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Market Wrap

Sewing a Zigzag Stitch

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In late February, equities nearly fell apart. Market action since then has been zigzagging prices back and forth across the torn place. Is this just embroidery to temporarily hide a tear or reinforcement that will hold?

Some market participants apparently believed that yesterday's FOMC statement had signaled the end of the needed reinforcement period. Equities took off with a running stitch. However, during the overnight session, our futures signaled something else. They failed to respond to soaring gains in other global bourses until about an hour before the U.S. cash market open, when they inched up. A failure to respond to overseas gains can be an important signal to U.S. traders. Maybe some more zigzagging is needed after all.

Introduction

The day's candles on the indices could have been anticipated after yesterday's big-range day. Large-range days are often followed by small-range ones, and that's what happened today with some key exceptions. The BIX, the S&P Banking Index, reversed all of yesterday's gains and then some. Oil-related indices such as the OIX and XOI posted strong gains, boosted by crude's jump above $60.00. As I type, crude futures are up to $61.69 in after-hours trading. The S&P 500, Dow, Nasdaq, Russell 2000 and other indices all sport small-bodied candles or doji, indicative of indecision, however. Technicians consider these candles potential reversal signals, although that signal would have to be confirmed by a big-range drop tomorrow. Otherwise, they're more likely indicating some needed sideways consolidation of gains. Let's look at the charts.

Charts

Last Thursday, I noted that all of the indices covered in the Wrap looked as if they were trying to set up some kind of formation that hadn't yet been firmed up, likely a triangle, and that there wasn't a good trade until there was a break of whatever formation set up. Most indices did set up a triangle, and that break, an upside one, occurred yesterday on most indices.

Annotated Daily Chart of the SPX:

I have no confidence in the intermediate-term or long-term bullishness of this move because the chart gives us no confidence as yet. Although yesterday's post-FOMC reaction pushed indices higher than the 50-sma's that I'd anticipated would be resistance at the next broadening effort, I've been warning bears for weeks not to count on a big drop being the immediate result of the first decline. I'd thought that a volatile, messy, choppy period could result instead, and nothing tells me yet that such a period has concluded. Nothing seen here guarantees that the SPX isn't just broadening its consolidation pattern, for example. If trading, be vigilant about protecting profits and consider smaller-than-normal positions because I'm not confident that anything has been decided yet.

The Dow also produced a potential reversal signal today, again with the emphasis on "potential."

Annotated Daily Chart of the Dow:

If a downturn should begin tomorrow for the Dow or the other indices, do not hold on for the entire downside target if prices reverse high again and threaten to take away your profit. Don't let a profitable trade turn into a loser in this climate. Study this chart a moment and consider what that kind of chopping around over the last few weeks can do to options premium unless a trader is great at scalping the perimeters of the formation.

The Nasdaq also produced a potential reversal signal, with its chart proving even more interesting. The Nasdaq rose all the way into a near challenge of a former rising price channel.

Annotated Daily Chart of the Nasdaq:

The SOX still zigzags in a haphazard formation. In the interest of keeping this Wrap from being any longer than it already will be, I'm skipping the SOX chart tonight.

The Russell 2000's chart proves a bit more puzzling.

Annotated Daily Chart of the RUT:

Markets that can run up that high in a day or two can certainly run back down the same distance in a day or two. All that supposed converging support may not mean any more then that it meant when it was supposed resistance on the way up. However, without that strong push lower, the RUT looks destined to chop around a bit, with a bit more bounciness than heaviness seen here. In other words, without a strongly negative tenor tomorrow, any pullback on the RUT might find support at any of those layered support levels pointed out above.

Annotated Daily Chart of the TRAN:

I don't have room for all the charts I'd like to include in tonight's Wrap, but bond yields and crude futures both climbed today. Although the TNX, the ten-year yields, had over the last weeks dropped below the optimum right-shoulder level for the potential inverse head-and-shoulders formation on its daily chart, it did not drop low enough to invalidate the formation. Yields would need to rise rather soon toward and beyond their 200-sma at 4.77 percent to keep that formation from being invalidated, however. While I don't count on these formations to confirm or meet upside targets if they do, we are compelled to note that there is a potentially bullish formation on the chart of these bond yields. We're hearing stories of tightening credit every day now, and some equities, particularly among the small caps, will begin to suffer if yields rise too much.

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Today's Developments

When weekly jobless claims dropped to a six-week low, both bond yields and equity futures climbed. Equity traders viewed the news as positive, but bond traders were already rethinking the previous day's bond bounce and subsequent dip in yields. After all, the FOMC had still named inflation as the predominant risk to the economy.

