too bad the supply of homes is now getting out of line with demand. The recognition there will eventually have an impact on this sector but for now, bears beware.

U.S. Dollar chart, Daily

Thanks to the French the US dollar got a strong shot in the arm this week. The rally looks strong and I'm sure it's being assisted by the short covering by those who could have sworn the dollar would see 70 well before 90. There is a Fib target up near $90 which is also where there is a price projection based on the ascending triangle it broke out of.

Gold chart, June contract, Daily

Even though the US dollar only pulled back a little, it looks like the gold bugs took that as a positive sign and are jumping in to buy the dip. I'm sure there was also short covering as the steep sell off looked to be a little overdone. The disconnect with silver (which is up while gold was done over the past month) also has gold shorts feeling a little nervous. If gold bounces up to 427-428, trendline resistance, watch for it to roll back over, especially if the US dollar is still rallying.

Sector action was mostly green today, led by the airlines. Technology was also strong, getting a boost from new M&A activity - Sun Microsystems' (SUNW 3.79 -0.11) proposed $4.1B cash offer for StorageTek (STK 36.36 +5.13). Strength in Semiconductor, due in part to a 3.5% surge in KLA-Tencor (KLAC 46.87 +1.57) after Wells Fargo initiated coverage with a Buy rating and $55 target, as well as gains in Disk Drive (i.e. SUNW/STK deal) and Networking. The strength in tech helped the Nasdaq close at its best levels since January 18.

Consumer Discretionary paced the way higher, even though May same-store sales growth of 2.9% checked in at the low end of trade association ICSC's 3.0-3.5% range. Target (TGT 54.65 +0.82) and Nordstrom (JWN 64.02 +2.67) both hit 52-week highs after posting May comps growth of 5.1% and 7.4%, respectively. May comps from Federated Department Stores (FD 69.09 +1.39) and May Department Stores (MAY 38.70 +0.39), however, missed analysts' expectations, but shares of both retailers climbed amid news that Citigroup (C 47.71 -0.01) will acquire their credit-card portfolios.

Telecom Services was also strong following an update regarding next month's shareholder vote to approve the proposed $35B Sprint/Nextel merger and a 4.2% surge in shares of Alltel (AT 60.65 +2.40), which is acquiring Western Wireless (WWCA 41.31 +1.21). Health Care was also an influential leader to the upside. Energy eked out a modest gain as oil prices closed lower following larger than expected inventory builds...

Leading the downside today was the gold and silver index and the financials but they were only marginally red.

Tomorrow morning we get the release of the May Jobs numbers. The consensus is for a drop back to +185,000 jobs (whisper number is +175,000) which would be a drop from April's +274K gain. The unemployment rate is expected to stay the same at 5.2%. With the government having adjusted the April gain and not having an "adjustment" for the May numbers, it could be worse than expected. The market appeared to be on hold today for this release and the early morning reaction to the number may not be where the cash market will head after the initial opening. Since we're parked next to significant resistance, it may be worthwhile to wait for the initial flurry to die down and we get to see which direction the market is going to take. I think the next move will give us plenty of opportunities to get in on corrections. Getting whipsawed out of trades is no fun so waiting for a "quieter" entry may be the more prudent thing to do.


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