The month of May ended badly with a -208 decline but the Dow posted full month gains for the first time since 2009.

Market Statistics

The Dow started the day with erratic movement but slowly rose to a gain of +67 at 11:AM. Unfortunately, it was all downhill from there. When the Dow rallied to resistance from Thursday at just under 15,400 the sellers appeared and the index slipped back into negative territory. When the afternoon selling window arrived at 2:PM the move accelerated to the downside triggering sell stops as volume rose sharply.

The Dow fell to a three week low at 15,120 and the S&P at 1,632. The Nasdaq and Russell were more restrained and did not even close at the low for the week.

Dow Chart - 15 Min

The market was weak for a month end when funds are typically window dressing for their statements. Bull markets climb a wall of worry but tend to peak when bullish data appears. We have had a huge wall of worry for the market to climb over the last two months but data this week seemed to improve. What we are seeing could be worries that we are approaching an inflection point where bullish data will force the Fed to cut back on QE.

The economic data on Friday was a surprise. The May ISM Chicago (PMI) spiked to 58.7 and well into growth territory after falling into contraction at 49 in April. Analyst expectations were for a minor gain to 50.0. The headline number went from a 40-month low in April to a 14-month high in May. The +9.7 point gain was the largest monthly gain in more than 20 years. I would not be very surprised if there was a data issue in this abnormal rebound but the internals were very bullish.

The new orders component rose from 53.2 to 58.1. Order backlogs spiked +12 points from 40.6 to 53.1 and the highest level since 2001. Employment surged from 48.7 to 56.9. The gain in the internal components suggests there was actually a strong pickup in business in the Chicago area in May.

The ISM data in this report jumped +6 points to 54.1 suggesting the national ISM on Monday could also surprise to the upside but I am not holding my breath.

Remember, the Chicago area economy is heavily influenced by the auto manufacturing sector. We know auto sales are strong and that may be a major cause for the spike as they begin gearing up for the model change later in the summer. This contributed to the decline in April when manufacturers cut production when inventories ran ahead of sales. The other regional reports have not been this positive with weakness in almost every region. The ISM Manufacturing on Monday will be a key indicator for national activity.

Chicago ISM Chart

The final revision for the May Consumer Sentiment rose again from 83.7 to 84.5 and the highest level since 2007. The present conditions component rose from 89.9 to 98.0 and the highest level since August 2007. The expectations component rose from 67.8 to 75.8 and the highest level since November.

Sentiment is at a new post recovery high and that has to be bullish for the market. Unfortunately that is negative for QE. Every positive economic report brings us that much closer to the end of QE but traders can rest easy because it would take a couple months of positive data before the Fed is going to deviate from their current position. Of course markets tend to look six-months into the future so I would not be surprised to see cracks in the rally if the economic data from next week continues to improve.

Consumer Sentiment Chart

The positive data kicked treasury yields up another +2% to 2.16% on the ten-year. That is a new 52-week high and analysts are evenly divided on whether yields will continue rising. Goldman Sachs issued a sell signal on bonds on Friday. Goldman said the selloff in bonds is for real and said their yield target for the end of 2013 is 2.5%. They said they would be looking for opportunities to trade the bond market from the short side.

UBS took issue with the Goldman call saying the "market has overreacted." UBS said there was only a slim possibility the Fed would begin tapering QE purchases anytime soon. "We were surprised by the Treasury sell-off last week in response to the various Fed speakers. Chairman Bernanke's testimony to the Joint Economic Committee seems particularly even handed."

Apparently investors were not convinced with the UBS rebuttal and the selling continued. There is serious resistance at 2.4% so Goldman's target of 2.5% could be tough to reach without movement from the Fed.

Ten-Year Treasury Yield Chart

Barclays 20+ year Treasury ETF (TLT)

The economic calendar for next week is chock full of critical reports. The ISM Manufacturing on Monday is likely to contradict the ISM Chicago from Friday. This would be market positive since bad data is good for continued QE. However, the impact may not last long with the ADP Employment, ISM Services and the Fed Beige Book on Wednesday. That is a perfect storm of economic data. Employment for May is a huge unknown with estimates for the ADP report at +157,000 jobs. The QE junkies will want to see a weaker number. The ISM Nonmanufacturing is a tossup but even a decline is expected to remain in expansion territory over 50. The Fed Beige Book will summarize the economic activity in all 12 Fed regions and conditions "according to the Fed" have been improving in recent months but only slightly.

