After a day like today one has to wonder why we even bothered to turn on the computers. Take the day(s) off before FOMC and come back in the morning. Today was no different as the market goes into freeze mode while it waits for our new Fed Chairman Bernanke to announce what everyone already knows is going to happen--we're going to get another 0.25% rate increase. But of course what we don't know is what the Fed will say as to what's next. The market wants to hear that the Fed believes this should be the last rate increase and that they want to now take a neutral approach. With that kind of statement the DOW will instantly be 100 points higher. And you could probably make a reasonable bet that the Fed will not be that clear in their statement.
There are many who feel the market is set up for a disappointment, a sell the news event, tomorrow. When you consider the market has rallied up to new highs, if not all-time highs, you have to wonder what could propel this market any higher. Are there still a lot of shorts out there that could light another rocket booster? If the Fed doesn't give the market exactly what it wants (as stated in the 1st paragraph), it just might throw a tantrum and drop a 100 points on the DOW. That seems like a pretty reasonable assumption and I would worry about that if I was long the market. But oddly enough, if that's what the market is geared for, we could see just the opposite reaction. There may be enough short positions, betting on a negative reaction, that a few good buy programs could blow them out of the water.
So we're on hold until those with more money than you and I have will place their bets based on their interpretation of what the Fed really meant to say even though he said something other than what you thought you heard him say which was in fact different than what he didn't say. Clear as mud? OK good, you're ready to trade. On top of a market that is on hold until the FOMC announcement we had a very quiet Monday morning. There was an absence of the usual Monday merger and acquisition announcements, no major earnings and no major economic reports. So again, remind me why we turned on our computers this morning?
As I look over the charts, I see a mess. I see intraday consolidation that gives me a different impression depending on which index I'm looking at. And I see inter-market divergences where some are pointing higher out of this while others are pointing directly lower. As I looked over my comments from last Thursday's Wrap I was tempted to just write "ditto" for today's commentary. See Thursday. But we'll look the charts over for any subtle hints for what's going on and why I'm seeing different pictures from the various indices. We should at least have some levels to watch so that we'll get some clues when the current consolidation breaks.
DOW chart, Daily
The DOW is continuing to consolidate on top of the trend line along the highs since January 2004 and it takes a break below 11200 to indicate at least a larger pullback is in progress. Until that were to happen the current sideways consolidation looks bullish and suggests a break to a new high is coming instead. Even if we get a pullback below 11200 though I'm not so sure it will mean much--I think we could see another rally leg into early April. It will take a break below 11K to negate that likelihood.
SPX chart, Daily
Ideally SPX will get a brief pullback to about 1291 to find support at its October uptrend line and then one more rally leg into early April. It would then give us an ascending wedge from January's low with the requisite 5-wave count and that small ascending wedge would then be completing the larger wedge from October. The negative divergences we're seeing support this interpretation. It would take a break below 1270 to suggest a high is already in. If we don't get much of a pullback but instead rallies to a new high, there's a chance we could see a major high get made this week.
SPX chart, 60-min
The close-up view of the leg up from March 8th shows the current consolidation after the rally up to the 1310 area. This consolidation makes it look like it will resolve to the upside. From an EW perspective it looks like a 4th wave triangle and these usually lead to the last leg of the rally--the 5th wave. This interpretation says we'll rally out of the FOMC announcement and head up to at least 1320 before potentially topping out, and it could be a very important top. If we instead see a drop out of this pattern it shouldn't go very far before turning back to the upside again. Two equal legs down from the high on March 21st would take it to just above 1291 which matches support shown on the daily chart by the October uptrend line. I would be a buyer there to test the upside.
Nasdaq chart, Daily
The consolidation pattern since January still looks like a bull flag and suggests upward is next. But we could first see a pullback to its October uptrend line near 2265 before setting up another rally leg. Upside potential is 2355 by a Fib projection and then up to 2380 at the upper trend line.
QQQQ, 120-min chart
The QQQQ gives the opposite impression from the charts above (although I'm somewhat neutral on the COMP because the pattern is just too ugly) in that this looks ready to break down. It's choppy rise off its March 23rd low looks like a correction to the sharp drop from March 21st. That suggests the bounce will fail and we'll see new lows as this heads down to the bottom of its down-channel. Based on the other indices I'm not ready to believe that yet but I wouldn't want to be long the QQQQ based on this chart.
