The S&P closed at a new high by 3 points at 1,900 on very low volume.

Market Statistics

The new high at the close on very low volume on a Friday before a holiday weekend could cause a major market move at the open on Tuesday. Professional traders and institutional investors were not in the market last week and they are going to have to make some hard decisions at the open on Tuesday. Do they follow the +32 point rebound over the last three days or do they hit the sell button and exit at the highs ahead of the seasonally weak summer period?

Existing shorts will be fretting all weekend given the high close right at very strong resistance. They will be hoping for a negative open and a resurgence of the weakness from the prior week. If the markets open higher we could have another short squeeze Monday even though it will be Tuesday. Monday's are known for massive short squeezes and next week Tuesday will be Monday as the first day of trading.

About the only thing I don't expect for Tuesday is another calm day. I expect a major move and assuming there are no headlines to upset market sentiment that move could be higher. There are simply too many shorts that are going to be forced to cover on any further gains. Hedge funds know this and they can pull the trigger on a buy program or two at the open to force those shorts to cover. Tuesday should be exciting one way or the other.

New home sales for April helped set the stage for Friday's continued rally. Sales rebounded from 407,000 to 433,000 annualized units, a +6.4% gain. March sales were revised higher from 384,000 to 407,000. April was still the second lowest month in more than a year.

Home sales in the Northeast fell by -26.7% to 22,000, the west was flat at 92,000. Sales in the south rose +3.1% to 235,000 but the Midwest was the huge winner with a +47.4% gain to 84,000. Months of supply declined from 5.6 to 5.3 and the median home price fell -3.1% to $270,800. New single family homes for sale totaled 192,000, flat with March but up +19% from April 2013.

The two biggest reports for next week are the Durable Goods on Tuesday and GDP revision on Thursday. Durable goods orders are expected to have weakened from +2.6% in March to -1.4% in April. If this is true it will negatively impact the Q2 GDP, which some people are expecting to be over +4.0% growth.

The Q1-GDP revision due out on Thursday is expected to decline from the +0.1% growth in the first estimate to a -0.8% contraction according to Moody's. The general consensus is for an uptick to +1.3% growth but almost nobody with any economics background is expecting that large a print. It will be interesting to see how the market reacts to a negative number and how the Q2 estimates are revised after this report.

Analysts seem to believe that we are going to get a monster snapback from the weather related low in Q1. While we won't get that Q2 number for another two months the estimate revisions are constant and ongoing.

The manufacturing and services data from the Richmond Fed on Tuesday will also be relative to the market since these numbers are for May. Expectations are for a slight gain from 7.0 to 9.0 on the manufacturing component.

One important economic item did not come from a report. I monitor the Baltic Dry Index as an indicator of the number of global shipments of dry goods. Rates slipped to post recession lows at $647 per day in 2012 as the global shipment of goods slowed to a crawl. In late 2013 the price to ship dry goods nearly quadrupled to $2,337 per day in December. Since then the prices have declined sharply to $964 on Friday with far more available ships than cargoes. This is a symptom of slowing global demand. We should not get too excited by analysts claiming a global recovery in progress.

China is slipping to the slowest growth in more than a decade. Europe is in danger of a recession. The ECB is likely to launch a new stimulus program on June 5th to avoid deflation. The sanctions against Russia are going to further slow European commerce. The tensions between Japan, Vietnam and China are continuing to build. The entire Middle East and Northern Africa is in turmoil. These are not events that stimulate global commerce but instead impair it. Read between the lines if somebody is claiming a global recovery.

Hewlett Packard (HPQ) reported its 11th consecutive quarter of declining sales on Thursday evening. The declining revenues forced CEO Meg Whitman to announce up to 16,000 additional layoffs in addition to the 34,000 previously announced. This will leave Hewlett with about 300,000 employees worldwide. The company said consumers are buying fewer PCs and printers but more smartphones and tablets. The average smartphone today has more computing power than a regular PC just 10 years ago.

Earnings came in at 88 cents and in line with estimates. Revenue fell -1% to $27.3 billion and slightly below estimates for $27.4 billion. Revenue has declined every quarter since 2011. IDC said quarterly shipments of PCs fell -4.4% in Q1 to 73.4 million units. Hewlett Packard had a 16% share of the market making it number 2 behind Lenovo.

Whitman was as upbeat as possible about HP's future stating the continued layoffs would lead to greater profitability. HP is restructuring its product lines to reduce its offerings and streamline production. They are planning on introducing a 3D printer that they believe will capture significant share in the market later this year.

HP shares dropped sharply in afterhours trading on Thursday but rebounded +6% on Friday. Apparently somebody was excited about Whitman's forecast.