Lastly the biggest economic report of the month is the Nonfarm Payrolls on Friday. Expectations are for 165,000 jobs and the same level as April. This one is also a tossup because the various employment components in the regional activity reports have been mixed. The key will be how much the sequestration has weighed on employment by government contractors.

The Nonfarm report is actually worthless as an economic report. It is just an estimate and is almost always revised significantly in the months ahead. The government has better data but this report is simple and civilians are used to the high profile headline numbers. Since we don't get to vote we are hostage to the Nonfarm numbers even when they are wrong. Expect another large influx of new part time jobs as employers get setup for Obamacare in January.

Economic Calendar

After the close on Friday the government PMI numbers from China officially came in "stronger than expected." Of course that depends on what you were expecting. I mentioned last week the government numbers were normally "optimistic" and I expected them to be stronger than the HSBC flash PMI. The "official" PMI rose from 50.6 to 50.8 in May. Analysts had expected a decline to 50.1. Earlier in the week the HSBC flash PMI fell to 49.6, a 7-month low and the new orders component sank to 49.5. Both numbers represent contraction.

The official government number could lift the Asian markets on Monday even though nearly everyone understands the number is more than likely artificially inflated.

At the close on Friday the MSCI indexes were rebalanced. This is done quarterly and always produces a high volume event. Retirement funds and mutual funds indexed to a MSCI index are forced to buy and sell stock at the close to maintain their index weightings. For instance the MSCI Global Standard Indexes saw 61 securities deleted at the close and 60 stocks added to the indexes. The MSCI Global Small Cap Index saw 372 additions and 334 companies deleted. Multiply this across multiple MSCI indexes and you see why the volume can be heavy. You can see the list of additions and deletions here: MSCI Rebalance

Some analysts were blaming the afternoon swoon on the MSCI rebalance. Others, correctly so, pointed out that a nearly equal number of stocks were being bought as being sold and other than an increase in volume the normal impact on the markets is usually limited.

Another factor impacting the markets is the volatility in the Nikkei. The Nikkei is in meltdown mode despite the +185 points gained on Friday. After the Nikkei close the futures plunged to the point the Dow was expected to open down -90 on Friday. Just before the afterhours session closed on the Nikkei the dip was bought and the big drop was erased. You can't see it on the chart below because this is a cash chart. Art Cashin has been pointing out all week the extreme moves in the Nikkei after the regular session and traders are trying to find out what is happening in that thin market.

The selloff in the Nikkei and the afterhours volatility is probably another reason investors did not want to be long the U.S. markets over the weekend. Uncertainty is not an investor's friend and given the volatility in the U.S. markets there were probably more than a few traders wanting to go into the weekend flat.

There was more than $3 billion in stock for sale on the NYSE at the close. One floor trader said that was the most he had ever seen.

Nikkei Index Chart

Last week was also a first in the money flow department. According to Lipper equity funds lost -$513 million last week for the first negative outflow in 2013. ETFs saw outflows of -$1.1 billion. More than $13 billion flowed into money market funds yielding almost zero. The market tide may have turned.

There was a lot of chatter on stock TV and in emails about the appearance of the Hindenburg Omen. I debated whether to even include this topic today but I got a couple emails on it so here goes.

The Hindenburg Omen is basically a volatility event where the market is rising as evidenced by the 50-day average but there is a surge in both new 52-week highs and 52-week lows on the same day to more than 2.2% each and new highs are not more than twice new lows. Also, the McClellan Oscillator must be negative. Lastly the first appearance of the conditions must be confirmed by a repeat appearance within 30 trading days for the Omen to be valid. Did I mention this is a VERY obscure indicator?

According to Jonathan Krinsky, a technical analyst at Miller Tabak, Friday was the second appearance with the first on April 15th making this a valid Omen. In theory this predicts a serious market crash within the next 40 days.

April 15th

1) NYSE New 52 Week Highs = 70 , New Lows = 77 . Both exceeded 2.2% of total issues that day.
2) The 10 Week (50 Day) Moving Average Was Rising
3) The McClellan Oscillator was negative
4) New 52 Week highs were NOT more than twice 52 week Lows
All 4 criteria were met.

Wednesday, May 29th there was a second "observation", which confirms the Omen.

1) NYSE New Highs = 58, New Lows = 104 . Both exceeded 2.2% of total issues that day
2) The 10 Week (50 Day) Moving Average Was Rising
3) The McClellan Oscillator was negative
4) New 52 Week highs were NOT more than twice 52 week Lows

Personally I think people are really reaching for an excuse to blame something as rigid and convoluted as the Omen for the market decline. There are so many valid reasons for market movement we don't need to look for omens in all the wrong places.

