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Market Wrap

An Answer to Last Night's Question

HAVING TROUBLE PRINTING?
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In Keene Little's introduction to his Market Wrap last night, he asked whether yesterday's bounce was merely a relief bounce or the start to a larger bounce. He believed it to be nothing but a relief bounce. Traders stumbling to their televisions this morning had their answers after they turned on CNBC. It was going to be a bad day for equity bulls.

Introduction

Anticipated or, better-said, dreaded morning developments worsened the early morning jitters. Those anticipated developments included economic releases, earnings from several home builders, and addresses by Treasury Secretary Hank Paulson and Former Fed Chairman Alan Greenspan. A rise in crude prices above $76.00 a barrel and eventually up to a day's high of $77.24 before it slipped back later into negative territory didn't calm those jitters, either.

I riveted my gaze on something different, however, something that had held my attention since yesterday. I had been watching the U.S. dollar/yen pairing, the value of the dollar against the yen. Those who read my Wraps have seen several charts in recent months comparing the inter-market relationship of this currency pair to U.S. equities. Yesterday, the chart of the USD/JPY, the symbol for the dollar versus the yen in my charting program, revealed important support being broken. That was a warning sign to those watching this pair to gauge how equities might act. This morning, even the euro/yen pair dropped to test key support.

Annotated Daily Chart of the USD/JPY:

Of concern here is what happens to the yen carry trade. The yen carry trade has been discussed many other times in the Wrap and I've been hearing it discussed on CNBC all day today, so I don't want to bore readers with a long discussion for which I'm not qualified anyway. In a quick and perhaps over-simplified review for the benefit of newbie traders, some global investors have been funding their purchases of the world's equities by borrowing yen. Due to Japan's low interest rates, they can borrow those yen, pay low interest rates on their loan, and use the yen to purchase something that's escalating at a rate higher than the interest rate on those loans. Lately, to a large degree, that money has been spent on equities.

If interest rates rise in Japan or if other currency relationships make it more expensive to borrow those yen, traders must unwind those equity trades. In Japan, worry rises that the Bank of Japan may raise interest rates in its meeting next month. An important report on consumer prices is due tonight, and that report might impact the Bank of Japan's decision. Overnight last night, a BOJ official expressed his belief that the central bank had to watch that figure closely.

As Jim and Keene have so expertly discussed in recent weeks, concerns about leveraged buyout deals have increased jitters, and they worsened the concerns today. Almost prophetically, Jim warned this weekend what could happen if news of a postponement or canceling of a leveraged buyout circulated this week, and we did hear such news.

We've all discussed the fallout from the sub-prime concerns, and this afternoon, further news surfaced. Bear Stearns (BSC) said it had seized the assets of High-Grade Structured Credit Strategies fund when the fund couldn't meet its margin requirements. The firm had suffered big losses, due at least partly to the problems in the sub-prime mortgage market, and BSC had earlier lent it $1.6 billion. BSC said it would liquidate the fund in an orderly manner and that its own hedging procedures would protect the value of the portfolio from any further declines.

The day's rout occurred on record volume for the year, CNBC headlines noted, but I couldn't confirm that as the figures in the table show. I deferred to Jim, who was able to provide me with the following numbers: NYSE volume: 6,045,466,000 shares; Nasdaq volume: 3,520,496,000 shares; and AMEX volume: 51,283,000 shares.

Trading curbs were instituted. The Dow lost more than 311 points, but at one point during the day, it had fallen almost 450 points. The Russell 2000 narrowly missed turning negative for the year, having dropped below the December 29 close before bouncing. Words such as "biggest" were being applied to losses instead of to gains. So, was damage done to bullish equity charts today? Let's look.

Charts

Annotated Daily Chart of the SPX:

I'm going to say something that's going to go counter to almost everything you've heard, but it's something I've learned through the study of Tom Williams' theories, as expressed in his book, MASTER THE MARKETS.

Today had strong volume, right? Who is capable of producing that record volume? Not you and me, the retail trader. I can't move the markets, and neither can you. Only big money can. And what did big money do today?

