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Market Wrap

Struggling at Resistance

HAVING TROUBLE PRINTING?
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My overall sense as I look at the charts and watch the market struggle is that we could be at some very serious resistance here. But then every time the market pulls back a little it flies back up catching all those who dare to short the market. This has a way of scaring the bears away and once they're disgusted and finished trying is usually when the market drops hard. With no bears in the market it's harder to get short covering rallies started. And that makes bulls more fearful about buying dips. Bears serve a very useful purpose in the market and lest you think they're despicable creatures, know that they're greatly needed.

The other, more bullish, interpretation of what's going on this week is that we're just consolidating near the highs and getting ready to blast higher. We've seen this time and again where the market consolidates just underneath resistance before finally mustering up enough courage to charge across the line. The way this market is chopping up and down gives me the impression of consolidation. The number of new highs vs. new lows (check the chart above) gives me the impression there's some accumulation going on. So while the daily charts are giving me bearish feelings I can't help but feel the market is setting another bear trap. Maybe it's all the false moves and no follow through and I'm just feeling antsy about this market but I don't trust it. We'll take a look at what the charts are telling us and at least have some levels to monitor for some clues as to what's coming next.

As has been the case all week, today was a quiet day for economic reports and of course earnings season has essentially wound down. It will be a couple of weeks before warnings, er, guidance is issued so we're in that quiet period where the market is left guessing. This could also have something to do with the market just marking time here. We received the unemployment claims numbers today and they were generally good with no surprises (and no knee jerk reactions out of the futures at 8:30 AM). Initial claims fell 20K to 278K which was lower than expectations for 300K (whisper number was 258K). The 4-week average initial claims fell 1,500 to 281,750. Continuing claims were up 41K to 2.5M while the 4-week average dropped 20K to 2.5M which was a 5-year low.

The Help-Wanted Index came out at 37, down a point from the previous 4 months and at the lower end of the small range this index has been in for the past year (35 to 42). Ken Goldstein, labor economist at The Conference Board said, "Economic growth may be picking up in the first quarter but the labor market indicators aren't showing much improvement through January. The economy only generated about 195,000 new jobs in January." It's little surprise that the consumer sentiment about job prospects over the next six months dipped in January.

At 10:30 AM we got the crude oil and natural gas inventories. Crude oil (excluding what's in the Strategic Reserve) rose 1.1M barrels to 326.7M barrels, putting it well above the upper end of the average range for this time of year. Even gasoline supplies are the highest they've been since June 1999. Working gas in storage was 2,143 Bcf, down 123 Bcf but 410 higher than a year ago this time and 694 higher than the 5-year average.

With the higher inventories and falling prices for energy one would think we should be seeing a stronger market. If it weren't for the fear premium currently priced into oil, it would probably be closer to $55, or even $50 according to some, instead of hovering above $60. It's been my contention that we'll see inventories build and then level off once production is scaled back after it's recognized that the economy is slowing down. The price of oil and equities will probably drop in unison. But let's see what story is told by the charts.

DOW chart, Daily

Price is up against resistance and the daily oscillators are threatening to roll over. This is the first of several daily charts that look bearish. Based on this chart I would suggest tightening up stops on long positions and start nibbling on short positions. But the consolidation here could be bullish for at least another stab higher and that higher level could be above 10200 which is the upper trend line that runs across the highs from January 2004.

DOW chart, 120-min

A little closer view of the leg up from February 7th shows price is now on its uptrend line. If the market doesn't immediately rally tomorrow, this uptrend line will break and that could be the signal that this leg up is finished. Whether we would then consolidate in a larger correction before pressing higher or start a more serious pullback can't be known yet, but it would say the current move higher is finished. The bearish divergence against the last high on this 120-min chart, and the oscillators rolled back over, say we're probably going to break down from this up-channel. But, take any rally tomorrow seriously since the market may only be setting a bear trap here.

