I thought we might see some selling on Friday and then a continuation of that on Monday. We did get some selling on Friday, probably a little unwinding of the opex induced rally earlier in the week. But there was no follow through today. While the indices were marginally in the red today, the market held up reasonably well. At first blush that looks bullish, and it could be, but the short term pattern suggests it's more likely a bear flag that formed today and we're likely to see a continuation of some selling tomorrow, maybe after an early morning high (but not necessarily).
If we see some symmetry in the decline from Friday's high, we could see another leg down to equal Friday's decline (that would give us DOW 11260 and SPX 1297). SPX 1295 should be strong support for various reasons to that level continues to be a good place to identify whether the tide has shifted. But the longer term chart suggests a new low for this pullback should be a good opportunity to trade on the long side if you're a trader. Longer term traders/investors should have an opportunity to cinch up their stops and squeeze as much out of this rally as possible. I don't like the vulnerability of the market as far as establishing new long positions (I'll get into that more in a little bit) but active traders who are able to watch the market intraday could have another opportunity to do some buying.
It was actually a very quiet day today. There were no major economic reports and only a few earnings reports that had a chance to move the market, none of which really did. This leaves me enough time and space to get into something I wanted to provide an update about. I had introduced the Hindenburg Omen back in September 2005 and more recently talked about a signal that can be used to gauge the risk of Fed intervention in our market (PPT or simply a liquidity push through the primary dealers, or mega-banks). We've recently seen some Hindenburg Omen signals and we're close to a level where we could see another liquidity injection so it'll be good to spend some time reviewing both of these things below.
But first let's review a couple of charts to get a sense of what happened today.
DOW chart, Daily
The DOW continues to look stronger than the other major market indices. The flight to the bluest of the blue chips is not necessarily bullish and it continues to look defensive--funds want to park their money in the most liquid stocks in case they need to bail in a hurry. This chart appears to have momentum on its side for an additional advance and that's what I'm expecting. As I mentioned above, if we get two equal legs down in the pullback from last Friday's high, that gives us 11260 as an area to watch for support. It might not even get down that far if more money flows into the DOW relative to the others. Assuming we get another leg up it could be a very choppy ride, especially if we're into the very last leg of the rally. So if you're trying to trade this, be careful about the whipsaws. If you're long the market and wondering where to get out, I would use a break below 11100 or SPX 1295 as a stop level since a break of either of those levels could be an indication that a much larger and deeper correction is underway. If the DOW reaches the top of its ascending wedge pattern this week, which would be very close to a Fib and Gann target at 11465 I might want to pull stops up real tight and squeeze as much out of this as you can while not wanting to give much back. We're getting close to "sell in May and go away".
SPX chart, Daily
SPX is also pulling back slightly which should lead to the last push higher. The top of its wedge pattern, a Fib target and a Gann target all line up near 1324 as a potential top. While 1295 should be an important support level, it takes a break below its 50-dma, currently at 1293, to signify a top could be in. But the break needs to hold and as we've seen in March and April, the two previous breaks were head fakes. That might actually sucker some bulls into buying the next break but I would not recommend that.
Nasdaq chart, Daily
The COMP has room to bounce around without hitting the walls of its ascending wedge pattern. This one has started to look a little more bearish as though there's some rotation going on out of techs and into the blue chips. The odd thing is that there's not a lot of selling in the small caps so I'm not sure what is playing out here. A break below 2300 would be serious but until then we should see this press higher and there's upside potential to above 2400 but that's looking doubtful the way the techs have been behaving.
QQQQ chart, 240-min
The large cap techs, which QQQQ represents, appear even more bearish than the COMP primarily because of its inability to make a new high with the COMP on April 20th. The 50-dma for QQQQ is at 41.53 so keep an eye on that level for support, or not. While the chart isn't real bearish yet, I don't like the looks of it from a bullish perspective. I certainly would not want to buy this.
