Market Internals


U.S. equities closed flat to slightly lower today after pulling back from their morning highs. The crude complex also pulled back after jumping higher this morning. Treasuries, however, finished near their highs. Traders apparently act on the assumption that plans will be announced at the end of the week that will keep bond prices high and yields low. That bond-buying wasn't isolated to the U.S. In Spain, 10-year yields dropped lower today, too.

Monday's Developments

The National Hurricane Center downgraded its forecast for Isaac today. It expects Isaac to be a Category 1 rather than a Category 2 hurricane by its expected landfall. The storm could still prove dangerous as it heads toward New Orleans. Isaac may not boast high wind speeds, but it is characterized as an unusually wide storm, with winds extending more than 200 miles from its center.

Ahead of expected storm surges, mandatory evacuations of low-lying areas outside New Orleans had already begun by mid-morning today. I know people as far west of the storm as Port Arthur who will be spending this evening and tonight checking Isaac's path. In low-lying areas, the decision to evacuate must be made well ahead of a storm's arrival, when its forecast path may still be uncertain. Older residents along the Gulf Coast will remember times when they went to bed feeling safe and woke up to a storm that had altered its course with roads all but impassable. Roads are flooded well in advance of the storm's arrival.

At New Orleans, officials predicted storm surges six to twelve feet above normal. At Panama City, the prediction is for about four to seven feet above normal. Maximum rainfall amounts of 18 inches are possible in Southeastern Louisiana, the government warns. With landfall expected Tuesday night to Wednesday morning, no one can ignore the comparisons to the upcoming August 29 anniversary of Katrina's landfall in 2005.

Isaac Tracking Chart:

Residents won't be the only people being evacuated. An AP article published yesterday indicated that oil companies were already evacuating offshore workers from platforms and cutting oil and gas production. BP had temporarily halted production by Sunday, and Royal Dutch Shell was in the process of doing so. Apache and Murphy Oil were joining them.

When Isaac was downgraded, the crude oil complex pulled back sharply from the early morning highs. Futures had reportedly been sent higher by Isaac's altered and more westward path through the Gulf and news of a refinery fire in Venezuela. That refinery fire had killed dozens and was projected to do more harm to production than Isaac, although that's yet to be determined.

Some experts pegged the pullback in the crude complex to renewed speculation that supplies would be released from the Strategic Petroleum Reserves rather than to the downgrade of Isaac's projected strength. Other sources called that speculation a rumor that should be discounted. Jim Brown has been covering the speculation about such a release in his Wraps and in his newsletter, OilSlick.

Not all building storms this week involve the weather. As market participants parse each word spoken by Federal Reserve presidents this week leading into the Jackson Hole Economic Symposium, Chicago Federal Reserve Bank President Charles Evans spoke sweet words to those hoping for more stimulus.

Addressing the Hong King Bankers Club last night, Evans said the central bank should move right now to initiate a bond-buying program that would keep rates low. The difficulty for us lies in determining whether he's speaking out of turn or speaking as part of an orchestrated effort to manage expectations ahead of Jackson Hole. Futures traders weren't taking any changes. They bid U.S. futures higher in the premarket session.

This bidding higher occurred despite some weakness in global bourses. The Nikkei 225 managed a positive close, up 0.16 percent, but it dropped from about 10:00 am local time on, into a close at or near its low of the day. The Hang Seng lost 0.41 percent; the Straits Times, 0.20 percent; and the Shanghai Composite, 1.75 percent. European bourses had been weak early in their sessions, too, although that changed about the time our futures bounced, too.

President Evans is an alternate member of the 2012 Committee, not a voting member, so some skepticism should remain about whether he's speaking with the voice of the FOMC. Another alternate, St. Louis Fed President James Bullard, sounded quite different last Thursday when he said economic results were "good enough . . . to keep us on hold." A week earlier, Philadelphia Fed President Charles Plosser said he didn't see "much benefit" in such an easing program, and Dallas Fed President Richard Fisher questioned why do it if it had been proven to have little effect on unemployment? Fisher has also expressed the fear that FOMC action too close to the election might be deemed a political step, an impression he hopes they can avoid.

