Short Takes

As of 8:15 am ET, European stocks are up roughly 0.20%, we have positive news from Research In Motion & Oracle, and the market is looking for a slight uptick in consumer confidence to be released at 9:55 a.m. ET.

Most market observers believe a break above 1,130 is unlikely based on (a) weak volume and (b) strong trading range resistance just a few points above us. We share those concerns. However, we must be prepared for a possible break above 1,130 over the next week or so based on a clear improvement in the market’s technicals (charts and indicators) and recent economic data (weak but not projecting a double-dip).

While stock charts can look intimidating, the basic tenants of technical analysis are fairly simple. From a bullish standpoint, you want to see indicators make new highs as markets make new highs. Many indicators give bullish signals when they move above a “zero line” or midpoint of a range.

The most important element in reading charts may be to look for changes in terms of “has this happened before in the current rally?” For investors, rather than traders, weekly charts are more important since they can filter out normal volatility. A daily chart can look quite healthy during a countertrend rally in a bear market; that is not the case with a weekly chart. In fact, on the weekly charts of the S&P 500 shown here, there are numerous examples of indicators being at levels that are rarely seen during a bear market. This tells us while we are concerned about lack of conviction from buyers; the market is not as weak as it may appear at face value.

The CCM Bull Market Sustainability Index (BMSI) was basically unchanged yesterday closing at 1,993, which keeps it near the top end of the neutral range and the low end of the bullish range.

As we stated in Investment Contingency Plans 2010-2011 (see video 2:00 to 2:50), we will be looking at both the technicals and the fundamentals if the S&P 500 is able to break above 1,130. The chart of the S&P 500 shown in Stock Market’s Internals Improving still applies as we head into Friday. The market has resistance near 1,124 and then again near 1,150. A logical place for pullback support comes in near 1,090. The top end of the S&P 500’s current trading range on a closing basis is 1,127; intraday was 1,131. On a weekly closing basis, the number to watch is 1,122. With pros and cons relative to a sustainable move above 1,130, the best strategy is to pay attention with an open mind. If a break above 1,130 occurs on tepid volume and questionable breadth (advancers vs. decliners), it will be a yellow flag.

The stock market’s internals are healthier than they have been in seven weeks. The CCM Bull Market Sustainability Index (BMSI) has poked its head out of neutral territory and into the very low-end of bullish territory. Wednesday’s BMSI reading came in at 2,036. We designed the BMSI as an “it’s time to pay attention” index. It is telling us to pay attention right now as the BMSI sits on the neutral-to-bullish line of demarcation.

The ongoing problem with the current market is lack of buying conviction and/or tepid volume relative to what we want to see to confirm the market’s improving internals. The top end of the S&P 500’s current trading range on a closing basis is 1,127; intraday was 1,131. On a weekly closing basis, the number to watch is 1,122. If we can close above 1,122 on the S&P 500 this week, that would be another step in the right direction. In terms of possible investment strategies above and below 1,131 on the S&P 500, Investment Contingency Plans 2010-2011 outlines attractive asset class mixes based on several market scenarios.

The daily CCM 80-20 Correction Index closed yesterday at 465, which is not all that concerning. Of the 56 significant market corrections we studied to develop the 80-20 Correction Index, only one of them occurred with a daily 80-20 value lower than 465. This means 98% of significant market reversals occurred after hitting higher 80-20 Correction Index levels than what we have today.

On a pullback, we have the 50-day moving average (MA), the 89-day MA, and an upward-sloping trendline intersecting near 1,090. If we can move higher, which may come after a pullback, 1,150 is a logical area of possible resistance.

With the Bank of Japan intervening in the currency markets, we will have to keep an eye on the U.S. dollar. The research piece Yen Intervention: Impact on U.S. Dollar, Copper, Oil, Silver, and Gold looks at the last period of yen intervention (2003-2004), which may help shed some light on possible investment outcomes in the present day.

In today’s global environment of slower growth and high debt levels, no country wants a strong currency. Japan has seen the yen rise more than 10% since May, which has exporters very uneasy in the Land of the Rising Sun.

Japan’s estimated $20 billion foreign exchange intervention on Wednesday leads to a logical question of the potential longer-term impact on the U.S. dollar and commodities. While intervention can play a role in the currency markets in the short-to-intermediate term, market forces that were in place prior to the intervention will most likely continue to impact the U.S. dollar, copper, oil, silver, and gold.

According to the Wall Street Journal:

If history is any guide, Wednesday’s intervention was just the opening salvo. When Japan last intervened in the market to push the yen down, it sold an estimated 35 trillion yen ($421 billion) from January 2003 to March 2004.

