We still do not like this market in the intermediate-term, but we would like to see how things play out near the blue arrow in the chart above.

The relevant point for us today is the markets fell sharply during the period of uncertainty. You can argue the uncertainty relative to Europe in 2011 escalated as the S&P 500’s 50-day moving average turned down (see red arrow in chart above), which is an indication of a weakening uptrend. Moving averages are used to filter out shorter-term volatility, allowing us to focus on the bigger picture in terms of trends.

Fast forward to the present day and we find more uncertainty related to outcomes and possible repercussions in Europe. This morning’s Wall Street Journal captures the gravity, and possible short time frames, relative to this stage of the Greek tragedy:

Swedish Finance Minister Anders Borg, whose country is in the EU but not a member of the euro, warned Tuesday while attending a meeting of EU finance ministers in Brussels that Greece may be nearing the end of its time in the euro zone. “We are very close to the end of the road,” Mr. Borg told reporters. “The situation is very serious.”

The markets seem to understand the serious nature of the challenges facing Europe. Last week, the slope of the S&P 500’s 50-day moving average turned down, indicating a shift toward risk aversion. While there is no question the market’s current bias is to the downside, any good news could spark an oversold rally similar to what we saw in June 2011. Like June 2011, an oversold rally may prove to be short-lived.

Markets are always looking ahead. Given Greece most likely will hold new elections in mid-June and that by the end of June, the country must detail and approve fresh measures to close a budget gap of €11.5 billion, the markets are anticipating increasing uncertainty in the weeks ahead.

Between mid-June and the end of June, Greece must form a new government and pass controversial budget measures. All this seems like a tall order from the market’s current perspective as evidenced by the recent break of the Dow’s 22-week moving average (MA). All things being equal, a move below the 22-week MA is a bearish signal.

Another question facing the markets is what happens if Greece fails to make the necessary budget cuts to obtain additional aid. From Scotland’s Daily Record:

If Greece refuses to make cuts, European leaders are likely to withdraw bailout funding agreed in March and an exit from the euro is almost certain. And if that happens, the impact on the UK and other European countries would be devastating.

The S&P 500 has also reacted to the heightened risks in Europe by dipping below the 22-week moving average. The markets are in the process of shifting from “risk-on” to “risk-off”. A move below the 22-week can be short-lived (see early 2010 below), but it should be respected until the market provides some bullish clues.

Another major area of uncertainty is the possibility of an escalating flight by depositors from Greek banks. From today’s Wall Street Journal:

The steady outflow of deposits from Greek banks hasn’t yet turned into a full-blown bank run, and the European Central Bank has nearly limitless capacity to provide banks with additional liquidity. But economists have long warned that a run on banks could develop if the population fears Greece’s departure from the euro is imminent and that their savings would evaporate. A bank run could trigger the euro exit if it reaches a scale that forces Greek authorities to freeze bank accounts and print their own currency to keep the financial system alive.

Like the Dow and S&P 500, tech stocks are in the process of breaching their 22-week moving average. The moves on weekly charts become more meaningful if they carry into the end of the week.

Adding to the concern about a possible full-blown run on Greek banks, is the real possibility that ECB support could disappear if Greece fails to make the necessary budget cuts by the end of June. Both the long and shorter-term trends in the euro reflect the real possibility of membership changes in the EU. The euro has remained below its downward-sloping 200-day moving average (see red arrow below), which is often used to define a bear market. The purple arrow shows the shorter-term moving averages have recently rolled over in a bearish manner. Like stocks, the euro could experience an oversold rally on any good news from Europe, but the long-term trend remains firmly down.

The most significant area of uncertainty relates to the Greece-leaves-the-euro scenario. The Wall Street Journal touched on the topic this morning – note the use of the unfriendly-to-the-markets term ‘collapsing’:

If Greece leaves and investors begin to question the viability of the euro in other vulnerable countries, such as Spain and Italy, Germany and the rest of Europe could be forced to take bold action to keep the currency from collapsing.

As we noted on May 10, gold appears to be questioning the ability of central bankers to ward off deflation. As of Tuesday’s close, gold’s 200-day moving average continued to roll over in a bearish manner. The chart below also shows the shorter-term moving averages (green, red, and blue thin lines) crossing below the 200-day MA, which is also negative relative to trends in the yellow metal.

