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Market Wrap

The Market Got Hammered

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As I had discussed last Thursday, there is major concern by investors of a global economic slowdown due to a global contraction in liquidity. Japan fired the warning shot across the bow when it announced a couple of months ago that they were seriously considering ending their zero-rate [interest] policy (ZRP). Many savvy investors have been borrowing yen to invest elsewhere since any gains on their money was immediately profitable. This in effect flooded the global market with free money. The Bank of Japan's (BOJ) policy board will be meeting June 14-15 to decide what to do with their interest rates and it's widely believed they will raise rates. Of course after the blood bath in their stock market this week nothing is a given.

Japan's free-money policy has of course been exacerbated over the past several years with huge liquidity injections by our own Federal Reserve bank (since we have the unique ability to create money out of free electrons--you know, the ones emanating from the dead brain cells of our politicians, but I digress). Other countries with their low interest rates have aided and abetted this liquidity push as well. And now all of a sudden everyone seems to pulling on the reins together to get this runaway stagecoach to stop.

Once the free-money well dries up we will experience the removal of huge sums of money from the capital markets. Recently many countries have raised their interest rates in an attempt to stop inflation. Higher interest rates put a squeeze on credit availability which in effect removes even more money from the global economy. Within the last 24 hours we've seen interest rate increases from the European Central Bank (ECB), South Korea, Turkey and India. The Bank of England (BOE) left interest rates alone but are expected to raise them soon. Our Fed governors have been out in full force this week to ensure the market understands that the Fed is tilting towards further rate increases (or at least that's what they want the market to believe--called jawboning). The ECB is expected to raise rates again next month. It seems the world bankers have agreed on the need for speed; the speed of interest rate hikes that is.

The resulting liquidity contraction is having a very negative effect on worldwide markets, and not just in equity markets. The commodity markets are getting slammed. After running up into parabolic peaks (can you say another bubble?) it didn't take a genius to figure out what was going to happen next. Gold is down $125/oz (-17%) in less than a month. In the same time silver is down over $4/oz (-27%). Copper, a measure of industrial needs, is down -17%. Lumber, a great measure of construction needs, especially housing, is down more than -20% from its January peak and almost -15% from the end of April's bounce. This speaks volumes about our slowing economy even if the Fed wants to remain in "data" mode and wait until the horses leave the barn before closing the door.

Foreign markets took a bath today as well. Japan's Nikkei 225 index plunged 3.1% to its lowest level in 6 months and its largest 1-day drop in a year. The Nikkei is down almost 8% just this week. Hong Kong declined 2.3%, India down 4.7% and Korea -3.5% to a 7-month low. The London FTSE was down -2.5% to 5563, making it its lowest level for the year and its 2nd worst 1-day decline this year. The German DAX and Paris CAD-40 were both down -2.9% Therefore with all the foreign markets down so hard it was little wonder that our markets followed suit and pushed equities down to levels not seen since last November for the S&P 500 and Nasdaq, and February for the DOW.

But then a curious thing happened. The bulls couldn't stand it any longer and just had to buy this "dip". The DOW recovered more than 200 points off its low and closed 180 points off its low. The S&P 500 climbed 22 points (equivalent to 220 DOW points) off its low. Both closed marginally in the green. It was a classic v-bottom and in the process left bullish hammer candlesticks at support, which I'll show in the charts. In fact some of the candlesticks are even more bullish dragonfly dojis with small green bodies. The bulls couldn't ask for a much better green light here. But was today's bounce just a way oversold dead cat bounce? Too early to tell.

I'm going to take a little time tonight and show, in addition to my normal charts, a couple of longer term charts to show two possibilities that are playing out here and some levels to watch in hopes that we'll get some clues as to how to play this market from a longer term perspective.