SPX chart, Daily

SPX is also facing resistance but at its trend line across the highs from January 2004 (the one that is at 10200 for the DOW). Like the DOW it could be consolidating here in preparation for a run for the roses and unlike the DOW it has no other trend lines above it to act as a brake. If it were able to clear its current hurdle, there is an upper Fib target of 1312.72 that it might have its sights set on. But also like the DOW, this chart is looking bearish with overbought oscillators threatening to roll over while price is up against resistance (in other words not enough fuel to propel it higher). If it rolls back over it will leave more negative divergences on MACD. I would short this chart in a heartbeat if I had nothing else to go with.

SPX chart, 120-min

A closer look at the leg up from Feb 7th shows SPX is not as close to threatening a break down as is the DOW. The bottom of a parallel up-channel is down near 1280. The negative that I see is the bearish divergence at the last high but if price can work its way sideways while relieving the short term overbought conditions we could still have a new high in our future as depicted on the chart. This chart tells me to temper my bearish enthusiasm after looking at the daily chart.

Nasdaq chart, Daily

I lowered the uptrend line from October to have it go through the spike low on January 3rd and between that broken uptrend line and its downtrend line from the January high, price found it to be solid to punch through. It might even be another kiss goodbye against the uptrend line. There are several mixed signals coming from the techs and the fact that they're so much out of synch with the rest of the market right now is making it that much more difficult. We seem to be in what I refer to as tub-sloshing. Money (water in the tub) is sloshing back and forth between the techs/small caps and the large caps but the overall market is spinning its wheels. When everyone gets synched up we'll have little doubt which direction to trade. The techs are looking bearish at the moment though and I'm expecting the COMP to pull back further.

SOX index, Daily chart

The COMP tried to rally this morning but the SOX was the anchor around its neck. And without the participation of the SOX, the COMP wasn't going to make it very far and it didn't. The SOX barely closed below its uptrend line from October and at the same time so did MACD. I'd been saying follow the break in MACD whichever way it goes and now it looks like down. A break below its 50-dma at 518.83 that holds below that level would be bearish.

BKX banking index, Daily chart

This is a weird one. I did not expect to see the banks breaking out, especially without the participation of the broader market. This is either our leading indicator, in which case we should all be thinking long (like the signal we got off the October low), or this is a bull trap for investors. It's a little hard to see on this chart but price jumped above and then closed below the trend line along the highs since November. It left a spinning top doji which is a shadow above and below the body and in this case the body is very small. This candlestick is either indecision here or the setup for a reversal pattern. A red candle tomorrow would confirm a likely reversal and a sprung bull trap.

As we study the charts we are looking for evidence of turns in the market. Some of us like to trade momentum and grab chunks out of the middle of a move. But we're all looking for resistance and support so as to avoid getting caught on the wrong side of the fence. Today's charts tell us we could be approaching a high for the bull market of 2002-2006. On Tuesday I discussed the plight of two-income families and how they have less resilience to financial shock than did the single-income families 30+ years ago. This is important as we are into a period where real hourly wages are down since 1998. A greater portion of today's family's income goes towards fixed expenses and there's less available for discretionary spending (or a cushion against job loss). Therefore as wages drop, that cushion has been shrinking even more.

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As hourly wages have dropped in the past, consumer spending was typically right behind it. With consumers being such a strong engine behind our GDP growth, any drop in spending causes a slowdown in our economy. Studies have shown a direct correlation between consumer spending, recessions and obviously the stock market. As we know, the stock market is forward looking. It tries to sniff out economic changes six months down the road. Many economic reports are lagging indicators since it takes a while for them to register the changes that are already taking place. Employment reports are an example of a lagging indicator--by the time the unemployment rate begins to tick back down, employment confidence and therefore consumer confidence has already reflected concern about employment in general. If people start worrying more about their job security they'll be less inclined to spend and borrow. So by the time the employment numbers start to worsen, the stock market will have already started to turn down.

Whether it's fear of losing a job or seeing a reduction in overtime affecting take-home pay, a reduction in income will lead to a slowing economy. In 1999, real hourly wages turned down but the recession and bear market was held off for over a year because of the wealth effect (and subsequent borrowing) from the stock market. Something I've discussed recently is the amount of equity that was first taken out of the stock market which held up consumer spending. Then the housing market provided the "income" and consumers have been able to maintain their spending, and life style, to an extent that would not have been possible without that equity extraction. Normally, a reduction in real wages means a reduction in spending and an economic slowdown. The following two charts (excuse the small print in the chart as I had to squeeze them down to fit the page) show the comparison between the S&P 500 (top chart) and the earnings vs. expenditures (bottom chart).

