Market Internals


She's back. German Chancellor Angela Merkel has returned from her holiday. Her government's return this week may have contributed to the intraday volatility.

The global trading day started out calmly enough while we were still sleeping, echoing the title of a Reuters article this morning: "Dog days of August spell calm but no relief." Certainly, through early August, the U.S. and many global markets have seen market calm. The calm has been expressed by steady or rising markets amid extremely low volatility measures. The calm continued despite a bombardment of troubling global economic reports and news reports and was often attributed to hopes of further easing.

Among other developments, this weekend brought a U.S. political choice in the U.S. that creates stark differences in the way U.S. tax and spending policies might develop, much smaller-than-expected GDP growth in Japan, and an admission by Italy's finance minister that he would not introduce further austerity measures this year amid a growing deficit. While some reporters speculated that Italy would need a bailout, the finance minister denied that report. The finance minister blamed smaller-than-expected growth for the increasing deficit but said the country would still meet its EU obligations.

Last night, some Asian markets had indeed been calm in mixed trading but certainly not all. The Nikkei 225 dropped only -0.07 percent and the Hang Seng, -0.27 percent. The Straits Times climbed 0.35 percent. China's Shanghai Composite lost 1.51 percent, however.

This has not been a calm summer for those trading stocks listed on the Shanghai Composite. The index began dropping from its May 4 closing high of 2452.01 and fell into its July 31 closing low of 2103.63. After an August relief bounce that brought it back to 2174.10, it has turned down again and last night closed at 2136.08.

Shanghai Composite, Chart by (c)2012 Yahoo, Inc.:
Monday's Developments

Overnight, our futures proved a little more jittery than some might have preferred. They weren't entirely calm, perhaps presaging the day's volatility. Futures had been knocked back into negative territory, with the SPX futures down as much as 5.6 points during the night. However, futures calmed between about 2:30-3:30 am ET and then began climbing along with European bourses which were also bouncing off their overnight lows. That bounce didn't last once our cash market opened.

Many indices zoomed down and then back up again. At the end of the day, headlines were reporting that the gaining streak had been broken, but SPX, Dow and RUT losses were small--at 0.13, 0.29, and 0.26 percent, respectively--and the NDX gained 0.05 percent. Those calm-seeming numbers belied the real action, however, and some individual stocks saw big moves.

What happened after the cash markets opened to undo that Zen-like calm? Many forces combined. Last week, buyers had sent index prices up to key round-number and psychologically important levels, but they couldn't push them above those numbers after days of attempting to do so. Technically, the markets needed either a gap above those numbers that would prompt shorts to cover again or to retreat and regroup before making another attempt.

With that being the technical setup, disconcerting articles being appearing at about the time our markets opened. Chancellor Merkel's government came back and began issuing news bulletins. One has to wonder if the Italian finance minister's statements this weekend proved a last straw for Chancellor Angela Merkel's government. Perhaps in an attempt to kill two birds with one stone or rather kill one and warn others in the same flock, Michael Fuchs, a senior member of Chancellor Merkel's party, addressed the situation with Greece. He said that "Germany cannot and will not agree to" a new aid package for Greece, that Germany had reached a limit and there would be no more "last, last, last chance" for Greece (Reuters, "Senior Merkel ally sends stark warning to Greece").

In an op-ed piece published in The Wall Street Journal, European Economic and Monetary Affairs Commissioner Olli Rehn affirmed that ECB bond purchases would be available only for those member states that meet conditions the ECB sets, although those conditions have yet to be determined. (Is anyone else sighing yet?) In an interview for Belgian newspapers, ECB Governing Council Member and head of the Belgian central bank Luc Coene reminded readers of the ECB's experience last year in buying Italian bonds and then seeing the Italian government fail to meet pledges it had made. "Only when there's [SIC] no more Spanish and Italian bonds in the market" will the market turmoil stop, he claimed (Bloomberg, "Merkel Returns to Crisis as Bond Buying Remains in Focus, Patrick Donahue).

