Option Investor
Market Wrap

Grinding Higher

Printer friendly version

A look at the past few days shows a market that wants to rally but is having a hard time doing so. It was looking like some big funds may have been trying to distribute stock since small rallies were quickly sold into. It didn't prevent the indices from moving higher the past week but whenever I see overlapping choppy rallies it's a good signal that it's probably not a rally that's going to last. You usually see negative divergences associated with new highs and that's been true all this week.

After last week's sharp rally on Wednesday and then a sharp decline into Friday we've seen the market attempt to push higher. With a price pattern that looks ready for a deeper pullback I'm getting the feeling that we're going to just consolidate in a big sideways move through the summer. This would be typical anyway since we don't usually have enough buying or selling power to really move the market. If you've been following my commentary for several weeks you know that I've been following two possible scenarios to try to determine what the longer term picture will look like.

With the summer months upon us I've been thinking it's too early to expect any kind of major market decline. Again, without a significant catalyst it's just not likely we'll see a large decline, which is what the "immediately bearish" scenario suggests we'll see. For that reason I've been speculating that we'll see a choppy summer rally instead. But now I'm wondering if we'll get something in between--a big sideways consolidation through the summer which would set up a large decline in the fall. It certainly fits the "seasonal" picture. I'll show how that might look in the SPX daily chart below.

The grinding move higher the past week is one of the reasons I'm starting to lean to this in-between view. The internal price action (3-wave moves) suggests consolidation rather than a directional move. This is speculative at the moment but if the current rally leads to another pullback to near the June-July lows we'll probably see another push back up before the market is ready to roll over for good (in keeping with my longer term bearish outlook for the market).


31 Closed Trades; 28 Winners

Jonas Ferris picks good companies whose insiders are buying, too. With this record, it's easy to see that tracking insiders works; now see how we make it easy.


The pundits (including me) all have their views of the market and why it does what it does. For me, rather than look for excuses as to why the market rallied or why it sold off, only to reverse that action with the same kind of news the next time, I look for price patterns to tell me which way I think the market is going to go. This is the basis for Elliott Wave Theory and I believe is better than trying to guess how the market will react to certain news or even to other technical indicators such as trend lines and moving averages.

The speculation about what the Fed will or will not do with interest rates is beyond old. After the past many rate increases the speculation always comes back to whether or not the Fed is done. And when the market participants think the Fed will be done, the market rallies (or so we're told that that's why the market rallied). This is of course very perverse. The Fed will stop raising rates when they see the economy has slowed down enough. And when the economy slows down so do companies and their growth rates. And when companies' growth rates slow down their stock prices usually get punished.

When you look at the facts and see that the market is consistently down 6 and 12 months AFTER the Fed stops raising rates one must wonder why we constantly hear the market will rally on news the Fed is going to stop. My theory (and I'm a bit of a conspiracy theorist on this) is that the Big Boyz of course know this and they perpetuate this notion that the Fed stopping raising interest rates is a good thing for the market. They then use the ensuing rally to offload their inventory to the poor saps who buy the market at the high. When the Fed announces they will pause/stop their rate hikes, and the market gets a monster rally, you will want to unload your inventory with the Boyz and get short.

I digress but I really think this is important because we're probably very close to seeing the Fed put the breaks on. It's all a matter of how much they want to economy (and housing) to slow down before they're happy. They know full well the economy is already slowing but we don't know how far they're willing to take it. Into a recession is my bet.

This brings us back to the larger price patterns I'm seeing in the market--we got the big drop from the May high and if we now consolidate through the summer it will be a setup for another big leg down this fall. The timing for a market dump in Sept/Oct is setting up. In the meantime if you're trying to trade this market you'll need to understand that it's a scalpers market. While you can get some nice multi-week swings you won't be able to hold onto those long or short plays without giving it all back again. Trade in and out and keep taking small profits in order to slowly build your account. Selling credit spreads has been working because they take advantage of a market that doesnt go anywhere. Directional players have been losing unless they take profits regularly. That will probably continue through the summer is the way I see it.

Before reviewing the charts there were some economic reports worth reviewing. The durable-goods orders number rose by 3.1% in June which was considerably stronger than the 2% expected by most economists. This was led by a strong surge in transportation orders (up 52.1%) on aircraft and ships (defense related). Without the transportation orders the durable goods number would have been +1.3%. While the durable goods number has been up in 4 of the past 5 months, the not-so-good news is that capital equipment orders have been dropping, up only +0.4% for June and down from May's +1.3%.