The chart below shows the performance of the U.S. dollar index during the last period of yen (FXY) intervention by Japan.

Since the yen makes up only 13.6% of the U.S. dollar index (UUP), it is understandable intervention by Japan may have a somewhat muted effect relative to the dollar’s longer-term path.

Since commodities are often used as a way to hedge against a weak dollar, we also looked at the commodities markets during the last prolonged yen intervention period. Like the U.S. dollar, the commodity markets were most likely driven by the fundamentals of the day more so than any actions by Japan.

Therefore, based on this one anecdotal piece of evidence, our longer-term outlook relative to the dollar and the commodities markets may not need a significant adjustment due to Wednesday’s episode of yen intervention. Shorter-term, there may be a reluctance to butt heads with policymakers in Japan while taking the other side of the trade. With a meeting coming next week, you can bet the Fed is keeping a close eye on developments in Japan. More comments and a chart of longer-term trends in the U.S. dollar (or lack thereof) can be found in a recent post, Pimco’s Bill Gross Aligns with Warren Buffet in Bet against Deflation.

With all the talk of a deflationary depression, it is interesting to note that Bill Gross, the world’s most successful bond manager, and Warren Buffet both have made bets against long-term deflation. The following excerpts are from a Bloomberg story, Pimco Makes $8.1 Billion Bet Against `Lost Decade’ of Deflation, dated 10/15/2010:

Bill Gross’s Pacific Investment Management Co. made an $8.1 billion wager that the U.S. won’t suffer a decade of deflation like the one that crippled Japan starting in the 1990s.

“We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” Mihir Worah, the head of Pimco’s real return portfolio management team, said in an e- mailed response to questions.

Worah said Pimco’s inflation floors are “analogous” to the $36 billion of equity index put options that Warren Buffett’s Berkshire Hathaway Inc. has on major stock market indexes, including the S&P 500. Berkshire received $4.9 billion in derivative premiums in return for agreeing to make payments to the counterparties, starting in 2018, if the stock indexes are lower than when the contracts were signed.

While the derivative contracts suggest that deflation fears have increased, the risk of deflation in the U.S. is lower than it was in Japan because the two countries have different currency policies, said Donald Ratajczak, an economic consultant and former director of the Economic Forecasting Center at Georgia State University.

“We don’t care as much about our dollar,” said Ratajczak. “People who are betting on ten years of deflation are making a bad bet.”

As shown in the long-term (1987-2010) monthly chart of the U.S. dollar index below, the dollar has no clear trend currently (2009-2010), which we refer to as a consolidation pattern. If a break below 80 occurs, we could see a relatively rapid move toward 75. The U.S. dollar index closed yesterday at 81.08.

Tuesday’s close on the CCM 80-20 Daily Correction Index (a.k.a. 80-20) was 346.42, which remains below a concerning level. However, the 80-20 Correction Index is designed to help assess the risk of a correction within an ongoing bull market. Today’s markets may not be strong enough for the 80-20 to be all that relevant. If the S&P 500 can break above 1,130 or hold above its 200-day moving average for a time, then the 80-20 Correction Index should become more relevant. The CCM Bull Market Sustainability Index (BMSI) remained basically unchanged at 1,936, keeping it near the top-end of neutral territory.

The immediate fork in the road for stocks involves whether we (a) remain in a range between 940 and 1,130 on the S&P 500 or (b) can see a sustainable move above 1,130.

The CCM Bull Market Sustainability Index (BMSI) closed Monday at 1,943, which pushes us closer to the top of the neutral range with bullish territory in sight.

The ongoing and big concern in the current environment is the lack of interest in the markets, as evidenced by lackluster volume, especially on the major ETFs, like SPY, QQQQ, and DIA. The positives, which tell us a break to the upside has better odds than many believe, include good market breadth, improving technicals, and economic data which still points to a double-dip recession as the lower probability outcome.

The market will be looking for any comments related to quantitative easing in the Fed’s statement due to be released Tuesday, September 21st at 2:15 p.m. ET. We also have mid-term elections in seven weeks. If the market forecasts significant turnover on November 2nd, it may help push the S&P 500 above 1,130.

The video below covers possible investment contingency plans for S&P 500 levels ranging between 940 and 1,130. The video can be watched “as is” below or you can view it with a larger screen via the YouTube version. If you have a fast internet connection, the YouTube video is a little clearer if you view it in 480p. If you have a slower internet connection, it may be better to watch it in 360p (the default) via the YouTube version.

We have been underwhelmed with the market’s advance in the past few days; we would like to see some convincing participation before we become interested near current levels.