Germany has to cooperate before the European Stability Mechanism, the $614 billion permanent rescue fund, becomes active. The ESM has to be approved by Germany's Federal Constitutional Court, with a ruling expected September 12. Some rumors have begun circulating that more popular support will be sought, in the form of a referendum.

As these reports were appearing, European bourses began falling off their day's highs. Most also saw some just-before-the-close buying that kept them from closing at their day's lows. The FTSE 100 closed lower by 0.26 percent; the DAX, by 0.50 percent; and the CAC 40, by 0.27 percent. That last-minute burst of buying managed to close Spain's IBEX 35 higher by 0.31 percent after it had tumbled from its day's high into negative territory. Yields on Spanish 10-year bonds closed lower at 6.841, down 0.06600, although they had reversed off their day's lows as equity indices were reversing off their day's highs.

Story stocks today included Google (GOOG, 660.01, up 18.01 or 2.81 percent). As part of its reorganization or reinvention efforts for Motorola Mobility, GOOG announced its intention to cut 4,000 employees at Motorola Mobility, amounting to 20 percent of the work force. One-third of those cuts will be of U.S. employees. GOOG will close 94 offices across the globe, trimming operations in Asia and India. The company will abandon unprofitable markets and low-end devices and will concentrate on a few phones with features they hope will recapture the popularity of Motorola's phones. As part of the research I'm doing for a novel, I've got a formerly wildly popular Motorola brand cellular phone from the late 90's sitting on my desk, reminding me of how sought after the company's phones once were. However, many experts point to the current difficult competitive atmosphere for companies attempting to pick up the crumbs left behind by the iPhone and Galaxy phones. Note: In a late-day announcement just as this was going to press, GOOG announced that it would buy the Frommer's guides from publisher John Wiley and Sons.

International Paper (IP, 33.94, up 1.31 or 4.02 percent) also figured among the story stocks. The price headed higher after a Credit Suisse upgraded the company's stock to an outperform status. Perhaps Louisiana-Pacific (LPX, 12.56, up 0.56 or 4.67 percent) benefited from reflected glory, achieving a 52-week high during intraday trading.

Elan (ELN, 11.60, up 0.50 or 4.50 percent) will spin off Neotope Biosciences in order to create two companies, Elan Corporation plc and Neotope Biosciences plc. The first will be focused on generating growth and the second, on drug discovery. If the spinoff is completed, ELN expects both to be listed on a U.S. exchange by the end of the year.

Sysco (SYY, 30.14, up 1.30 or 4.51 percent) reported earnings that were six cents better than consensus predictions, with revenue equal to the consensus. The company reported food cost inflation of 3.3 percent.

Groupon (GRPN, 7.55, up 0.11 or 1.48 percent) shares plummeted in after-hours trading after reporting. Profit was better than expected, but gross billings dropped. The company forecast Q3 revenue of $580-620 million. That placed the midpoint below the previous expectation of 605.5 million. As this report was prepared, the stock was at $6.39, down $1.16 or 15.36 percent from the day's close.

And, once again, what is a discussion of story stocks of the day without a discussion of Apple (AAPL, 630.00, up 8.30 or 1.34 percent)? Early in the day when many stocks were diving, AAPL was gaining. Excitement over the rumors about the September 12 release of new products, the upcoming dividend payment, and perhaps interpretations of news coming out of the AAPL/Samsung litigation supported AAPL prices and sent them higher. Sometimes it seems that AAPL is single-handedly lifting the markets. According to some writers, it is single-handedly lifting the August dividend payout of the S&P stocks to a higher percent of the SPX value than is the historical norm for August.


Those new to my Monday Wraps might find the following two paragraphs useful when interpreting the charts. Those who have read the Wraps can skip straight to the charts. I set up nested Keltner channels on my charts. It's a run-of-the-mill channeling system like the more familiar Bollinger Bands. As with those more familiar BB's, channel boundaries are often targets for upside or downside moves. They also mark levels where prices might find support or resistance on closes. When several channel lines converge, that potential resistance or support might appear stronger, just as it would if 20-, 50- and 100-sma's all converge in one spot.