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First let's review the two economic reports out today--jobless claims and wholesale inventories. Needless to say the market paid no attention to them, or even to the news that Zarqawi and his marauding band of terrorist leaders were taken out with a couple of well-placed guided bombs. I can only imagine the glee in the soldiers who watched (probably with laser guidance) as the house was blown to smithereens. May they face their own justice now withOUT their 40 virgins.

Initial claims for unemployment benefits fell by 35K last week, from the previous week's revised figure of 337K, to 302K, well below the 330K economists were expecting. The 4-week average of new claims fell by 5,750 to 327,750 which was slightly above expectations.

Wholesale inventories rose 0.9% in April which was higher than expectations for a 0.5% gain. But sales rose faster than inventories, up +1.3% in March, which was the largest increase since last September. Therefore the inventory-to-sales ratio dropped slightly to 1.16 months in April from 1.17 in March, matching the record low in January. Sales of nondurable goods increased 2.9% in April, also the biggest gain since last September. These were good numbers. Too bad no one was listening. I suspect more than a few people punched out of their long positions this morning to then only watch as the market completely recovered. Only time will tell whether or not you were right to liquidate and protect your account. I think it's always a good idea to protect your account no matter what the market does after you do that--the time you don't liquidate will be the time the market keeps going against you; trust me, I know.

Let's review today's charts and then at the end I'll review some longer term charts and possible price paths for us to watch for.

DOW chart, Daily

Hammer #1. That tiny little green body on top of this hammer candlestick pattern is bullish when it's at strong support, as the 200-dma and the March 2003 uptrend line are. Price swung down through support, nailed a few hundred thousand stops and then reversed in a v-bottom and recovered 180 points off the bottom. Not a bad performance. Now we need to see follow through otherwise this will have been just a wicked dead cat bounce that stopped out a bunch of shorts. Volatility has returned with a vengeance so don't let a one-day move make you think that's the new direction.

SPX chart, Daily

The SPX also left a very bullish dragonfly doji but it's not in as bullish a place--lots of space below. It also wasn't able to regain its lost 200-dma. First hurdle for the bulls tomorrow is its downtrend line from June 2nd, just above its closing price at about 1261.20. If it can rally above Wednesday's high of 1272.47 then the higher high will tell us the bulls are putting something together here. If instead this drops back down below today's low, the bottom will likely fall out and we'll see a very sharp and fast decline. It's a wide range to wait for some clues in this regard but welcome to increased volatility.

Nasdaq chart, Daily

Another nice hammer on support which is the uptrend line from August 2002 just above 2100. While not clean, the decline from the April high can count complete for a 5-wave move down. If true that's important because all 5-wave moves are followed by a correction (if not reversal) of that move. That would suggest we'll get a bounce at least back up to the 200-dma. This morning's low is a must-hold otherwise we have a potentially much more bearish wave count in progress. Like the SPX, the levels we need to watch are yesterday's high and this morning's low. It's a wide range but until one of those breaks we really don't know which way this market is headed.

QQQQ chart, Daily

Take note of the bold (a)-(b)-(c) EW labels on this chart because it could be an important labeling for the bulls. As I'll show in the chart of the COMP at the end of this report, it's possible that today's decline finished the pullback that will now lead to a summer rally to new market highs before the big, long bull market is officially dead. By essentially testing October 2005's low and leaving a bullish hammer in its wake today, we might have seen the end of the pullback from January. However, it's equally possible in my mind that the current leg down, from June 2nd is just getting started (in which case we'll see 36 in a heartbeat). Today's low must hold or else the bulls are in serious trouble (from an EW perspective).

SOX index, Daily chart

I don't see enough in this chart to get me bullish. All kinds of support levels have been broken, it's in the middle of space and I haven't seen any bullish divergences to tell me the selling is losing momentum. In light of this, today's bounce was just a dead cat bounce. If we get some follow through to the upside that climbs above 480 I'll change my tune.