The key points of the omen are the rising market and increased number of new 52-week lows. The increased number of 52-week lows in a bull market suggests the market breadth is shrinking and the gains are being made by progressively fewer stocks.

I pulled a couple charts to illustrate this fact. The first one is the percentage of S&P stocks trading over their 50-day averages. This was 94% two weeks ago but has fallen to 67% as of Friday. I don't need a complicated omen to tell me that is bearish. This chart clearly shows me that market breadth has been weakening for the last two weeks.

Percentage of S&P stocks over their 50-day average

If we take that one step further and use the 200-day average we see the same thing. In theory the number of stocks over the 200-day should remain high for a longer period of time because the longer term 200-day is typically lower than the short term 50-day average. In the percentage chart below that has fallen from 94% to 89% over the last two weeks. I would not call that bearish yet but any further increase is a clear sign of market weakness.

Percentage of S&P stocks over their 200-day average

The following chart shows the advance-decline percentage line on the S&P-500 contrasted with the S&P on the bottom. It does not take an advanced chartist to see the breakdown in progress.

S&P Advance/Decline Percent

The following chart shows the Bullish Percent Index. This shows the percentage of stocks with a Point and Figure buy signal in the S&P. This has eased from the 91% reading last week but is still very bullish. One word of caution. This can change rapidly because point and figure charting contains price point threshold values and a $1 move can turn a stock from buy to sell when that move crosses a price point. Note the sharp drop in July 2011 and April 2012.

Bullish Percent Index Chart

Sample point and figure chart on Anadarko (APC)

The dollar rebounded slightly from Thursday's three week low and the impact was felt in the commodities. Thursday's drop propelled gold to a two week high at $1417 but Friday saw a -$24 decline despite the drop in the equity markets. Since most of the decline in equities came in the last 30 minutes the fear trade in gold did not have time to reappear. If equities are down again on Monday I suspect gold will recover the $1420 level.

Dollar Index Chart

Gold Chart

Crude oil began its post Memorial Day decline with a breakdown of support just above $92. OPEC met on Thursday and agreed to leave the production quotas unchanged at 30 million barrels per day. The Saudi Oil minister was again quoted saying "$100 is a fair price for oil and demand is strong. We are happy." However, since they did not decrease the quotas there is a good chance Brent prices will test that sub $100 level with a close at $100 on Friday. WTI lost $2 to $91 and will likely retest $86.

WTI Chart

Brent Crude Chart

After taking March and April off the banking sector gained +9% in May and the XLF is up +21% since December 31st. Analysts are saying the sector is overdue for a correction and the second quarter is going to be tough for bank earnings. Apparently not many people are listening since the XLF only lost -1.6% on Friday and remains at 52-week highs unlike the Dow and S&P. BAC, JPM and WFC all hit new 52-week highs on Friday.

XLF Chart

In stock news NetFlix (NFLX) rallied slightly after it was named to the Nasdaq 100 beginning on June 6th. It is replacing Perrigo (PRGO). This means fund managers indexed to the Nasdaq 100 will have to buy NFLX shares by the close on June 5th and sell PRGO. They both have about the same market cap at $12 billion. This will add to the normal daily volume in NFLX and potentially smooth out some of the volatility in the stock. Discussing NFLX in the company of other traders is like discussing politics or religion. Everybody has an opinion and they are normally pretty firm in their beliefs. You either believe the stock is going to the moon or back to single digits and there are very few opinions in the middle.

NFLX Chart

Tesla Motors (TSLA) announced it was adding more supercharging stations across the U.S. so Model S owners can travel across the country without worrying about their driving range. The supercharging stations will be able to give you three hours of driving time on a 30 min charge. They are increasing the number from 9 to 27 by the end of June and to further rise to 100 by the end of 2014. Tesla plans on installing stations within reach of 80% of people in the U.S. and Canada in 2014 and increase that to 98% in 2015. The goal is to provide a supercharging station every 80-100 miles. The stations cost $150,000 each without solar and with a solar component that rises to $300,000. The Tesla Model S costs $70,000. Tesla said it will offer a smaller $30-$40,000 car in 3-4 years. It is nice to be Elon Musk these days. He just bought another $100 million in Tesla stock in the secondary offering to bring his ownership in Tesla to 23% and the recent gains added $2.9 billion to his net worth.