Foot Locker (FL) reported earnings on Friday of $1.11 that beat estimates by 5%. Revenue rose +14% to $1.87 billion and easily beat estimates of $1.79 billion. Same store sales rose +7.6%. There was no impact from severe weather here. They opened 27 new stores bringing their total to 3,464 in 27 countries. The company said overall sales were up in the mid single digits so far in May and sales growth for children's products were up in the high teens. They are going to be opening new Kids Foot Locker stores in some markets. Shares rallied +1.5% on the news to close right at a new high.

Earnings for next week are highlighted by Autozone, Michael Kors, Toll Brothers, Abercrombie & Fitch and Costco. There are a few other companies you might recognize but overall the Q1 earnings cycle is trickling to a close.

Friday was the lowest volume of the year at 4.5 billion shares. The S&P closed at a new high but right at round number resistance at 1,900. Investors can make money in a low volume market but the lower the volume the bigger the risk. When volume returns it may not be on the same side of the tape. Note in the chart below how the volume has been declining since early May. The 30-day volume average is trending lower.

The Volatility Index ($VIX) closed at a one-year low at 11.36. This, like the low volume, is a definite warning signal. This is only .06 points away from a seven-year low. On March 15th 2013 it closed at 11.30 and you have to go back to February 2007 for a lower reading when it closed at 10.02. Whenever the VIX moves under 12 it is typically followed by a significant spike in volatility and decline in the equity markets.

While the VIX is not infallible it comes pretty close. I am sure you have seen these comparisons charts before but bear with me. Over the last year the VIX has been close to 12 four times. Only the dip in November did not result in an immediate decline in equities. On that occasion the volatility spiked back to 16 in the weeks to follow but equities only declined about 50 S&P points.

I view the VIX as one more warning signal to be coupled with things like the weakness in small caps and mixed economics as valid reasons to be cautious on equities next week. This is especially true with the S&P at record highs and the VIX at 7 year lows.

Another way of looking at it in this chart tweeted by @Not_Jim_Cramer using the macro implied volatility.

The three major indexes are trading in their tightest range for May since 1987. That is another clue that a major move may be just ahead. Over the last three months the spread between the S&P 500’s intraday high and low has been less than 5%. To find a three month range where the S&P 500 traded in a narrower range over a three month period, you have to go eight years back all the way to October 2006. Since 1984 there has only been six other periods where the S&P traded in a narrower range. The average spread between the S&P 500's intraday high and intraday low over a three month period is 13.2%, or more than 2.5 times the current three month high-low spread. (Data from Bespoke)

Over the last four years the week after Memorial Day has been down an average of -2%. Memorial Day is considered the start of summer and a period typically weak for the markets. The major Q1 earnings are over and there is little in the way of news from corporations to move the markets.

Hedge funds are having a really hard time so far in 2014. The S&P is up +2.83% as of Friday's close, the Dow and Nasdaq are flat and the Russell is down -3.2%. The average hedge fund is flat for the year and it has been a battle just to remain even. If you think you are having a tough year in the market you are not alone. People that are paid millions to pick stocks are struggling to break even. That is how confusing this market has been.

The AAII Sentiment Survey for the week ended on 5/21 had 30.4% bulls, 26.4% bears and a whopping 43.2% neutral. This is the most neutral the survey has been in nine years. Investors don't know what to do so they are doing nothing.

On the bullish side the market has handled a lot of bad news in 2014 and it is still setting new highs. The Ukraine problem has come and is fading. The polar vortex killed commerce in Q1 but companies still beat those lowered earnings. Economics suffered some pretty sharp declines in some cases. The Q1 GDP is probably going to be negative. The treasury market is forecasting serious economic weakness and a sharp decline in equities with the yield on the ten-year hitting a 52-week low at 2.47% in the prior week. The Fed is removing stimulus at $10 billion a month and since that taper started the equity markets have basically been flat. When it ends the markets are not likely to rise in celebration but probably decline without the steady drip of cash into the system. The Russell 2000 dipped to correction territory and the big caps failed to follow for the first time in 36 Russell corrections.

All things considered it is somewhat bullish that stocks are still at new highs. We all know this slow melt up is not going to last forever. Something we don't yet know about is going to pop up to trigger a drop of 10-15% in the S&P. It may not be next week or next month but it will eventually happen. The bulls all hope the correction will appear after we have risen another 10-15% and they have pocketed another round of gains. The bears want it to start next week from that nice round number at 1,900 on the S&P. Neither group is likely to get their wish.

Another way to look at the recent market is a stealth correction. We don't have to have a sudden downdraft that goes on for weeks to have a correction. You can also have a correction or consolidation in place. Since March 4th the S&P has been moving repeatedly on both sides of 1,865 without moving too far from that center line. Every little blip was sold and every dip bought. It has been that way for 3 months. The Friday close pushed the S&P gains for the year to 2.82% and 1.21% of that gain was last week. That could be a sign the consolidation is over and the markets are going to move higher.