SOX index, Daily chart
The SOX was looking bullish there for a few days but now can't seem to hold on to its 50-dma. It's kind of stuck in the middle presently and while I would be more comfortable short this index rather being long, I don't think there's a good trade here. There's not a reasonable place for a stop. The most recent high and low are the markers for what should happen next and until then I would stand aside. If it does break the October uptrend line, there's not much room before it finds potential support at its 200-dma nearing 490. Perhaps a break of its uptrend line, bounce off its 200-dma and then a failed test of the broken uptrend line--that would set up a good short play.
Before continuing on with a look at the banks, I want to review the sell signals we're now getting in the market.
Hindenburg Omen Update
Several months ago, actually back in September, I had mentioned a signal that identifies the market's vulnerability to a crash, or at least the potential for a significant decline. It's called the Hindenburg Omen signal and we've now received 4 of these signals in the past couple of weeks. Usually when they occur in clusters, as they have in April, the potential for follow through is higher. I had promised that I would discuss this signal when it occurred again so here we are.
The last signal we received was back in September 2005 and the one before that was in April 2004. Each of the two previous times have been met with a huge influx of money, as measured by M-3, as the Fed doused the market with excess liquidity. I'll show a chart after this Hindenburg Omen update to show that we could be getting ready for the PPT to jump into action and save the day again as they did the two previous times. But even if liquidity is pumped up (and we don't know for sure since M-3 is no longer reported) and the PPT does their preemptive strike again, what these Hindenburg Omen signals tell us is that the market is vulnerable and therefore protective measures should be taken. No major stock market correction has occurred without first seeing a Hindenburg Omen signal. Not all signals generate a large stock market correction (I'll mention the odds in a little bit) but it does say the market is vulnerable.
As a reminder about what these Hindenburg Omen signals are, the origins of the term was traced by Peter Eliades (stockmarketcycles.com) and the work that Norman Fosback, author of "Stock Market Logic", did back in the 1970s. But credit for the discovery and naming of the Hindenburg Omen is given to Jim Miekka and Kennedy Gammage who wrote a report called the "Sudbury Report". The signals that identify the Omen were then further refined to include a couple of other criteria that more accurately predicted the ensuing stock market corrections. This work was done by Dr. Robert McHugh who writes a newsletter at technicalindicatorindex.com. The signal derives its criteria from the NYSE due to its larger size of included stocks, and it looks at new 52-week highs and lows. One of the requirements for the signal is a higher than normal number of new highs AND new lows. The reason both new highs and new lows are considered, as Peter Eliades states, is that "it indicates the market is undergoing a period of extreme divergence--many stocks establishing new highs and many setting new lows as well. Such divergence is not usually conducive to future rising prices."
There are five requirements for a Hindenburg Omen signal to have the greatest chance of success in seeing a market decline follow:
For April 2006 there have now been 4 Hindenburg Omen signals and therefore we have a confirmed signal (confirmed meaning more than one signal). There's a very good chance today created another signal which will make 5. Once the final numbers have been confirmed I'll know for sure but it looks like 3409 issues trades today and the common number between new highs and new lows is 75 which gives us the required 2.2%. All of the other criteria as outlined above were met today. While the cluster of Hindenburg Omen signals tells us the market is vulnerable to a steeper than normal correction, the problem is that it's not necessarily a good trading signal. A market correction could start the next day or up to 4 months later.
The wide range of days between the signal and a market decline is hardly helpful if you want to go out and back up the truck and load up with some long put options. In other words, don't do that. What it is helpful for is to identify market vulnerability so that you can protect long positions you might have, and establish a trading plan for playing the short side of the market should we get some additional trading signals. In other words, knowing the market is vulnerable tells us to be looking and watching for an opportunity to play the short side but we need to let the market tell us when. On average the market started a significant decline within 6 weeks.
