Short Takes

While there are some concerning differences, from a technical perspective the total stock market ETF (VTI) below marched higher after a similar bout of weakness in late 2010. Even if we follow a similar bullish path, next week could see some weakness. Therefore, if we make a move on the long side of the market, it will be in a measured incremental step. In the graph below, note the similarities of the moving averages (focus on the slopes and relative orientation). Breaking to a new weekly high would increase our comfort level with the similarities below.

We may use broad vehicles for some exposure to the U.S. and Europe. We may convert to a dividend heavy strategy once our research is complete, but as of this writing, the market looks strong enough to warrant some exposure. It depends on how we close.

Developed by Sherman and Marian McClellan, the McClellan Oscillator is a breadth indicator derived from net advances, the number of advancing issues less the number of declining issues. We can think of the McClellan Oscillator as the short-term cousin of the Summation Index, which we have referenced recently.

While stocks can and may still fall a good bit further (see August 2011 below), today’s low reading in the McClellan Oscillator tells us to be open to a rally relatively soon. The chart below is not a timing mechanism, but a signal to pay attention.

Price and trends are what matter most. The uptrend in stocks remains intact, but it is looking long in the tooth. We have talked about market breadth in the past; below are two updates as of Friday’s close.

The Dow Jones Industrial Average has a weekly setup that can signal a reversal. It adds another rock to the bearish wheelbarrow.

Sixty-minute DeMark charts tell us the next push higher may be met with selling. If we move higher on the open Monday, counts could hit exhaustion in one to five hours of trading (depending on which count is used). An S&P 500 push toward 1,384 to 1,398ish seems within reason, but it may have to come relatively quickly rather than via a slow drift up.

IWO closed at 92.83, which was below the level we posted Friday before the open. All of the above mean little until we see signs of a reversal. However, they do show a rally that is increasingly vulnerable to a correction. The market has been very resilient, which gives the bulls the benefit of the doubt for now.

A few key markets have chart patterns that may help us with the market’s next move. A handful of markets/ETFs, including the NASDAQ, OEF, IWO, the Dow, and IVW, have three candlesticks which show hesitation in the minds of investors. The table below shows Wednesday’s highs and lows, which as outlined below are important relative to the pattern.

The pattern (below) includes a “new” high, a “bearish engulfing”, followed by an “inside day”. This pattern can precede a relatively sharp move in either direction. The keys are Wednesday’s highs and Wednesday’s lows. A break/close above or below Wednesday’s high/low typically will telegraph the pattern’s next directional move.

Wednesday’s session was filled with bearish engulfing candlesticks, which can signal a point of trend reversal. Things looked good for the bears on Wednesday. However, Thursday’s session increased the odds of a continuation of the current trend, which shows the importance of waiting for confirmations of signals and patterns.

The chart of the NASDAQ Composite shows the pattern occurring three times in the last three months. The pattern is not bullish or bearish; it depends on the direction of the break. The pattern is present as of Thursday’s close (upper right).

Another bullish break is possible, especially when you consider the second load of printed money that was pumped into the system by the ECB this week. A few markets have violated DeMark risk levels (”stops”), which means they could push higher. Many markets still have DeMark trend exhaustion setups in place, including recent readings on weekly and monthly charts. A handful of markets, mostly foreign, could record weekly sell setups next week.

All the elements are in place for trend exhaustion (at least the set-ups). At the close on Friday, we had exhaustion signals on short (minutes), intermediate (day/week), and long-term (monthly) charts. Until we see some evidence of a turn, the set-ups are just that - “set-ups”. One yellow flag for the bulls is the weakness in industrial metals, such as JJC and DBB. Transports (IYT) have also been weak recently.

All indicators, including DeMark’s, should be used in the context of the big picture. While the indicators can give some fabulous signals, they are not immune to giving false signals, especially in strongly trending markets. We have strongly trending markets currently. Therefore it is prudent to have contingency plans in place for bullish and bearish outcomes. DeMark indicators are proprietary tools developed by Tom DeMark of Market Studies, LLC.

As we have mentioned on a few occasions, even if DeMark exhaustion signals prove to be “wrong”, they can still give us some good information. The text below, taken from Tom DeMark’s book New Market Timing Techniques, puts some context around these concepts:

Stop Loss: Since this stop-loss technique was created over 20 years ago, it’s been applied to a number of indicators. It still has an amazing ability to protect me from prematurely exiting a trade, as well as its ability to be sufficiently sensitive to changing market conditions. In fact, there have been individuals who have used TD Sequential, and once this stop loss has been triggered, they have exited the trade and have, at that same time, successfully reversed their positions, because when a TD Sequential trade does not work, as Paul Tudor Jones observed and described it, “it really doesn’t work.”