We outlined in an October 2011 video the magnitude of the problems related to a global economy saddled with too much debt. In today’s world, the markets have become a battleground for deflationary and inflationary forces. The deflationary forces are writedowns and defaults. The inflationary forces come from central bankers desperately trying to keep asset prices artificially boosted in an effort to “buy time”.

You can make an argument that the best way to monitor the inflation/deflation battle is to look at commodity prices. Commodities are used to hedge against the unlimited amounts of paper/electronic money that can be created by the ECB and Fed. Commodities are also in greater demand when the global economy is growing. As shown in the chart below, commodities reacted to the eye-popping injection of cash from the ECB in late 2011. However, the sugar high from the ECB could not carry commodities over the bull/bear demarcation line (the 200-day). The failure of the CRB Index to clear its 200-day moving average in late February was the first clue the deflationary forces had not been extinguished by the ECB’s printing press.

Traders, with much shorter time horizons than investors, create “tradable” oversold bounces. A trader-induced rally could come at anytime, but even that is not guaranteed given the news of the day. The S&P 500 dropped 17% in summer 2011 with little in the way of resistance from traders.

Our risk model, which tracks the health of the markets using numerous sources, has dropped firmly into neutral territory. Until it shows some meaningful improvement (more than an oversold bounce), we will continue to take cues from our defensive coordinator. If the head-and-shoulders pattern turns out to be the market’s guide in the coming days, longer-term investors should pay closer attention if the S&P 500 trades between 1,280 and 1,306.

We will get a DeMark buy setup today on the S&P 500, but the DeMark chart also has resistance between 1,343 and 1,350. A setup could lead to a reversal or a completed buy countdown (meaning more declines could follow).

It is possible the head-and-shoulders pattern we mentioned on May 13 could open the door for a push toward 1,280 to 1,306, but an oversold bounce is also a possibility.

The serious and fragile nature of the situation in Greece is underscored in the excerpts below from a May 15 Bloomberg article:

“The euro (FXE) breakup story is gathering steam again,” Marchel Alexandrovich, a senior European economist at Jefferies International in London, said in a research note. “If Greece were to ever exit the euro, no amount of reassuring comments will convince investors that other countries won’t soon follow.”

“Greece needs to elect a pro-reform and pro-austerity parliament or I foresee big problems,” Dutch Finance Minister Jan Kees de Jager said. “There is no room to weaken the agreements by reforming less or reducing spending cuts.”

The chart below shows the performance of the VIX or “Fear Index” (VXX) relative to the S&P 500 (SPY). When the ratio is falling the acceptance of risk is stronger than fear or risk aversion. On the left side of the chart, fear began to increase in July 2011. The thin colored lines are moving averages, which are used to smooth out day-to-day volatility, allowing us to focus on trends. All three of the moving averages turned up last July (blue, red, and green lines), indicating escalating concerns by investors. Notice as of Monday’s close, all three moving averages have turned up for the first time since October 2011.

Still focusing on the chart above, fear now has a clearly defined uptrend relative to the S&P 500. The ratio broke the downward-sloping blue trendline (see green arrow) in April 2012. A higher low was made near the blue arrow. The ratio recently made a higher high to complete a change in trend (purple arrow). The right side of the chart above looks similar to the left side. Stocks did not perform well in late July/early August 2011, meaning it is prudent to keep a close eye on risk assets in the present day.

Today’s Wall Street Journal reminds us that even when some form of a resolution comes out of Greece, it is unlikely the markets will stop obsessing about the mountains of debt in Europe:

A Greek exit from the euro zone would exert more pressure on Portugal and Ireland. Portugal and Ireland are already expected to get fresh financial assistance of some form. Guntram Wolff, of Brussels think-tank Bruegel, believes that, should Greece exit the euro, the market will turn its attention to these two vulnerable countries.

The market’s concerns about further deflationary bond writedowns are encapsulated in the waning interest in commodities (DBC). Commodities, often used as an inflation hedge, have made a lower high (below blue arrow in chart below), and have violated a three-year old bullish trendline (red arrow).

On the bullish side of the ledger, the weekly chart of the S&P 500 below is nearing the intersection of parallel trendlines that have acted as both support (green arrows) and resistance (red arrows). In a May 13 video, we highlighted a Tom DeMark (Market Studies, LLC) “buy setup” that may be in place as of Tuesday’s close on the S&P 500 futures. Several individual stocks and sectors have similar, and potentially bullish DeMark setups in place or forming.