TSLA Chart

Even with the Friday decline the markets ended with a gain for May. It was the first positive May since 2009. It was the best May for the Nasdaq Composite and Russell 2000 since 2005. It was the first time since 1996 the Nasdaq and S&P started the year with five months of gains. For the Dow it was 1995 the last time there was a five month gain to start the year. Actually, for the Dow it was the best percentage start for the first five months since 1987. It was the best start for the S&P since 1991 and for the Nasdaq since 2003.

The S&P broke through support at 1,640 and did not even slow down. There was a second lower high at 1,660 and then a lower low at 1,630. Friday was a clear breakdown even if it was just the rebalance issues forcing the drop.

The S&P has support at 1,620-1,625 followed by the 50-day average at 1,600, which happens to also be round number support.

S&P chart - 90 Min

S&P Chart - daily

Friday's decline pushed the Dow to 15,120 and -422 points from the May 22nd high at 15,542. That is a -3.3% decline. Unless market sentiment has really changed for the worse we are not likely to see a much bigger drop. The next support level is 15,050 followed by round number support at 15,000.

The 30 day average (15,045) has been support since January and it looks like it will be tested again on Monday. A break below the 50 targets 14,500.

Dow Chart - Daily

The Nasdaq is holding up much better than the Dow or S&P. The Nasdaq is still well above its lows from the prior week and still above uptrend support. The battle the Nasdaq lost was overhead resistance at 3,500. There is a clear pattern of lower intraday highs. Initial support is now 3,450, 3,425 then 3,400.

The RSI and MACD I added to the chart the prior week worked perfectly to signal the turn in market direction.

Nasdaq Chart - Daily

The Russell failed completely at 1,000 and now appears to have put in a double top. However, the Russell and the Nasdaq were the best performing indexes on Friday. The Russell lost only -1% and failed to make a lower low. This better relative performance suggests something was amiss in the big caps since there were far more small cap stocks being rebalanced than big caps. I have mentioned several times in the last month that managers forced to put money into the market were putting it in highly liquid large caps. In retrospect it appears there was a sell program in large cap stocks late Friday. Was it some large hedge fund racing to the exit and hoping to get lost in the MSCI volume? We may never know.

What we do know is that the Russell was stronger than the Dow and S&P and that suggests the broader universe of fund managers remain bullish on the market. If there was a sudden panic by fund managers the small caps would be the first to crash.

Initial support is 980 followed by 970.

Russell 2000 Chart

Under the new Dodd-Frank rules hedge funds with assets of more than $150 million had to register with the SEC by March 30th. The concept and reporting were to allow the SEC to understand how much leverage existed and who had it in order to prevent the next big crisis. The SEC issued new rules on what the funds had to report including short sales, margin loans, etc. What the SEC found was that most of the top funds had far more assets and liabilities than previously reported. Many had more than double the previously reported amount.

They now have to report assets bought with borrowed money or margin rather than just their cash purchased positions. They found the top 50 funds had exposure of more than $1.3 trillion or more exposure than they had before the 2008 crash. They had previously reported only $622 billion in assets. For instance the Millennium fund founded by Israel Englander previously disclosed $13.5 billion in assets. In the March filing they disclosed $119 billion. The Citadel fund run by Ken Griffin had previously reported $12.6 billion in net assets. The new report listed $115.2 billion. These funds are leveraged to extremes. If the market were to really roll over it would be a blood bath. Some 31 of the top 50 funds reported gross assets of $949 billion and more than double the previously reported $422 billion. Let's hope there is no sudden market crisis or we will be living 2008 all over again.

Taper the taper talk!

The Fed better taper off on the taper talk or they are going to crash the treasury market and the equity market. They have been so successful in confusing investors as to when a tapering of QE3 might begin that yields are at 13-month highs. As yields rise the treasuries become more attractive and dividend stocks become less attractive. If they don't stop the taper talk they are going to find interest rates back up in the 2.5% range and equity investors moving to the sidelines to avoid the market crash that will come with the official taper announcement. For years the Fed was criticized for not communicating enough. Now they seem to be communicating too much and they are all speaking from a different play book.

The interest rate on a 30-year mortgage rose +0.22 points to 3.81% last week and the highest rate in a year. That is up +15% from the 3.31% low set in November. It is significantly higher than the 3.35% in early May. Too much taper talk and they are going to kill the housing market.

While I do not expect the economy to recover enough for the Fed to begin tapering until Q4 at the earliest there is always the risk they are going to be forced to taper because they are going to run out of treasuries to buy. I have written about this before but with a shrinking supply of new paper they are going to be buying everything in the market if they keep their purchases at $85 billion a month.

