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Still No Decision Yet

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Still No Decision Yet

This is getting older than old. For the 4th week in a row now I'm saying 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. However, the kind of consolidation we've seen after the rally from the April low is typically bullish since a correction can be either time, price or a combination of the two. We've certainly had enough time. The challenge for the immediate future (next several days) is what the current consolidation is telling us. If I look at just the consolidation and forget about what the market was doing before mid-May, it looks bearish and says we have a big down day or two right in front of us. If I look at the bigger picture this consolidation is telling me I should be looking to get long the market. I think we have both possibilities coming and for the nimble there could be a good trading opportunity directly ahead.

I went back a few years looking for similar patterns where the market rallied into a tight consolidation like we've seen over the past month. In every case the slight upward bias to the consolidation led to a spike down--a big red candle or two. But then, interestingly enough, this then often led to a continuation of the rally. That's why I'm saying if you're nimble you might be able to catch a swift decline, perhaps 20-30 SPX points (200-300 DOW points), and then get ready for a rally to new annual highs. This fits both the short term and longer term patterns that is setting up. If we top out near the March high of SPX 1229 (we're already close with a high of 1212 today) this week and then get a hard sell off early next week, the bears will be out with party hats celebrating their victory--they'll be claiming a double-top, non-confirmation by the DOW, etc. I'm afraid that would likely be premature on their part since I think a hard rally will follow shortly thereafter, fueled initially by all those bears who get wide-eyed in front of the rally and start short covering in a big way. Adding credence to this down/up scenario is some information from Jim Patterson who writes market commentary. Here are some statistics he dug up this week:

"Over the past four weeks the Dow has been contained within a 1.57% range. That is the narrowest percentage range on record. We can not include data prior to 10/01/1928 because they only kept track of the closing value for the Dow. The Dow is making history right now with its currently narrow range. Historical comparisons: 10-14-1956 1.89% range after which the Dow went straight up; 3/15/1948 1.9% range after which the Dow went down 2 days (fake out move) and then went straight up; August 1993 2.05% range followed by a nice upside move; early December 2004 2.13% range followed by move into 2004 year end high; July 1953 2.15% range followed by about a 2% up move before turning lower; 2/2/1944 1.82% range followed by 2 down days (fake out move) and then higher into another 2.12% 19-day range on 3/2/1944 after which prices exploded higher.

What the above data points out is that the DOW has moved appreciably higher each time after a tight consolidation like we've been in, and the current one is the tightest in history since at least 1928. When the range gets extremely tight, the market tends to resolve to the upside. But the move higher is some times preceded by a strong thrust lower which turns out to be a head fake to hit the stops on long positions and suck in the bears creating a bear trap. This swift drop is typically a 1 to 2 day sell off.

Considering the fact that we're about to finish options/futures expiration tomorrow, and that post-opex Mondays tend to be negative, I am thinking we have a very good chance of seeing this market break swiftly to the downside and we could see a couple of hundred points shed by the DOW. That's what the short term consolidation with an upward bias tells me. But the longer term pattern with a consolidation after a strong rally into it, and with the above history demonstrating the likely outcome here, we should expect a resumption of the rally. Both of these expectations fit past patterns in the stock market. The other reason to expect a rally is end of month/quarter this month. There's nothing more the fund managers would like to see than a run up into month end, polish off their books and then take the rest of the summer off.

And that's where the longer term picture turns bearish. There are some cycle studies pointing to mid-July as a peak in the market to then be followed by a long slide back down the hill into the end of the year. If SPX manages to rally up to its 62% retracement of the 2000-2002 bear market decline (1253), it would be a classic finish to the bull market run we've been in since October 2002. The larger bear market could then reassert itself as we start the 2nd leg of the bear market decline. Another leg down that takes 18-24 months would take us into the end of 2006/early 2007 before finding a bottom. Protect your accounts!

Looking at the other indexes like NDX and the COMPQ, the pullback from the high on June 2nd looks very corrective (overlapping highs and lows on the way down). The techs could easily get another leg down in their downward correction but the pullback looks like it will resolve higher. The small caps (RUT) simply need a correction! That index has been on fire and needs a rest. Let's take a look at the various charts.

DOW chart, Daily

The DOW has actually been able to put together a string of 5 green days, and 8 days if you don't count a very small down day on June 2nd. This sounds impressive until you realize those 8 days only amounted to 134 points, or 1.3%. The NDX can sneeze and move that much in a morning. All of the work over the past 4 weeks and the DOW is up only 55 points from its closing high on May 24th, 17 trading days ago. So it is this sideways consolidation that is longer term bullish but internally it looks like it's going to get a big down day or two before it's ready to resume its rally. Pulling back to 10,375-10,400 would not be at all a stretch and will be just enough to pull in the bears.

SPX chart, Daily

The SPX has had more of an upward bias to its consolidation but this upward bias is actually what gives it a more bearish short term pattern. The choppy rise into its high, and the fact that it's chopped its way higher underneath its broken uptrend line, calls for a steep pullback to enable it to recharge its batteries (suck in some bears) so as to have enough fuel to charge higher. A pullback to 1185--1190 would be reasonable.