The markets may be due for a bounce or multiple-week rally. However, based on the news from Europe and technical deterioration that has taken place, a rally may prove to be nothing more than a selling opportunity. We will keep an open mind, but the market needs to show us something in terms of technical strength - the bias remains down until proven otherwise.

It is possible we are looking at a similar scenario to summer 2010, when stocks weakened considerably between May and July. Things did not turn around until Ben Bernanke strongly hinted at QE2 in his August 2010 Jackson Hole speech.

In a May 13 video, we outlined numerous ways to monitor the markets over the coming weeks.

Greece’s biggest anti-bailout party, Syriza, said for the second time in as many days that it won’t join a unity government, pushing the country closer to new elections that have sparked concerns about a euro-area exit.

Nine-MSN, in a story dated May 14, also gives little encouragement relative to progress in Greece:

Emergency Greek cabinet talks have yielded no clear progress, raising the prospect of new elections that could scupper reforms and drive the country out of the eurozone. If a cabinet cannot be formed by Thursday, when parliament convenes, new elections will have to be called in June.

The S&P 500 finished last week firmly in neutral territory and near support. Unless a breakthrough comes in the Greek political stalemate or central bankers step in, the S&P 500 may break below the neckline of a potentially bearish head-and-shoulders chart pattern (see below).

Should the pattern come into play, the video below describes how the possible downside targets of 1,306 and 1,280 were derived. The video also provides updates on the CCM Market Models, DeMark targets, and valuations of blue-chip dividend-paying stocks.

If the S&P 500 futures make a clean break below 1,350 and the CCM Risk Model retreats below 50, we may take another incremental step away from risk. The bulls could get a jump start if a new Greek cabinet can be formed sometime before Thursday.

Since the credit markets in Spain and Italy have shown renewed signs of strain, the timing for elections in France and Greece was less than ideal for policymakers. On Friday morning, there were rumblings from Europe giving some basis for optimism to the post-election situation in Greece.

From the BBC:

The leader of Greece’s main socialist party, Evangelos Venizelos, is holding a series of talks on forming a coalition to deal with the debt crisis. Mr Venizelos is the third party head to try and reach a deal since Sunday’s election produced a hung parliament. Earlier, observers said there was some hope of a deal after Mr Venizelos met the head of a smaller, left-wing party.

The political rhetoric in Greece has centered around the renegotiation of the country’s bailout terms. Just to make sure the story remains tense and unsettling for the markets, Germany weighed in on Friday, something that we knew was only a matter of time. From the Vancouver Sun:

Germany told Greece on Friday that staying in the euro zone was its own choice and that it must not stray from austerity if it expects to get international cash. In a speech to parliament, Foreign Minister Guido Westerwelle said Germany wanted to help Greece stay in the euro zone but made clear the EU-IMF loans needed to stave off bankruptcy hinged on continued spending cuts and tax hikes.

Our market risk model has moved out of bullish territory and firmly into neutral mode. The chart of the German stock market below highlights the weakening trends. The black line is the German stock index. The thin colored lines are moving averages, which are used to filter out volatility enabling us to more clearly see the underlying trend in stock prices.

U.S. investors have taken note of renewed tensions in Europe, both in the credit markets and between Greece and Germany. As we noted before the open on May 7, stocks have very little room for error from a technical perspective (charts, trends, VIX, etc.).

This chart shows some areas we will be watching should the weakness in stock prices persist. While markets can reverse at any time, it is not hard to envision the S&P 500 revisiting 1,280 sometime in the coming weeks. We have a high cash position and we are not adverse to raising more cash should stocks be unable to regain their balance soon.

In terms of a possible buying opportunity, notice stocks established a strong uptrend after the ECB intervened in the credit markets with printed money. The ECB-induced reversal in December 2011 is not unlike the reversal in summer 2010 after Ben Bernanke’s Jackson Hole speech, in which the Fed Chairman signaled another round of money printing was on the way. If the markets continue to fall in the present day, the odds are good central bankers will crank up the printing presses again. A good risk-reward entry point may arise immediately after the central bankers tip their hand.

Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

If you question the goal of boosting asset prices, watch this 2010 video, which explains how quantitative easing works in the real world. As seen via the price of gold, the markets have been questioning that “a determined government can always generate higher spending and hence positive inflation.”

