Short Takes

We would be more apt to book profits this week rather than add to our risk exposure. While not in red territory, the CCM Market Models have reached “Tired Bull” readings.

Given the strength of the recent push higher, there is also ample evidence to suggest an attempt at higher highs may follow any relatively short-term pullback. We will continue to monitor things with an open mind and maximum flexibility, but within the context of a defensive bias until the market shows some strength again.

We have been working almost non-stop attempting to find if/what it may make sense to rotate into (staples? bonds? emerging markets? make no changes?). The market has not shown its hand since we have not seen significant weakness yet (more of a stall). If we pay attention and continue to monitor things closely, we will not stray too far from a prudent allocation.

Profits are hard to come by; we may book some more soon. In the meantime, we will continue with our “where to go or should I stay” analysis. Numerous steps are left to complete this morning (as of 6:45 a.m EDT), meaning we should have a clearer picture over the next few hours.

The bad news: (1) ISM number was weak, and (2) the risk-on vs. risk-off chart below remains weak. The good news: (1) the chart below is trying to hold near point F, and (2) silver is outperforming gold today, which shows some belief that central banks can “successfully” inflate. The chart below has been updated. The description of the chart has been provided again FYI.

On August 28 and August 30, we pointed out some caution flags on the chart of the S&P 500 (SPY) relative to intermediate-term Treasuries (IEF). While the chart that follows looks complex, it is based on the simple concepts of support and resistance. When the ratio is rising, stocks are in favor relative to bonds (see chart below). When the ratio is falling, bonds are strong relative to stocks. An updated version of the chart as of Thursday’s close is presented here; the stock/bond ratio is at the top with the S&P 500 below it.

1. Points A1 and A2 (see chart) show the twin peaks made by the S&P 500 last spring. Points B1 and B2, which occurred simultaneously with the stock market’s peaks, show where the stock/bond ratio (SPY/IEF) was rejected by the downward sloping blue trendlines (acting as resistance for risk).
2. Points C and E show where the stock/bond ratio is running into similar resistance in the present day. The red arrow to the left of B2 shows an important support break for “risk” relative to “risk-off” (see gap to left of arrow). The break of support for risk in April occurred on the same day the S&P 500 peaked at point A1.
3. Point E shows a similar break of risk-on support that occurred on August 30 (this week). The two red arrows show similar support breaks for risk relative to risk-off. The horizontal line F could act as support for risk in the days ahead, meaning we must keep an open mind about where stocks go from here.
4. The blue arrow shows the S&P 500 flirting with a break of support near 1,400 (bottom of chart). If stocks remain weak, point D shows an area near 1,388 where buyers may become interested again.

As a central banker, the ECB head knows better than to say he “will do whatever it takes” to defend the euro days before a policy statement, and subsequently deliver nothing in the statement. Well, that is what exactly happened over the past week. The head of the ECB, Mario Draghi, promised the world and delivered absolutely nothing today, except more words. Seeing the futures were up 11 points earlier today, it is clear the market wanted a reason to rally. The reason did not come.

As of 10 a.m. EDT, the S&P 500’s chart still looks good. The downtrend from the April high has been broken (see line A). Line A may now act as support. The recent peak occurred at a logical point; lines B and C form a parallel trendline channel. Price remains within the upward-sloping channel. The S&P 500 remains above its upward-sloping 50-day (blue line); it is also above the upward-sloping 200-day. Should weakness continue, the S&P 500 has possible support between 1,360 and 1,320.

The most encouraging sign today is the VIX. The VIX rises when fear rises. In the wake of the disappointing Fed and ECB statements, you would expect the VIX to be moving significantly higher today . As of 10:00 a.m. EDT, the VIX was down 5.38%.

If you removed the symbols from the two charts shown here and asked, “Which market looks healthier?”, the answer would be the S&P 500. Obviously, that is subject to change, but even after the central bank statements, the market is holding up fairly well. In contrast to the S&P 500, the VIX is below both its 50-day and 200-day; both moving averages have negative slopes, which leans bearish.

While it is not a fully formed pattern, you can see the possible makings of a bearish head-and-shoulders pattern on the chart of this VIX above (see “S H S”).

The recent weakness in the markets is concerning, but not overly so. A Fed meeting is a little more than two weeks away. The odds are extremely low the Fed does not deliver at least some encouraging language in their July/August statement. They do not need to announce QE3, they just need to hint at it. QE2 was hinted at in late August 2010, but not announced until early November. As shown below, the markets did not wait for the formal announcement.

The S&P 500 and NYSE Composite Index have numerous forms of support relatively close. We are open to hedging our long positions between now and the Fed meeting. Given what we know today, any hedge would be relatively small in terms of percentages, at least the first incremental step. Flexibility remains extremely important.

In the next 24 hours, we will post a video showing numerous markets and important support levels. We have reviewed daily, weekly, and monthly charts for roughly 130 ETFs this weekend.

Four points for investors to ponder before Friday’s employment report:

Point One: It is the market’s reaction to the number that matters, not the number. Even if we had an advance copy of Friday’s report, it would not be easy to predict the market’s reaction. A good report on the labor front could be interpreted as bullish (economy better than expected) or bearish (the Fed will not print). A bad report could be interpreted as bullish (Fed prints) or bearish (economy on the rocks). A Yahoo Finance story takes the bullish view of a good report:

After back-to-back data disasters in April and May, the June Non-Farm Payroll report out tomorrow could bring investors some much needed relief. While economists, on average, are expecting a modest rebound to 100,000 new jobs created last month from 68,000 in May, some industry veterans think the final report of an otherwise awful second quarter will be a whole lot better than that, especially considering today’s better-than-expected ADP Private Payroll report.

