For the last week, several resistance levels were broken across the major indexes but the one that counts returned to cause trouble on Friday.

Market Statistics

Friday Statistics

The S&P rallied through strong resistance at 1,999 on Friday morning to trade as high as 2,009 before falling back to earth to close at 1,999.99 and exactly where it will cause the most indecision over the weekend.

I have been showing the following chart for the last two weeks with the Fibonacci retracement levels. We fought the battle at the 38% level and 1,927 two weeks ago. The prior Friday the S&P rallied exactly to the 50% retracement level at 1,963 before dropping back to close at 1,948. This Friday the S&P rallied through 1,999 before falling back to close at that level. Coincidentally the 100-day average is 1,999.82 so there was double resistance at that level.

I received this email from a reader on Thursday.

I realize analysts can have different opinions but I thought things like resistance levels were fact based. Last night Keene said that above 1992 on the SPX would suggest heading to next resistance at 2024. Tonight Thomas seems to be similar but looking at 2020. But you see trouble at 1999. Do you all just read the charts differently or are you saying the same thing and I am just missing it?
Officially Confused.

If that reader was confused, I am assuming there are other readers confused. I pulled up Tommy's chart and the 2,020 level he was referring to was the horizontal support/resistance from the September high and the November low. This is a valid resistance level and I highlighted it with arrows.

In my regular S&P chart that I have been showing for months that 2,020 level has been clearly visible as resistance for a long time.

In Keene's chart from Wednesday he mentions the 50-week moving average (WMA) in blue at 2,033 on the weekly chart and the 200-day moving average at 2,024 on the daily chart (not shown). Both of these are valid resistance levels. Keene was looking for a continued rebound through the resistance at 1,992 to the 50-wma and then a failure at that level. On my chart above, I have been referencing that horizontal resistance as 1,990 for several months but Keene was more accurate at 1,992 from July 2014. I try to use round numbers in my descriptions when possible because humans tend to focus on round numbers and it makes the text easier to read.

As you can see from the various charts above we are all talking about the same levels but we are using different time frames and different focus points. At any given time, there are probably 20 different technical analysis tools that an analyst can use. We each use the ones we like the best. I find it best to use the KISS principle in my descriptions. (keep it simple stupid)

During certain periods in the market the S&P tends to react differently to various technical levels. For instance, the moving averages have not been much use to me recently because the big market moves have been well away from the averages. It was not until Friday that the slowest of the majors (100, 150, 200, 300) the 100-day came back into play. All the daily averages were well above the current market. Also, you can tell by the congestion in Nov/Dec the S&P was ignoring them at that time. The moving averages only work well in a calmer market like the Mar-May 2015 period where the S&P was using the 100-day as support.

With all the technical tools available to us as analysts, it is our job to determine which ones are working in the current market conditions. For the last two weeks I changed my default S&P chart to the one with the Fibonacci retracements because that was the technical levels "I" thought were the most appropriate at the time. Once we move over the 1,999 level for several days, I will discard that tool because it will no longer be relative to the current market and I will focus on other tools that are more appropriate.

I hope that helped readers to understand why each of us is reporting the same thing only in a different way. You can always email me at the link at the link at the top of the page and I will try to answer any questions.

The market stumbled out of the gate on Friday after the February Nonfarm Payroll report showed a gain of +242,000 jobs. That was well over estimates for +193,000 and the initially reported +151,000 gain in January. The January number was revised up by +21,000 to 172,000 and the December number was revised up by +9,000 to 271,000.

The labor force participation rate actually rose by 0.2% but the unemployment rate remained unchanged at 4.9% (7.8 million). The labor force rose by 555,000 workers as more people began looking for a job again. The manufacturing sector lost -15,000 jobs and the service sector gained +257,000 jobs. The energy sector lost -18,000 jobs. The average hourly earnings declined -0.1% after a +0.5% gain in January.

