Option Investor
Market Wrap

Biggest Up Day Since Spring 2003!

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That's what the headlines are after today's rally. Believe it or not, it's actually better for the bulls if the rally sneaks up on the market. These fast sharp moves higher actually smack of short covering, as in too many bears were caught on the wrong side of the market in their post-FOMC expectations. But that's just a heads up for what today's market might have been.

Let's not throw cold water on the bulls yet. They had a great day today and should enjoy it. The DOW, up 217 points today, had its biggest up day since April 2003. If you'll remember, March 2003 marked the low for that year. The Nasdaq had its biggest up day, +62 points, since the March 2003 low, and the same is true for SPX, +27 points today. The SOX, after testing its 200 weekly moving average yesterday, had a very big day--up +17 for a 4% gain today. The Transports were up +160 for a 3.3% gain. All in all it was a very bullish day.

The internals of the market supported today's prices, mostly. Advancers handily beat decliners almost 5:1. Advancing volume beat declining volume better than 10:1 (that actually borders on blow-off). But interestingly, new 52-week highs were beat out by 52-week lows 227 to 233. These kinds of numbers tell me this is probably a bear market rally instead of the start of something bigger to the upside. That's a heads up to those who are long the market.


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The plus for the bulls today was the fact that the equity put/call ratio was higher than normal. This says there were a lot of non-believers in today's rally, which is exactly what the bulls want to see. At best I think we're in for a choppy rise through the summer. At worst (for the bulls) the current rally is an end to a 3-wave advance off the June low and we're getting ready to resume the decline that started from the May high. The very negative setup, if this bounce is all we're going to see, is that we're getting ready for a very hard down move (from an EW perspective).

I will once again update the SPX weekly charts at the end of this report to show where we are in the bigger picture. While we don't have an answer yet as to what we can probably expect for the summer. The completion of the 3-wave advance will be when we watch carefully for the next move. It'll be the next move--choppy sloppy pullback or sharp decline--that will give us the clues we need for what follows.

First let's get to today's economic reports, of which there were a few. Starting off we had the unemployment numbers. New claims were up 4K to 313K which was slightly above forecast for 310K. The previous week's number was revised up to 309K from 308K so actually the new claims were up 5K but what are 1000 unemployed people to government bean counters. The 4-week average was dropped by 6,000 to 305,500 which is the lowest number since February. Continuing claims rose by 54K to 2.41M but the 4-week average dropped by 2,750 to 2.40M. That's the lowest number for the average since January 2001.

Help-wanted ads in U.S. newspapers fell in May to 33, down from 35 in April and also less than the expected 35 for May. That compares to 38 a year ago. I'm not so sure this is an accurate measure anymore. Perhaps they should look at places like Craigslist.com and of course the other online sites. But if the measure is correct, it's an indication that businesses may not be as optimistic heading into the 2nd half of the year. The ads declined in al nine regions of the U.S.

The final number for GDP for the 1st quarter showed a strong growth rate of 5.6%, the fastest rate in 3 years. This follows an anemic growth rate of 1.7% in Q4 of last year. Economists are expecting growth to moderate some and come in closer to 3% for the next few quarters. The improved growth rate was helped by the mighty consumer, business investment in equipment and software, an improvement in the trade deficit and higher federal government spending.

Consumer spending rose 5.1% making it the fastest pace since Q3 2003. It made up 3.5% of the 5.6% GDP growth. Spending on durable goods rose 20.3% after dropping by 16.6% in Q4 so that was a nice reversal. Business investment increased at a 14.2% rate in Q1, which was the fastest growth in 6 years and it contributed 1.5% to GDP. Corporate profits were up 11.9% for the quarter as compared to a year ago, and up 28.5% year-over-year, the fastest annual growth rate in 22 years. This obviously helped them improve their investment picture. Exports were up 14.7% while imports were up by a lower amount of 10.7%. This is what helped our trade deficit picture. The accompanying chain deflator, a key measure that the Fed uses to check inflation, came in lower than expected at 3.1% vs. 3.3%.

The big news for the day was obviously the FOMC interest rate announcement. No surprise they raised rates .25%, the 17th in a row, to 5.25%. Many economists expect they'll raise rates again in August or September to 5.5%. There were significant changes made to the FOMC statement which basically stated they will be forward looking and not as concerned about what has happened in the past. This was probably done to assuage the market's concerns that the Fed is going to go too far, as they've always done (and will probably do again). Whether this sounded bullish to the market, or whether the market was just ready to rally regardless (which is what I believe), equities shot higher after the announcement and it had already been up nicely. There was no sell-the-news event post-FOMC this afternoon.

The FOMC announcement said that further rate hikes would depend on their outlook for inflation and growth. They believe "some inflation risks remain," even as economic growth cools. They look at productivity improvements and the slowing in the housing market as having a cooling effect on inflation and growth. This is what prompted many to believe that that means the Fed is going to stop their rate hikes while they wait to see what happens next. But isn't that what the market thinks after each rate increase? Pardon my cynicism about the market's expectations. Like I said, I think the market just wanted the FOMC announcement out of the way so it could get on with its buying. After all, we've got some window dressing to do and get it done quickly before the month/quarter ends tomorrow.