They bought.

I can hear you screaming at me through the monitor, but unless big money was soaking up the supply we dumped on the markets, how could prices bounce and bounce so strongly? Think about it. This wasn't mom and pop trader covering their shorts before tomorrow's GDP that produced that caliber of bounce.

Does that mean that markets won't crater again tomorrow or sometime next week? Nope. As you've heard me say before, big money can afford to start entering ahead of you and me. They can be entering for a short-term play only, although I would think that less likely. Or, they can be wrong, which they sometimes are.

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However, do you really want to bet heavily against them? Spend some time tonight looking over instances when you've seen such strong springs off support and note what happens afterwards. Often, perhaps after another retest or a lower low with bullish divergences or on lower volume, markets put in some kind of a bounce. That bounce doesn't always produce new highs, but there's usually a bounce attempt soon.

Am I saying to load up on calls? Nope, I'm not saying that, either. All those other instances over this last year when the SPX bounced after springing higher were produced while the SPX trended higher, and the climate has definitely changed. I'm just saying to be careful about any bearish short-term conclusions right now.

If the SPX bounces, resistance may be quite strong near the aqua-colored 72-ema, if it's not turned back before then, at about 1491-1492. Watch those levels for rollover potential, and certainly have plans for protecting any short-term bullish plays at those levels. Bears, you don't want to see any bounce get much past that 72-ema on a close, or the SPX is right back in that chop zone from the last couple of months, and it could stay there again for an equal amount of time, chopping out a right shoulder.

Let's look at other charts. The Dow also sprang off its low, as already noted, and what a low it was. Still, when viewed on a daily chart, the Dow's chart looks more bullish or at least less bearish.

Annotated Daily Chart of the Dow:

We're beginning to see a pattern here, of strong springs off support. The Nasdaq followed that pattern.

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

The RUT's chart most resembles that of the USD/JPY, excluding the RUT's strong bounce off support. That bounce didn't happen with the USD/JPY, and that's sounding a note of caution to my conclusion that big money was at least nibbling at stocks today. In my opinion, that nibbling wasn't confirmed by the USD/JPY action or even the EUR/JPY (euro versus yen) action, although the EUR/JPY did perform better, holding support better.

Annotated Daily Chart of the RUT:

The TRAN's direction sometimes predicts the Dow, SPX and OEX's, so is important to watch.

Annotated Daily Chart of the TRAN:

Today's Developments

Today's economic calendar was full. Initial and continuing jobless claims started the day at 8:30. Last week's number was revised slightly higher to 303,000, but those claims turned lower again this week. While fewer initial claims encourages those who want a healthy job market, as we all do, the number again hovered near a seasonally adjusted 301,000 new claims for last week. That's barely above the 300,000 benchmark that marks a labor market that might be tight enough to be increasing inflation pressures. The four-week moving average now reaches 308,500. Continuing claims fell but the four-week moving average still rises. The insured unemployment rate stayed steady at 1.9 percent.

The advance June Durable Goods was released at the same 8:30 time slot. The previous figure for durable goods had weakened, and they did again, to a 1.4 percent increase in durable goods orders. Economists had predicted a 2.5-percent increase. If strong demand for airplanes hadn't propped up the orders numbers, durable goods orders would have fallen 0.5 percent.

Components revealed that orders for core capital equipment goods fell 0.7 percent. Core capital equipment goods are those items companies buy to increase their production. After this result, some market watchers presumably questioned whether the annualized 3.6 percent estimate for the second-quarter GDP, to be released tomorrow, remained accurate, and certainly whether those higher whisper numbers will be.

Other components of the Durable Goods number showed mixed results. Orders for transportation goods, which include aircraft, rose 6.1 percent, but orders for computers and electronics, excluding semiconductors, fell 4.6 percent, for example.

June's New Home Sales were released at 10:00, with analysts pegging expectations at 890,000-900,000, down from the previous 915,000. The number proved much weaker than anticipated. New home sales dropped 6.6 percent to a seasonally adjusted annual rate of 834,000, dropping close to March's 830,000 low. The Commerce Department calculates that new home sales are now 22.3 percent lower than the year-ago level.