Healthcare added 57,000 jobs and education 29,000. Retail payrolls increased 54,900, hospitality +48,000 and restaurants and bars 40,200. The bad news in the report was that the majority of jobs were low paying service jobs in food service and hospitality. That means cooks, wait staff and hotel maintenance. Since February 2015 the U.S. has created 360,000 food service jobs and only 12,000 manufacturing jobs. Since 2007 about 1.6 million food service jobs have been created and 1.4 million manufacturing jobs lost. Charts

The larger U6 unemployment number declined 2 tenths to 9.7% and a low for this cycle. The number of part time workers rose by 304,000 to 20.615 million so a significant number of the new jobs in February were part time jobs.

Despite the low quality of the jobs created in February there was a flurry of analysts claiming the big jobs number put the Fed rate hikes back on the table. Former Philly Fed president Charles Plosser said a rate hike at the March meeting would be a "close call" if he were voting. He also said the Fed might have to accelerate their hikes in 2016 with some of them being 50 basis points instead of 25 bps.

However, the Fed funds futures are not predicting a material change in Fed posture. The first chart below was the implied probability of a Fed funds rate at 75 basis points after the June meeting at 29.6%. This was the picture on Thursday night. The chart below it is the same chart as of Friday night showing only a 2.4% increase in that probability to 32.0%. That is hardly a big jump.

Charts from the CME FedWatchTool

Thursday Futures

Friday Futures

If we step out farther on the curve to the December meeting, the futures were showing a 40.7% chance of a hike to 75 bps by the December meeting. The second chart shows the probability as of Friday night and the 75 bps probability did not change but the probability of the rate remaining at 50 bps actually declined from 37.3% to 33.1%. However, the chance of it rising to 100 bps rose from 17.7% to 20.2% based on the futures contracts out to December.

From my point of view, the outlook did not change appreciably and the futures are showing very little chance of future rate hikes in 2016. The equity market should not be fearing a rampant Fed.

Thursday Futures

Friday Futures

The economic calendar for next week is relatively light other than the ECB rate decision on Thursday morning. That could impact the markets and the Fed decision the following week. Mario Draghi has repeatedly implied the ECB could make additional changes at that meeting. However, Draghi has a history of trying to talk the markets around without actually doing anything. The markets are expecting some additional stimulus this time so doing nothing could be market negative.

In stock news, Yahoo (YHOO) shares gained +3% after the company said it was exploring the sale of $1 to $3 billion in patents, property and other non-core assets. The CFO told investors at the Morgan Stanley Technology Conference that the committee tasked with planning the sale/spinoff of the core business is also looking at a quick sale of some assets. Yahoo has sold or licensed more than $600 million in patents over the last three years. Shares are at a two-month high after the company hired JP Morgan and Goldman Sachs to explore strategic alternatives, which is code for "find us a buyer."

Big Lots (BIG) reported earnings of $2.00 that beat estimates for $1.98. Revenue of $1.58 billion missed estimates for $1.6 billion. The company also announced a $250 million buyback plan. Shares rallied 2.4%.

Staples (SPLS) reported earnings of 26 cents that missed estimates for 28 cents. Revenue declined -6.9% to $5.268 billion and also missed estimates for $5.4 billion. The company expects sales to continue to decline in the current quarter. Shares fell -3%.

Ambarella (AMBA) reported adjusted earnings of 64 cents that easily beat estimates for 47 cents. Revenue of $68 million beat estimates for $64.8 million. They guided for revenue in the current quarter of $55-$57 million, down -21%, which was below estimates for $62 million. That will be Ambarella's first quarter over quarter revenue decline in 18 quarters. Sluggish sales to GoPro (GPRO) was said to be the reason. A Needham analyst said Ambarella could be forced to cut its revenue outlook by 10-20% for the current year because of GoPro.

Ambarella said it was seeing strong corporate demand in IP security applications and drone sales. However, consumer sales of those items were flat. Shares declined -9% on the news.

