Option Investor
Market Wrap

Another Consolidation Thursday

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I could have written that title yesterday and almost did. If my Wraps begin to sound redundant, it's because the market action so often is. Wednesdays have often tended to be big up days while Thursdays are often spent consolidating the previous day's gains. Add in the typical opex pin-them-to-the-numbers action, and today's consolidation could have been predicted. However, I'll give you all the so-called reasons for the day's actions.

Introduction

If the yen carry trade truly governs our market behavior, developments in Japan last night hinted at a strong open in our markets. Instead, other clues surfaced that hinted at something different.

Japan's GDP disappointed last night, likely pushing back any rate hike in that country for a few months. The Bank of Japan left rates unchanged at its just-concluded meeting. The yen weakened.

However, Japanese equity investors did not celebrate the news and neither did our futures traders, as our futures were slightly below fair value heading into the open. Perhaps Japan wouldn't be raising rates any time soon, but that outlook wasn't true of many of the rest of the global economies where rate-hike worries seem to be the norm.

Then the weekly claims number dropped again, sending bond-yields higher and our equity futures even lower. Our FOMC doesn't want to see wage pressures added to other inflationary concerns.

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Even before the weekly claims number was released, futures traders may have had another often-mentioned worry on their minds: sub-prime loan failures and how they might impact the economy. FOMC Chairman Ben Bernanke was scheduled to speak on that topic today in Chicago at about the time the market opened. If anything had the ability to sour investors' party moods, it was a hint from the chairman that the sub-prime problem would bleed over into other sectors, especially with the weekly claims number already beefing up worries about tightening credit. If you didn't read Keene Little's discussion of some of the worries about the sub-prime problem in his opening comments in last night's Wrap, I suggest you find time to read them.

The Philly Fed was scheduled, too, and some might have been nervous that it, like Japan's GDP last night, would show more weakness than anticipated. Signs of a weakening economy combined with stronger wage pressures would not be welcome.

Charts

Annotated Daily Chart of the SPX:


I've removed trendlines from the Dow chart so that it's more easily apparent just how parabolic and unsupported its rise is as the Dow drives further and further away from strongest support.

Annotated Daily Chart of the Dow:


Annotated Daily Chart of the Nasdaq:

A look at a key tech index may provide clues as to why the Nasdaq churns.

Annotated Daily Chart of the SOX:

The SOX appears ready for a bounce, but if it instead begins closing daily bars beneath the 492-ish historical and Fib support and the 30-sma, it may be due for at trip down to deeper support at 484.

Rising interest rates today likely pressured the interest-rate sensitive small caps.

Annotated Daily Chart of the RUT:


Annotated Daily Chart of the Ten-Year Yields:

The sometimes inverse relationship of yields to equities (yields up, equities down) does not always hold. The relationship is governed by a complex interaction of equities, yields, currencies and commodities. I don't pretend to always understand it, not having a background in economics. I do know enough to know that this action can prompt some worry on the part of equity bulls, especially if yields should successfully push above their April high.

Annotated Daily Chart of the TRAN:


Today's Developments

The first economic report of the day was the usual weekly Initial Claims for the week ending May 12. Expectations were for 310,000-315 claims, up from the previous week's 297,000. Instead new jobless claims fell again, by 5,000 to 293,000, with the previous week's claims revised slightly higher to 298,000. This didn't soothe bond traders, with bonds being sold and yields being sent higher in the pre-market session. The bounce in ten-year yields sent them above a descending trendline that had held since late June, 2006. If anything signaled some concern about equities, gaining in that same period while yields dropped, that could have been it.

For newbies, yields probably rose because of the fear that a tightening labor market (fewer jobless claims) would lead to wage pressures that would increase inflation. If inflation is the Fed's primary concern, then rising rates may be indicating that bond traders, at least, don't put much credence in the Fed's ability to lower rates and have upped the possibility that rates might be raised. Last week's claims numbers were particularly significant because it was during last week that surveys were being conducted for May's nonfarm payroll report. That report is closely watched by the FOMC, and the members have continually reiterated their concerns about inflation.