Were Evans' sweet words anything more than his own views? Was he testing the waters? We continue to see the same mixture of views expressed in the Minutes released last week, so I'm not certain we're hearing anything new. If you've read the Minutes released last week, you've read that members "also exchanged views on the likely benefits and costs of a new large-scale asset purchase program." Many thought it might "provide additional support" while "others questioned the possible efficacy" and "some expressed concerns about the effects . . on trading conditions in markets related to Treasury securities and agency MBS." "Several worried that" the considered action "might alter the process of normalizing the Federal Reserve's balance sheet when the time came to begin removing accommodation."

Concern builds that market participants may be disappointed by this weekend's upcoming events when FOMC Chairman speaks at Jackson Hole at 10:00 am ET on August 31 and ECB President Mario Draghi speaks at the same time the next day. Articles describe the FOMC voting members as divided, a view that seems appropriate when the Minutes are closely studied.

Economist Michael Feroli mentioned that FOMC Chairman Bernanke might want to avoid turning "Jackson Hole into a policy-signaling event" (Zumbrun, Joshua. "Jackson Hole May Disappoint Investors Primed for Stimulus. Bloomberg). A former economist at the New York Fed, Eric Green, believes that Jackson Hole will instead be used to clarify views since data has been a bit firmer since the period covered by the Minutes. With the jobs data coming a week after Jackson Hole, Bernanke may be reluctant to move at the end of this week, some speculate.

We also have to figure out whether others, over in Europe, were speaking out of turn this weekend. German Chancellor Angela Merkel and her speechwriter must be two of the most frustrated people on the globe these days. Efforts to carefully frame Germany's response to the Greek Prime Minister's pleas to Germany and Italy last week were undermined this weekend. Those undermining her careful management of expectations were not political enemies, or at least they didn't start out that way: they included a member of her coalition and the head of Bundesbank, one of her former economic advisers.

The party member called for Greece's exit from the Eurozone. The Bundesbank chief questioned the legality of ECB bond buying, one tactic being considered to keep yields manageable in countries such as Greece, Spain and Italy. The Bundesbank chief, Jens Weidmann, compared central bank financing to an addictive drug. Although a Spiegel article characterizes Weidman as "increasingly isolated" and "a troublemaker," others have said that he is far from alone in his opposition. Certainly, Chancellor Angela Merkel's political opponents would agree with him, but even some politicians among her coalition partners reportedly do, too.

It's hard for retail traders in the U.S. to weigh the relative bargaining power of Evans with someone expressing deep concern over the prospect of further quantitative easing here in the U.S. and determine which view will prevail. It is even more difficult for us to weigh the personal and institutional strengths of Jens Weidmann against those who have changed position and say he must, too. We can't understand all the forces at work, or at least we can't if we don't spend our working lives researching such forces. Will Weidmann take the route of a predecessor, who resigned over his opposition to bond purchases? Will his view instead prevail? What is clear to us looking in from the outside is that a power struggle, a storm of sorts, ensues, but that's about all that's clear.

Some say that the situation is so dire that he and others who share his view have no choice but to concede. Others point to indications that the bond-buying may not even be needed, as some countries cut their deficits or build surpluses.

Chancellor Merkel's coalition member, Alexander Dobrindt, directed stronger words than Weidmann's, and directed them at ECB head Mario Draghi. According to a Reuters article this weekend, Dobrindt warned that Draghi risked taking a place in history as the "currency forger of Europe."

That storm wasn't the only factor impacting European trading. Germany's important Ifo Business Climate was released. That number dropped more than was anticipated, to 102.3, below the anticipated 102.7 and the prior 103.2. Although still well above its 2009 lows in the mid-80's, the Ifo has been trending down since May 2011, when it hit a high of 113.9. This number is derived from a survey of manufacturers, builders, retailers and wholesalers and is considered a leading indicator of the health of the German economy. It tends to be well correlated with economic conditions both in Germany and in the broader Eurozone.