SOX index, Daily chart
The SOX is making an attempt at a bounce but it looks pretty feeble. Like the QQQQ this one looks like it's going to drop to another low and I'd look at the 200-dma at 480 for support. This is also where we have the highs from last Aug/Sep and the pullback to January. A dip down to the 62% retracement at 469 would also not be unreasonable. If it manages to keep rallying from here, the 20-dma at 511 and 50-dma at 524 bear watching for resistance.
Last Thursday I started a discussion about the coming signs of a recession. I had mentioned the plethora of signals of a slowing economy, or what could happen to slow the economy. An example is the slowing of consumer spending as a result of a flattening (best case) in home values. Without the ability to withdraw more cash from their personal money tree in the backyard, consumers will be forced to live within their earned income. With real earnings down since 1998 it's likely to be a rude shock to the system. The yield curve inversion is another example and while it doesn't forecast a recession (yet), it has done a good job in the past at forecasting at least a slowing in the economy. I know a slew of economists, Bernanke included, have said it's different this time but they've said that Every time we've headed for a slowdown, with most consistently missing the actual start of a recession. They know how to look backwards, not forward.
I then discussed the little-mentioned (by the press) change Bernanke is making for the banks. He announced on March 8, 2006 at the Independent Community Bankers of America conference that he is concerned about the level of risk banks have taken without the commensurate returns. By stating this he sets in motion a process whereby the Fed bank examiners will go into these banks and start downgrading the ratings on the loans they deem riskier. This causes the bank to have to set aside more money into their reserve account for bad loans and that obviously will have a negative impact on the bottom line (takes money out of earnings). If you missed the introduction to this topic, you can read it in Thursday, March 23rd's Wrap.
In addition to downgrading the rating of a loan, these examiners can declare loans as doubtful and/or a total loss which would mean the bank will have to take money out of its reserve account to cover the loss. More negative impact to its bottom line. And when all this starts to happen it's usually the commercial loan portfolio that gets hit first. Bernanke addressed the commercial real estate loans but next on the list would be doubtful retail loans and we know that personal bankruptcies and foreclosures are on the rise. What's interesting about this process is that nothing really changed except the examiner's opinion of the loans. The bank was running along fat dumb and happy and suddenly they're faced with having to increase their reserve account by some huge number and that can only be done by taking it out of earnings. These examiner sessions and reports are secret and can not be shared with the public. Hence the first time the public knows about it is when the bank announces an earnings warning. Another shock to the system out of the blue (the modus operandi of the Fed it seems).
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This examination process also ends up with an overall bank rating, again secret and not to be disclosed publicly without criminal penalties. After all it's only our money in there so why should we know what the bank rating is. If an overall bank rating is lowered that's when presidents and chairmen lose their jobs. There is no appeal process to this examination review. So if you suddenly see a president and/or chairman of your bank leaving "to pursue other opportunities" you may want to move your money. But you can imagine how intimidating this process is for the bank and its loan officers who don't want to lose their jobs. The only loans they'll make from then on are to people who don't need the money. Those with good projects that would help the community and economy but show more risk potential will not see a dime from the bank. So they go off to Larry the loan shark to get the money they need and pay an exorbitant fee and interest rate and that further curtails economic growth.
Willing buyers will have more difficulty finding money to buy properties which reduces demand. At the same time the banks are calling in the loans on all those properties where the loans have been deemed below satisfactory so that they can get the loans off their books and free up their capital stuck in the reserve account. That forces property owners to sell their property at a time when demand has dried up because people can't get loans to buy the property. The seller must drop his/her price in order to sell. You can see how a vicious cycle develops. But it doesn't stop here--the unwinding process is just getting started.