Inventories of unsold homes remained steady at 537,000, but other articles note that with slower sales figures, that now amounts to a 7.8-month supply. Economists had predicted a 7.1-month supply level. Regional reports showed that sales at three out of the four regions declined. The median sales price declined 2.2 percent year over year. Those economists who were calling a bottom in the housing market several months ago appear to have been wrong. The CEO's of homebuilders were always more cautious than the economists, and they appear to have been right.

The government released the weekly natural gas inventories at 10:30. The Energy Department reported that natural-gas inventories rose 71 billion cubic feet for the week ended July 20, roughly in line with predictions.

The last of the three FOMC districts reporting manufacturing data this week was the Kansas Fed, with its Manufacturing Survey released at 11:00 this morning. Although I doubt few were paying attention to this survey, the Tenth District reported that manufacturing activity "rebounded slightly," to 10 in July. To put that slight rebound into context, it's important to remember that manufacturing was down sharply in this district in June, tumbling to -2 from May's 20. Also, the new orders index fell its third straight month, with the district's report commenting that the new orders index had fallen to its lowest level in five years. Prices of raw materials increased, but those prices didn't appear to filter through to finished goods prices. Indices measuring future activity remained mostly optimistic.

Companies reporting today included AMGN, F, MMM and XOM. XOM surprised the trading community by missing expectations. Because it's currently the most heavily weighted SPX component, its gap lower this morning colored trading screens red.

Homebuilders Pulte (PHM) and D.R. Horton reported losses. The story was familiar with D.R. Horton, with the company writing down its deposits on land and the value of its unsold inventory. Beazer (BZH) also reported, with that company's release noting that the company didn't know when to expect an improvement in the challenges it faces in the current housing market environment.

Ford (F) fared better. Its cost-cutting and other turnaround efforts produced a profit for the second quarter, its first in seven quarters.

Apple (AAPL) also fared better after beating expectations last night. Some of its gains could surely be attributed to short covering, but, whatever the reason, AAPL helped keep the carnage in the tech sector from being worse than it would otherwise have been.

When Treasury head Paulson spoke today, he mentioned a "very major correction" in the housing market. He still insisted that the sub-prime issues were mostly contained and not ultimately a threat to the economy.

After-hours reporters included KLAC, QLGC, FLEX, AMGN and others. Not all those reports were in as this report was prepared, but as I was typing, QLGC was falling to $16.00 in an initial reaction after reporting earnings of $0.12 per share and AMGN was climbing to $56.90. Remember that these initial reactions do not always prove predictive of the next day's trading pattern. Also, shortly after the close, Gap announced that Glenn Murphy would be the new CEO.

Tomorrow's Economic and Earnings Releases

Many have awaited one of tomorrow's economic releases, the second-quarter GDP at 8:30 EST. Jim Brown discussed expectations in his weekend newsletter, noting that "the fireworks could start" with this release. He had also noted the likelihood of fireworks beginning with news that a major buyout deal was experiencing difficulty with funding, and that appeared to be the trigger this week. In our current environment, when gains and losses alternate, however, you never know which direction will predominate.

Official estimates for the GDP, as Jim noted, hover around 3.2 percent. Into last weekend, whisper numbers had ranged even higher, but enthusiasts were beginning to tamp back their expectations. They may have done so again after today's releases. Markets balance in a precarious place right now, and a too-strong jump from last quarter's 0.69-percent growth could raise rate-hike fears, while a failure to grow the economy enough heightens fears that the slump in housing and the recent credit problems could spill over into the economy.

Other releases tomorrow include July's Consumer Sentiment at 10:00 and the ECRI Weekly Leading Index at 10:30.

Companies reporting earnings tomorrow include CVX. Other companies are BHI, BLX, CCU, CEG, FO, IDXX, IFX, INF, IR, ITT, MHS, OPY, RTRSY and SEPR.