To give an indication of how often these signals occur, we've had 23 Hindenburg Omen signals, following the 5 criteria outlined above, in the past 21 years, 8 of which were generated since the high in 2000. Here's a chart of the DOW and the generated signals:
DOW and Hindenburg Omen signals, 2000-2006 (courtesy technicalindicatorindex.com)
As you can see, some signals presaged much greater corrections than others. Since 2004 we've seen the Fed mass producing new money at the times of the last two signals and inserting into the banking system through the markets. What we don't know, but can surmise, is how much the market has been held up by this money. Traders who like to play the short side of the market need to keep this fact in mind since it doesn't appear the Fed is letting up on money creation (one look at the sinking dollar and rising commodities, like gold, silver and oil, will tell you the Fed has probably been busy). How much the market will correct is anybody's guess. We've seen numerous times when bad news hits the market it suddenly blasts off to the upside. You would normally expect the market to sell off, so be careful during these times because we've seen time and again the market get hit with a lot of buy programs in order to keep take the shorts out of the game.
Looking at past corrections following a Hindenburg Omen, they can be grouped by the amount of the decline so as to give us probabilities based on past history since 1985 (again, with the caveat that the Fed will do its thing to prevent major sell offs). About 9% of the time the signal will fail--no major decline (meaning something less than 5%). But there is a 74% chance the stock market will correct at least 5%. That would take the DOW from 11400 down 570 points to 10830, or lower. There is a 52% chance the DOW will correct at least 8% (10490) and there is a 39% chance the stock market will experience a panic sell off (defined as a correction greater than 10%--DOW 10260 or lower). A market crash (15% or more) happened 26% of the times the Hindenburg Omen was generated (DOW back under 10K). The Hindenburg Omen signal occurred before the stock market crash in 1987, before the start of the 1990 recession, and even a few weeks before the LTCM debacle in 1998.
Once the signals are generated the stock market many times rallied afterwards. This was often a sucker rally as it pulled in the last of the buyers before getting sold off hard. It was likely a result of the Boyz pushing the market up in order to sell into it, distributing their stock to the masses. Choppy rallies inside ascending wedges are usually indicative of this process and it looks suspiciously similar this month. Even the strong 200-point rally on the DOW saw another Hindenburg Omen signal generated that day (there were still a large number of new 52-week lows that day). Here's an updated chart of the NYSE to show it has the same pattern as the others:
NYSE chart, Daily
The ascending wedge, defined by the uptrend line from October and the trend line along the highs since January, has negative divergences backing up the bearish interpretation of this pattern. And now we're getting these Hindenburg Omen signals so it seems we're all set up for a nice correction that should be a good tradeable event. The trouble is, those who have the money (the Fed and the mega-banks) also see this and they see the rising short interest ratio (including increasing number of long put options). I've lost count how many times we've seen these bearish ascending wedges in the past, with the negative divergences included, that suddenly and inexplicably shot out the top in a strong rally. Never underestimate the power of buy programs, short covering and panicked new buyers.
So now that we see the market is vulnerable to a steep market decline, there's another chart that I said I'd keep you posted on. This chart is also done by Dr. Robert McHugh with technicalindicatorindex.com and he refers to it as his PPT Risk Indicator. This is the latest update through Friday, April 21st:
PPT Intervention Risk Indicator, DOW vs. CBOE put options (courtesy technicalindicatorindex.com)
The idea behind this chart is that the PPT needs the shorts. They hate short players but they need them in order to be successful in what they're trying to do (hold the market up). Just when the market is most vulnerable, and the betting is getting heavy on the short side (short stock, long puts, short futures and in general a high short interest ratio), is really when the shorts have been most vulnerable. With lots of Fed money and the mega banks' trading teams, we've seen how easy it is to create relentless buying programs that hammer the bears. The combination of short covering and panicked buying from new buyers who are afraid of missing the boat, sparked with massive buy programs, creates a large rally. Some times it lasts a few minutes, other times it lasts a few weeks.