As this slowdown in demand and increased supply problem develops, property values drop. As the collateral value of the properties on the banks' books drops, more loans are rated below satisfactory by the bank examiners. And the loans that were previously rated below satisfactory because of cash flow concerns now have the added problem of a drop in collateral value. This will push some of these loans into the doubtful category, if not into default against their covenants, which requires the bank to set aside 50% in its reserve account against that loan. More hits to earnings. More bad bank ratings and more presidents fearful for their jobs. Senior lenders get shown the door and are replaced with people who are very good at demanding the bank's money back. Once when I was at a struggling company I was on the receiving end to one of these bank demands and I can tell you it's no fun trying to come up with alternative sources of capital. Needless to say, in this scenario bank lending comes to a virtual halt and bank earnings end up in the toilet. And all the while the commercial real estate business also takes a nose dive and you see many distressed property sales.
What this leads to is a credit crunch and it is a credit crunch that leads to recession. By the time expansion stops and recession starts to hit, it's too late for the number crunchers (economists) to do anything to stop it. They typically look at last quarter's data which is why they're usually 3-4 months behind in recognizing the signs. A recession is usually led by a real estate collapse. And it starts with a wink and a nod from the Fed Chairman to the examiners to do their thing. Here's Bernanke's statement made at that Independent Community Bankers of America conference on March 8th, "The rapid growth in commercial real estate exposures relative to capital and assets raises the possibility that risk-management practices in community banks may not have kept pace with growing concentrations and may be due for upgrades." Examiners, start your laptops.
This all leads to a reason to keep an eye on the banks. As go the banks, so goes the economy. We have the mega-banks, the Fed primary dealers, pulling in their billions of dollars through their trading departments but the majority of banks clearly do not have that advantage. They have to make their money the honest way and watching their performance will give us a good heads up as to what's coming down the pike. So, how are the banks doing?
BKX banking index, Daily chart
The banks are pressing higher into the apex of a small ascending wedge which appears to be ending a larger ascending wedge. Negative divergences on MACD support this interpretation and it says we should be looking for a top instead of a breakout. The pattern with the current small pullback would look best with another small push to new highs, maybe as high as 110 but I doubt it'll get that high. That move should finish off the rally in the banks so watch for the breaking of uptrend lines after that to indicate a high is probably in. Until that happens though, the banks are in an uptrend.
U.S. Home Construction Index chart, DJUSHB, Daily
The home builders are hanging on here but still finding resistance at the 50-dma as well as an old broken uptrend line, both just above 900. If it can rally further it should be able to make it up to the 200-dma at 947. If it drops back down it should find support at the uptrend line at 840. With excess inventory building one would think there are two likely outcomes for the home builders--one, they'll slow down their building, or two, they'll heavily discount the homes to get them sold. Neither scenario entices me to be a buyer here but we'll let the chart speak for itself. It needs to break below 840 to confirm the next leg down is underway.
Oil chart, May contract, Daily
Oil traders are a non-committed lot these days. No one seems able to push oil out of its $61 to $65 price range. By this daily chart, and my interpretation of it, I'm thinking it's going to break down. The H&S pattern is bearish and the hard drop from January followed by the current consolidation says we should expect another leg down. Now we'll just wait to see if it happens or not. If too many start to lean that way we could find some kind of outside event trigger a lot of short covering.
Oil chart, May contract, 120-min
The closer view we looked at last week shows the consolidation since the spike down into the February low. The current leg up, wave-e on the chart, should be the last one within this pattern. It could stop short of the upper boundary, give us an over-throw of it, or anything in between. A break below $61 should be an indication that the leg down is in progress.
Oil Index chart, Daily
The consolidation pattern in the oil stocks doesn't look quite the same as for oil but it has the same potential--it should break lower out of this which means the 200-dma and uptrend line near 537 should only be a speed bump. But if stocks in general get another rally leg up, the oil stocks will probably participate and we could see this index rally back up towards 600. And if oil breaks above $66 at the same time then we could see this index head for new highs. Looking at just this index doesn't give me a good enough impression at this point to make a call. Watch oil and if it's dropping along with equity prices then you'll definitely want to be short this index.
Transportation Index chart, Daily
The current small bounce in the Trannies after getting body slammed last Thursday so far looks like a correction to that spike down. That would say this should turn back down at any moment. But this index has had an uncanny ability to just keep rising so it will take a break of its October uptrend line at 4464 to say a high has probably been made. The EW count of the rally calls the last high (if it's the last one which I believe it is) a major high as THE high. Now we'll wait to see if it agrees with me or not.