This morning global stocks and commodities are rallying on better than expected news:

Europe’s economy may grow almost twice as fast as previously forecast this year with a more “moderate” expansion in the second half, the European Commission said (Full Bloomberg Story).

European stocks climbed to a four- month high as regulators announced new capital rules for banks, while economic reports from China and Europe boosted confidence in the recovery. Asian shares and U.S. futures rose (Full Bloomberg Story).

Industrial production in China rose 13.9 percent in August from a year before, the most in three months, and retail sales and lending figures topped economists’ estimates, statistics bureau and central bank data released Sept. 11 in Beijing showed. Imports also accelerated, in another sign Chinese growth is picking up after a second-quarter moderation (Full Bloomberg Story).

The CCM Bull Market Sustainability Index (BMSI) closed Friday at 1,364, which is in neutral-to-bullish territory. Market breadth and volume have been mediocre in recent days. We would like to see some improvement on those fronts as we approach two key levels: (1) the 200-day at 1,115, and (2) overhead resistance near 1,130.

We have a video update in the works covering our contingency plans for market levels between 940 and 1,130 on the S&P 500 Index. It should be ready for viewing either later today or sometime on Tuesday.

Not much change in our thoughts in the last 24 hours. Thursday’s gains came on relatively unimpressive market breadth. Friday has wholesale trade numbers on tap at 10:00 a.m. ET. Other than that, there are few data points to influence market participants as we head into the weekend. The CCM BMSI closed yesterday at 1,360, mainly due to improvements coming from weekly market indicators. While the market’s recent advance has been tentative, further gains remain possible.

This morning’s employment number showing a decrease of 27,000 initial applicants for unemployment has been well received in the markets. All things being equal, we would prefer to see a positive move like this, but a decrease of 27,000 is not all that relevant when one considers the noise in the data. Said another way, an increase of 27,000 would not have been all that alarming. However, in today’s data driven, binary risk-on/risk-off environment, any small indication of economic strength or weakness can impact markets in a fairly significant manner in the short-run.

Until we see some buying with conviction, backed by some decent volume, we will remain somewhat tentative relative to adding risk to our portfolios, especially more volatile cyclical positions. We have a Fed meeting in less than two weeks; the statement and market’s reaction to it may help bring some clarity to a somewhat directionless market. CCM’s Bull Market Sustainability Index (BMSI) closed yesterday at 1,228, which shows some significant improvement in health of the markets over the past two weeks (from very weak levels).

With the U.S economy experiencing slower rates of growth, it is important to keep an eye on other global economic engines, such as China. Looking at one piece of anecdotal evidence, Stephen Green points out the following in a Bloomberg opinion piece:

China is, as we all know, an investment-heavy economy, so wheel-loader sales are a pretty good leading indicator: Companies only buy them if they plan to use one over the next 24 months. In July, 15,823 new loaders rolled out of the showrooms. That represented a 50 percent increase in seasonally adjusted sales compared with a year earlier. This is hardly the kind of number that one would expect from an economy on the verge of collapse. (Full Story).

While market breadth was decidedly negative and the magnitude of the decline was significant, Tuesday’s market slide was not backed by strong conviction from sellers. The table below compares trading volume from Tuesday’s drop to volume on a recent day where markets were higher. The conviction of buyers recently was much more pronounced than what we saw from sellers yesterday. It may not mean much if sellers pick up the pace, but taken in isolation, Tuesday’s drop was a little less concerning than it appeared.

The battle between the “risk-on” trade and “risk-off” trade continues. The bulls have made a little progress recently allowing us to move away from the bull/bear demarcation line as measured by the CCM Bull Market Sustainability Index (BMSI).

All our models indicate a weak market, but one that still argues for some patience. Markets may not cooperate with the “trading range” theory with some calling for the S&P 500 to remain between 1,010 and 1,100 for the foreseeable future. With the Fed on tap in two weeks and mid-term elections coming in two months, we have to be prepared for a break, either up or down. Flexibility remains very important.

The S&P 500 gained 63 points from the lows made three trading days ago. The futures are down this morning, which is not overly concerning given the recent sharp move away from 1,040 on the S&P 500. Debt concerns remain relative to Greece and the European banking system. We enter the week with a flexible mindset. Relatively sharp moves higher or lower are possible in a market that remains very data-and-news-of-the-day dependent. In line with our actions in recent weeks, our bias is to hold/reduce cyclical assets and hold/add to more defensive-oriented assets such as utilities, consumer staples, dividend-payers, and fixed income. As we mentioned last week, slowing growth calls for a more balanced portfolio mix.