For the benefit of subscribers, I mark potential upside and downside target/support/resistance levels with ovals, usually green for upside and red for downside. Orange ovals are sometimes used when the darker-colored ones would not allow for a clear examination of the next target. From now on, I will mention the nearest potential support or resistance level in the discussion on the chart, but not the further-out ones. They can be located on the charts if price breaks through the nearest levels on consistent daily closes. If an interpretation such as "support levels appear stronger than resistance, so up looks more likely than down" is possible, I'll tell you. Often we traders must be able to defend our trade against a move in either direction.

As with any type of potential support or resistance, those with profits should be protective of those profits as support or resistance is tested. If prices find support and climb, look to the next higher oval, even one just broken through, as potential resistance. Do the reverse when resistance is breached. Hopefully, this format provides you with the information you need without requiring all night to read as happens when I list each potential support or resistance level individually.

Annotated Daily Chart of the SPX:

Is it time for a trip down through that channel again or is the SPX going to hit the top of the channel line instead?

When we examine the SPX chart, we see that it has perhaps begun a pattern of finding support on daily closes at or above the (red) 9-ema. This is what the SPX tends to do when it's rallying at its strongest. However, it's been only a short time since the SPX was still chopping back and forth across that red 9-ema in a no-pattern chop zone. Bulls need to see the SPX continue daily closes at or above that moving average or risk seeing the price drop down through the rising price channel again. Potential support levels are marked along the way if it should begin dropping through that channel. Unfortunately for those trying to make decisions, we now have to consider the 1348-1365 level a potential support zone where support could be found anywhere along the way, rather than looking at a specific number within that zone as a line of demarcation.

But why are we talking about declines when the SPX bounced off its lows today? Until the SPX breaks soundly through the resistance it's been testing for a week, we have to consider that the 9-ema might be retested.

Let's look at the more bullish case. Sustaining daily closes at or above a rising 9-ema maintains more likelihood that the SPX will continue reaching toward the marked top of its rising price channel, joining with historical and Keltner resistance found there. Make decisions ahead of time how you'll protect bullish profits if that level is tested, in case the SPX pulls back instead of charges through the resistance.

Further upside and downside targets are marked in case the SPX breaks through maintains daily closes outside the closest potential support and resistance levels.

Annotated Daily Chart of the Dow:

The Dow's chart is similar to the SPX's, with the red 9-ema soundly tested today and with a bounce from that moving average. It was a good thing for bulls that the bounce appeared when it did, and it's slightly disturbing to the bullish case that the Dow has needed to test that moving average two trading days in a row rather than bouncing strongly from Friday's close after Friday's successful test of the 9-ema.

Sustained daily closes beneath the 9-ema strengthen the possibility that the Dow will roll down toward the bottom of its rising price channel, with a likely potential support zone marked on the chart. As with the SPX, continued chop back and forth through that zone over the last few weeks make it a zone rather than a specific aha! price point that we can mark as a decision point.

Sustained daily closes above that 9-ema make it more likely the Dow will reach toward the top of its price channel, with a likely resistance zone marked there, too. Make plans ahead of time to protect bullish profits if that upside target is closely approached. Further upside and downside targets are marked in case the Dow breaks through either the support or resistance zones on sustained daily closes.

Annotated Daily Chart of the NDX:

The NDX has led the way for other indices, climbing all the way to the top of its price channel. However, it has not closely approached its April high, as the SPX and Dow have done. The NDX may then have had a little easier time rising through its channel without quite as much overhead. It had some distance to go before nervous bulls started taking profits in their trades, if that's what's going to happen.

Potential Keltner and historical resistance begin to kick at the highest orange rectangle. Bullish profits should be protected while this level is tested if the NDX should continue rising.