U.S. Dollar chart, Daily
The US dollar almost broke out to the upside but couldn't quite do it. It has pulled back to its 50-dma once again and now we'll see if it acts as a spring to launch it above the downtrend line. The longer it consolidates here the more bearish it will become so we'll just wait for a break to give us some more clues. This should also help identify the direction oil and gold might take (counter to the dollar).
Gold chart, April contract, Daily
Gold is either about to break north or stay stuck inside its consolidation pattern, which currently looks like a bull flag. The downtrend line from January and the broken uptrend line from November intersect just above 567. Two equal legs up from its low on March 10th is at 568.30 which is essentially where gold stopped today. If it's going to turn back down it will do it from here and that's why I recommended a short play in gold early today. The stop goes just above and keeps risk tight. A drop back down towards 530 could then set up a nice long play, maybe even up to crack the $600 level. If it were to break below 530 it will probably find support at its uptrend line from last July at 510. We'll be switching over the June contract later this week.
There were no major economic reports today but here are tomorrow's and the rest of the week's reports:
Tomorrow will be another quiet day for the market. Not only are we waiting for the FOMC announcement, but we also don't have much in the way of market-moving earnings or economic reports. Tomorrow morning's lonely report will be Consumer Confidence. If it were to drop more than expected there could be an initial reaction from the market but I suspect the market is pretty well locked into its range as we head into FOMC. Friday will be an important day for economic reports but until then there shouldn't be much, other than the post-FOMC cha-cha-cha dance, to move the market.
With today's wait-and-see attitude the internals matched the externals. We had below average volume and mixed breadth so we have no divergences or anything jumping out and calling our attention to something that could be setting up. Expect another boring 3/4 day before FOMC and then stand aside and let the bulls and bears crash around in the china shop. Once the dust settles we might be able to hitch a ride on the final direction. I mentioned the cha-cha-cha dance (I think I originally heard this from Jeff Cooper, an analyst I respect). As many of us have observed, watch for the direction of the market heading into the FOMC announcement (the 1st cha), a reaction to the announcement (2nd cha) and then another reversal (the 3rd cha). Often times that 3rd move is the one that will continue into the close. I've tried to figure out if the following day you can expect a reversal or a continuation of the post-FOMC move into the close but I haven't been able to find a pattern.
Because I see enough differences in the indices to warrant more caution than usual, it makes it difficult for me to make a guess as to which way the market will head, at least for the next few days, once we get past FOMC. The techs (NDX/QQQQ more so than the COMP) make me think we'll head lower. But if I had to bet on a direction I'd say we're going to see the market launch higher. The patterns for SPX and DOW, as shown in charts above, make it look like the current consolidation patterns will resolve to the upside. But that's a guess with less confidence than usual because of the different picture I get from the techs. If we do see a pullback into Wednesday after FOMC I wouldn't be a bit surprised to see sudden buying emerge in the form of buy programs. Catching many traders short seems to be a favorite tactic of those with lots of money to do this (the mega-banks and their trading teams along with lots of Fed money). That could propel us higher into the end of the week so as to close the week/month/quarter on a high note.
Seeing a rally into early April also would fulfill a scenario I see playing out in a larger pattern. On Thursday I'll get into a little more about cycles and Gann to show that we have a very interesting correlation of dates and price levels using the Gann Square of Nine chart and Fib projections. It shows the 2nd week of April could be a key turn window and I'm hoping we'll see a rally into it to mark it as potentially an important high. I'll go over some price projections as well but as an indication I see the DOW above 11400 and even approaching 11500. In addition to the use of Gann and Fibonacci tools, another "timing" tool is to look at major cycles that we see in the market. For example, a 10-year cycle shows a high made this month in 1996. A 100-year cycle had a high this month in 1906. Jim discussed the month of March being an important month of turns so it's possible we'll see a high this week. But I have a suspicion that the program buyers know this very well and will do what they can to thwart (actually to use) the bears to help drive the market higher. But we can see the weekly oscillators in overbought so one has to look at oneself in the mirror and ask, "Self, is this is a good time to go long the market?" I think your self knows the answer. Good luck tomorrow and don't force trades in this environment. We'll have plenty of other opportunities. See you on the Monitor.