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This PPT risk indicator chart shows when the market is most vulnerable to a PPT attack--when there are a sufficient number of shorts in the market to help the buy programmers launch a buying spree that can last for many days if not weeks. We're currently approaching that time, and interestingly it's at a time when we're seeing multiple Hindenburg Omen signals. Driving the shorts out of the market actually makes the market more vulnerable to a significant decline because the absence of shorts in the market removes buying pressure in a panicked sell off. If only the Fed understood this. The above chart shows that the latest reading is 15.4% (it's hard to see the new high against the right side of the chart). This measures the percentage of the 10-day moving average of CBOE put options to the 30-day average. Each time this percentage has climbed up to 18% we've seen a spurt of buying induced by program buying. Friday's reading is close to that level and is a heads up for some potential intervention. Possibly a little more selling and we'll be ready for the PPT setup.
The banks continue to be a good proxy, or at least they're not showing any divergence with the broader market. They continue to hold support and as long as that's true, we should be looking higher.
BKX banking index, Daily chart
Support continues to be the October uptrend line and its 50-dma, both of which were briefly broken before the Boyz closed the bear trap and ramped the market higher last week. That was beautifully done I must say. I dislike immensely the gross market manipulation that is going on, and the gross profits the mega-bank trading teams are making, but I've got to hand it to those trading teams. The way they pushed the market just far enough down to pull in the shorts, by breaking those support levels, and then following that with a relentless 200 point DOW rally to get the shorts screaming for cover, well, it deserved a golf clap that's for sure. I do hope they get paid back dearly, and I think they will. Their arrogance will get them into trouble when the market overwhelms them with selling they can't stop. Some day. But I digress. As long as the banks hold support I'm looking for them to top out near the December 2004 high.
U.S. Home Construction Index chart, DJUSHB, Daily
The home builders continue to look relatively weak. They closed on the long term uptrend line and if the broader market gets another rally leg going in the next day or so, the builders should bounce as well. But this is beginning to look more threatening to those who are long these stocks. Any break below the last low near 820 would be a strong sell signal.
Oil chart, June contract, Daily
After what could be a brief over-throw of a parallel up-channel, oil appears ready for a pullback now. The daily oscillators appear to be tipping over. How much of a pullback can't be known of course but the larger pattern makes me think we could see a pullback to the uptrend line and/or 200-dma, both of which are rising. Maybe that will mean a pullback to about $65. I've relabeled the EW count to make this an ending pattern rather than a setup for a strong rally out of the next pullback. It should get another leg up after the pullback but I'm thinking it could be the last leg before a much deeper and longer pullback. Oil would likely hit $80 but I'm not sure it'll be much more than that. This is all speculation at the moment since I'm not even sure what kind of pullback we'll get but based on the larger pattern now, this is my best guess as to what's happening.
Oil Index chart, Daily
Follow oil. Any questions? It's really that easy since the oil stocks are in synch with oil and as long as that's true one should follow the other. The stocks will often lead the commodity so if you see some divergence between the two, go with what the stocks are telling you.
Transportation Index chart, Daily
The Trannies are in a tight little parallel up-channel now so we have the boundaries to use for guidance here. The upside potential is currently near 4880 if it manages to rally above its Fib target of 4771.50. I don't have a middle line drawn in for this channel but it appears to be stalled at about the midline. This midline is often where the very last wave up finds resistance so it bears watching here. It takes a break of its last low at 4565 to indicate a longer term high is probably in place.
The US dollar continues to drop lower, just at a time when China's president is visiting the U.S. I'm sure Bush was asking the Chinese to revalue their yuan to weaken it so that we are more competitive in China and to help alleviate the huge trade deficit we have with China. In fact the Group of Seven nations issued a strong statement (for them) in singling out China to take action to move toward greater foreight-exchange flexibility. After revaluing the yuan 2.1% against the US dollar last July it has appreciated by the same amount since then. Many feel the yuan is undervalued by as much as 40% against the US dollar.
Many lawmakers in the U.S. blame China for the large trade deficit but really it's global capitalism at work. Just as we like to have immigrant farm workers to keep the cost of our produce low, so too do we like the cheaper Chinese goods. Just wait for their electronics manufacturing to really take off, and then their cars. Don't blame the Chinese, blame the American consumer. Besides, with China now the largest creditor to the U.S., owning nearly $900B of our stocks and bonds (mostly bonds), all they have to do is threaten to sell their holdings of U.S. treasuries and watch how quickly we back down. We made this bed and now we have to lie on it. The US dollar isn't looking so healthy at the moment.