The European bourses we watch most closely had opened in negative territory, seemingly reacting to German Chancellor Merkel's clarifications. Most trended down or sideways for several hours until they bounced along with our futures, reacting to Evans' words. There might also have been some sell-the-rumor, buy-the-fact reaction to the much-watched Ifo, or it might not have been as bad as some had feared it would be. The bounce here in the U.S. didn't stick, but it did in Europe. The FTSE 100 closed flat; DAX, higher by 1.10 percent; CAC 40, higher by 0.86 percent; and Spain's IBEX 35, higher by 1.21 percent.

Here in the U.S., Monday's economic release schedule usually proves light. With the exception of Federal Reserve Bank of Cleveland President Sandra Pianalto's address before the Area Business Luncheon on Newark today, that was true this Monday, too. However, after Evans' statements in Hong Kong and the market reaction, it was only to be expected that market watchers would glean her prepared statement and responses to the Q&E session for clues. Unlike Evans, Pianalto is a 2012 voting member of the FOMC.

She addressed three topics: background on the Federal Reserve, the FOMC and monetary policy, and her economic outlook and perspective on current monetary policy. She went out of her way to clarify that she was providing only her opinion and not that of her colleagues. She referenced uncertainty about Europe and fiscal policy in the U.S. She expects economic growth of about 2 percent this year and a "very slow improvement" in the jobless rate. While headlines I read afterwards hinted that she was in favor of more easing, she in fact pointed to the "limits to what monetary policy can accomplish." She said we must be cognizant of those limits and also of "the costs and risks of further actions." She is not certain that future efforts would be as effective as past ones, and she feels it "conceivable" that future policies could "interfere with financial stability."

Her bottom line was that she was "supportive of actions that provide economic benefits with manageable risks." She had made it clear during her speech that some of the tools currently being employed were relatively new and warranted further analysis. It read like a recap of the "many" and "some" statements from the Minutes.

Story stocks today included Hudson City Bancorp (HCBK, 7.45, up 1.01 or 15.68 percent), signaling its agreement to be acquired by M&T Bank (MTB, 89.82, up 3.95 or 4.60 percent). MTB will pay HCBK shareholders $7.22 per share, a 12.0 percent gain on Friday's close.

AOL (AOL, 33.86, up 0.94 or 2.86 percent) announced a special $5.15/share cash dividend. The dividend will be payable on December 12, 2012 to shareholders of record at the close of business on December 5, 2012. The company also will repurchase $600 million of common stock under a fixed-dollar collared Accelerated Stock Repurchase Agreement with Barclays Bank. These funds will be made up of funds previously approved and an additional $10 million approved August 26. The funds will be paid up front, and Barclays will deliver the stock in increments, beginning with about 4 million shares on August 30. The company expects the majority of the repurchased shares to be delivered by year's end. The company will take steps to ensure that no "change of control" be triggered by this action.

ImmunoGen (IMGN, 14.62, up 0.78 or 5.64 percent) reported significant improvements in patients participating in a drug trial of trastuzumab emtansine, a breast cancer drug, with the trial completed by Roche (RHHBY). The drug utilizes an IMGN technology. Roche develops it in an agreement with IMGN and Genentech, and Genentech has also submitted a Biologics License Application to the US FDA for the drug. RHHBY has Phase III trials testing the drug in both previously treated metastatic HER2-positive breast cancer and newly diagnosed cancers.

We can't mention story stocks without mentioning Apple (AAPL, 675.68, up 12.46 or 1.88 percent), reaching for another new high. The company did not appear to be ready to make nice with Samsung today, announcing that it wants to ban sales of eight Samsung devices. A Business Insider article concluded that most of those devices were outdated and related to last year's Galaxy S II models.

Seadrill Ltd (SDRL, 41.43, up 0.30 or 0.73 percent) reported earnings $0.33 better than the consensus with revenues of $1.12 billion only slightly better than the $1.12 billion consensus. The company increased the cash dividend by $0.02. The company's report included information about downtime on the deepwater rigs in the third quarter, too, with that time related to a now-resolved issue.