Last week I speculated the "correction anticipation" trade was overdone and that was bullish on a contrarian basis. When so many analysts are expecting a particular market event the odds of that event happening actually diminishes. While we won't know for weeks if the correction call was right we do know that any further gains are going to cause serious pain for all those traders still short.

However, and you knew there was a however, the market breadth is still terrible. More than 47% of S&P stocks are down more than -7%. More than 35% are down more than 10% and more than 50% of the Russell 2000 stocks are down more than 16%.

Only 74% of the S&P 500 stocks have a buy signal on the Point & Figure charts. With the S&P at a new high you would think there would be more bullish stocks. Only 65% of the S&P stocks are above their short term 50-day average. That is the lowest ratio at a new high since 2007.

Percentage of Stocks with P&F Buy Signal

Percent of S&P 500 Stocks Above the 50-Day Average

One of two things can happen. Either the breadth is going to improve and push us significantly higher, or that breadth is going to continue to deteriorate and eventually sink the market.

This is still a big cap rally despite the rebound on the Russell 2000. Remember this chart from my Tuesday commentary? We got the breakout by the Nasdaq big caps and now the next challenge is the old resistance highs from 3,720-3,740.

If we look at a different set of 100 big cap stocks using the S&P-100 ($OEX) it is also approaching strong resistance. This is the biggest of the S&P stocks and with the exception of 4 days in April they have been in a steady uptrend since the January decline. However, that drop in January should serve to remind us that selloffs do happen even to the bluest of the blue chips.

The S&P made a new closing high by +3 points but missed making a new intraday high, which is 1,902.17. The low volume melt-up concerns me but there is a strong chance of a major short covering bounce on Tuesday. That will fade if something happens overseas to push the futures lower. The presidential vote in Ukraine is this Sunday but it appears Putin is relaxing his posture by sending some troops back to their bases. This does not mean there won't be violence at the polls or after the election. It just means a big flare up is less likely. As of late Saturday the election violence appears to be accelerating so there could be market risk due to post election headlines on Tuesday.

That is the only real global trouble spot that could negatively impact our markets on Tuesday. Unfortunately the headlines that do the most market damage are the ones we don't see coming.

The +32 point S&P rebound from the 1,868 low on Tuesday is rapidly reaching overbought territory. However, the big drop on the 15th probably cleared a lot of weak holders so the S&P could have room to run if the shorts get squeezed.

Support is well below at 1,870 and we are at resistance at 1,900. If the shorts get squeezed the next material resistance is 1,925 where two levels of resistance converge. If we did reach that level it would be a 57 point rebound and definitely into overbought territory.

The Dow did not set a new high but it did close just over strong resistance at 16,600. The Dow lagged the S&P in what could be a signal money is rotating back out of the blue chips that were in favor and being redistributed into those stocks with better outlooks and back into the small caps. A 63 point gain on a holiday Friday is not bad but the pace of gains over the last two days has slowed.

The Dow's record high close from the prior week was 16,735 and that means there is roughly 129 points before the Dow hits that resistance. Short covering could lift the Dow that high on Tuesday and then reality return on Wednesday with that resistance level sold. Initial support is 16,540.

The Nasdaq Composite closed just 5 points over what I had labeled as critical resistance at 4,180. I went back this weekend and examined those prior levels again and it was actually a 4,183 close on January 14th and April 9th so I had it labeled wrong. That puts Friday's close right at that critical resistance level.

The Nasdaq actually had stronger momentum over the last three days and those tech stocks out of favor just a week ago are back on the momentum highway. Note the top 7 stocks in the winners list below. I view this as a positive change in sentiment and any further move over that 4,183 level should trigger significant short covering.

The Russell 2000 rebounded strongly last week to close at 1,126 and +40 points above the May 15th lows. The Russell gained +2% for the week and most of that was in the last two days. The Russell hit correction territory at 1,087 and the February lows at 1,082 on the 15th and apparently that was good enough for small cap investors. However, it has a long way to go to catch up with its big cap brothers. The closing high back in March was 1,208 and that means another 78 points before it hits a new high.

Along the way there are multiple levels of strong resistance with 1,165 the toughest test. I am encouraged by the dip buying in the Russell but I am far from convinced it will make a new high in the near future. The odds are much stronger it will fail again somewhere in the rebound and we will make a new low this summer.

The Stock Trader's Almanac, keeper of all things seasonal, published this composite chart of the last 36 years of Russell 2000 performance by month compared to the blue chips. Small cap shares are typically weak from June to November and strong from November to March.