When you update market models every day, you notice subtle shifts in investors’ perceptions relative to risk and inflation. While it looks flat in the chart below, the slope of gold’s 200-day moving average ticked down on Wednesday.

The 200-day moving average (MA) is commonly used by traders to monitor long-term trends. Gold is now below its 200-day MA and the slope is trying to roll over; both lean bearish for gold. Since the 200-day monitors long-term trends, the analysis here is related to the longer-term outlook.

Gold is commonly used by investors as a hedge against inflation. Inflation can surface after a significant round(s) of money printing from central banks, like the Fed and European Central Bank (ECB). The central bankers are fighting deflationary forces related to the purging of debt, which can occur via writedowns or defaults. Greece recently wrote down their debt, meaning they told bondholders you will get less back than we originally promised when your bond matures. A writedown is deflationary since it destroys wealth and reduces the amount of money in the financial system.

Gold is an excellent way to monitor investors’ perception of how the battle between inflationary forces (money printing) and deflationary forces (purging debt) is playing out. In the chart below, investors were betting on the central bankers and inflation. The black line is the price of gold. The thin colored lines are moving averages, which are used to filter out the noise of day to day volatility. The chart below shows a strong trend and bias toward future inflation.

When Europe’s enormous debt problems became the market’s primary focus in mid-2011, investors began to realize how big, and how deflationary, the problem was. The right side of the chart below looks quite different than the left side. Notice on the left side, price never came back to the 200-day, nor did the “faster” moving averages ever cross the 200-day. The right side of the chart looks different and breaks the pattern of inflationary fears.

The chart below shows the last two times that (a) the price of gold broke below the 200-day MA and (b) some of the “faster” moving averages crossed below the 200-day. In Case A, the slope of gold’s 200-day (pink) never rolled over in a negative manner. In Case A, stocks performed well after gold’s bout of weakness (see bottom of chart in late 2006). In Case B, the slope of gold’s 200-day did roll over in a bearish and deflationary manner. Stocks did not fare well (see red arrow lower right). As a reminder, gold’s 200-day is trying to roll over in the present day, which looks more like Case B.

How can all this help us today? As long as the chart of gold remains in its current state (bearish 200-day/bearish moving average crossovers), we should manage all risk assets with care (from an intermediate-term perspective). If the slope of gold’s 200-day regains a positive bias and buyers flock back to the yellow metal, it would send bullish signals for risk/inflation protection assets, including stocks. Looking at things from a bullish perspective, the daily chart of the gold miners ETF (GDX) completed a “bullish engulfing” candlestick pattern on May 9, which can be an early sign of a reversal in price.

If you question the gravity of the problem of too much debt, (a) ask yourself why the economy has remained so weak when interest rates have basically been at zero, and (b) watch this October 2011 video explaining the European debt crisis.

Cons:

In DeMark speak the S&P 500 confirmed or “qualified” a bearish break of TDST level 1,365 today with a lower open. An exhaustion setup signal could come as early as Tuesday (known as a “9 up”), which means weakness could persist for at least four more trading days.

The pink trendline that we first showed on May 7 was broken today on a closing basis (near green arrow).

One of the charts we highlighted earlier in the week closed today with an RSI less than 50. RSI closed at 48.95 on the SPY/IEF weekly chart. The chart is explained beginning at the 8:17 mark of the May 7 video below. The RSI reading below 50 becomes more meaningful if it carries into the weekend.

In the chart below, trendlines A and B have been broken. The green arrows near point C show where the S&P 500 held twice near 1,360. On Wednesday, we closed below 1,360 (point D).

Pros:

Despite what feels like perpetual weakness, the S&P 500 is only down 1.06% for the week, as of Wednesday’s close. Buyers have stepped in at 1,347 (Tuesday) and 1,343 (Wednesday).

The short-term bullish divergences we showed on May 8 are still in play (slopes of A, B, & C below). The S&P 500’s 100-day moving average, a potential form of support, sits at 1,346 (see thin blue line near point D below).

In the chart below, the trendline above point A may offer support, which calls for a little patience.

The weekly chart of the S&P has possible support via the trendline above the purple arrow. The red, blue, and green arrows show how this trendline interacted with price. The thin pink line is the 22-week moving average, which may attract buyers near 1,344.