U.S. Dollar chart, Daily
The dollar has dropped down to potential support at the bottom of a parallel down-channel for price action since the March high and looks ready for a bounce. But I suspect it will continue down that steeper channel until it reaches the bottom of a larger down-channel where the different trend lines intersect at the end of May at the dollar's previous low of $86.15. Two equal legs down from the November 2005 high would be at $86.36.
Gold chart, June contract, Daily
Gold is acting a little volatile at the moment so we'll have to see if it consolidates sideways near its high (which would be bullish) or instead starts a deeper multi-week pullback. Right now I'm leaning towards a deeper pullback and am thinking we'll get something in the neighborhood of $550, or wherever the uptrend line from July 2005 happens to be by the time price reaches it. It should shake out quite a few gold bulls before it's ready to resume its rally.
There were no major economic reports today but the following shows the reports due for the rest of the week:
The day had a negative tone even though much of the day was spent recovering from an initial drop early in the morning. The market internals supported the negative tone of the market so there wasn't much that signaled major divergences. If anything it does tell us the day was more negative than price would indicate. Down volume was nearly twice the up volume. Declining issues were greater than advancing issues by a 3:2 margin. The number of 52-week lows was higher than average and new highs were lower. It looked like more distribution was going on today.
Sector action shows almost all red today, led by energy indexes, securities broker, gold and silver, networkers and the SOX. The few green sectors on my list were the utilities, TRAN, computer hardware and biotechs. That's a mixed bag of green sectors and not very telling. It was very likely stock specific that helped each sector.
Before finishing off with some of today's earnings reports, I'll finish up with my expectations for tomorrow which is for a brief rally in the morning (possibly) that should set up a shorting opportunity (for day traders). We should get another leg down to match the move down on Friday and then we should have a buying opportunity for a new rally leg (which I think will be the very last one). Traders should have a couple of trading opportunities here. Investors or longer term traders will need to be cautious as failure could happen at anytime and downside surprises could be swift.
Actually everyone needs to be cautious. Here we are with Hindenburg Omen signals that warn us of the potential to see a much larger correction than we've seen for over 3 years now. But countering that we've got an indication that the short interest in the market at the current time could have us set up for a multi-day or even multi-week rally (the kind we often see with lots of program buying). In other words, it could get very volatile out there and both sides would be subject to severe whipsaw. Have your trading plan ready and stick to it.
Most of all stick to your trading rules, especially risk management. Don't be in a hurry to catch a move if you missed it. Instead let the market come to you otherwise let that bus leave without you; plenty more busses will come along. Chasing busses is usually not a smart thing to do; sucking diesel fumes gives you bain dramage. I think we're into a period when you should be particularly choosy about your trades since the risk is going to increase as we top out, which is what I believe we're in the process of doing. Good luck tomorrow and I'll see some of you on the Monitor.
Prior to the market's open, or during today's trading, the following is a sampling of some of the companies which reported earnings today (courtesy MarketWatch):
Xerox Corp. posted first-quarter net income of $200 million, or 20 cents a share, compared with $210 million, or 20 cents a share, a year ago. Total revenue dipped 2% to $3.7 billion. The Stamford, Conn. company said negative foreign currency factors contributed to the revenue fall. Xerox sees second-quarter earnings of 22 cents to 24 cents a share.
Caterpillar Inc. reported first-quarter net income rose to $840 million, or $1.20 a share, from $581 million, or 81 cents a share, a year earlier. Sales rose to $9.39 billion from $8.34 billion. The Peoria, Ill.-based machinery maker lifted its 2006 profit forecast (predicting earnings of $4.85 to $5.20 a share, up from a previous outlook of $4.65 to $5 a share). The forecast for sales was unchanged.