The Dow Transports ($TRAN) have broken out not just to a new high but to blue sky territory. This is positive for market sentiment because a bullish transport sector is supposed to mean a booming economy. I reported the prior week that rail car loadings were rising sharply and truck traffic was at new highs. With summer upon us the airlines will be booked solid and the three major components, truck, rail and airline, are now in rally mode because of improving fundamentals not simply bullish investors.

Another sign the economy is improving is a record high in gasoline production. In April the API said the U.S. refiners produced an average of 9.79 million bpd. That is a +9.2% rise over 2013 levels. Distillate fuels that include diesel and jet fuel rose +12% to 4.95 mbpd, a record for April. Gasoline consumption rose +2.7% to 9.0 mbpd. Distillate demand rose +8.8% to 4.21 mbpd and the most for April since 2007. Refiners processed 16.1 mbpd and a record for April. Last week U.S. oil production rose to 8.434 mbpd and the highest level since 1988. The sharp rise in U.S. production is keeping our gasoline prices in check even though WTI prices are now over $104. Without this level of production the global price for oil would be well over $110 where it is today.

There are positive signs the economy could be growing but it may be another couple of months before it will show up in all the reports. The economy is millions of people all growing and producing at different rates in different local economies but eventually the hot spots will spread and a real recovery will begin. At least that is what the major analysts are saying.

On the flip side of the economic argument the Bloomberg Consumer Comfort Index for May worsened. The expectations gauge that tracks where the economy is heading declined from 49.0 to 42.5. The share of respondents who said the economy was getting worse rose to the highest level this year. The weekly sentiment measure declined from 34.9 to 34.1 and the third consecutive weekly drop. More than 37% of respondents said the economy was worsening, up from 31% in April. The buying-climate component, which asks consumers whether this is a good time to make purchases, fell from 32.2 to a six-week low of 30.9.

Random Thoughts

If you can't produce economic growth using regular methods you can always add in not so normal sources of income. For instance Italy is so desperate to show GDP growth they have decided to add in prostitution and illegal drug sales into their GDP calculations for 2014. Just so they can compare apples to apples they will go back and add those sectors into the GDP for prior years as well. Italy has suffered four recessions in the last 13 years and the current GDP is -2% lower than it was in 2001. They currently have a deficit that is 2.6% of GDP and right at the EU allowed deficit limit. By adding illegal drugs and prostitution into the calculation the GDP will rise significantly and allow the government to spend more money and still stay within the deficit limits. It is amazing what lengths government officials will go to in order to maintain their spending habits.

Tuesday was the 141st birthday of the Levi's 501 jeans. CEO Chip Bergh said "We are the ultimate in sustainable apparel. If you buy our jeans they will last a lot longer than most people's waistlines will."

The Wall street Journal reported that investors were "piling into the shares of small, risky companies at the fastest clip on record, in search of investments that promise a chance of outsized returns." They compare this trend to lottery tickets where the chance of a reward is negative but the amount of the reward if it does come is extremely large. "The behavioral explanation is that some people are willing to risk a known sum in exchange for the possibility, remote though it may be, of becoming humongously rich next week." People that invest in penny stocks don't really expect a return unless they win the stock lottery.

U.S. retailers missed earnings estimates by the widest margin in 13 years according to Bloomberg. Chains were missing projections by an average of -3.1% with 87 retailers or roughly 70% already reported. You have to go back to Q4-2000 for a larger miss at -3.3%. Over the long term chains normally beat by +3%. Analysts blamed the severe weather that forced store closings and keep shoppers at home. That was actually bullish for online retailers that saw their business increase as shoppers elected to buy online rather than fight the weather.

Investors withdrew $8.2 billion from equity funds for the three weeks ending on May 14th. There were $3.2 billion withdrawn in the latest week. Bond funds saw inflows of $10.4 billion over the last three weeks. Stocks may be at record highs but many investors are heading for the safety of treasuries.

The World Trade Organization (WTO) ruled against China in a complaint on imported autos. The WTO said China improperly imposed tariffs on imported vehicles, including those made by GM and Chrysler. China began adding the duties in 2011 after the U.S. government bailed out the automakers during the global financial crisis. The duties were eliminated in December after they saw where the WTO was headed. The duties were as high as 21.5% on U.S. cars and SUVs. China claimed the vehicles benefitted from government subsidies and were sold in China for prices below market value, known as "dumping." The vehicles sold in China in 2013 totaled about $5.1 billion. A 21% duty netted China more than $1 billion a year.

The S&P's current bull market streak of 963 days is nearly twice the average number of days without a correction. Ice Cap Asset Management says it has been 1,277 days since a -20% correction.

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Enter passively and exit aggressively!

Jim Brown

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"Bear markets don't act like a medicine ball rolling down a smooth hill. Instead, they behave like a basketball bouncing down a rock-strewn mountainside; there's lots of movement up and sideways before the bottom is reached."

Daniel Turov, Barron's May 21st, 2001