The four-week moving average, usually considered more significant, fell to 305,500, the lowest level in more than a year. Continuing claims fell, too, as did the four-week moving average. The number of workers still collecting benefits remained steady.

April's Leading Indicators followed at 10:00 EST. This Conference Board release does not often prove market moving, but today it might have added to the concern apparent in early trading. Expectations ranged from a drop of -0.2 percent to flat, but the index actually dropped 0.5 percent. Worse, seven out of the ten indicators declined, and the ones that did rise were stock prices and money supply. What happens if tightening credit dries up the money supply and stock prices dip as a result?

Ameliorating part of the concern was a sharply higher revision of March's number, to a 0.6-percent rise. The previous number had been higher by 1 percent.

Natural gas inventories came next, at 10:30 EST. Inventories rose 95 billion cubic feet, just shy of expectations. Natural gas prices spiked, but they may have also been reacting to hurricane-related fears or other developments in the energy complex. Crude futures rallied, too, closing at $64.85 according to my feed. The AAA reported today that demand would likely be higher during the Memorial Day holiday, despite gasoline today reaching prices not seen since last August. In addition, refinery production problems, a diversion of some tankers due to weather problems in the Gulf of Mexico and heightened geopolitical concerns added to upward pressure in the energy complex.

The last release of the day was one of the most important of the week, the May Philadelphia Fed's Index. Not all the Fed's district reports prove important in predicting the Institute of Supply Management's read on manufacturing activity (ISM), a report the FOMC considers important, but the Philly Fed report is one that is. May's index measuring sentiment in the manufacturing index rose to 4.2, the highest reading seen since January's. April's had been 0.2. The rise was higher than the 3.0 analysts had predicted.

Both encouraging news and worrisome news could be found under the headline number. Worrisome news included a rise in the prices-paid index to 32.3 from the previous 24.3. Although one article concluded that most manufacturers were able to pass the increased costs onto customers, that same article noted that the prices-received index fell to 2.2 from 5.2. I don't know, but rising prices paid and falling prices received doesn't indicate that firms were able to pass on price increases to their customers to me. That's bad news for firms, but good news for consumers and the Fed, watching for increasing inflation concerns, so it could be spun any way you wanted it.

Job growth was strong, too, rising to 12.9 from the previous 2.5, and that, too, could be worrisome for those watching out for wage pressures to increase inflation pressures. Other components were more upbeat without the troubling overtones. New orders, unfilled orders, production and shipment indices all increased.

Fed Chairman Ben Bernanke, speaking at a banking conference at the Chicago Federal Reserve, spoke about the sub-prime issue. Although most headlines characterized his talk as reassuring to the markets, it wasn't totally good news. While he thought the broader impact from the sub-prime sector difficulties would "limited" on banks or thrift institutions, he did not believe that housing had bottomed. He predicts more delinquencies and foreclosures this year and does believe that the slowdown in the housing sector has been one important reason for the slowdown in the economy. Headlines ran with his positive comments, while fewer featured his warnings that institutions are already tightening their lending standards, with that tightening already spilling over into the prime market.

More M&A activity news was released today. AirTran Holdings Inc. (AAI) extended its offer for Midwest Air Group (MEH) until June 8. Neither of these two comprises a component stock of the Dow Jones Transportation Index (TRAN, DJT, depending on the quote source). In addition, Alliance Data Systems (ADS) and Acxiom Corp (ACSM) are both being acquired.

In other company news, firm Stifel Nicolaus downgraded Caterpillar (CAT) to a hold rating from its previous buy rating, noting that the firm felt that the climate for consumer spending might pressure economy-sensitive stocks like CAT. That downgrade was blamed for CAT's performance today, but it was time for profit-taking or hesitation in many of the high-flying stocks of late. CAT closed at 74.84, after gapping below yesterday's 75.95 close, but it also bounced well off the intraday low.

J.C. Penney (JCP) reported earnings of $1.04 a share or $238 million, with sales of $4.22 billion. This beat EPS estimates of $1.03 a share but appeared to miss sales expectations of $4.39 billion. The company appeared to raise expectations for the second quarter, however, according to a www.Marketwatch.com article. JCP gapped higher but found resistance at its converging 30- and 50-sma's.

