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An Expired Feline Bounce

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The current bounce bothers me. It's lacking in the strong program buying department. In past rallies off steep pullbacks we've seen some monster buy programs kick in which in turn caused monster short covering. The volume in those previous bounces tended to be high. I've been looking but I'll be dipped if I can find something similar occurring here. Hence the dead cat bounce. Or for those concerned we might hurt cat owners' feelings, perhaps this is a soft ball bounce. Past rallies have been more like super ball bounces.

This morning opened up on an upbeat note as the futures had been pushed higher in the overnight session and there wasn't anything in the early morning session to dampen some bullish enthusiasm. But the lack of program buying, other than an occasional spurt higher, gave the market a kind of listless feel to it. Shorts may have been taking some profits after seeing the market wasn't continuing lower so today's rally could have been a lack of sellers more than eager buyers. But the end result was a nice day for those who are long the market. In fact, considering some of the internals, such as the advancing volume and issues over the declining volume and issues, as seen in the chart above, I'm surprised we didn't see a double of what the market rally was. So there was much more buying but just not aggressively so.

There may have been some fear by bulls of tomorrow's core PCE (Personal Consumption Expenditures) deflator which traders may react to since it's one of the numbers the Fed will use as part of their data analysis. Bernanke gave the market a quick shot in the arm this afternoon after answering some questions in a letter he sent to the Joint Economic Committee in which he stated he can't ignore movements in asset prices and that monetary policy must be forward looking. He said he believes long-term inflation expectations are well contained. Not long ago that kind of news would have sparked a huge rally. Once we get past tomorrow morning's economic reports (Personal Income and Spending and the revised Michigan Consumer Sentiment) we'll see if the market can hold onto today's gains, and build on them.

The preliminary GDP number was released this morning and showed the economy growing at a strong 5.3% in the 1st quarter. This was a little slower than the government's first estimate of +5.8% but an increase over the +4.8% rate reported on April 18th, and much better than the +1.7% for the 4th quarter. Replenishment of inventories and improved shipments overseas are credited for the increase. The +5.3% growth is the strongest we've seen since the 3rd quarter of 2003. Unfortunately this measurement is not a leading indicator but instead only tells us what we've done. Most estimates are for a slowdown in this growth as we move into the 2nd half of this year. The Chain Deflator held steady at 3.3% and indicates the economy grew at a rate that sustains respectable profit growth while keeping inflation under control

Jobless claims data showed initial claims fell 40K to 329K, higher than expectations for 318K. The previous week's bump up to 369K was due to a partial government shutdown in Puerto Rico so I guess those people were back to work the following week. The 4-week average rose 3,250 to 337K, the highest since October 2005. Continuing claims rose by 38K to 2.42M and its 4-week average at 2.41M was the lowest it's been since the end of 2001.

While continuing claims are down 7%, the help-wanted index is unfortunately down to its lowest level seen in 45 years, coming in at 35, down from 38 in April and below expectations for 38. Whether this is because companies are not offering as many jobs, or if it's because jobs are getting filled before the need to post them, it reflects a tight job market. This index has dropped in all nine U.S. regions over the past three months.


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Existing home sales fell 2% to 6.76M in April, which was slightly above expectations for 6.74M. This resulted in an increase in inventories which rose 5.8% to 3.38M, a 6-month supply at April's sales rate, and it's the largest supply of unsold homes since 1998. Many homes are sitting on the market longer now which is typical. It takes a while for sellers to realize the buyers are balking and by the time they lower their selling prices they often lag the market decline and start chasing prices lower but are usually slightly behind what the market will bear. If you need to sell a home this year, and need to sell quickly, you'll probably be better off pricing aggressively and getting it sold in the first 30 days. I've been in your shoes too many times to count and I know how this will play out.

The median sales price grew at 4.2% in the past year to $223K, which was the slowest increase since January 2001. There are many areas reporting price declines and I strongly suspect that will be the rule rather than the exception this coming year. Sales are down -5.7% year over year.

In some other news, splashed across the front pages, a jury found Enron's founder and former CEO Kenneth Lay guilty on all six counts of fraud and conspiracy charges. I suspect he didn't really understand what was going on in his company but instead depended on those working for him but to that I say tough. People at the head of company are highly compensated to know what's going on and shame on you if you don't. A captain of a ship will be relieved of duty and maybe even court marshaled if his ship is involved in an accident and was the cause of the accident. Even if the captain was not on the bridge at the time. No questions asked, he's out of there.

Jeffrey Skilling, the CEO, was found guilty on all securities fraud counts but acquitted of insider trading charges. I of course have no idea what was presented in the court room, and while I applaud the jury's verdict I do wonder how Skilling got off on the charges involving insider trading. Hellooo? How come he was able to get out of there with his money while everyone else's blew up in a puff of smoke? Actually there wasn't even any smoke.