Every DOW component was in the green today. The laggard, Big Air (Boeing--BA) was up only 0.43% while the leader was McDonalds (MCD) which was up 5% after getting an upgrade. Let's see what the charts look like.

DOW chart, Daily

Just as I will show two different scenarios, one more immediately bearish the other intermediate bullish, at the end of this report, I'm showing the start of the intermediate bullish scenario with this chart (the next chart, SPX, shows the more immediate bearish wave count). Notice the pullback from the May high is clearly a 3-wave move. That's the definition of a correction, in this case a correction of the longer term rally. This says we'll see the DOW work its way higher through the summer to new market highs. The first thing the DOW needs to do though is get through some potentially tough resistance. Obviously the 50-dma, which is where the DOW stopped today, needs to be recaptured. A kiss goodbye here would be very bearish. The market moves in measured steps and if we look for where we'll have two equal legs up from the June low that's at 11355 so if the 50-dma doesn't stop the rally I'll be looking for that level as an upside target for now.

SPX chart, Daily

SPX has a similar looking chart to the DOW but a tad weaker. As opposed to the EW count for the DOW I show a very bearish setup here. Instead of a 3-wave pullback from the May high, this wave count shows a 1-2, 1-2 wave count to the downside. This says get ready for a very fast and very hard decline right around the corner. I don't know yet which will happen--the DOW's wave count or SPX's--but we should be close to getting some clues after this bounce finishes. For now SPX has resistance where it stopped today--at its broken uptrend line from March 2003. Just above is its 50-dma at 1276.74. And unlike the DOW, the SPX is already close to the point where it will have two equal legs up in its bounce--at 1276.94. Therefore the 1273-1277 area is tough resistance by few different measures and the bulls will have their work cut out for them. A decline from here, or after a touch of the 50-dma would look very bearish (kiss goodbye against solid resistance) and the bearish wave count on this chart says you do not want to be long this market. Now we wait for some clues.

Nasdaq chart, Daily

The COMP continues to look weaker than the DOW and SPX because it's under both its 50 and 200-dma's, with the 50 crossing down through its 200. Not bullish. Two equal legs up in its bounce off the June low is at 2175 so from there up to its 50-dma, currently at 2213 but dropping fast, could be tough resistance for the bulls.

QQQQ chart, Daily

The Q's look like they're set up for another drop to a new low but I don't get the same bearish picture out of this as I do for SPX or the COMP. The way this will turn more bearish is if it consolidates sideways for another month or so. But so far it's looking to me like a new low should be followed by another larger bounce. The SOX gives me a similar impression.

SOX index, Daily chart

The leg down from April did a near-perfect tag of its Fib projection at 422, and also tested its 200 week moving average yesterday at 425. I don't show that here but take a look at a weekly chart with that average and you will see that over the past several years that has been a very important average to keep your eye on. It has either used it for support or resistance and it's currently acting as support. A drop below 425 that stays there on a weekly closing basis would be a strong sell signal. But until that happens I actually like the setup on this chart for a long play. The problem is there is a lot of disagreement between important indexes, and like the picture between the DOW and SPX, or between the two weekly charts of SPX at the end of this report, we'll need some more clues to help establish a better picture for what the market might do this summer.

BIX banking index, Daily chart

We'll get to see if the banks are going to ping-pong between the 200-dma, which it bounced off of at the June lows, and the 50-dma just above at 378.31. The bulls will want to see price consolidate at/around the 50-dma. The bears will want to see a sharp rejection of price there.

Securities broker index, Daily chart

This chart is one of the cleanest from an EW perspective. The decline from its April high to the June low looks like a clean 5-wave move. That's impulsive and that sets our trend--down. The current bounce should be a correction to that decline and then we should get another leg down to at least match the April-June leg. After breaking the steeper uptrend line at the end of April, and then testing it in early May, we had an ideal sell signal there. Now we could be setting up for the same signal at the most recent broken uptrend line from May 2005, currently at 214. Just above this line is the 50% retracement of the decline at 216. The 50-dma is at 217. These combined will make for a very difficult time for the bulls. I would say of all the charts I reviewed tonight, this one makes me the most immediately bearish. Based on this chart, and using it as our canary in the coal mine, I'm seeing the canary starving for oxygen here and is about to keel over.

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

As expected, the home builders have been consolidating near the low and the current bounce is a very choppy sideways/up correction (bear flag). This is a classic correction of the decline. It has found resistance at the bottom of the down-channel that it fell out of. This is very typical. This is a short play waiting to happen.

Oil chart, August contract, Daily

Looks bullish to me. The longer term uptrend line held the test while the shorter term downtrend line, and the 50-dma, has been broken to the upside. We could see a pullback to retest either the 50-dma or broken downtrend line but if it holds, and I suspect it will, it will be a good place to buy oil.