With AAPL and GOOG both performing so well today, the NDX's intraday pullback wasn't significant on this chart, not even approaching its 9-ema. Some bifurcation is beginning to exhibit itself among the indices, as several of us have been pointing out in these Wraps. Does the outperformance of the NDX indicate that the other indices will be pulled upward, or does the underperformance of the RUT and the Dow Jones Transports mean that the NDX will be pulled lower along with other indices? Today, it meant that the other indices would be pulled upward.

We're warned that something is afoot, but we don't know the outcome. We know the usual outcome when the RUT and Transports underperform, but we don't know if that will be the outcome this time.

For now, those in NDX stocks or related options should prepare for the possibility of a pullback for a 9-ema test or a jump up toward 2750. It looks time for a 9-ema test, but the jump up can't be ruled out, either. If 9-ema support or 2750 resistance fails to hold on sustained daily closes, the next potential targets are marked on the chart.

Annotated Daily Chart of the RUT:

The RUT's former rising price channel was started from the same time period as that seen on the other charts. The RUT's channel rose sharply. Unlike what happened with the other indices shown, the RUT broke through the support of that rising channel. The index has since risen twice to retest that channel from the underside. Neither time has it broken through again on sustained daily closes. For that reason, I'm leaving that original channel on the chart while removing the ones drawn since then.

I removed those others because the RUT hasn't maintained a trustworthy pattern. As is apparent from examining the chart, the RUT has been chopping back and forth across the red 9-ema in a way that indicates that there's no trustworthy trend here. We can't yet count on a breakdown below or above the 9-ema to prove anything. For now, we're still seeing lower highs and lower or equal lows, and that's not bullish. However, as long as prices haven't broken through the recent swing lows, it's not confirmed bearish yet, either. It is instead a sideways choppy mess.

The RUT pierced its red 9-ema today. We can all see the result, the bounce after that test, but we've already established that the 9-ema is not as good a predictor as it sometimes is because of the chop. As the chart indicates, a broad swath of potential and past support levels exist at and just below the RUT's current price level. Which of those is most meaningful if the RUT should break through that 9-ema? We won't know until or unless that level is breached on daily closes, and we can observe the action. However, the chart suggests that daily closes beneath about 779-780 set up a retest of the 7/24 and 8/02 lows.

The upside demarcation line may be easier to define. Sustained daily closes above about 809-811 set up a potential retest of the early July high. Bullish profits should be protected if that high is closely approached. Further upside and downside targets are marked on the chart for those cases in which the RUT breaks through supposed support or resistance on sustained daily closes.

Tomorrow's Economic and Earnings Releases

Retailers as represented by the S&P Retail Index, the RLX, moved in a tight range today, with today's small-bodied candle produced in about the middle of a rising price channel in which the RLX has been moving. Tomorrow's response to the 8:30 numbers may give us a heads-up about other indices. In the 2011 rally, the RLX was helping to lead the way, but it hasn't even begun to approach its spring 2012 high in this latest one.

Like it or not, we also have to be cognizant of what's going on in Asia and Europe, too, and the 5:00 am ET time slot includes a lot of important economic numbers for the Eurozone.

What about Tomorrow?

Despite the seeming roller coaster movements of the markets today, most indices covered in this Wrap traded between the boundaries of their smallest Keltner channels on the 30-minute charts. The day's action amounted to noise, without much predictive power. As is often typical of the RUT, it overshot boundaries, but let's look at the other three first.

Annotated 60-Minute Chart of the SPX:

The SPX gyrated within the boundaries of its flattening smallest Keltner channel, marked in grey on this chart. Today's action was not predictive of next action. If you're a bull, you think this is consolidation before an upside breakout. If you're a bear, you think that this is yet another sign that the buyers don't have enough energy or will left to send the SPX through that next resistance.