Of course, the Republican Convention will draw much attention, too. We can expect the GOP's take on the economy and solutions to the perceived problems to take center stage over the next couple of days.

Those who would like to watch graphics related to Tropical Storm ISAAC can find them at this National Weather Service site.


Those new to my Monday Wraps might find the following two paragraphs useful when interpreting my 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:

Last week, the SPX drove up through its rising regression channel. The index could not bulldoze through the waiting Keltner resistance marked by the upper purple channel line. That meant it could not reach the top of its rising regression channel on that upswing.

The SPX did pierce the Keltner resistance and the April peak high. Then it fell back and closed that day below the waiting Keltner resistance, marked by the purple line on the chart. That was not a good sign, and the candle left behind was a bearish one. The resistance was shown to be strong.

Since then, the SPX has again churned back and forth across the (red) 9-ema rather than using that moving average as a trampoline. On strongest rally behavior, prices might pierce that moving average intraday, but closes would be above it. We're seeing chop around it instead.

Because the SPX is not displaying its typical behavior when rallying strongly, the next move remains less certain. It is about equally likely that the SPX will drive up toward its next upside target or down toward its next downside Keltner target, marked on the chart with green (upside) and (red) triangles, respectively. At each of those marked potential targets, historical and rising channel resistance or support join potential Keltner resistance and support on daily closes. With this setup and known geopolitical uncertainty ahead, market participants should be prepared to defend trades if the SPX should head either direction. The chart formations don't strongly suggest a next direction, although they do suggest that the SPX isn't as strong as bulls would like it to be.

If the marked nearest resistance or support should be breached on daily closes, the next potential targets are marked. Later, we'll look at intraday charts to see if we see any more clarity, but don't count on it.

Annotated Daily Chart of the Dow:

The Dow's performance has begun to differ from the SPX's, although they had been in lockstep. For now, the Dow's performance looks weaker on a Keltner basis, at least. The Dow could not achieve the same upside Keltner target last week, turning down well ahead of the upper purple Keltner channel boundary. Today, it produced another close beneath the red 9-ema. When I examined Dow components this afternoon, I noted that only 10 out of the 30 posted gains. Those showing the biggest percentage losses included AA, BAC, CAT, IBM and HPQ. Biggest dollar losses were CAT and IBM.

Now the Dow threatens to form a pattern of daily closes beneath the 9-ema, which indicates at least short-term weakness if the pattern continues. Such a pattern would give a little more weight to the possibility that the Dow will dip down to the bottom of its rising channel to test support rather than or before rising to the top of the channel to test resistance. For now, the conclusion is tentative and can quickly be overrun by some announcement by someone, somewhere, but that's the setup as it exists. As we will see from studying other indices, we're getting a mixed short-term view of the various indices.

The transports, the Dow's sister index, provides no clues that will help clarify the Dow's strength versus weakness. The transports have been chopping in a coiling formation back and forth around a nexus near 5086-5100 for months. Its failure to follow the Dow up to new recent highs has been a matter of some concern to those traditionalists who follow Dow theory.

Green and rectangles mark next upside and downside targets for the Dow, where potential resistance and support on daily closes can be supposed to exist. Although the setup gives a preference to a downturn, the candle setup does not, so market participants need to be able to defend their Dow-related trades should the Dow head up as well as down. In case of a breakout of either zone on consistent daily closes, further targets are marked, too.

Annotated Daily Chart of the NDX:

If the Dow looks weaker than the SPX by Keltner and regression channel standards, the NDX looks stronger. It broke out of its rising channel and confirmed that breakout by finding support at the upper boundary when it pulled back. Resistance had been converted to support. Furthermore, the NDX's (red) 9-ema has converged with the top of the former price channel, lending its support, and the NDX found daily-closing support there, too.

The NDX can't quite pull free of the Keltner support it's testing, however, and that's a bit worrisome. It may have producing some closes at or slightly above that potential resistance at the purple channel's upper boundary, but the NDX hasn't been able to build on those gains, questioning the NDX's strength.