IBM chart, Weekly

Another bearish chart--this time we're looking at a weekly chart of IBM. The break of its uptrend line from October 2002, the break of its January low and its inability to get much of a bounce today with the rest of the market, or off its September 2005 low, makes me think this decline has just gotten started. Weekly stochastics is heading down hard now. It could be entering a 3rd of a 3rd wave down here. I'm a seller of IBM based on this chart.

BKX banking index, Daily chart

The banks can't get off dead center if dead center is defined as the 50-dma. Look at that mess of candles clustered around that moving average, and the October uptrend line. This choppy consolidation looks like a continuation pattern. Once it's complete it looks like it's going to let go to the downside. The securities broker index gives me the opposite impression though

Securities broker index, Daily chart

Giving me the opposite impression to what I see in the banks, the securities broker index looks like it could be finishing a 5-wave move down from its high, and doing so at its 200-dma. This index gave us a great heads up the broader market was in trouble so we'll watch this one. A rally above 220 would tell us that at least a multi-week upward correction is in progress.

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

I had mentioned last week that a break below the bottom of its intersecting parallel channels would likely see a spill to lower levels and it's looking like that's what we're getting. Other than that dinky little hammer candlestick today, in the middle of space, I see no reason not to expect this to continue lower. No bullish divergences yet. Sell the rallies still.

Oil chart, July contract, Daily

It's taking forever but oil is still chopping its way lower as I have been expecting it to. If and when it reaches its uptrend line and/or 200-dma I could be interested in buying oil or the stocks. But that will depend on the broader market at that point. If the global economy is really slowing down, as I believe it is, the demand for oil could drop drastically.

Oil Index chart, Daily

Oil stocks got slammed with the rest of the market today but also did a very nice recovery into the end of the day. Very bullish dragonfly doji at support and stochastics has barely registered the turn back down this week. Seeing nothing else I'd be a buyer of this chart.

Transportation Index chart, Daily

If the Trannies can get some follow through to the upside it could leave a bullish divergence on MACD. But I get the feeling on this one that it will only be good for a bounce before turning lower again. It takes a rally above 4800 to prove me wrong on this one.

U.S. Dollar chart, Daily

The US dollar got a strong bounce today and actually this week. But I think it's just the ending move to an a-b-c bounce from its May low. Upside Fib projection, 50-dma and a broken uptrend line all around the $86.50 area tell me that could be the target and the end of the bounce. It should then drop to a new low but I continue to believe the $83 level will set up a longer multi-month bounce in the dollar.

Gold chart, August contract, Daily

Gold, like so many of the other commodities, is suffering a rapid withdrawal of money from an over-inflated run up in prices. It is down $125 in less than a month (-17%). Silver is down -27%. Parabolic rises have sharp declines and this is it. Now we wait to see if support around $600 kicks in. There's also a Fib projection for two equal legs down in its decline at $588.70.

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

There's nothing exciting about tomorrow's economic reports and should not affect how the market opens. I suspect we'll be more influenced by what the overseas markets do, which should be up if they follow today's U.S. equity markets.

A quick review of the sectors today leaves a mixed message, kind of like the flat finish we had. You wouldn't know it by looking at the sectors what happened intraday. Looks like a boring flat day. The losing sectors were led by gold and silver, internet, networkers, software and some other technology. The green board was led by biotechs, healthcare, disk drives, retail, the oil index and financials.

Looking at the numbers in the table at the beginning of this report doesn't really show what happened today since this morning's numbers looked more capitulatory than anything else. This morning's lows saw huge down volume and declining issues vs. up volume and advancing issues. But take a look at total volume--it was huge today and certainly smacks of some kind of bottom put in today. The number of new lows is not capitulatory but then we could only be looking at an intermediate bottom vs. a bottom after a long decline. The put/call ratio is also up in the territory that has marked lows.