CCM’s technical models have flipped into bullish territory. In the last three weeks, standard technicals have turned impressively in numerous markets. Our approach will be to observe with an open mind and make adjustments as needed.

We remain in an event-driven market. One headline from Greece could spark another sharp leg higher or a steep correction. Given what we know as of Sunday afternoon, we believe a pullback or correction would represent a buying opportunity. However, we are still crunching some numbers and reviewing charts, but the weight of the evidence has been trending in a bullish manner since the ECB and Fed flooded the banking system with “liquidity” (a.k.a printed money). As the chart of central bank balance sheets shows below, we are currently in uncharted territory in terms of global money printing. Notice how the ECB’s balance sheet goes vertical near the end of last year (green line far right). Money printing, in the short run, leans bullish. In the long run, it will end badly, but that could be years away. Chart courtesy of Grant Williams via Zero Hedge.

Reuters on central bank actions:

Some central banks have quietly unleashed a fresh flood of money in recent weeks.

The ECB has pumped half a trillion euros of three-year ultra-cheap money into its banks with more to come on February 29. The Bank of Japan and Bank of England are printing fresh money with new bond-buying programs, and Sweden’s Riksbank surprised with an interest rate cut last week. And last month the U.S. Federal Reserve extended until late 2014 its pledge to keep rates ultra low.

James Rickards, an investment banker at Omnis, called the latest central bank measures a risky inflation strategy “to scare us into spending.” Neal Soss, chief economist at Credit Suisse, sees them as a wise investment to secure a vulnerable upswing.

“The massive expansion of central bank liquidity should better prevent and insulate the real economy from financial shocks. If that’s the case, the current upswing in cyclical momentum may prove more sustained than previous speed-ups,” Soss said.

As we noted in Tuesday’s video, the S&P 500 did get another push higher this week. We closed right in line with the 1,343 number. DeMark aggressive sequential daily for S&P 500 moved to a 9-13 “exhaustion” count as of today’s close. SPY volume traded roughly 27% below a typical day, meaning the conviction behind today’s move was weak. Table still set for next week - we will see what Monday brings.

Based on traditional technical analysis, the market is increasingly looking more like a bull market. Daily, weekly, and monthly DeMark counts tell us to be careful over the next few weeks. A close above 1,343 would add to the bullish evidence. Failure to close above 1,343 leaves a crack in the bearish door. Using the recycled daily DeMark count of the S&P 500 as a guide, the market could push higher at least until February 9. If gains hold up today, we may take a position on the long side of the market. Based on action above or below 1,343, we can make adjustments in either a bullish or bearish direction. We have been waiting for some resolution below 1,343; we may get in the next week to ten days. Monday’s video provides additional detail on the bull and bear cases. We still prefer Germany to the U.S. on a valuation and technical basis.

We still have no resolution (bullish or bearish) relative to the S&P 500 below 1,343. The most recent push higher in the S&P 500 was relatively strong with daily RSI moving above 70. The 2011 chart below shows we may need a weak bounce/push higher sometime in the coming days if stocks are to move significantly lower. Notice the low levels of RSI (top) and MACD Histogram (blue bars) when the S&P 500 tried to recover from early weakness in a reversal pattern.

In early January we stated it made sense to see how the S&P 500 acted between 1,285 and 1,340 (see 1:47 mark of video). Today we sit at 1,316, which means no resolution has come yet. We will pay attention with an open mind, but it is always good to have a base case laid out for the short-, intermediate-, and long-term. From a short-term perspective:

1. The last push higher in the S&P 500 looked too strong technically for a typical end of a move, which means it would not be surprising to see another push higher, maybe beginning from 1,316ish to 1,293ish.
2. If we push higher, resistance may come in near 1,327, 1,330, and then 1,340.
3. If the move higher is weaker, using indicators such as RSI, it may be followed by more significant downside, possibly below 1,200.
4. Potential areas of support to watch would include 1,285, 1,275, 1,253, 1,210, and 1,192.

A more immediate bullish scenario may follow breaks of 1,330 and 1,343ish. Numerous markets in the United States are looking tired on monthly charts. Thursday’s high was 1,333; so, exercising some patience if we move as high as 1,343 makes good sense.

From Bloomberg:

The last time RSI exceeded 70 while the VIX stayed below 20, 11 months ago, the S&P 500 reached a 32-month high before dropping 6.4 percent over the next month, data compiled by Bloomberg show. The VIX is the benchmark gauge of S&P 500 options prices. “We’re definitely in a rare spot,” Josh Dollinger, Chief quantitative and technical strategist at BTIG in New York, said in a telephone interview. “These are extreme readings. They more often than not prove to be exhaustion tops.”