I say wait until you see sustained 30-minute breakouts out of this channel and the converging other Keltner channels, either direction. Then look to the next marked target, where next potential resistance (at upside target) or support (at downside target) might lie. As can be seen on all the charts and not just this one, bulls don't want to see support at the converging green and lower purple support levels/targets broken on sustained 30-minute closes. Next potential targets are much lower and point to the possibility of a hard and fast drop if that break occurs.

Annotated 60-Minute Chart of the Dow:

The Dow's chart is similar. The other Keltner channel lines have not converged quite so closely, so the potential support and resistance zones are a bit broader. Next potential targets on sustained 30-minute breakouts are marked. If the breakout is to the downside, bulls want to see the support at the converging green and lower purple channel lines hold on 30-minute closes. The next potential target is much lower.

Annotated 60-Minute Chart of the NDX:

The NDX led the way higher today but it did not break out above the resistance converging near the smallest Keltner channel's upper boundary. Like the other two indices, the NDX traded within a noisy zone without next direction being determined. If there is a breakout either direction with sustained 30-minute closes outside that grey channel, the next potential targets are marked, with resistance and/or support on 30-minute closes also possible at those next target levels. If the breakout is to the downside, potential support is layered a bit differently for the NDX. Bulls want to see the support at the lower green channel line hold on 30-minute closes. The next downside target is much lower.

Annotated 60-Minute Chart of the Russell 2000:

The RUT demonstrates an early morning breakdown out of the smallest Keltner channel and decline down to the converging green and lower purple channel lines. As bulls hope all the indices do if such a breakdown occurs, the RUT did find support on 30-minute closes at the converging green and lower purple channel lines. At least it did so today. That support bounced the RUT strongly, all the way back above a 796-798 potential support/resistance level. It stopped just below that magic 800 number.

The RUT's price is back inside that smallest Keltner channel again. The RUT still shows a pattern of lower highs and lower lows on this intraday chart. While that tight pattern had looked like a possible bull flag pullback, today's action made it look less potentially bullish, but we have to discount the RUT a bit since it tends to be the bad-boy index, overrunning boundaries. Bulls need to see the RUT maintain 30-minute closes at the converging support levels where it found support today if it should drop again. Otherwise, the RUT risks dropping toward the next, much-lower potential target. Potential upside targets are also marked if the RUT drives higher tomorrow morning.

What do I think? In the strongest trending markets, here's what happens, using the SPX's daily chart as an example. The SPX gains strongly, pulling far ahead of the rising 9-ema. Done, on 8/3. Then it trends sideways to sideways up for a few days while the 9-ema cycles closer underneath it. Done. Then the SPX drops down rapidly, testing that 9-ema before rising again.

Doest that 9-ema test sound familiar? It should because that's essentially what the SPX has done. Now it just has to perform the next part: a strong gain tomorrow.

However, there's a big caveat that questions whether the SPX and other indices are following that pattern or are just plain old stalling before pulling back. In the strongest trends, the Dow Jones Transports are usually leading the way to the upside or following closely after the Dow. The RUT is usually leading the way to the upside in the strongest trends with no "or following closely afterwards" part. It just tends to lead. And, importantly, the VIX and RVX are usually high and starting to roll over or about to roll over when such new trends start.

That is not happening. That is not our setup here. Instead, we have the transports lollygagging below. We have the RUT dropping harder on down days than other indices and looking weaker on the daily and intraday charts on a technical-analysis basis. We have the volatility indices at scary-low levels, not peaking at highs.

Either we're about to have a repeat of the mid-2000's phenomenon when the VIX kept dropping and then moved between about 10-13 a lot of time while the SPX was charging higher or else . . . we're going to have the usual outcome when volatility indices are this low and the RUT and transports are underperforming the other indices. I don't know which it's going to be. When I'm finished writing this Wrap, I'm going to find my kayaking hat with its strap under the chin. I'll need that strap so I can better hold onto my hat once the markets decide which way to go. We may not get much warning. Whether you're bullish or bearish, please do not take on too much risk in this market environment.