Short Takes

As noted yesterday, we don’t like the look of the market and will most likely take an incremental step away from risk today. The chart below may impact the size of our incremental step. Price, in the middle of the chart, has made a lower low (see A2 vs. B2). RSI has a flat look to it (A1 vs. B1). The MACD histogram has a short-term, bullish divergence (A3 vs. B3), which gives some hope for stabilization in price near B2. You can see the divergences by comparing the slopes of the orange, pink, and green lines.

It should be noted the divergences above do not appear on the S&P 500’s weekly chart, which would be much more meaningful. Short-term divergences like the one shown above can be wiped out via further weakness, but it is good to know it exists relative to position sizing.

As summed up by Reuters below, the situation in Greece remains fragile:

Radical Leftist Alexis Tsipras began efforts to form a Greek government on Tuesday by renouncing the terms of an international bailout and threatening to nationalize banks in a statement likely to reduce his chances of success. His uncompromising stance may lower already slim chances of forming a coalition by scaring off the former ruling parties New Democracy and socialist PASOK, while further unsettling jittery investors.

The market has reached levels where further deterioration may call for some defensive moves. As the table below shows, the CCM Market Models remain perched on the bullish/neutral line. The risk model reading of 50 means 50% of the signals side with the bulls and 50% side with the bears.

The chart below is an updated version of the one covered in a May 7 video. RSI closed above 50 on Monday; it remains perilously close to a bearish cross. Note the trend in the relative performance of stocks (SPY) to bonds (IEF) after a weekly RSI close below 50 - bonds did better than stocks, which is what the falling ratio tells us.

While the chart of the S&P 500 below looks complex, the concepts are easy to follow. The two red arrows near point A show where the downward-sloping pink trendline acted as resistance in the past. The blue arrow near point B shows the same line is trying to provide support near 1,357. Point C shows the green 50-day moving average with a flat slope. If the slope turns over, it indicates a possible shift in the intermediate-term trend. If 1,357 does not hold, points D and E highlight the next levels where buyers may step in.

As noted in the video below, the markets have little margin for error from a technical perspective, which means they have been in need of some good news. Good news did come this morning from Europe in the form of better than expected factory orders in Germany. On Sunday night, S&P 500 futures hit a low of 1,342. As of 8:30 a.m. EDT, they stood at 1,358 or 16 points above Sunday night’s low.

Why were the S&P 500 futures so weak on Sunday night? Elections were held over the weekend in France and Greece. The markets knew there was going to be some political turnover, but the magnitude of the turnover, especially in Greece, was worse than anticipated. Two key problems have surfaced:

1. It will be very difficult to form a new government in Greece with no clear majority party/coalition coming out the other side of the elections. It is possible another round of elections will need to be held creating more fear, uncertainty, and doubt for market participants.
2. Nicolas Sarkozy was ousted by disgruntled voters in France. The Sarkozy-Merkel tag team is no more, creating uncertainty relative to the direction of future debt crisis policy.

A third problem relates to the market’s slowing momentum from a technical perspective. Daily and weekly charts have little room for error as of Friday’s close. Given the news from Europe over the weekend, it is unlikely the technicals will improve during Monday’s session. The video below shows clear deterioration in trends and momentum; it also explores an excellent way to monitor the battle between “risk on” and “risk off”.

One thing we have noticed over the years while building financial models is markets that are on the edge technically can find their footing just as they appear to be ready to accelerate to the downside. That’s not a forecast for the current market, which remains on the edge technically, but it serves as a reminder to keep an open mind about where we go from here.

Shifting back to the process of a forming a new government in Greece, Bloomberg reported:

New Democracy leader Antonis Samaras is trying to put together a government after a Greek election that raised fresh questions about the country’s euro membership and triggered the biggest stock-market rout in four years. Samaras will be given three days from today to put together a coalition from an assembly split down the middle on whether to renege on the terms of bailout agreements negotiated since May 2010. New Democracy and the socialist Pasok party, enemies until the country’s crisis threw them into a national government together this year, are two seats short of the 151 seats needed for a parliamentary majority.

With another weak labor report and less than favorable seasonal considerations for stocks, we have been keeping an eye on the current market relative to weakness in the springs of 2010 and 2011.