SPX chart, 60-min

I wanted to zoom in a little on the SPX consolidation pattern to show what I think is setting up. The internal wave structure supports the bearish ascending wedge pattern and calls for a high tomorrow to be followed by a swift pullback to at least the bottom of the congestion around 1190. It might even need a drop below 1190 to really pull the bears in so as to provide enough short covering fuel to rocket this higher into end of month and into July.

Nasdaq chart, Daily

You can see by the overlapping red and green candles that the pullback in the techs is corrective, which says we should expect higher. If the broader market (and the small caps) pull back sharply then I'm sure the NAZ will follow. The techs and small caps have been on a different path than the blue chips and this one might consolidate above the uptrend line, currently near 2050, while the blue chips feel a little more pain. Or if the NAZ can hold above 2050, it might lend support to the broader market and we'll get a shallower pullback than I'm expecting.

SOX index, daily chart

From last week's weekly chart, this daily chart shows a little more clearly how the SOX essentially failed at the downtrend line from December. So far the pullback looks like it might be supported by its 200-sma which is down near the uptrend line that it recovered on this rally. I would look for the 411 area to hold on any further pullback.

BKX banking index, daily chart

The banks look bullish. The pullback was clearly corrective, it held on top of the broken downtrend line the whole time and looks ready to do something here. It still has its 200-sma at 99.59 to contend with, and will likely pull back with any broader market correction, but the pattern looks bullish here. I also like the stochastics turning up from near oversold and MACD getting ready to cross back up after pulling back to the zero line.

The early morning reports didn't excite the pre-market futures crowd much as the cash market opened relatively flat. Before the market opened there was some new N&A activity to report--Pfizer (PFE) plans to buy Vicuron Pharmaceuticals (MICU) for $1.9B in cash while Integrated Device Technology (IDTI) has agreed to acquire Integrated Circuit Systems (ICST) for $1.7B in cash and stock. Earnings reports included Goldman Sachs (GS) who missed analysts' Q2 earnings forecasts for the first time in nine quarters. It's their first decline in quarterly profit in about three years. GS attributed its quarterly miss to "challenging market conditions," but stated the economic outlook remains favorable, its client franchise remains broad and deep, and that it retains a leadership position in critical businesses. Show me the money is always my first reaction to such statements but obviously investors today were encouraged enough to buy their stock--GS closed up $3.46, +3.48%, at $102.59. Give some more of that punch. Supposedly investors took into account the fact that many analysts expected Goldman, given its larger exposure to trading, to report the miss. So, heavy exposure to trading, that's causing them to lose money, is not a problem. As I've always said, I will not trade fundamentals because it never makes sense to me. Take a look at the daily chart of GS though--price stopped right at the intersection of its 50-dma and 200-dma (at 102.95). Its 50-dma is ready to cross down below its 200-dma, something it hasn't done since June 2004, and this kind of action normally triggers computer sell programs. Just a heads up if you own GS.

The Weekly Jobless Claims numbers were released and showed jobless benefits rose a statistically insignificant 1K to 333K, marking the fifth straight week the data has been in the narrow range of 330-335K, while the steady trend in claims remains consistent with the 180K average gain in nonfarm payrolls recorded so far in 2005. The continuing claims rose 58,000 to 2.64M while the 4-week average claims were up 2,750 to 335,000.

We got some housing numbers as well--May housing starts rose a modest 0.2% to 2.009M units (consensus was 2.050M), but marked the fourth time in five months that starts have surpassed the 2.0M annual rate. May building permits missed forecasts, falling 4.6% to 2.050M (consensus was 2.106M) and below April's 22-year high of 2.148M, but this was still above the level of starts, which suggests that starts will remain at high levels in the months ahead. Homebuilders remain on pace to record their best year since 1978. One look at the housing index chart below will tell you how investors feel about these bullish numbers.

The DOW suffered a little today due to a sell off in GM (-0.72, $35.62) after it warned the UAW it may reduce health benefits for UAW retirees by as much as $2.0B over two years unless the union agrees to cost-cutting concessions before contract expiration in 2007. I thought this was announced a few days ago and was the reason the stock rallied so hard a few days ago. Fickle investors. Oh by the way, GM is also battling its 200-dma ( from below). Countering GM was relatively good performance by Alcoa (AA, +0.37 at $27.95) and Honeywell (HON, +0.78 at $38.05).

Disappointing the market at mid-day was the release of the regional manufacturing activity. The June Philadelphia Fed index was -2.2, well below expectations of 10.0 and further demonstrated that manufacturing is slowing down. Even though there is a different read from the abutting regions of NY (Empire Index) and Philadelphia, and therefore doesn't provide a consistent read for the national ISM figure, the first negative reading on the Philly Fed in roughly two years has took some of the excitement out of what was already a tepid rally.