CNBC covered the “good” is “bad” angle:

May’s dismal jobs report prompted immediate speculation of further easing by the Federal Reserve, and even though the Fed extended one program at its June meeting, the market is still looking for signs that it could do a third, larger scale “quantitative easing,” or QE3 asset purchase program. “I think the whisper is closer to 110,000, 120,000,” said John Briggs, senior Treasury strategist at RBS. “Anything between 80,000 and 130,000 doesn’t matter. It shouldn’t be a major market mover,” he said. However, Briggs said the equity market is being supported by the idea of Fed easing and a really good number might actually be a negative to some in risk markets.

Point Two: The S&P 500 is clearly in an intermediate-term uptrend. The trend began four weeks ago. As of Thursday’s close, the S&P 500 was above its 20-, 50-, 100-, and 200-day moving averages, which is indicative of favorable conditions for investors. The 50-day moving average is currently flat, indicating some indecision, but the slopes are positive on the 20-, 100-, and 200-day moving averages, which leans bullish until it changes. All trends have counter-trend rallies. The S&P 500 could drop 37 points on Friday and still remain above the bullish trendline from the June low near 1,330. As long as the S&P 500 remains above 1,330, we will view any pullback as a buying opportunity.

Point Three: The table and chart below were described in detail on June 21; updated versions are shown below. The pullback scenario, similar to points A (2010) and B (2011) in the chart below, remains viable in the present day. If and when the hurdles below are cleared, which could happen soon, it would increase the odds of stocks pushing higher in the near-term. For investors, if the Relative Strength Index (RSI) on the S&P 500’s daily chart can close above 65 in the next few days, it would be another step in the bullish direction.

Point Four: Thursday’s close was weak with RSI failing to retake 70 on the 60-minute chart below. It is far from earth-shattering, but it shows waning bullish interest in the very short-term. On a more positive note, the S&P 500’s 5-, 10-, and 15-minute DeMark charts are close to getting “buy setups”, which leaves a crack in the door for buyers early in Friday’s session. DeMark indicators are proprietary tools from Market Studies, LLC.

A push above 1,375 on the S&P 500 would be a good step for the bulls on Friday, leaving us more open to redeploying additional cash. Below 1,375, the short-term risk-reward profile tells us to be patient; a better entry point may come somewhere between 1,363 and 1,330. A break of 1,330 would put the “visit to the June lows” scenario back on the probability table.

We have added a new video to the previous post (see below). The video covers the German DAX, foreign stocks (EFA), equal-weight S&P, gloabal stocks ex-U.S., and the VIX Fear Index.

Nothing dramatic occurred on Tuesday in terms of changes to our market models. The Bull Market Sustainability Index (BMSI) did pop back into the low end of “healthy” territory, which makes us more open to redeploying cash. The other models (MRM, 80-20) remain in neutral territory. The classifications are updated automatically each day based on the current readings relative to historical readings.

Our current allocation remains in line with the recommended allocation, but that may not be the case if we get some bullish follow-through this week. Even if we rally, based on what we know today, the door remains open to lower lows sometime in the next few weeks. We may be in a bottoming process, which implies it could take some time.

As a point of reference, we have not yet seen a bullish MACD cross on the daily or weekly chart of the S&P 500. If we are to see a sustained rally both would have to see “black over red” on MACD.

The markets advanced early Tuesday after a report on home sales exceeded forecasts. On the earnings front, AT&T (T) and 3M (MMM) came in above consensus. With an important Fed statement and a durable goods report coming on Wednesday, we will be monitoring our market models, support, and moving averages closely.

After the recent rise in Spanish and Italian bond yields, it is possible the market is expecting too much from Wednesday’s Fed statement. From a bullish perspective, any hint of additional Fed asset purchases in the central bank’s statement could give a tired market a bullish injection.

The support table below is one of the ways we are tracking the market’s downside risk should the Fed disappoint. The levels shown come from two DeMark indicators, Setup Trend (TDST) and Propulsion (PROP). All things being equal, we would prefer to see the ETFs in the table remain above both of the potential forms of support. Red boxes show ETFs that were below the given level as of Tuesday morning. Green levels show ETFs that were above the given level as of Tuesday morning. On average, the ETFs remained 0.16% above TDST support and 0.95% above the PROP support.

In the table above, a bearish break of the PROP “support” levels could be followed by increasing momentum to the downside. ETFs that remain above the PROP levels will tend to maintain a bullish bias from a momentum perspective. DeMark indicators are proprietary tools offered by Market Studies, LLC.

When we study markets, we tend to classify them as bullish, neutral, or bearish. A “bullish correction” is one that remains relatively tame or is relatively short in duration. As shown in the table below, the median CCM 80-20 Correction Index (80-20) reading at the end of a “bullish correction” was 34. The 80-20 closed Monday at 37. None of our models have moved from bullish to neutral territory yet, which means some patience remained in order as of Monday’s close.

Should the values in the table above begin to breach neutral territory, it would increase the odds of a more substantial pullback. The CCM Asset Allocation model currently has a 67% exposure to risk, which respects the possibility of further downside while acknowledging all three major indexes remain above their 200-day moving averages (in red below).

Not too many bad things can happen when the slope of the S&P 500’s 50-day moving average remains positive (shown in blue above). If the 50-day does turn over in a negative manner, it will send another “be careful” message to investors.

Since the situation in Europe could return to full-blown crisis mode at anytime, we are producing a client video showing some of the specific risk controls that are built into the new CCM Market Risk Model. The video should be completed sometime in the next 24 hours.