Tomorrow's Economic and Earnings Releases

Tomorrow's lone economic release of importance is May's Preliminary Michigan Sentiment, released at 10:00. Expectations are for a slight drop, to 85.0-86.5, depending on the source, from the prior 87.1. This release used to have great import in the markets before everyone decided that sentiment would remain positive forever. If it weakens considerably, it could do impact markets again. If you're in plays at the open tomorrow morning, or considering them, decide ahead of time if you want to exit plays before the release or wait until after it to enter new ones.

What about Tomorrow?

Tomorrow is due to be either another consolidation day or a real decline, but when has what it's "due to be" mattered lately? Do watch the futures' reaction to overnight trading in foreign bourses and tune into the TNX's chart when bonds open prior to the cash equity market open. A further rise in bond yields may continue to pressure markets that already look toppy and in need of a retracement to support.

We've all warned at various times that any deeper retracement, any go-away-in-May type of move, could occur quickly, if it does occur. If you traded through some other toppy periods, such as the late 1999 and early 2000 period, you understand how quickly your winning positions can be converted to losing ones, so maintain sound account-management practices. When you can enter a long almost anywhere, no matter how bad the entry, and eventually prosper just by holding on, those account-management skills are sometimes lost or forgotten.

The problem is that these markets are momentum driven, so anything that's showing up in the charts can and often is undone, and momentum can keep going on far beyond the time when warning signs begin to show, so bulls continue to be rewarded for going long, no matter how good or poor their entries. Bears have mostly been scalded, no matter how much evidence is behind their entries..

All that is just to say that no matter what's showing up on short-term or long-term charts, no matter the typical big-gain-consolidate-sideways pattern that has been long established, anything can happen.

In today's choppy trading, I watched the SPX's three-minute Keltner chart for some guidelines. Some of the things seen on this chart might give you some insight into what's happening fist thing tomorrow morning.

AAnnotated 15-Minute Chart of the SPX:

As you can see on the far right, the setup again favors a rise through the channel . . . if all conditions are the same as they were Thursday. Your first sign that something is different would be if you're seeing three-minute closes beneath that black-channel support, especially if the SPX should gap beneath it tomorrow morning and then find resistance at it. That would suggest a fairly quick trip down toward 1508.50 or so. Be really careful if the SPX should gap lower and move quickly down to that lower-channel support at about the time that the Michigan Sentiment number is released, because that release could break prices either direction. The same should be said for a move up toward either 1515.70 or 1517 early tomorrow morning ahead of the Michigan number.

Remember this setup is only for the beginning of trading, and this is a three-minute chart, so the setup can be overruled by larger market forces. It may help you gauge what's different or what's the same tomorrow morning, however, getting a handle on whether choppy consolidation might be again expected or whether a more directional move will likely occur. For those of you who don't have access to Keltner channels, you can still set up the moving averages employed here. The important aqua midline is a 120-ema. The smallest channel uses a 9-ema and the middle, black channel employs a 45-ema. I watch the SPX and OEX's intraday moves most often on 3-minute, 7-minute and 15-minute charts, although I also use a 30-minute chart to give me the bigger picture for intraday moves.

Keltner charts give me targets, the outside of the channels. If you're using only the moving averages, you won't have those, but you will have the ability to see if the moving averages are providing support or resistance and if the short-term ones are crossing below or above the longer-term ones, clues as to the short-term bullishness or bearishness.

I don't know how charts will set up tomorrow. The SPX usually tends to consolidate sideways for three or four days before beginning to dip down toward the 10-sma again, but lately, it's shown more volatility and it's tended to trade across the 10-sma and linger there a bit longer. That may be speaking of a little more weakness creeping in, but that's just a warning for you bulls. It's not advice for you bears to plow into new plays. If you're a good scalper, you can look for your plays, but if you're not, wait for evidence.

For tomorrow, then, prepare for either sideways-to-sideways up consolidation or an actual downturn, but don't be too surprised if the bulls prevail again. Watch the TRAN and MID for guidance. Both have tended to lead the SPX a bit lately.

Annotated 15-Minute Chart of the Nasdaq:

 

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