Capital goods orders are a sign of companies' outlook for the future. Even if they have lots of cash they won't spend in on upgrades or new equipment if they see a slowing in demand for their products. Orders for core capital equipment were up an annualized +3.2% for Q2 which was the smallest gain in the past 6 quarters. Purchases of equipment and software was down to an 8% pace (still good) for Q2 from Q1's +15% pace. Some of the durable goods rise of 3.1% was in inventory so the sales to inventory levels will have to be monitored carefully over the next few months.

Unemployment claims fell by 7K this past week to 298K so back under 300K. This is below expectations for 310K. The 4-week average also fell, dropping 4,250 to 312,750. Continuing claims fell by 23K to 2.47M. The Help-Wanted Index for June stayed the same as May's at 33 and was in line with market expectations.

Lastly, we got the New Home Sales number for June which at 1.13M annualized rate was down slightly from May's 1.17M and below expectations for 1.16M. This equated to a 3% drop in June. Revisions to prior months lowered the numbers and make the housing market even weaker than previously thought. Year-to-date sales are down 11.9% and down about 18% from last summer. The home-builder survey has dropped significantly further, down 46% in the past year, and that suggests new home sales have much further to drop in order to match up.

Unsold home inventory continues to rise--up by 0.7% to a 6.1-month supply from May's 5.9-month. Home not yet under construction represented 19.1% of the inventory and is the highest since 1991. Inventories have climbed +24% year-to-date and builders are offering all kinds of incentives to move product. Their stock prices have of course reflected concern by investors. They are cutting their profit outlooks on a monthly basis at this point, especially with cancellations rising.

Of course it won't be only the home builders who will have to cut their growth/profit objectives. As the economy slows down we'll be seeing everyone and their brother cutting expectations. We'll have to wait and see what the common excuse will be. The oilman ate my profits is my guess.

On to the charts.

DOW chart, Daily

The DOW got a bounce back above its 50-dma but seems to be stalling at about the same level above this moving average as the last time in early July. Those shadows above the candlesticks are bearish. Today's dojo, or more bearish shooting star, is a negative omen for tomorrow. But the candlestick pattern needs a red candle tomorrow to confirm the bearish picture. The negative divergences at each of the new highs this week supports the idea that this is ready for a turn back down. The March 2003 uptrend line and 200-dma just under 11K will likely offer some support for at least a bounce.

SPX chart, Daily

SPX is doing the same thing as the DOW with an attempt to push back above its critical moving averages but it's not very convincing in the way it's doing it. The internal price action (3-wave moves) is leading me to believe we're going to consolidate for at least another month and probably two months. I've drawn in a potential sideways triangle pattern that I think will play out. It suggests we'll see price turn back down and head for the bottom of the pattern near 1230. From there, perhaps in mid-August, it should turn back up to the top of the pattern into September. That would be the conclusion of the triangle pattern (waves a-b-c-d-e) and would be a great setup for a longer term short play. I would expect a leg down at least equal to the one from May to June (over 100 points, or 1000 DOW points).

Nasdaq chart, Daily

After finding support at the October 2005 low the COMP hasn't made much of the opportunity to bounce away. The longer it consolidates down near the low the more bearish it will become. Watch the downtrend line from May up near 2120 if it rallies up to there. But I'm not so sure it will make it even up that high. Maybe a sideways move over to the downtrend line, hugging the October 2005 low in the process.

QQQQ chart, Daily

The Q's paint the same picture as the COMP now. I've got it labeled bullishly, having just completed an A-B-C pullback from the January high but I would have expected a bigger bounce by now. Like the COMP the longer it hangs around the low the more bearish it will become.

SMH index, Daily chart

The January and April 2005 lows and a Fib projection at 29.40 provided support for the decline but it already looks like it's running out of steam. Today's shooting star doji, if followed by a red candle tomorrow, is bearish looking. SMH failed at its 20-dma in today's bounce. That 20-dma is important for swing traders to monitor.

BIX banking index, Daily chart

The December 2004 high was resistance again for the banks and today they dropped hard. The 50-dma caught this index but the daily oscillators don't look so good. This looks bearish to me but it could set up just a large sideways consolidation similar to what I mentioned for SPX and the DOW above.

Securities broker index, Daily chart

We'll continue to watch the broker index since it's been such a good canary for us. When it dies the market has been right behind it. Failing to recapture its 50 and 200-dma's would be a bearish statement here. The 50-dma crossing down through the 200-dma is already bearish and is backing up what the techs have already told us.