Smith & Wesson (SWHC) reported earnings that rose +293% to 59 cents and beat estimates for 39 cents. Revenue rose +61.5% to $210.8 million and easily beat expectations for $174.93 million. The company raised guidance for the current quarter and the full year. For Q1 they expect earnings in the 51-53 cent range and revenue around $210-$215 million. For the full year, they expect earnings of $1.68-$1.70 and well over analyst estimates for $1.42 and their own guidance of $1.36-$1.41 they gave in early January. Smith said they were increasing production rates because inventories had been depleted. There was a record 2.613 million firearms background checks for the month in February. While a record for February that was down from an all time record of 3.31 million in December.

AMC Entertainment (AMC) agreed to purchase Carmike Cinemas (CKEC) for $1.1 billion and assumption of debt. AMC currently operates 5,426 screens and Carmike operates 2,954 screens. Carmike investors will receive $30 a share. Carmike posted earnings on Monday of 27 cents that beat estimates for 10 cents and shares jumped $3 on the news. The announcement of the deal with AMC added another $4. Sellers who tried to short the earnings spike were killed with the new announcement. This is a great deal for AMC because Carmike screens are suburban and rural while AMC screens are mostly urban based. There will be very little overlap. AMC shares rallied on the news so investors saw the possibilities.

The private equity acquisition of Keurig Green Mountain was completed last week and GMCR was removed from the S&P-500. Taking the place of GMCR in the S&P will be UDR Inc (UDR), an independent real estate investment trust. The company owns, operates, acquires, renovates, develops and manages multifamily apartment communities. They have an ownership position in 50,646 apartments and 3,222 homes under development. In conjunction with S&P notifying them of their inclusion into the S&P they immediately announced a secondary of 5 million shares. Goldman Sachs and Bank America are the underwriters. UDR traded 54 million shares on Friday compared to average daily volume of just over 1 million.

A lot of analysts have a lot of different reasons for the rally last week. Some are blaming it on economics, China, etc but I believe a lot of it was due to the spike in crude prices and the expectations for the Fed to hike rates sooner rather than later. The banking sector moved sharply higher after the ISM Manufacturing report came in higher than expected on Tuesday and the auto sales for February came in very strong at 17.54 million units, in a month that is typically weak. Expectations for future rate hikes moved bank stocks sharply higher. That is the heaviest weighting in the S&P.

The second highest weighting is energy stocks. Crude oil rallied 10.6% for the week on absolutely no changes in fundamentals. The S&P Exploration ETF (XOP) rallied +21% since Tuesday's low at $23.97.

The rebound in oil prices came on hopes for a production freeze in the Middle East that will lead to a production cut when OPEC meets on June 5th. These hopes are significantly misplaced. There is a remote chance that a freeze will be honored simply because everyone is already producing at maximum output and cannot produce any more. There is also a remote chance OPEC will come to their senses and cut production quotas at the June meeting but that is three-months away and not a reason for oil prices to spike nearly 11% last week.

However, the oil market has been heavily shorted for more than a year. It was the easy trade for portfolio managers and hedge funds. When the double bottom was formed at $26, a lot of those shorts began covering. Stimulus out of China in the form of another reserve ratio cut helped to accelerate that short covering because China is the largest importer of oil.

As portfolio managers began to cover their oil shorts the price of energy equities also began to rise and suddenly those needed to be covered as well. Energy equities have been shorted even more than crude itself. Worries about defaults and bankruptcies made the sector very attractive to the bears. Suddenly those heavily shorted companies were rising again. Console Energy (CNX) spiked 58% in a week. Why? Because short interest in Console was 29%. Offshore driller Transocean (RIG) spiked 76% last week because their short interest was 36%. Nobody can look at the Transocean chart below and blame that spike on investors suddenly wanting to own Transocean after they reported additional rig cancellations the prior week. That was pure short covering.

Multiply that short squeeze across more than 200 energy stocks and add in the spike in the financial sector and you have a major reason for the market rally. The real question we need to be asking is will it last.

