Short Takes

Yesterday, we noted some bad news would probably be needed to tip the scales in this market. This morning’s economic data fits the “bad news” bill. From Reuters:

New orders for long-lasting manufactured goods fell in January by the most in three years as demand slumped across the board, suggesting the economy started the year on weaker footing than expected. Durable goods orders dropped 4.0 percent, the biggest decline since January 2009 when the country was still mired in a deep recession, according to Commerce Department data on Tuesday.

We often use the Summation Index as a way to monitor the markets “internals”. The Summation Index is a market breadth indicator that is derived from the number of advancing and declining stocks in a given market. The concept of breadth is easy to understand; healthy markets have broad participation during rallies (a stable or rising Summation Index).

The charts below are busy, but the concepts are simple. In the present day (shown below), the Summation Index climbed above 1,300 and has now started to decline (see orange box and blue arrow top right). The blue arrows to the left show the previous times the Summation Index turned down after a rally in stocks; the S&P 500 corrected soon thereafter (see purple boxes at bottom). Corrections in stocks (purple boxes) also occurred after RSI turned down from high levels (red boxes top); the far right red box shows the similar setup we have in RSI today, which leans bearish.

The concepts presented in the chart above apply to the 2003-2004 chart below as well. The Summation Index turned down from above/near 1,300 and stock market weakness/consolidation followed. RSI (red boxes below) also dropped below 70, just as it has today (red box above far right).

The chart below takes a closer look at the 2003 case. After the Summation Index rolled over from a level near 1,300, the S&P 500 dropped 5% over the next two weeks.

The setup in 2009 was similar. Stocks dropped 5.5% in three weeks (point A), rallied 8.7% over the next three weeks (B), and then dropped 9.1% over the next four weeks (C).

The takeaways for us today are (a) the odds favor some type of pullback beginning in the next week or so, (b) markets may be volatile for a time while making little progress, and (c) we have to be open to higher highs in the coming months. As noted in yesterday’s post/video, two items carry a bullish bias in the short-run: (1) the take up of ECB’s second round of three-year loans is announced Wednesday, and (2) Wall Street likes to “mark up” stocks at month end.

While evidence of a probable 5% to 11% stock market correction keeps piling up, the bulls remain in control until we see tangible signs of a bearish turn. The video below mainly focuses on the current oversold nature of the VIX and the possible ramifications for stocks. Other video topics include a bearish divergence in the Transportation Average and the next round of money printing in Europe.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

We are working on a video to update the ongoing case for a correction in stocks. The video will touch on the VIX, transports, and possible pullback buy candidates (opportunities/ETFs/sectors/regions of globe). The video should be posted sometime late Saturday or before noon on Sunday.

Europe - The Problem That Won’t Go Away - From Reuters:

The head of the Eurogroup of euro zone finance ministers, Jean-Claude Juncker, said on Friday he could not rule out that Greece may need a third bailout.

In case you lost count, we are now working on the second bailout. Debt levels are unsustainable in the long-run; not just in Greece.

In technical analysis, the term “confirm” speaks to increasing the probability of a specific outcome. From a tactical perspective, there are numerous ways to confirm a reversal in price. Some of the most aggressive methods have already confirmed a reversal (increased the odds the signals are valid). A more conservative approach, based on today’s trade, would be to wait for a close below 1,343. An even more conservative level is 1,331, which remains a fixed point of possible support for prices. If we fail to surpass yesterday’s high of 1,367.76 today, it will add one more rock to the reversal wheelbarrow. It’s only 1 p.m. - so we could still see an up close. A move toward 1,374 cannot be ruled out. As of this writing, the set-ups for a correction remain firmly in place. Market breadth is weak; if it improves over the next three hours, the odds of a late day rally would improve.

The current weekly chart of the S&P 500 (SPC5/cash) appears to meet the criteria outlined below for a 9-13-9 Sell Count, which could have bearish implications for risk assets in the coming weeks. DeMark indicators are proprietary tools developed by Tom DeMark of Market Studies, LLC.

The Bloomberg book DeMark Indicators by Jason Pearl lists the requirements for a TD Sequential 9-13-9 Sell Count for probable trend exhaustion as:

1. The TD Sell Setup must not overlap with the previously completed TD Sell Countdown.
2. There must be a bearish price flip between the TD Sell Countdown and TD Sell Setup.
3. No Completed TD Buy Setup can occur between the TD Sell Countdown and TD Sell Setup.

The current weekly chart of the S&P 500 appears to be a mirror image of Figure 1.21 in Jason Pearl’s book DeMark Indicators. The TDRisk level, which is similar to a stop-loss level, for the weekly 9-13 sits at 1,363.

We also have a recently completed 9-13 Sequential Sell Countdown on the monthly chart of the S&P 500. Similarly, a valid 9-13 Sequential Sell Countdown was completed on the daily chart of the S&P 500 on February 9, 2012. Therefore, at the present time, we have Sequential trend exhaustion signals on the daily, weekly, and monthly charts of the S&P 500 Index.