S&P 500, 1972-2006, courtesy stockcharts.com

Real hourly earnings vs. real consumer spending, courtesy "Ahead of the Curve" by Joe Ellis

The top chart shows the S&P 500 since 1965. Because of the large run up in the stock market during the 1990s, the rest of the corrections prior to that period, even the sharp correction in 1987, look small by comparison. The bottom chart shows a graph of real personal consumption expenditures (PCE) in black and real average hourly earnings in green, also since 1965. The yellow vertical bars are periods showing when we were in a bear market. The small black bars at the bottom are periods of recession. I tried to match up the S&P 500 chart with the bottom chart so that you could correlate the timing between the two. An interesting thing to note is that recessions were typically at the tail end of the drop in PCE.

There is a correlation between the direction in PCE and the stock market. Some disconnects occurred in the past, such as the mid-1980s after the Reagan tax cuts, where PCE dropped but the market continued to rally. But then there was the big "correction" in 1987. The stock market typically follows PCE very closely which says we should be watching it instead of listening to a bunch of economic reports that are typically lagging indicators. By the time the economists get around to recognizing that the economy is in trouble, the damage has already been done in the stock market and then it typically begins its recovery at the point a recession is recognized. For a much better predictor of the stock market follow PCE, and normally PCE follows real wages.

This is especially noticeable after 1998. The lower chart shows a direct correlation between PCE and real wages for most of the 30+ years covered by this chart. And this makes sense of course--as real hourly wages drop, people stop spending as much. As goes real wages so goes PCE. As goes PCE so goes the stock market, ergo, watch real wages for stock market direction. But the last several years seem to have departed that direct relationship which creates a conundrum as Greenspan liked to say.

Notice on the bottom chart the period after 2000. Real wages have been steadily dropping since 1998 except for a brief leveling off and slight up-tick in 2000-2002. After that up-tick real wages began a downward trek again. But notice what has been happening to PCE--it has been in an uptrend through the same time frame and most of 2005 until a sharp fall off in the latter part of the year. The red trend lines since 2001 show the divergence and it is in stark contrast to the historical pattern of the previous 30 years. The reason, as we've discussed, is due to equity extraction from the stock market and then housing that has filled the income gap. But we're seeing a slowing in refinancing and new home equity loans and this will slow spending considerably. In other words, unless real wages make a significant jump higher (which would have the Fed aggressively raising interest rates) PCE will come tumbling lower since the gap between real wages and PCE is now quite wide. And a steep drop in PCE will presage a steep decline in the stock market.

You can see that PCE has already dropped fairly hard in the latter part of 2005 but the stock market has refused to follow. Let history be your guide here, it will follow it down. We're seeing a slowing in the economy, a slowing in spending and a drop in consumer sentiment. Many investors have their head in the sand and do not want to see any warnings about the market (if they're even looking). Forget about the funnymentals of the companies you follow. Forget about why it should be different this time. Go with history and history says the stock market is about to follow that black line in the bottom chart and that's all you really need to know. Get yourself some protection and if you like playing the short side of the market we shouldn't be far from knowing when it's safe to get in the water.

And of course we want to keep a close eye on the housing market because it will give us a heads up as to whether or not we're really going to get a slowdown in the housing market. If the housing market can hang on, and interest rates stay low, and refinancings continue and the bankruptcy rate drops, and consumer sentiment stays high, and..., well we just might be able to hold off on any nasty correction. This index deserves close attention:

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

Whatever got the bankers excited also got the home builders excited but to a lesser degree. This index almost made it up to its 50-dma just under 938 and just shy of its 50% retracement of the drop from January at 942. Its 200-dma is a little higher at 947. So there's some strong resistance just above and the daily stochastics has zoom-climbed back up near oversold. This kind of move in stochastics with relatively little movement in price is usually not a good sign for the move. This will likely roll back over soon.