Further pullbacks into 9-ema tests can't be ruled out, and, in fact, look likely unless the NDX can soon sustain daily closes above last week's high though daily closes. If the NDX can break to the upside that, it sets a potential upside target at the top green rectangle.

For now, a pullback to 2757-2766 can't be ruled out. Any drop below the 8/24 low of 2750.64 that isn't reversed within an hour or two suggests a further drop, at least toward 2730 and perhaps closer to 2680-2700.

With homage to Neil Armstrong, all it takes is one leap for NDX to clear the hurdle of the resistance it's been battling, but for now, it has not been successful in clearing that resistance. Give some thought to the possibility of how your NDX-related trades will function if the NDX pulls back to stronger support this week. Further potential downside targets are marked, too, if the ones mentioned are breached on daily closes.

Annotated Daily Chart of the RUT:

Last week, I mentioned that I was leaving the former rising channel "as is" on the RUT's daily chart since the RUT had been rising to retest it from the underside. I thought it had some proven validity. Last week, the RUT rose up to perform a picture-perfect retest of that former support line from that channel again, and that former support once again served as resistance. It and the converging Keltner resistance (upper purple channel boundary) seemed to form an electric fence that repelled the RUT.

Now, like the SPX, the RUT chops back and forth across the red 9-ema. A drop toward the nearest red rectangle's convergence of historical and Keltner support seems about as likely as a rise back up to retest the potential resistance formed near that former rising channel's lower trendline.

If this were any index other than the RUT, that long candle wick left when it retested that channel last week would suggest that down would be more likely than up from here. However, this is the RUT, and it's not just any other index. If our impossible-to-quantify trading pattern is emotion-based, the RUT is one of the indices most impacted by that type of trading pattern. It's held hostage by it. Moreover, the small businesses that compose the RUT are more impacted by interest rates and so more sensitive to news that would suppress or increase yields and interest rates. Expect continued emotion-based, squirrely trading patterns for the RUT until some of these issues have been settled.

If the RUT should break through either of those marked nearest support or resistance levels on consistent daily closes, the next potential targets are marked on the charts.

Tomorrow's Economic and Earnings Releases

By tomorrow evening, we will also be getting news bullets from the GOP convention and also coverage of what does or doesn't happen with Isaac.

Whatever happens tomorrow, it will all be weighed against what could happen at the end of the week. As a reminder, the Jackson Hole Symposium opens Thursday, August 30, and continues through Saturday, September 1. FOMC Chairman Ben Bernanke is expected to speak Friday, August 31, at 10:00 am ET, and ECB President Mario Draghi is expected to speak Saturday, September 1, at 10:100 am.

These meetings will, in turn, be lent special weight because of an upcoming September 3 EU Finance Ministers Meeting and September 6 ECB Governing Council meeting in Frankfurt. At the conference after the September 6 meeting, ECB President Mario Draghi is expected to address efforts to lower Spanish and Italian borrowing costs.

What about Tomorrow?

When we look at these intraday charts, something will become quickly apparent: those little rectangles connoting possible upside and downside targets, and potential resistance and support litter the charts. They're spread out all over the place. Few converge to show strong support or resistance. When this happens, it shows that we have chop, that it's difficult to trust support or resistance to hold, and that it's difficult to pinpoint any one specific level that is more important than another. This warns us to be careful of suppositions in this market climate.

We'll note something else on many of these charts, too. Let's take a look.

Annotated 30-Minute Chart of the SPX:

There's been an underlying bullish theme to the markets lately. Bad news is perceived as good news because it's taken to mean there's likelihood of more easing. Good news is sometimes perceived as good news, too, although occasionally, if it's good enough, it's bad news because that's perceived as lessening the chance for easing. It's just not a concept that I understand, but it is what it is.

That underlying bullish thesis is apparent on a shape spotted here on the SPX's intraday chart. There's a potential inverse or reverse head-and-shoulders formation, not yet confirmed. Whether you believe chart formations are predictive, whether the inverse form of this has a good or poor prediction of future action, plenty of market participants are going to spot it. It may be somewhat self-fulfilling.