In some stock news, Yahoo (YHOO 32.92 +1.13) and eBay (EBAY 33.92 +3.68) announced a strategic partnership for internet searches, advertising, online payments and a shared toolbar (just what we need, more toolbars). They plan on rolling out a test phase of their joint venture this year. This sounds very much like an attempt to thwart Google's (GOOG 382.74 +1.74) growth but GOOG's stock holders weren't worried.

Lastly, while we don't follow the bonds closely here, I found it interesting that today's bond auction did not go that well. There was a disappointing 5-year note auction, which drew 4.945%, as there was a lack of interest by foreign central banks and an indirect bidder participation of only 22.1%. Bernanke's statement, mentioned above, about not ignoring asset prices and the feeling long term inflation rates are under control, probably spooked bond holders who then sold them off. Yields were up about 0.04 across the 5, 10 and 30-year. The concern I have is that if foreign central banks (the biggest buyers of our debt) start to lose interest, we could find bonds selling off more (yields higher) and that could hurt both the US dollar and the bond market. That would in turn hurt the equity market, not to mention the housing market as mortgage rates head higher. We hardly have a trend here but I'm watching for the shot across the bow and am wondering if that was it.

After taking a drubbing since the market high on May 10th, this week we've at least seen some stabilization in prices. We've even had back-to-back green days so there are probably a lot of bulls starting to breathe again. The big question of course is whether or not the bounce will last. Let's see what the charts have to say.

DOW chart, Daily

The DOW pushed down to its April low but managed to find support there, just above 11K. Resistance for any bounce will now be its 50-dma and broken October uptrend line, both near 11283. In the same vicinity is the trend line across the previous highs of January 2004 and March 2005. If the bounce doesn't do much better than that you can see it will develop into a H&S pattern with the left shoulder the March high. With the neckline at about 11050 and the head at 11700, that would give us a downside price projection of 650 points from 11050 or 10400. At that point you might as well say we're going to get a test of last October's low. That's what I think will play out here as we head into the summer. But first we need to work on that right shoulder and that will be a multi-week affair into June.

SPX chart, Daily

The doji left at the 200-dma and then today's big green candle leaves a bullish reversal pattern on the chart. It looks good for a bounce. But there are multiple resistance levels for SPX to work its way back through. The previous lows in March and April (1272 and 1285) and then the 20 and 50-dma's (1294 and 1298, both of which are coming down and the 20 has crossed below the 50 for the 1st time since last November). If price goes more sideways than up here, it will look more bearish. But the consolidation could continue for a couple of weeks.

Nasdaq chart, Daily

The COMP looks like it reversed in mid air but it bounced off its gap close from November 1, 2005. Upside resistance will be at its broken October 2002-April 2005 uptrend line and its 200-dma. Both will meet in a couple of days around 2225. The price pattern looks like a relatively small consolidation here should be followed by a new low and then set up a bigger bounce from there. So perhaps it will make it down to its August 2002-April 2004 uptrend line near 2120 by that time.

QQQQ chart, Daily

Like the COMP the Q's look like a small bounce should be followed by a new low before it sets up a larger bounce. This doesn't quite jive with the picture I have for the DOW and SPX so it could continue to consolidate here instead of making a new low. I would expect the $40 area to be resistance.

SOX index, Daily chart

Contrary to the techs above, the SOX actually looks like it might be finishing up its decline (it was red today while the rest of the techs were in the green). A downtrend line from March 2003 through January 2004 (which marked the top of a large sideways triangle consolidation on the weekly chart), which was broken last November, acted as support on a retest. Just below that trend line is the uptrend line from April-October 2005. If it does break lower sooner rather than later, it will probably head for gap closure from back in November near 440.

Dj vu 1987
One of the things I like to do is look for repeating patterns in the stock market. Elliott Wave analysis is of course based on these repeating patterns, called fractals, which can be found in many different time frames. The wave counts repeat and they do so in various degrees (time frames). Human beings typically react the same way to stimuli and in our case it's the stimulus from the market. We react to the same patterns in the same way since the beginning. All the sophisticated computers and trading tools and all the program trading that's done nowadays has not changed the basic patterns seen in the market. It's one of the reasons sentiment indicators work and why being a contrarian is often the better path to success.

Not too long ago I showed a chart of the DOW from 1966 to 1982. It showed a pattern between 1966 and 1972 similar to what we've seen since 2000. Then the big drop to new lows in 1973-1974 could be a harbinger of what's to come for our stock market from here (such as new lows below October 2002). Take a look at an analog (comparison) between the lead up to the 1987 crash and what the market has done this year. I found the following four charts, courtesy of Dr. Robert McHugh from technicalindicatorindex.com over the weekend and wanted to share them with you. The prices are effective last Friday, May 19, 2006 but for the purposes of this comparison that doesn't significantly change the picture.