Oil chart, April contract, Daily

Oil bounced up to its broken uptrend line, gave it a kiss, and got slapped silly for it. If it's forming a right shoulder as depicted here, we could see price consolidate for a little longer, even be so bold as to try another kiss, but once it's done I expect to see prices roll back over and head for the lower uptrend line currently near $56.

Oil Index chart, Daily

The mid-line of its parallel up-channel and its 20-dma, both near 568, stopped the bounce and now this index is trying to find support at the 50-sma at 556. This could consolidate or rally a little further to relieve the oversold conditions but it should then roll back over and head for its uptrend line and 200-dma currently near 526.

Transportation Index chart, Daily

Based on the 3-wave pullback from last week's high I was thinking we'd see a new high in the Trannies. We got that yesterday and today and the move up from the low on February 17th looks like it might finally be it--the new high is leaving negative divergences against last week's high, as it should for a final wave up. This looks like a very nice finish to its rally now but confirmation will be a break of its uptrend line from February 10th which is exactly where it closed today. Any continued decline tomorrow and this will look like a top is in.

U.S. Dollar chart, Daily

We're getting a bit of a consolidation in the US dollar now and it needs to work off its overbought condition. It might be able to stay above its 50-dma at $89.86 otherwise it has layered support just below whether it's a Fib retracement or additional moving averages. This should continue higher once the pullback is finished.

Gold chart, April contract, Daily

As the US dollar works off overbought, gold is working off oversold. Each may continue to consolidate a little longer and gold could bounce a little higher--it has layered resistance from $550-570. Once this bounce is finished I expect the next move in gold to be down through its uptrend line.

Results of today's economic reports and tomorrow's reports include the following:

We have only one economic report tomorrow morning before the bell and that's the Durable Goods Orders. The expectation is for a drop from the previous month but if it's too much of a drop, signifying a more rapidly slowing economy, it could spook investors. Of course that will then bring out those who like to say a slowing economy will have the Fed backing off on raising interest rates and that will lift the market.

This "the market will rally when the Fed stops raising rates" idea is such a clear case of fiction told over and over again that it becomes believable. It's like the woman cutting off the ends of the ham before cooking it. When asked why she does that she says because her mother did it that way. When the mother was asked why, she says the same thing. When the great grandmother was asked why she did that she said because the ham wouldn't fit in her oven unless she cut the ends off. We have traders who simply believe what they're told. In a sense it doesn't matter because you trade with the flow and emotions in the market, not what is truth. If we could trade truth, trading funnymentals would really work.

Trying to figure out the market's reaction to news can be an exercise in frustration. But to set the record straight as far as what happens after the Fed stops raising rates, the Ned Davis group has pointed out that the stock market is down 71% of the time six months after the Fed stops raising rates. The market is down 64% of the time at the 12-month point after the Fed stops raising rates. With those kinds of odds why would anyone want to buy the market in anticipation of the Fed stopping their rate hikes? If anything, if I think the Fed is close to the end of their rate-hiking spree, I'd prefer to sell all my stocks. Personally I think the Big Boyz know this but they continue to spread this lie so that they get others excited about buying. This then gives the Boyz someone to whom they can offload their inventory during the major turn window. But hey, that's just me.

For tomorrow, be careful. I know, so what else is new. We've got major resistance just overhead and some good short term support right underneath us. It's no wonder the market is banging around without a sense of direction. If the market drops out of the gate tomorrow I'd prefer to play the short side since we should be at least be in the midst of a larger pullback. But if we get any kind of a bounce it might be signaling the end of the consolidation and I'd consider testing the long side. I say testing because we could see a 100-150 point rise in the DOW and it would be a nice run to latch onto, but we're near the point I believe where surprises will soon be to the downside. We have been in a choppy mess this week and that's made trading a challenging proposition unless you're very good at scalping small moves. Stock pickers are probably doing better than index traders. Futures traders are probably doing a little better than index options traders (options spreads need more movement than we've been getting). Good luck tomorrow and I'll see you on the Monitor.
 

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