What does all this mean? Our bias will be on the defensive side until these conditions have been cleared. As we noted on February 10, the current traditional technical state of the S&P 500 and the CCM proprietary market models both give the longer-term edge to the bulls. Given the situation in Europe, the recent vertical run in risk, and DeMark exhaustion signals, we must respect the downside risks even under current bullish conditions.

Even the early stages of new bull markets experience corrections. After surging off the March 2009 lows, the weekly chart of the S&P 500 experienced what is known as a “perfected sell setup” in DeMark speak. Following the sell setup signal in early June 2009, the S&P 500 corrected 9.1% in the next six weeks. At today’s close, we should see a perfected sell setup on the weekly chart of the S&P 500 Index. We also have extended charts in Europe as measured by indicators such as RSI (Relative Strength Index). The video below expands on the rationale behind increasing odds of a correction in risk assets. DeMark indicators were developed by Tom DeMark of Market Studies, LLC. Video contents:

1. 00:00 – 04:15 Market outlook
2. 04:15 – 14:26 DeMark indicators for the S&P 500 and Germany
3. 14:26 – 19:31 CCM Market Models

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

If and how the markets come down will help determine if we have a buying opportunity or a resumption of a deflationary bear market. Given the current readings of proprietary CCM market models, the odds currently favor a correction followed by more liquidity-induced upside (a.k.a. a buying opportunity). The bearish case could follow the “decoupling path” taken by emerging markets in 2008. Our approach will be flexible based on market action. During an orderly pullback, we will consider taking a stake in numerous markets, including Germany (EWG), gold (GLD), silver (SLV), agriculture (DBA), and Australia (EWA).

There are two possible ways to interpret the European Central Bank’s (ECB) program which offers unlimited three-year loans to European banks:

1. The ECB will print as much money as needed to save the euro.
2. The ECB wants to flood the financial system with liquidity to prepare for a hard default in Greece.

Fitch Ratings today reiterated its view that Greece will default even with the rescue package. Excerpts from a Reuters article on the current state of affiars in Greece are below:

Greek workers went on strike against austerity measures on Friday, docking ships and halting public transport, hours after euro zone finance ministers said Athens needed to make more cuts to convince them to release a financial bailout.

The euro and shares fell on Friday, reflecting concern over a possible failure in the debt restructuring after the European Union and International Monetary Fund indicated that a hard-won Greek deal on spending cuts and wage cuts did not go far enough.

Before they release more aid, Greece’s financial backers have demanded parliamentary ratification of the new austerity package this weekend, the identification of a further 325 million euros of spending reductions by next Wednesday and a strong commitment from all parties to implement the reforms.

In Short Takes, we often reference McClellan’s Summation Index, which is a measure of market breadth. From WSJ’s Market Beat:

With the market apparently reaching a point of exhaustion, Tom McClellan of the McClellan Market Report believes today “is going to be the top day.” His advance-decline summation index has reached an extreme-high level usually associated with “meaningful corrections.” McClellan says there is some risk he’ll miss out on further upside, but given the gains already seen and the fact that sentiment indicators are flashing big warnings about excessive bullishness, “I figure that this risk is pretty low.”

This morning’s bullish payroll report aligns with the “another push higher” and probable strength into next week scenarios. The area near 1,343 remains important on S&P 500, especially on a closing basis. We are open to making bullish or bearish adjustments, but we are still leaning toward the correction camp.

DeMark indicators look for price exhaustion, which speaks to a market that runs out of interested buyers. Based on the way the signals are generated, a market must exhibit some respectable price strength to establish “exhaustion”. The fact that DeMark counts have been slow to develop over the past six weeks is indicative of a weak and tentative advance in stocks.

Once again, we failed to hold the levels needed on Tuesday to generate an exhaustion signal on the daily chart of the S&P 500 Index. For the signal to occur today, we need (1) an intraday high greater than 1,303, and (2) a close greater than 1,295.50. Once we get the signal, there are some things to look for in the following days which increase the odds of a reversal.

Numerous markets and time frames still point to lower lows in stocks later in 2012. We believe the S&P 500 could push above 1,285 toward the 1,300 - 1,343 range. However, that move may be retraced fairly quickly, based on DeMark counts, increasing bullish sentiment, and still-elevated Italian bond yields. The negative implications of a 10-year Italian bond yielding 7% were outlined at the 00:29 and 13:00 marks of a December 18 video.

UBS created an interesting chart using the Juglar cycle, Kitchin cycle, and Dow Jones Industrial Average. According to Wikipedia:

The Kitchin cycle is a short business cycle of about 40 months discovered in the 1920s by Joseph Kitchin. The Juglar cycle is a fixed investment cycle of 7 to 11 years identified in 1862 by Clement Juglar.

Investors tend to get overly bullish near market tops and overly pessimistic near market bottoms. The latest AAII sentiment survey aligns with the idea of a probable peak occurring between 1,285 and 1,340 on the S&P 500. Bearish sentiment fell to the lowest level in roughly a year. Bullish sentiment rose to the highest level since early February 11, 2011; the S&P 500 peaked a week later (see below).