Long contracts on WTI are at record levels after shorts were obliterated. How many more investors will suddenly decide to buy crude oil when the fundamentals have not changed? In fact, the 10.4 million barrel build in crude inventories last week to 518 million barrels is another record high. Why would anyone want to buy crude oil with inventories expected to continue climbing for the next four weeks? You buy crude in April not at the beginning of March. The recent flurry of headlines triggered a monster short squeeze and that caused speculators to buy the bounce.

Without another headline flurry, this bounce in crude prices should fail. While I do not expect it to retest the lows, we could easily return to the low $30s and energy equities should decline with crude.

Longer term as in 2-3 months I do expect crude prices to rise as refiners begin depleting inventories as they build up gasoline and diesel supplies ahead of the summer driving season. It is entirely possible speculators jumped in early this year for the anticipated spring rebound in prices because of the headline flurry about the production freeze. If that is the case then much of the normal spring rise in oil prices is now priced into the market.

There is a little improvement in fundamentals in the U.S. energy market. The sharp rise in inventories has reduced the available storage space. Cushing Oklahoma only has about 3 million barrels left of its 70 million barrel capacity and they need that for operational capability. This means upstream producers are facing a slowdown in pipeline capacity headed into Cushing. Nothing can go into Cushing unless an equal amount is pushed into pipelines heading for the coastal refineries.

Because of the crisis caused by $26 oil last month many producers are actually cutting production. They have decided not to drill any more wells or only drill their very best locations. U.S. production has declined from 9.235 mbpd in late January to 9.077 mbpd last week. That is a decline of -158,000 bpd in the last six weeks. That is down from 9.61 mbpd at the peak last June or a -533,000 bpd decline from the peak. The EIA expects another 500,000 bpd decline in 2016 and another 200,000 bpd decline in 2017.

Active rigs fell another -13 last week with oil rigs falling -8 to 392. That is below the 400 rig low in Dec 2009. Gas rigs lost 5 to 97 and a new 30-year low. Total rigs declined to 489 and only 1 above the historic low of 488 in April 1999 after oil prices fell below $10.

The massive drop in active rigs will lead to a massive decline in U.S. production in years to come since shale wells deplete about 85% over the first three years. However, should oil prices spike back to $45 or higher we could see those rigs be reactivated at a very high rate. Shale production has declined slowly but it could be restarted very quickly. Analysts estimate there is as much as 2.0 mbpd of production that could be brought online within 24 months because the fraclog (wells drilled but not fracked) is continuing to grow. Once prices begin to rise those wells can be completed very quickly.

I went too much in depth about why oil prices are likely to decline after last week's spike but it should only be short term. That means the equity market could also decline with falling crude prices but only in the short term. If for some reason oil continues to rise then equities could follow. The correlation between oil and equities is very strong.

An even stronger correlation is the relationship between the High Yield market and equities. In the chart below, the HYG ETF is in red. Last week the high yield bond funds saw record inflows of $6.5 billion. Rising oil prices removed some of the concern about defaults in high yield debt, which contains a lot of energy debt. The sector spiked and relieved the downward pressure on the S&P. Since the low on February 11th, the HYG is up 7.6% and the S&P is up +10.5%.


So how much is too far too fast? Is a 10.5% rebound in the S&P in 15 trading days something we should be concerned about? Absolutely! We have gone from oversold to overbought and the various factors that gave us lift, oil, energy stocks, financials and the high yield rally, may have run their course.

However, I believe market sentiment has changed. For the first two months of the year, the rallies were sold and volatility was high as we fell into correction territory. After a short term double bottom at just over 1,800 three weeks apart the sentiment has changed to buy dips rather than sell the rips.

March and April are normally good months after a weak start to the year. At the end of April the "Sell in May" cycle begins. I would like to believe that whatever amount of profit taking we could see next week is limited and the sentiment remains bullish into the Fed meeting the following week.

In the chart below the S&P stopped at exactly the 61.8% Fib retracement level and the 100-day average. If we see any material profit taking, we could see a decline back to the 1,963 level or even to the 1,950 level where we battled for a week. Both of those should now be support. If we move higher from here, the high from Friday at 2,009 and the resistance from September at 2,020 should come into play. Note that the downtrend resistance from December is almost exactly 2,020 as well. On the bottom of the chart, the RSI is solidly into the oversold area but as you can see from October, it can remain there for sometime before the pendulum swings back in the opposite direction.