The neckline roughly coincides with the upper boundary of the purple channel. Most times, the SPX and other indices, too, tend to stay within that channel, although they stretch it up or bend it down at times. Most times, the SPX finds support on 30-minute closes at the lower boundary and resistance on 30-minute closes at the upper one.

This chart would suggest then that if the SPX can sustain 30-minute closes above that upper channel boundary, marked with the nearest green rectangle, it will have confirmed the reverse or inverse head-and-shoulders. Bullishness will be confirmed, as long as those 30-minute closes hold above that level, and a potential upside target is in place. But we didn't need Keltner channels or inverse head-and-shoulders to tell us that. We've seen resistance near 1416-1418 over several days. The Keltner channels just give us another confirmation level to watch.

If the SPX sustains 30-minute closes below that green moving average, the 120-ema on the 30-minute chart, then it's setting up a potential retest of potential support that ranges from 1404 down to Friday's low and maybe even as low as 1394-1395.

Trading inside the shoulder area constitutes chop. If the SPX chops back and forth inside that shoulder area too long, then the whole head-and-shoulders formation is rendered useless as a predictive tool, and it's clear bulls didn't yet have the strength to confirm it.

Annotated 30-Minute Chart of the Dow:

The Dow's version of the inverse head-and-shoulder isn't quite as well formed, and that right shoulder is extending a bit longer and lower than is comfortable for the bulls. Still, similar precepts are there.

The Dow ended the day testing the bottom of the right shoulder. If it drops through that zone on consistent 30-minute closes tomorrow, it sets up the potential for a drop to the 13060-13075 zone and maybe even deeper, into a retest of Friday's low.

If the Dow instead can maintain consistent 30-minute closes above about 13160-13165, confirmed by a move above today's high, it sets up a potential move up to 13200-13210. Consistent 30-minute closes above that level or a gap above it tomorrow morning that holds beyond the first 30-45 minutes of trading potentially sets up a retest of last Tuesday's high.

Annotated 30-Minute Chart of the NDX:

The NDX's pattern on this chart is different. An optimist can find a potential inverse head-and-shoulders, but it's almost a scribbled rendition of one rather than a well-formed formation. Between about 2775-2800, the NDX just trades in a choppy zone without much of a predictive pattern. While these chop zones can certainly be wide enough to damage or help an intraday trade, they just don't offer many predictions. If the NDX forms consistent 30-minute closes outside this range, the next potential targets, where next resistance or support might also be found on 30-minute closes, are marked on the chart.

Annotated 30-Minute Chart of the Russell 2000:

By the close, the RUT had dropped from the daily high and was tangled in a web of potential support/resistance lines even tighter than those seen on other charts. This should have been a strong-enough convergence of support that it immediately bounced the RUT, but it didn't do that and hasn't been doing that. A drop to about 804-806 looks about as likely as a climb to 811-812 or maybe even 814-816, and vice versa. It's not going to be until there are consistent 30-minute closes outside of that purple channel until there's any meaningful movement at all, and then that's just enough to predict a next short-term potential target. Those targets are marked on the charts.

No one knows what's going to happen. That's apparent from the rhetoric we're getting as well as from the action shown on the charts. I personally continue to be careful because I've been through market setups when markets were testing recent highs while volatility indices were at strong support. I know what usually results--an equity rollover--so I'm trading relatively small. I have enough cheap downside insurance that I'm not going to lose my shirt or my trading portfolio if markets roll down again. However, because I was also trading through the mid 2000's when these conditions were followed by a continued grind upward in equities while volatility indices sank to unbelievably low levels, I do make appropriate adjustments to my trades when they start leaning too much to the bearish side. I do not rely on the "it has to reverse" adjustment. You shouldn't, either. Markets don't have to do anything, and they certainly don't have to do it when you want or need them to do it.

To all those in the path of the hurricane or of the associated winds or storm surge, we at Option Investor convey our hope that you and yours stay safe.