So we're left to wonder whether today was an important tradeable bottom or if the bounce off today's low just a dead cat bounce. This leads me to a review of some weekly charts that I wanted to show that have two different EW counts on them, one bullish for the summer, the other bearish for the year, having already started the next big leg down. Starting with the COMP, which in my mind has the best chance for a summer rally, look at the following weekly chart and the large ascending wedge since January 2004:

Nasdaq chart, Weekly, More Immediately Bearish

There's a big ascending wedge from the October 2002 low and I've got it labeled as a complex double zigzag wave count. This only means there are two A-B-C bounces separated by a middle wave that is labeled 'X'. This wave count makes up a larger degree wave-(b) (bold on the chart) that offsets or corrects the 2000-2002 decline which is wave-(a) (bold). This chart and one below are labeled the same as far as the wave-(a) and wave-(b) go except where wave-(b) is.

The chart above, which I label as "More immediately bearish" says the correction to the 2000-2002 decline has finished and that we've just begun the next big leg down in the secular bear market. If I use this interpretation then today's bounce was just a dead cat bounce and we should prepare for a lot more downside. In this case I would expect Wednesday's 2184 high to hold. In fact the downtrend line from June 2nd, currently at 2160 will probably hold back the bounce.

Nasdaq chart, Weekly, Intermediate Bullish

There's a slight difference on this chart. The ascending wedge pattern is for price action starting from the January 2004 high. This means we'll have a "standard" A-B-C correction to the 2000-2002 decline. Often times wave-C forms what's called an ending diagonal and is essentially an ascending wedge (or descending wedge in a decline). These wave-C wedges have 5 internal waves, each made up of 3-wave moves. What that all means is that the internal action inside these wedges is notoriously choppy and difficult to trade. Would that adequately describe trading over the past 2+ years? At any rate, the current pullback may in fact be finishing up the 4th wave of this wedge.

If that's true then we need the 5th wave yet and that's what's depicted on this chart. It says we'll have a choppy rally through the summer which will take us to new market highs. I can only imagine the excitement of the bulls and the disgust of the bears. It would be a perfect setup for the market to turn down into the end of the year (maybe a little Q4 bounce). I actually like this scenario and think it has a lot of merit but what it needs is for today's low to hold. If today's low gives way, throw this chart out the window (make a paper airplane out of it first).

The following charts of SPX show exactly the same setups just to show this will not be just a tech show.

SPX chart, Weekly, More Immediately Bearish

I've added a price depiction to this chart to show what I mean by more immediately bearish. This would be a typical wave count for a decline, one that is just getting started if this scenario is playing out. I could be off on the timeline (hard to squeeze it in on the chart without mashing it all together. My expectation, by this scenario, is that we'll see a decline into the fall (Sept/Oct time frame) to finish wave-1 down, and then an a-b-c rally into the end of the year to finish wave-2. That would set up a hard decline in wave-3 as we enter the new year in 2007. This actually fits some longer term cycle studies very well.

SPX chart, Weekly, Intermediate Bullish

This one is just like the chart of the COMP--a choppy rally through the summer and then the start of the new bear market in the fall. In order for this scenario to play out, this morning's lows must hold. If SPX drops back below 1235 I'd say hang onto your, um, hats as it could get wild to the downside. If we get a rally above Wednesday's 1272.47 then there's a good chance we've got something bigger starting to the upside. Any rally above 1295 and we've got something seriously more bullish. There's a wide range there before we'll know for sure (as sure as we can know anything) which scenario could be playing out here.

As we continue from here I'll keep these charts updated and use them in my weekly review. If things change before my Thursday Wraps I'll be posting on the Monitor for those of you who follow that. It could get interesting soon. But understand that if its the intermediate bullish case that we'll be starting from here, you'll have a continuation of the choppy sloppy patterns to try to trade. And this time we'll mix in slow summer trading with it. Ugh, I think I'll go on vacation now if that's what we're headed for. Good luck tomorrow as we figure out what's next. I'll see some of you on the Monitor.
 

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