The Dow stopped at exactly the same 61.8% retracement level as the S&P and with the 100-day average at 17,045. These are critical resistance levels and it could be a challenge for the Dow to move much higher. However, the Dow is not as overbought as the S&P as you can see by the RSI at the bottom. The Dow is approaching those levels but could reach that downtrend resistance at 17,300 before the overbought begins to be a problem.

Remember, if energy and financials begin to take profits it will drag the Dow lower.

The Nasdaq Composite is lagging the prior two indexes and just closed over the 50% retracement with a lot of effort over the last couple of days. Friday's 9-point gain was a challenge with a higher open then a drop back into negative territory in the afternoon. A burst of buying at the close put it back in the green. The Nasdaq traded in a 59 point range to end up with only a 9 point gain. The intraday high was 30 points higher than the close.

If the rally were to continue the next material resistance is 4,806 and that is the 61.8% retracement level followed by 4,822 and the 100-day average. A breakout there could see another 100-point gain to 4,926. It would take several very bullish days to push the Nasdaq that much higher. If profit taking does arrive, we are probably looking at a drop back to support at 4576-4600.

The Russell 2000 was the strongest index last week with a 4.3% gain. The Russell has a significant number of financial, energy and biotech stocks. Those were the hottest sectors and therefore the Russell was strong. The index closed just over the 38.2% retracement at 1,078 and that is a critical level. Note also that the index has respected the 100-day average currently at 1,102. Any serious profit taking probably knocks the index back to 1,050 or possibly 1,035. I believe it would take a major market event to knock us back that far but anything is possible. The strength in the Russell has helped stimulate bullish market sentiment and I would sure hate to see that fade.

Note the extreme overbought level in the RSI.

While I would like to see the bullish trend continue next week, I would be surprised if we did not see some backing and filling before moving higher. Until proven wrong I would be a buyer of any dips in expectation for the historical trend for March and April to be bullish. Obviously, anything can derail that trend at any time. The ECB decision on Thursday would be either a boost or a bust for the market. However, the Fed meeting the following week typically produces a positive market on Monday and Tuesday.

Despite our best efforts, analysts cannot predict market movement with a high degree of accuracy. There are simply too many external variables that cannot be predicted on a daily or weekly basis. Investors short oil and energy stocks lost billions over the last two weeks because the rebound was unexpected. Once traders begin to expect something it is normally too late. We just need to trade what the market gives us and always be prepared for the unexpected. In this case the "expected" would be some profit taking and the "unexpected" would be a continued rally.

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Random Thoughts

Where did all the gold go? Blackrock temporarily suspend issuance of new shares in the IAU Gold Trust. The trust has seen inflows every day in 2016 and the ETF has been trading above its net asset value (NAV) for most of the year. IAU has more than $8 billion in gold and has expanded by $1.6 billion year to date. The trust said February marked its largest creation activity in the last decade.

When the demand for shares exceeds the supply the trust can create new shares by buying gold to back them. The trust ran out of authorized shares and they had to request a new registration from the SEC before they could create more shares. For the IAU this is just a paperwork approval process that occurred because demand has surged so suddenly and has nothing to do with the actual gold. However, the press coverage did turn up some troubling facts that may not go away.

I have reported in these pages multiple times over the last several years about the imbalance of "paper" gold compared to "real" gold. Paper gold is where somebody sells shares or ownership in gold that is supposedly stored in their vaults. You get a piece of paper that says you own so many ounces of gold. In reality quite a few of those firms that sell paper gold only have a fraction of the gold required if everyone suddenly wanted to turn in their paper for real gold. This is similar to owning a futures contract on gold. When the contract matures, you can either sell it in the market or file to take delivery.