Oil Index chart, Daily

If I'm leaning bearish the broader market (which I am) how can I be bullish on the oil stocks, as the price depiction on the chart shows? Good question. It's one of the reasons I'm not whole-hog bearish the market. There are too many indexes like this one that challenge my bearish opinion. It's why I'm keeping myself honest and waiting for the next move (explained more at the end of this report) to give me some clues for the summer. But based on this chart I'm thinking a consolidation will follow and that will be a time to buy. Stay long if you're already long.

Transportation Index chart, TRAN, Daily

And here I thought we had seen the high for the year in the Trannies. But nooo, it has to pull a bullish rabbit out of the hat and give us only a 3-wave decline from the May high. By rallying above the bounce high from early June, it has confirmed the pullback from the year's high as just a correction of the longer term rally. That says we should expect new highs. We might form a big sideways correction that lasts months but regardless, we should expect new highs in this index (and that should be the last one, really really this time). This is another index that's keeping me from getting super bearish the broader market.

U.S. Dollar chart, Daily

As expected, the US dollar tested its broken uptrend line and found it to be resistance. Nice kiss goodbye there with a sharp drop today post-FOMC. We should now see the dollar start another leg down and we'll see if the $83 area provides more solid support which is what I'm thinking will happen. The decline in the dollar may help give gold, and other commodities (like oil and oil stocks), a lift. Gold certainly got a nice bounce today.

Gold chart, August contract, Daily

On the daily chart gold's $20 bounce today doesn't look like much. That's because it's being compared to $150 swings before it. The trouble I see for gold bugs is that the bounce off the June low is looking like a correction to the hard decline. I'm thinking it will fail at or below its broken uptrend line from November 2005, currently near $560. Whether it finds support at its uptrend line from last year, which would be a retest of the June low, or drops to a Fib projection at $531 is hard to say but I don't expect much lower before we see a much larger bounce back up.

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

Tomorrow's economic reports could be market moving if they come in much different than expected. But it'll be Friday, a summer Friday at that, and after today's strong rally there's a high probability that no one will care about the reports. A consolidation day would be a typical day tomorrow.

Sector action today was all bullish--not one red sector on my list. Leading the pack to the upside were gold and silver, networkers, oil service (OSX), securities brokers, SOX, biotechs, airlines, Transports and many of the tech indexes. At the bottom of the green pile, pulling up the rear were utilities, banks, retail and the oil index. But even the laggards were up better than 1% with some approaching 2%. Everyone caught some money showering down on them today.

It's time for our big picture update. I'll continue to monitor both EW scenarios, using the SPX weekly charts, until one becomes the winner. We could be close to getting the clues we need in order to determine the winner. First up is the bearish picture.

SPX chart, Weekly, More Immediately Bearish

Referring to the daily chart above, it has a bearish wave count that says the decline from this year's high is a 1-2, 1-2 wave count to the downside. That calls for a 3rd of a 3rd wave down and those are the fastest and strongest waves of the bunch. It will border on a market crash. From a weekly perspective, the price depiction on the above chart is what it would look like, maybe worse. I show a wave count that says we'll see a larger degree 1st wave down of the new bear market that will get us back down to the April 2005 level near 1050 and it would likely happen before the end of the summer. From there we'd see a huge corrective rally (wave-(2) on the chart) that takes us into early 2007 and probably back up to around 1150 before setting up another very large decline into the rest of 2007. Here's a little closer view of this, using the daily chart.

SPX chart, Daily, More Immediately Bearish

Looking at the weekly chart with a closer view I show what the decline might look like. If it becomes more certain that this is the path we're on I'll use this daily chart to track our progress through the summer. But the bullish alternative says this scenario just isn't going to happen.

SPX chart, Weekly, Intermediate Bullish

This weekly chart shows an larger ascending wedge from 2004 and the need for another 3-wave move up to finish it (all of the 5 internal waves of a triangle consist of 3-waves and that's why wave-(v) on the chart will be a 3-wave move). These patterns are filled with choppy price action and I know we'd all agree that's all we've seen for more than two years now. If this depiction is correct we can expect more choppy price action through the summer as the market heads for new highs into the fall. That would then be the end of the bull market but for now, if this one is correct, it's too early to think long term short.

I'm waiting for some clues as to which scenario is playing out. If the "intermediate bullish" scenario is playing out then the current bounce will be followed by a choppy sloppy sideways/down pullback. That would tell us to expect higher and it would increase the chances for a bullish summer (hard to trade but bullish). On the other hand if the current bounce is followed by a sharp decline that takes out this week's low (1237 for SPX), then the "immediately bearish" scenario gets the nod. If that happens you will not want to be long this market. Get short, stay short into the fall, and enjoy the ride of your life. Hopefully we're close to getting our answer

For tomorrow I don't expect much. After a big rally like today it's common to get a consolidation of the move. It being a summer Friday will only add to the potential boredom for the day. The move up from this week's low looks like it needs a consolidation followed by another new high (could be an equal or minor new high) so I don't like the setup for shorting it here (for scalpers). But next week, after this leg up is finished, that's when I'll be watching carefully for clues as to the above longer term question. Good luck tomorrow and I'll see you either on the Monitor or back here next Thursday.

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