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

I'm thinking the broader market is ready for another pullback and if that happens I don't see how the home builders can rally on their own (unless it's because they're deeply oversold). But the bullish divergence on this index says short players beware. It's highly possible we'll see a consolidation near the lows and another new low with more bullish divergences before this will get a bigger bounce. If it manages to get above 650 then we've got the bigger bounce clearly in progress.

Oil chart, September contract, Daily

With support at the 50-dma and daily oscillators looking ready to turn back up it's possible we've seen all the pullback we're going to get in oil. But the larger pattern has me thinking an important high could already be in. Therefore I'll be watching to see if we instead get a bounce to a lower high in which case we should then see a test of the uptrend line from last November.

Two oil company reports, and the speculation leading up to them, prompted a buying spree in the oil stocks this week. Exxon Mobil reported net income up +36% and over $10B. They reported better refining margins and of course higher crude oil and natural gas prices. This was their best-ever 2nd quarter. Shell joined Exxon in reporting better than expected profits of $1.13 a share vs. 78 cents last year.

Oil Index chart, Daily

After the pullback from the early July high I was looking for another high to finish off the rally leg from the June low (to give us a 5-wave move). We got that this week and I strongly suspect that this will be followed by a deeper pullback. We'll probably see a negative divergence at this high. I'd consider taking some profits if you're long these stocks. At least sell some calls to protect some of your profits.

Transportation Index chart, TRAN, Daily

The Trannies have been hammered since the early July high. The 50-dma barely caused a ripple and only got the briefest of a retest. Yesterday and today price just sliced right through the 200-dma. This should catch the attention of major funds. There's a good chance this will head down to its uptrend line near 4100 and perhaps a Fib projection target at 4000.

U.S. Dollar chart, Daily

After retesting the broken uptrend line, again, the dollar has pulled back and now should continue lower. Still looking for the $83 support level to be tested.

Gold chart, August contract, Daily

I'm not real sure about gold right here. It's on the edge. The bounce up to the 62% retracement of its sharp drop has the potential to be all there is for the bounce and now it will continue to another low below 550 and maybe even down to a Fib projection at 495. But the price pattern is suggesting that the pullback in July is corrective which means we should see price continue higher. I need to see additional price action before making a better call on this one.

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

Tomorrow morning will be busy with economic reports. The Employment Cost Index is a number closely monitored by the Fed since it gives them a picture of wage inflation. GDP is expected to show a slowdown from Q1 but at this point is priced into the market (as long as there aren't any big surprises). Nonfarm Payrolls is a number that could move the market if it's a surprise. The Michigan sentiment and factory orders also have the ability to move the market. So tomorrow morning could see some volatility around these reports.

Sector action was almost all red today. The few green players were the securities brokers, telecom and semiconductors. The red sectors were led by healthcare, networkers, gold and silver, disk drives, transports, biotech and airlines.

Today's internals matched up with sector action even if the major indices didn't reflect much of a negative day (except small caps and tech). Total volume was good, especially for a summer day, at 5.2B shares. Down volume was not quite twice the up volume and declining issues were about 1.5 times advancing issues. New 52-week lows edged out new highs 248 to 239. Nothing jumps out at me with these numbers but do reflect the fact that today was a negative day.

There are no update to the SPX weekly charts since they look the same as last week. We're still waiting to see if the current rally attempt turns into something more, goes sideways as in the triangle idea I showed in the daily chart above, or drops through the June low. The longer price continues to consolidate on a weekly basis above the trend line along the lows since August 2004 the more bearish it becomes.

Tomorrow should be a negative day as well if we're to get some follow through to today's pullback which is what I see happening. While I see the likelihood for a decline in the DOW back down to the 10800-10900 area and SPX back down to the 1230 area I don't think the market is setting up for a hard decline. I know a lot of people are chomping at the bit to get short this market in a big way and have the stash of put options to prove it. If you're sitting on a bunch of puts I hope they're December/January. If they're any closer you stand a good chance of watching your time premium evaporate as this market takes its sweet time to move.

If you're just the opposite and you're sitting on a bunch of call options I'm beginning to think this is all we're going to see. At least sell some calls against your positions and work your cost basis down over the next few months (same tactic for longer term put options--sell some lower puts and create some spreads to lower your cost basis in hopes you'll have a bunch of cheap options by the time the market rolls over.

It's Friday tomorrow and we all know what summer Friday's can be like. Take your time on entry setups or just let the market go. Next week will give you lots more opportunities. If you follow us on the Monitor I'll try to offer some short play setups as long as that continues to look like the way we're headed. For everyone else I'll see you here next week. Good luck in your trading.

Market Wrap Archives