Affymetrix Inc (AFFX 28.83 -0.20) reported first-quarter net earnings of $1.83 million, or 3 cents a share, down from $16.2 million, or 24 cents a share, during the year-ago period. The Santa Clara, Calif.-based maker of technology for genetic mapping posted revenue of $86.4 million vs. $88.6 million. Analysts polled by Thomson First Call had forecast first-quarter earnings of 4 cents a share on revenue of $90 million. Excluding the impact of stock-based compensation expense, the company reported net income of $4.2 million, or 6 cents a share, for the quarter.
Broadcom Corp. (BRCM 41.57 -2.08) said quarterly profit nearly doubled on surging demand for its chips used to power consumer electronics and high-speed Internet gear.
Capital One Financial (COF 85.56 -0.53) reported a 74% jump in quarterly profit as the credit card and banking company benefited from an improved credit environment and began integrating last year's acquisition of Hibernia Bank.
Cree Inc. (CREE 29.89 -0.51) reported fiscal third-quarter net earnings of $24 million, or 31 cents a share, up 16% from $20.7 million, or 27 cents a share, in the year-ago period. Revenue at the Durham, N.C.-based semiconductor component maker rose to $107.7 million from $95.8 million last year. Analysts polled by Thomson First Call had forecast earnings of 26 cents a share on revenue of $107 million.
F5 Networks Inc. (FFIV 59.89 +1.99) reported second-quarter net earnings of $16.1 million, or 39 cents a share, up 33% from $12.1 million, or 31 cents a share, during the year-ago period. The Seattle-based company posted revenue of $94.1 million vs. $67.7 million. Analysts polled by Thomson First Call had forecast second-quarter earnings of 50 cents a share on revenue of $95 million. Excluding stock compensation expense, net income for the second quarter was $20.3 million, or 49 cents a share.
Foundry Networks Inc. (FDRY 14.55 -0.75)said its quarterly profit rose 15% on stronger revenue, though its profit, excluding stock-option expenses, came in just shy of analysts' average estimate.
Freddie Mac (FRE 60.20 -0.16)said it will pay $410 million to settle securities class-action and shareholder-derivative lawsuits filed against the mortgage giant over accounting shenanigans between 2000 and 2002.
Halliburton Co. (HAL 80.30 -3.03) reported almost $500 million in first-quarter earnings and tallied its revenue at more than $5 billion, as record results at its energy-services operations overcame slowing U.S. military work in Iraq.
PMC-Sierra Inc. (PMCS 12.18 -0.52) swung to a first-quarter loss on the cost of employee stock options and acquisition-related charges.
SanDisk Corp. (SNDK 59.21 -0.84) reported a first-quarter profit that fell almost 47% from a year ago due to a series of one-time items that negatively affected its bottom line.
VeriSign Inc. (VRSN 24.10 -0.33) said first-quarter profit slumped 68%, hurt by acquisition-related charges and the cost of employee stock option expenses
American Express (AXP 51.79 -0.47) reported first-quarter net income fell 8% against the year-ago period, before it spun out its Ameriprise financial-advisory unit. Operating earnings rose 18%. First-quarter net fell to $873 million, or 69 cents a share, from $946 million, or 75 cents, in the year-earlier period. Revenue rose 12% to $6.33 billion.
After the close Sun Microsystems (SUNW 4.98 +0.05) announced that Scott McNealy resigned his position as CEO, a position he held for 22 years, and promoted Jonathan Swartz to the position. Schwartz is currently the President and Chief Operating Officer. McNealy retains his post as Chairman of the Board. The move may be an attempt to bring new leadership to the struggling company.
SUNW announced earnings for their 3rd quarter which was a loss of $217M, or -6 cents a share, as compared to a loss of $28M, or -1 cent a share, a year ago. Nothing like delivering a hot potato to Schwartz with the instruction "here you handle this, I'm done". The loss was not a surprise to analysts and losing that much money must be a good thing since the stock price shot higher in after-hours, closing up another $0.45 at $5.42, +9%. There must be a lot of confidence in Mr. Schwartz. The good news is that SUNW is up about 130% from its low of $2.34 in October 2002. The bad news is that it is still about 70% below its 2000 peak.