Comparison of DOW in 1987 and 2006

As you can see, the 5 months of this year look remarkably similar to the 5 months leading up to October 1987. The big difference is that the DOW made a new high in May whereas it did not do that going into October 1987. That could be a big difference since we haven't yet had a correction to the this month's initial decline, such as the market had into October 1987. Assuming we'll get that correction, that would stretch out the pattern and make it look different. But the similarity here should have all of us paying careful attention.

Getting in a little closer to the action over the past month shows a very tight correlation of the pattern. The DOW bounced a little this week (I updated the chart to reflect the price change through today) and it takes us to the point on the 1987 chart where it dropped like a stone:

Comparison of DOW in October 1987 and May 2006

This analog suggests we're about to witness a crash below 10K for the DOW. Will this pan out? Why would it? I have no idea to either question and frankly I doubt that it will follow. I show these charts not to scare anyone but instead to give a heads up. If we were to follow this pattern it could be devastating to many peoples' accounts, especially if you own stock on margin. I remember 1987 nearly wiped out a friend's portfolio (and he had a sizeable account at the time) after he was forced to liquidate nearly every stock he owned only to watch the market recover a few months later. Are you wearing protection? A hard hat or better yet some put options is what I'm thinking (buy yourself lots of time in case we get a month long bounce first).

Another comparison to 1987 is the McClellan Oscillator Summation Index. This chart shows a comparison in the previous two months leading up to the 1987 crash.

Comparison of McClellan Oscillator Summation Index in 1987 and 2006

The readings for the MSI here are different than what I can find on stockcharts.com (from DecisionPoint.com). I can't find the MSI readings on stockcharts.com for 1987 to make a direct comparison to today's readings but the comparison above is what's important. The fact that the curve looks so similar, especially when comparing to the price patterns, is what could be potentially very telling here.

Here's the chart of the McClellan Oscillator and Summation Index (MSI), from stockcharts.com:

McClellan Oscillator and Summation Index

First thing to notice is the longer term negative divergence that developed over the past 6 months. This is a good example of why you can't trade these divergences but it does give you a heads up to something that just wasn't right with the rally and to hold the exit door open with your foot if you were long the market. Second thing to note is how the Summation Index has driven down into negative territory--not good.

Here's an explanation for this index that I pulled off the web: "If you add up all of the daily values of the McClellan Oscillator, you will have an indicator known as the McClellan Summation Index. It is the basis for intermediate and long term interpretation of the stock market's direction and power. When properly calculated and calibrated, it is neutral at the +1000 level. In a bull market, the Summation Index will typically vary between 0 and 2000. Readings above 2000 are indicative of very powerful bull market advances. Readings between 1000 and 0 point to the bear being ready to go on the prowl. And finally, if the reading reaches -1000, then a reversal in the bear market may be nearby."

So we have a reading of -280 (as of 5/24/06) on the chart above and that's not a good sign for the bulls. The negative divergences seem to have caught up with the market.

There's one other chart I've shown in the past and it's worth reviewing based on the most recent Michigan Consumer Sentiment number.

Comparison of DOW and Michigan Consumer Sentiment, 1999 to 2006

The stock market, not surprisingly, has followed consumer sentiment very closely. Especially as the consumer has become the engine behind GDP, as goes CS so goes their mood for buying or selling stocks. But we've had a major divergence since 2004 and one could speculate as to why (such as, is it due to all the Fed money being printed and jammed into the monetary system?) but one has to wonder how long that will continue. And if it's false propping, will we have a more violent correction? I raise this question because of the setup we see for a potential crash. That's not a prediction but it is speculation.

What this all boils down to for me is that we're entering a period of higher than normal risk and potentially much higher volatility. Those who like to trade credit spreads may find it riskier than it's been for the past 2 years. Whipsaws could be plentiful. And bullish positions could be at great jeopardy. Just be careful and watch the market closely. Do not let a big move go against you, in either direction. It might not stop.

But back to today's action, the banks and securities broker index are the two indices I've been watching closely for some market clues. Together they've actually been a good predictor for the broader market and therefore will continue to be monitored closely by me.

BKX banking index, Daily chart

The bank index pulled back to support at its uptrend line from January after dipping below its 50-dma. Many traders are looking at this and thinking we could see the same kind of move to the upside as we saw after the test of the 50-dma in April. Um, I don't think so. I think a bounce will be lucky to make it above 383. After a bounce here, which could take a couple of weeks or only a couple of days, this should proceed lower towards its 200-dma.