Just like with any futures contract in oil, gasoline, copper, etc, you buy you are assuming the gold will be there when the contract expires because the company behind the contract has put up some guarantee in order to be able to sell those futures. However, if I wanted to short gold, oil, copper, etc today I would just login to my brokerage account and sell a contract short. That obligates me to deliver that commodity if I do not close the position before expiration. Millions of traders around the world are short gold, oil, etc and could not supply the commodity if required.

As of a couple weeks ago, there were 542 ounces of gold claims (paper gold) for every ounce of "deliverable" registered gold in a warehouse. Presently there are only 72,000 ounces of registered gold in Comex delivery warehouses in the USA. In December, there were only 275,000 ounces. Link At the same time open interest in gold futures is about 40 MILLION ounces. There is no way to cover even a small percentage of those contracts if everyone suddenly decided to take delivery.

Dealers claim they are having trouble finding gold for sale. This gold "shortage" has lifted gold prices from $1,050 to $1,260 at Friday's close. Just imagine if only a small percentage of those holding paper gold contracts decided to take delivery. Gold prices could be several thousands of dollars per ounce in a matter of days.

The paper gold problem has been around for several years. People selling gold "investments" for gold stored in our vaults do not have all that gold stored. They know that everyone they sold to is not going to demand conversion to hard gold at the same time. They can deal with a small percentage of customers requesting their gold in any month because they are constantly selling new investments. Instead of physically holding all the required gold they hold futures contracts for the balance. They are holding paper gold contracts to back up the paper contracts they sold.

Eventually some economic or geopolitical event is going to occur that will have millions of holders of paper gold contracts wanting to take delivery in a short period of time and the paper gold market will collapse. Millions of investors are going to lose a lot of money when it happens. If you own paper gold or silver, I would highly recommend you convert it to real gold and put it in your safe. Not a safe deposit box but a real safe in your home.

The chart setup below has been called the best market indicator ever by John Carlucci. The chart itself is the percentage of S&P-100 stocks over their 200-day average. Currently there are 50% and approaching the rebound levels from October. On this chart, the 55% level would be seen as initial resistance with the 65% level critical resistance.

More importantly, the RSI, MACD and Slow Stochastic indicators are all at very overbought levels. As with all "indicator" systems they tend to over react when the market moves strongly in one direction in a short period of time. The S&P has rallied more than 10% in the last 15 trading days and that would definitely be considered "strongly in one direction." Source

That means the indicators could become even more overbought in the days ahead.

For a market that would seem to be strongly bullish, the investor sentiment numbers did not move very much last week. Bullish sentiment only rose +0.8% while neutral gained +1.3%. The bears are starting to fade with a -2.2% drop. That could all change over the next several days.

Marc Faber, the author of the Gloom, Doom and Boom newsletter said last year he did not think he would ever see another market rally in his lifetime. He is 69 years old. Last week he said "the market is extremely oversold, and from this extremely oversold position we can have a relatively strong rally." However, "this rally is part of the economic cycle and will eventually crest into recession." He projected the S&P would rally to 2,050 but not make it to new highs.

Faber has been wrong far more often than he has been right. As a contrarian indicator this call could be seen as a sell signal.

I reported last week that I thought the majority of the rally was a short squeeze. At the end of February NYSE short interest had risen to more than 18 billion shares and near the record high of July 2008. Short interest has risen for 7 of the last 9 months. We will not know for a couple more weeks how much of that short interest has been erased but it was definitely a factor in the rebound. You can bet that on a percentage basis the decline in short interest has been minimal. You cannot erase an 18 billion share short in just a week or two of reasonable short squeezes. If we were to have some totally unexpected event that sent the market significantly higher, that kind of short interest would be explosive for several weeks. One can only hope for that to come true.

JP Morgan speculated that the current short squeeze has room to run. They said the short interest on the SPY had declined from 5.43% to 4.75% but remains elevated from the 3.54% in early January. Equity ETFs saw $30 billion in selling in 2016. CTAs, which have been partially responsible for the 2016 selloff, are still short equities and have only covered one third of the short positions they opened in January. Source


Enter passively and exit aggressively!

Jim Brown

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