The three charts that follow allow you to compare the present daily chart of the S&P 500 to the spring peaks in 2010 and 2011. The thin colored lines are the 20-day exponential moving average (EMA) in blue, the 40-day EMA in red, and the 50-day moving average (MA) in green. Exponential moving averages move “faster” than simple moving averages by placing a greater emphasis on recent data. The current chart appears to have some support in the range between 1,360 and 1,390.

In April 2011, the slopes of the 50-day MA (green) and the 40-day EMA (red) did not roll over in a bearish manner. Subsequently, the market marched higher for two weeks. The notable difference in early June 2011 was all three MAs (green, red, blue) did roll over.

We see a similar pattern after the peak in 2010. Weakness in the market became more pronounced after (a) price dropped below all three moving averages (blue, red, green), and (b) the slopes of all three moving averages rolled over in a bearish manner.

Could today’s market (a) drop below the three moving averages, and (b) see the slopes of all three MAs roll over and subsequently go on to make new highs soon thereafter? Yes, however, the odds of a more pronounced and prolonged correction will increase if conditions (a) and (b) are satisfied. The take-away for us is if conditions (a) and (b) are not satisfied, then we should exercise some patience relative to the market’s current weakness. If (a) and (b) both occur, it becomes more likely that the market’s weakness will continue. A close below 1,360 would also bolster the intermediate-term bearish case. From a mathematical perspective, you can estimate the closing level for the 50-day moving average. Assuming the data we are looking at is correct, it appears as if the slope of the 50-day moving average will remain flat or positive on Friday unless we see a close below 1,363.

The CCM Market Risk Model (MRM) dropped from 90 on Wednesday to 74 on Thursday, which reflects a market that does not have much margin for error over the next week or so. With expectations for the Fed to launch QE3, we will also be monitoring possible strength in gold and silver.

The chart below shows the yield on a 10-year Spanish government bond. Given the recent weakness in stocks, it is a little odd that Spanish yields peaked on April 16. This increases the odds of the S&P 500 being able to hold above 1,360. Obviously, a spike back up in yields is possible, but it has not happened yet.

The table below shows that as of Thursday’s close, the big picture for stocks remained favorable while commodities continued to play the role of laggard. While there is still quite a bit of green on the equity side of the table, given the fragile state of the markets, it could migrate relatively quickly toward yellow and red.

While there is no question the current advance has shown signs of strain, big-picture risk measures remain in the bull’s camp. Our automated Asset Allocation Model classifies the daily readings of our three core market models. The results remain in bullish territory.

In today’s market, watching the yield on Spanish and Italian bonds is an excellent way to monitor the battle between acceptance of risk and risk aversion. You could make an argument that Spanish yields are being capped at 6.0% (red arrow).

Italian yields are most likely following the lead of the Spanish brethren. Both 10-year bonds remain near concerning “July 2011-like” levels, meaning the CCM table above could take a relatively rapid turn for the worse should yields begin to rise again.

Today we will let the charts do most of the talking. Below are updated versions of charts we have posted in the last ten days or so with some brief comments.

Market breadth continues to show bullish improvement from an intermediate-term perspective. (See original chart in this post.)

The ratio of “greed to fear” closed below two of the blue support lines below, but it still remains in a short-term indecision pattern (see green box). The ROC and Wm%R show the momentum for fear peaked around April 9 and has not shown considerable strength since then (red circle and orange box). (Original chart)

Tuesday’s session ended in a weak manner. The moving averages below should spark some interest from buyers should we revisit the 1,380 to 1,390 range (green arrows). (Original chart)

The S&P 500 has moved into the “white space” in the chart below, but Tuesday’s bar shows indecision at these levels. (Original chart)

Commodities have two decent looking candlesticks above the pink support line, which is encouraging, especially if it can hold into week’s end. (Original chart)

The German DAX remains above the intersection of the pink trendlines, which leans bullish longer-term as long as the levels are not breached on the downside. (Original chart)

It’s May 1 and time for the “sell in May and go away” chatter to pick up. Seasonal patterns are worth respecting, but you should also look for the market to confirm the seasonal tendencies. Since stocks tend to go up when central banks print money, creating a fear of inflation, and stocks tend to go down when deflationary/default fears pick up, commodities offer a good way to monitor the health of the markets.