Securities broker index, Daily chart

The broker index bounced off its uptrend line from May-October 2005 and its 200-ema. I expect to see a relatively small consolidation on top of the this support area but then a continuation lower. It shouldn't drop too much lower, perhaps to the 195 area before bouncing again at which time it will probably find the broken uptrend line to be resistance for another slap goodbye. At least that's how I envision this playing out over the next couple of months.

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

The housing index has dropped down to the bottom of both of its parallel down-channels near 700 and should find support here for a larger bounce/correction. It could even work its way back up to 800 over the next couple of weeks and not change the bearishness of this picture. If a small bounce is followed by a sell off that takes this index below its channels, that could signal some strong selling ahead.

Oil chart, June contract, Daily

I've been expecting oil to work its way down to its uptrend line and 200-dma, perhaps near $67 (July contract) by the time it gets there (assuming it will get there) before setting up another run higher. But the oil stocks have already made it down to this support level and therefore oil may not drop any further. Its 50-dma could continue to support this. But from a price pattern perspective, it would look best with another leg down.

Oil Index chart, Daily

The oil index managed to chop its way lower to its uptrend line and 200-dma. It got blasted lower with the sell off in the broader market. It looks ready to bounce now so keep an eye on oil--if oil continues lower then the oil stocks could follow, or at least consolidate near support for a while. A break below 530 would look bearish.

Transportation Index chart, Daily

After breaking the 50-dma the Trannies are now finding that to be resistance. If the bounce can develop some legs it could challenge its 20-dma at 4774 and even its broken October uptrend line near 4800. There is a Fib projection for the bounce that matches a 50% retracement near 4800 so that level could be very difficult to crack above.

U.S. Dollar chart, Daily

The dollar came within inches of its downside objective close to $83. I think it will make it there after a bit of consolidation first. From the $83 we should the dollar get a bigger bounce/consolidation, possibly even start another leg higher if a bullish alternate EW count plays out. But my preferred count says the dollar is only at the beginning of a big bear market decline. It would take a rally back above $88 to negate that bearish view.

Gold chart, June contract, Daily

Gold's parabolic rise definitely looks like a peak, now that we've seen a big pullback. Gold should find support at its 50-dma at $630 and get a bigger bounce off it but I believe gold will correct over the next many weeks down to $600 and possibly to the longer term uptrend line near $550 (which is also the level of the previous 4th wave and the 2nd wave of the extended wave-5 on the chart--these are often good retracement targets in a pullback).

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

The Personal Spending and Income numbers tomorrow will tell us how well the consumer should be able to do in the spending department (which drives GDP). If earnings are up but spending is down then we'll know more money is going into savings. That would be good for the consumer but bad for the economy, at least for the short term. Pumping up the nation's savings rate would have longer term benefits. The Michigan Consumer Sentiment should not have any surprises.

As mentioned briefly in the beginning of this report, the internals looked strong today. Advancing volume and issues swamped declining volume and issues, nearly 6:1 on the volume and 3:1 on the issues. Total volume was respectable. One of the measures that seemed out of place though was the number of new lows which actually exceeded the new highs. There may have been some unloading of stocks during today's rally, not a good sign if true.

Sector action was good across the board. The only red sector was the SOX. The green sectors were led by gold and silver, energy (the commodities got a good bounce), securities broker, biotechs and some other techs.

There's a little bit of a mixed picture between the different indices and sectors but there seems to be general agreement between most of them. The picture that I get is that we'll see a sideways/up correction to the steep decline we've had, or it might even just go sideways (meaning another pullback tomorrow) before continuing lower. We almost always have a bullish session going into holiday weekends and by that measure we should expect at least a mildly bullish day tomorrow. It might be a quiet trading day if a lot of traders abandon the market early to get their holiday weekend started early. Certainly as oversold as we are I would expect either time or price or a combination of both to correct the decline. The choppier the bounce the more bearish it will be. It would indicate another drop is right around the corner.

Today's bounce was pretty strong but seemed to lack the intensity of past bounces off deeply oversold conditions. I sensed a real lack of program buying and instead it seemed a lack of selling which let buyers back in but there was no pell-mell rush to buy. That's a change in character from past rallies and could be quite telling. I'm thinking surprises will be to the downside so be careful if you're long or trying to buy pullbacks here. The pullback could get away from you quickly. Do not assume it will come back since the next leg down (if that's what's coming) will be a doozy.

But again, I suspect tomorrow will be slow and slightly bullish. At least that would be typical. But I see resistance just overhead and a quick pop in the morning could run into a brick wall. The short side could be tough for day traders tomorrow but the long side may not gain much traction either. Come to think of it, sounds like it might be a good day to take off and start that holiday weekend. Good luck tomorrow and I'll see some of you on the Monitor. For everyone else have a great holiday weekend and I'll be back with you next Thursday.

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