Margin Debt, Confidence, Earnings, Inflation

It is official. The NYSE just published the latest margin debt numbers. The most recent reading of $384.37 billion topped the all-time high of $381.37 billion in July 2007. We are officially setup for the next big market crash as those margins calls come pouring in.

Let's see, consumer sentiment readings are at post 2007 highs. The bullish sentiment at Market Vane just hit 70% for the first time since June 22nd, 2007. The PE for the S&P just passed 16x and the highest level since late 2009. The net speculative long positions for S&P futures contracts is at a record highs of 37,449 contracts. Don't worry, be happy!

Mark Hulbert pointed out that the Consumer Confidence Index was a contrarian indicator. Low readings on confidence like those in early 2009 precede long term bull markets. Conversely overly high levels of confidence tend to come at market tops when the market bubble is about ready to burst.

S&P earnings for Q1 were just under +5% growth when the final tally was made. Only 38% of S&P companies beat on revenue but nobody cared. Earnings for Q2 are expected to grow by +3.5%, Q3 +8% and Q4 +13%. That is a hugely optimistic expectation since a large portion of Q1 earnings came from stock buybacks. Companies bought back so much stock they could meet the earnings per share estimates using the reduced share count. That only works so many times before you run out of cash.

Don't worry there is no inflation. Core "PCE" inflation came in at 1.05% and the lowest level since the government began collecting the data in 1960. The core PCE data is the inflation indicator most closely watched by the Fed. With inflation this low we are actually at risk of a deflationary cycle. This means the Fed is nowhere near tapering QE or they risk falling into Japan's footsteps with a lost decade of economic doldrums.


The U.S. markets suffered some extreme volatility last week as a result of the movement in the Japanese Nikkei. We should expect this to continue since the fiscal experiment currently underway in Japan is even more aggressive than the Fed's QE3.

The next set of thoughts paraphrase a very good article from John Mauldin this weekend. You can read the entire article here: Exporting Deflation PDF

Japan's GDP is close to 500 trillion yen or roughly $5 trillion dollars. They are running an annual deficit of roughly 10% of GDP. Their public sector debt (bonds, etc) is roughly one quadrillion yen. (1,000 trillion) Japan has a debt to GDP ratio of 245%. For comparison, Mexico is 35%, USA 73%, Germany 81%, Spain 85%, France 89% and Greece 120%. Remember Greece? Japan has been in a no-growth deflation period for the last 24 years. More than 24% of the annual budget goes for interest expense with interest rates at only 0.85%. If rates rose to just 2.2%, something that could very easily happen, it would take 80% of revenues to pay the interest.

The only way out of this mess is to create inflation by driving down the value of the yen. That cheapens the value of bonds and investors see what is happening and begin to sell. That drives up the interest rate and increases the amount Japan must pay for debt service or in this case the number of new bonds that must be sold, which increases the severity of the problem. Japan is has already announced a QE program much larger than the Fed's. Unfortunately in order to offset the rising interest rates it will have to be even larger. That means the BOJ is going to end up being the buyer of the majority of Japan's debt because pension funds and banks are not going to touch it. This means Japan is about to wage the largest currency war since the 1930s in an effort to drive down the value of the yen and make Japanese products desirable around the world. That means central banks around the world will have to respond with their own programs to prevent their currencies from rising so far it prices their products out of the market. There is a war coming and it will be felt in our equity markets. Expect more volatility in the Japanese markets and it will be contagious.


Iran is about to hold elections for a new president. The current favorite blessed by the Supreme Leader is Saeed Jalili. He said in a recent speech, "The goal of Iran and its allies is to uproot capitalism, Zionism and Communism and promote the discourse of pure Islam in the world." His campaign slogan, "No compromise, no submission" refers to the nuclear talks and sanctions being levied on them from the UN and EU. He was the nuclear negotiator for Iran. Things are not looking good for a peaceful solution to the nuclear issue with Iran. Jalili's first official act once elected may be to dodge bunker buster bombs dropped by Israel and the USA.

History has many instances where countries with an embattled administration have started a war or a limited military conflict to distract the population from some scandal or a poor economy. Is the U.S. about to decide Iran is suddenly worth attacking? I am not predicting but simply wondering what the future may bring.


No Sell in May but maybe a June swoon? I would not touch that prediction with a ten-foot pole but it is always possible. A correction will eventually appear. However, as long as the Fed is projecting QE3 for months into the future I doubt the market will decline significantly. Once they change that program the market will drop like a rock.

Enter passively and exit aggressively!

Jim Brown

Send Jim an email

"Nothing pains people more than having to think."
Martin Luther King