Selling in May has worked quite well the last two years. Therefore, a comparison of 2012 to the past two years is a worthwhile exercise. The chart below shows a weekly chart of the S&P 500 (top portion) and commodities (CRB Index) in the middle. The orange arrows point out the peaks in 2010 and 2011. The red vertical lines allow us to compare the S&P 500, CRB Index, and the two technical indicators, MACD and RSI. Detailed remarks can be found below the chart relative to the other notations.

The main takeaways from the chart above:

1. Using MACD and RSI, 2010 appears to be much more similar to the present day than 2011.
2. The two candlestick formations above the purple arrows (near A1 and A2) have a similar “bullish engulfing” look. The pattern was a head fake for commodities in 2010, which is something we need to be mindful of in 2012.
3. In 2010, MACD failed to experience a bullish cross (near B1/pink arrow), which occurs when the black line moves above the red line. Therefore, if we experience a bullish MACD cross in 2012, it would be a good sign for risk assets. MACD at B2/2012 still looks similar to B1/2010, which is a yellow flag for risk in the present day.
4. A good way to use RSI is any move above 57 during the week is a bullish signal – a weekly close over 55 is also bullish. Anything below those figures is worthy of some skepticism. RSI, as of Monday’s close, sat at 44 or still in neutral territory.
5. The recent break above the pink trendline by the CRB Index and the subsequent support shown by the same trendline gives the commodity bulls some hope.

Based on our market models, the bulls remain in control, but they look vulnerable. Numerous weekly charts have weak MACDs, an indication of slowing momentum. There is nothing wrong with a MACD slowdown, but the margin for error to reach more concerning MACD levels is somewhat thin.

The situation in Spain remains fragile. From CNN:

NEW YORK (CNNMoney) — Spain has fallen into its second recession since 2009 as its economy shrank for the second consecutive quarter, according to a government report Monday.There are now a dozen European nations that have had their economies shrink for two consecutive quarters, a condition that generally equates to a recession.

The silver lining is Spanish 10-year yields have dropped 0.22% this morning. While the equity markets are down in Europe, the aversion to risk has been somewhat muted given we had a downgrade of Spanish debt on Thursday evening and the weak economic data this morning.

Short-term, the market looks a little tired, but as shown below:

1. The slopes of the 50-day MA (blue), 20-day EMA (red), and 40-day EMA are all positive (near green arrow).
2. The S&P 500 closed above all three moving averages on Friday (blue arrow).

The numbers below can move rather quickly before the close, but as of post-lunch on Friday, the green box looks good and the orange box looks so-so.

On April 26, we mentioned the chart of the VIX “Fear Index” (VXX) relative to the S&P 500 (SPY) represented a good way to monitor risk in an environment with some conflicting signals. An updated version of the chart, as of Thursday’s close, is shown below. The bulls made some progress with the blue upward-sloping trendline being violated, which shows decreasing levels of fear relative to the willingness to take on risk (see red arrow).

Obviously, Friday’s GDP report can flip the chart above one way or another, but another bullish signal was given on Thursday. Near the blue arrow above, notice that RSI (Relative Strength Index) made a lower low and closed below 50. The lower low represents a short-term bearish divergence for the VIX relative to the S&P 500 (bullish for risk). The divergence increases the odds of continued VIX weakness.

We originally posted the chart below on April 23. If you look closely, price moved to/slightly above the trendline below 1,400 on Thursday. There is some white space above the chart, which could be filled by price.

Just as the odds of rain increase when skies shift from clear to cloudy, a bullish turn in market breadth increases the odds of a sustainable bullish turn in stocks. Keep in mind, cloudy skies do not guarantee rain. The chart below is an intermediate-term measure of market breadth (the Summation Index). Market breadth refers to the percentage of stocks participating in an advance. Broad participation leans bullish. On Wednesday and Thursday, the Summation Index moved higher – it had been declining for several weeks. The green arrows show where market breadth started to improve. The S&P 500 is shown at the bottom of the chart.

Commodities continue to lag stocks, which is not surprising in a deleveraging environment (a.k.a. debt reduction/less trading on margin). If you are a silver or gold bug, the chart below has yet to show much in the way of hope. The performance of silver (SLV) relative to the S&P 500 (SPY) has a bearish/downward-sloping 9-month exponential moving average (EMA) and a still ugly looking MACD, which measures momentum (see red arrows).