First-time jobless claims fell 4,000 to 316,000 on a seasonally adjusted basis. The four-week average decreased 3,750 to 326,000. Continuing claims fell 69,000 to 2.5 million, a six-week low. The four-week average fell a more modest 1,250 to 2.56 million. To keep these numbers in perspective, both initial and continuing claims have been declining for three weeks from levels that had reached highs not seen in more than a year.

The insured unemployment rate declined to 1.9 percent, but in a slowing economic environment, unemployment figures sometimes lag other indicators. Goldman Sachs economists warned that the jobless rate would likely increase in the next months.

At 10:00, the Conference Board released February's Leading Indicators. This index slipped a little lower than expected, with expectations at a 0.4 percent decline and the actual figure showing a 0.5 percent decline. An accompanying statement said that the economy's growth was likely to be moderate but erratic over the coming months.

At 10:30, the Energy Department announced that natural-gas inventories had risen 17 billion cubic feet. According to one CNBC commentator, "smart money" had expected a build anywhere from the single digits to the mid-teens, so the build was only a little bigger than anticipated. The build did not prove bearish for natural gas futures today, with the contract supported in trading.

An early but short-lived bounce in the TRAN this morning may have been helped along after the European Union agreed to open restricted flight routes to new competitors. However, the EU delayed the effective date from late this year until March 30 next year. Numerous conditions were imposed, with some EU members still unhappy with the U.S. for not dropping a rule that prevents foreign investors from owning more than 25 percent of an airline's voting shares. The topic was being hotly debated on NPR last night as I was driving.

Motorola (MOT) was blamed for the early sluggishness in the markets, although we all know that big-range days are often followed by small-range days no matter what company is reporting what news. MOT cut its forecast for profit for the current quarter and the year and announced a reshufflings of its executive lineup. CIBC World Markets downgraded its supplier RF Micro Devices.

Among other companies receiving downgrades today was Alcatel-Lucent (ALU). Goldman Sachs alluded to a freefall in revenue when downgrading the company to a neutral rating from its previous buy rating. While traders should be aware that upgrades and downgrades often don't produce the expected price movement, today's downgrades pinpoint the danger to bullish hopes as the new earnings season approaches. This is a danger Jim Brown mentioned a week or two ago. The recent signs of slowing in the economy could well be reflected in specific company announcements and reports, resulting in some stocks being dumped and maybe with a more generalized equity weakness or floundering.

We continued to hear news about financials and the housing sector all through the morning. Members of the Senate Banking Committee questioned regulators charged with overseeing the subprime mortgage market. Roger Cole, director of the Federal Reserve's banking supervision and regulatory division, tried to soothe the Committee's concerns. Although the Fed continues to be worried about developments in the mortgage industry, it is not yet seeing the subprime problems spill over into the other mortgage categories, Cole affirmed. Only about one out of every ten outstanding mortgages is considered subprime. The Fed doesn't believe that the difficulties in the subprime sector are over yet, however, and borrowers are experiencing "significant and personal challenges," Cole said. Later in the day, The Senate Committee Chairman announced that FOMC Chairman Ben Bernanke will testify before the Joint Economic Committee next Wednesday, and he'll certainly be asked about the subprime mortgage market as well as inflation and growth.

Corroborating the Fed's outlook, Countrywide Financial (CFC) revealed that foreclosures on last year's subprime mortgages may be the most the company has experienced, even higher than in 2000. However, CFC and lender HSBC (HBC) caution lawmakers against rules that might provoke a credit crunch for those borrowing money.

KB Homes (KBH) weighed in. The company reported that first-quarter net income fell to $27.5 million or $0.34 a share, down from $173.3 million or $2.01 a share a year ago. Still, that beat expectations of $0.25 a share, and revenue also beat expectations. The company also reported seeing fewer order cancellations, with the cancellation rate down to 31 percent from the previous 48 percent, although orders dropped 12 percent. KB Homes' CEO warned that current conditions could persist through the end of the calendar year. He mentioned that he was wary of the effect of the subprime fallout. KBH jumped at the open, but met resistance and pulled back from the day's high.

In other company-related news, the European Union's antitrust commissioner harshly condemned Microsoft (MSFT). The commission fined MSFT again, saying that the company hadn't done enough to enable competitors to make their software compatible with the Window's operating system.

NCB and Newscorp announced a deal in which they'll team up in an effort to challenge YouTube. They've reportedly inked distribution deals with AOL, MSN and Yahoo and have also lined up advertisers. They'll provide ad-supported video and reportedly are now in talks with TimeWarner and others to provide content.