But the oil market is chirping up again. The equity market is not paying attention to the monster coming out of the woods behind them (they're too busy watching the housing market's fireworks). Oil is set to rally to new highs but there seems to be little care by the broader market. That too shall change.

Oil chart, June contract, Daily

After stalling at the midline of its longer term up-channel, oil is rallying to new highs in its move up from the low on May 23rd. If price stalls here, the potential negative divergence on the daily chart points the possibility of a steeper pullback, but this one looks like it's going to head for new highs from here. A rally in oil above $60 into July will probably finally scare the bulls into selling equities which ties in with the larger pattern in equities calling for a rally into July and then a down year following that.

Oil Index chart, Daily

The oil index certainly has a whiff of new oil highs--the rally in this index has been a straight shot higher since its May 16th low. The rally in this preceded the rally in oil by about a week so watch it for signals for oil might do next. Right now it's saying follow me higher!

Transportation Index chart, TRAN, Daily

While the 200-ema provided support, and it's been able to get back above its 200-sma and 50-sma, it has the top of its down-channel to deal with (at about 3585). If and when the broader market rallies I suspect the Trannies give me a bearish feeling about the market and I believe it's giving us the heads up that the rest of the year is not going to be pretty. Lack of goods to transport is never a healthy sign of our economy.

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

As discussed above, the housing data shows a very strong housing market. The question is always how long that will last and when will the stock market start to sniff out a change. It's my contention that charts lead fundamentals and not the other way around. If the housing index stalls near its current level, at the top of a parallel channel, and the negative divergences showing up tell me it will, then it could also give a heads up for what's coming down the pike.

U.S. Dollar chart, Daily

The US dollar did a perfect tap of its Fibonacci price target of $89.35. This target was based on the 2nd leg up from the March low equaling 162% of the 1st leg up that ran from this past December to February. There are a lot of opinions about where the US dollar is headed and one is that the rally from December is merely a counter trend bounce. That would say the dollar will now head back down to new lows. It's far too early to tell and the form of the pullback from here (corrective or impulsive) will start to give some clues in that regard.

Gold chart, June contract, Daily

Gold buyers seem to be aware that the dollar has peaked for now--they've been buying up the yellow metal like it's going to run out soon. It easily got back above its longer term broken uptrend line and will soon be challenging its downtrend line from December. Whether the descending triangle (declining highs, flat bottom) turns out to be the bearish pattern it normally is or instead gets negated with a break of the downtrend, we'll just have to wait and see.

With regard to sector strength and weakness, almost everyone was in the green today. The advancing issues and volume over declining issues and volume showed a very bullish better than 2:1 ratio so the internals were strong. Total volume was decent. Price performance certainly didn't reflect that, it being a relatively flat day. But no one particular sector got the hammer today. The only red sectors were the drugs, pharmaceuticals and utilities, and they were only marginally red. Leaders to the upside were the gold and silver index, biotech, brokers, energy and the transports. Surging more than 1.0% was the Materials sector amid strong follow-through buying interest in gold, copper, aluminum and steel while upside Q2 guidance from Potash Corp. (POT 99.65 +3.31) provided a boost to the non-metallic mineral mining group. Computer hardware was the best performing sub-sector of the technology groups, surging amid reports that Michael Dell may be interested in licensing Apple Computer's (AAPL 37.98 +0.85) Mac Operating System. Providing support to the biotech group was Wyeth (WYE 43.51 +0.32), which received FDA approved for its antibiotic Tygacil, and AmerisourceBergen (ABC 68.02 +0.81), which affirmed its FY05 and FY06 EPS outlook. One of the factors negatively affecting the Utilities sector were valuation concerns sparked by consolidation in several utility stocks (i.e. EXC, PEG and AEP), all trading near 52-week highs.

The benchmark 10-year note, which got an additional boost following comments from Kansas City Fed President Hoenig, closed up 3 ticks to yield 4.08%. He commented that the Fed should not try to manage the yield curve and that they simply want to get yields to the neutral level. That level, and how fast they get there, will depend on the data. In other words we're left to guess what that might mean. He mentioned that the Fed believes the neutral rate is in the 3.5-4.5% range. He said inflation is in the watchful area and not at a warning stage. There of course is no discussion about the risk of recession. For now that's the elephant in the living room.

Early morning reports tomorrow shouldn't be market movers, unless the preliminary Michigan Sentiment number is way off base. These are the reports for tomorrow morning:

The tight consolidation we've been in for the past 4 weeks is about to break. We of course can't know which way it's going to go but the move will likely be very swift. Catch it right and you'll get a nice ride. If it moves against you and you don't honor your stops you probably won't be trading with us for very long. Until we get the break, the market is only offering very tight scalping trades. Once we get a break of this range you'll have an opportunity for a swing trade. What's that you ask? That's one of those trades that lasts for more than an hour. It's been a while since I've been able to do one of those. Don't get married to a position and if we get a strong move down, don't be bashful about taking profits too early. I suspect when a bottom is found we're going to come roaring back up. That's the ride you want to grab hold of. In the meantime, continue to take profits quickly.


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