What about Tomorrow?

That's a tough one. Tests of key levels of support and chart characteristics such as the SPX's test of its megaphone support suggest that it's time for a consolidation effort or perhaps a bounce attempt. The strong springs off the day's lows suggest the same, especially when they're accompanied by large volume. Only big money can produce big volume, and they weren't dumping everything or there wouldn't have been a spring. Big money can absorb what you and I dump on the markets, but we can't absorb what they do, so we were the dumpees and they were the absorbees, at least to some degree.

It's also difficult to bounce confidently when one stands on the edge of a precipice, especially if a strong wind is blasting against one's back. A collapse of the yen carry trade in overnight trading tonight could provide that strong blast of wind. If I have difficulty predicting our economic numbers in advance, I certainly have difficulty predicting Japan's.

Other than an occasional green candle every 90 minutes or so, the U.S. dollar/yen's 15-minute chart trended lower all day today, predicting that bounces would not last until the pattern began changing about 2:45. The adv/dec line could never pick itself up and rise. Watching these two inter-market and breadth indicators alone would have saved traders from trying to catch that proverbial falling knife until the bounces began, so I certainly suggest that they be watched tomorrow. In particular, begin looking for bullish divergences on the adv/dec line, as these sometimes, but not always of course, precede price bounces.

I drilled down to a three-minute chart for the USD/JPY to show you why I'm still not shouting "bounce alert" from the rooftops.

Annotated Three-Minute Chart of the USD/JPY:

For those who do not have a quote for this pair, you can watch the crawler above the screen on CNBC, where it's listed as "yen" on the left-hand side.

Annotated Three-Minute Chart of the SPX:

Keltner lines, as many of you know by now, are dynamic, but let's talk about what we see here. First, the failure of the USD/JPY to confirm its inverse H&S throws some doubt on whether the SPX will be able to do so. If it does, by sustaining three-minute closes above about 1490, this chart currently suggests an upside target just under 1503, but that target will move higher with price changes. The ultimate Keltner target might fit in well with a daily chart 72-ema test tomorrow, if the SPX confirms that inverse H&S. If the SPX drops back instead, blue-line support will likely move down toward 1475-1476, with next support below that firming up near today's low.

If that support doesn't hold, then I think we have to watch for a 200-sma and -ema test, considering the possibility that those moving averages may not hold, as they didn't today for the USD/JPY or the Russell 2000. You don't want to be trying to catch those falling knives if the SPX keels over.

The Nasdaq has already confirmed an inverse H&S on its three-minute chart, but it was showing some bearish divergence as it did.

Annotated Three-Minute chart of the Nasdaq:

This sets a potential 2622-2625-ish upside target, since the upper target line is likely to move higher as price does. Beware a break down below the gathering Keltner lines near the neckline of that inverse H&S, however. It will show that today's last-minute confirmation wasn't to be trusted.

The RUT's three-minute chart shows characteristics similar to the Nasdaq's.

Three-Minute Chart of the Russell 2000:

My conclusion? Those springs off the low seen on the daily chart and the tiny inverse H&S's seen on these three-minute charts all hint at bullish intentions. However, the USD/JPY action does not yet confirm those bullish intentions, so I'd remain wary, especially since I can't wait until Japan's consumer number and the Asian markets' reactions before filing this report tonight. I also don't know how the reaction to our GDP is going to impact markets.

With such stiff declines this week, we have to conclude now that markets have moved into a more neutral mood if not a downright bearish one. Charts show me the potential for markets to spend another few weeks hammering it out, but if the yen carry trade collapses, the market reaction will be telescoped into days or maybe even hours. So, look at these conclusions, at least consider the possibility that markets will attempt a bounce or consolidation attempt, but always remain wary of darker possibilities.

Don't bet the farm on anything right now. In fact, despite my call for a possible consolidation or bounce attempt, I wish I owned a farm, outright, and was producing my own food and biodiesel, because all this doom and gloom scares me. Sounds about right for a bounce, though, doesn't it, if everyone is scared?
 

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