Bear Stearns upgraded Proctor & Gamble on valuation and it gained. General Mills beat expectations and also gained.

Tomorrow's Economic and Earnings Releases

February's Existing Home Sales starts off the day's economic releases tomorrow, but the number won't be released until 10:00, after the cash-market open. Expectations are for the sales to decline to 6.3 million, down from the previous month's 6.46 million. This number could prove market moving if it's significantly different than expectations. The ECRI Weekly Leading Index is the only other scheduled economic release, and it comes thirty minutes later.

What about Tomorrow?

I read an article on Marketwatch.com this morning discussing the potential bullishness of yesterday volume pattern, with up volume being at least nine times higher than down volume. Two such days have occurred in close proximity, with another having occurred on March 6, and that's supposedly a rare and particularly bullish signal according to one researcher. The "fly in the ointment," as the article's author Mark Hulbert termed it, was the 9-to-1 down day on March 13.

Hulbert was discussing the research of Martin Zweig, who called 9-to-1 up days a significant bullish signal that resulted in higher prices over the coming months. Hulbert notes that research performed by an adjunct professor at Baruch College confirmed statistical significance in the gains seen after such a signal when compared to those during other periods, but even Zweig said that if such signals were accompanied by 9-to-1 down days, the upward thrust did not prove as strong.

To me, all these 9-to-1 up and down days signal upheaval and imbalance still in the markets, and I'm not sure it's sorted out just yet. I've been pointing out over several weeks the signs of accumulation that I saw as markets hit and then tested recent lows, so I have always been convinced that some bouncing around could occur instead of an immediate follow-through to the downside.

As explained last week, the corrective fan theory suggests that the rally off last summer's low has ended. Period. What happens next, though, doesn't have to be a steep decline. It could be a long period of disorganized flopping around, and last week that seemed as likely as an immediate resumption of the decline, with no chart signals to tell traders which to expect. I had warned traders to expect some rattling around within barriers that would eventually set up into some sort of formation, likely a triangle. However, the resistance might expand all the way up the 50-sma's, I warned. Even those didn't hold yesterday.

Yesterday's post-FOMC bounce carried the SPX and some other indices past their 50-sma's, further than I anticipated, but I'm not yet convinced that it was anything other than more of that zigzagging around, stitching over that ripped place in investor confidence, trying to stabilize it. It could be, but yesterday's rally wasn't the evidence that we need. Not alone. This is a dangerous time to trade, in my opinion, and at least until the volatility tamps down a bit, credit spread traders like me share the danger with those buying puts and calls and hoping for a directional move because these volatile moves can overrun our positions, too, especially if those triangles morph into broadening formations.

The thirty-minute Keltner charts tonight show us something that we haven't seen since I've been including them in the Wraps. Indices are in breakout mode on these charts, above the upper boundary of the widest channel I watch. Such breakouts signal that the move is extended, of course, but more importantly signal that momentum is strong and that countertrend plays are even riskier than normal until the trend changes. It hasn't changed yet, but the following charts display what needs to be watched.

Annotated 30-Minute Chart of the SPX:

If the breakout mode is erased and the SPX starts producing 30-minute closes beneath that widest (purple) channel boundary, the first downside target would be that channel's basis line, the aqua-colored one (120-ema). However, as with any other type of technical analysis, targets aren't always met. Support on 30-minute closes is sometimes found at the 45-ema, the pink line.

Here's what I like about the nested Keltner channels. If traders were watching this price action today, the pause might have prompted traders to consider a countertrend bearish play. However, this chart showed that the SPX was still bouncing from the same support that had bounced it all week, and it wasn't likely to retreat far. They would have dissuaded such an entry.

Remember that these lines are dynamic, and that they'll move with price tomorrow. Don't jot them down as they exist tonight and then expect them to have relevance late tomorrow afternoon . . . unless price has consolidated sideways all day tomorrow, too. Do let them guide you in earliest trading and perhaps take note of the basis lines. Even if you don't have Keltner chart capabilities, you can put a 9-, 45- and 120-ema on your charts.

Annotated 30-Minute Chart of the Dow:


Annotated 30-Minute Chart of the Nasdaq:


Annotated 30-Minute Chart of the RUT:

Just because I advise to "set the target" doesn't mean that I advise to enter a trade. That's for the benefit of those who will be trading. Absent a strongly directional day tomorrow with a distinctly bearish or bullish tenor, I see much potential for another consolidation day. That would be in keeping with other technical analysis tools. A day like today is typically followed by either another consolidation-type candle or a bearish day. Occasionally we get fooled and a strongly bullish day results, but that's not the typical high-probability result.

Trade carefully.
 

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