It has been an “interesting” week so far. The short-term market decline kicked off in earnest on Monday with Goldman’s commodity sale recommendation, the International Monetary Fund’s (IMF) downgrade on our 2011 GDP estimate, as well as a rumored cease-fire agreement in Libya. The commodity complex was slammed over the next two days as oil dropped from $113 to $105 for NYMEX crude. Interestingly, natural gas is up on the week. Department of Energy reported a huge draw on gasoline inventories and a larger build than estimated in crude oil inventories. Despite the build, crude rose on the news and closed Thursday near $108.44
Market Selloff Momentum
The decline thus far in the S&P 500 has been plagued by low volume. Volume peaks at distribution/accumulation zones. It also rises in the direction of trend and declines as the trend wanes. We can see very clearly in Feb/Mar that volume rose with the trend down as the correction woke people up. At the bottom, as shorts covered and new longs were placed, volume peaked. This was capitulation and bullish accumulation.
Now, let’s look at the current trend down. Notice no peak in volume near the top as longs should have sold and gone short. In addition, there has been no breakout in volume as price has begun a new short and probable intermediate-term trend down. If we were going to start a major correction here, we should be seeing volume increase with the new trend down.
The NYSE mixed data shows the same characteristics as volume on the SPY. Looking at the down volume during February and March, selling was intense as we hit above my threshold on 5 days. Additionally, we had three 90% down days with the first on February 22nd, the first day of the correction. Looking at down volume and declining issues over the past week, selling volume has been light. While declining issues have risen all throughout the end of last week into Wednesday of this week, we have yet to see a 90% down day marking intense selling pressure.
Looking at new highs and lows, we continue to see improvement compared to former peaks.
If people really thought the stock market was putting in a double top, we should be seeing more people exit, but volume flows seem to show that longs are taking a “wait and see” approach. I have to agree with them considering this market has shrugged off a lot of bears. Consider that the market has wiped away all the losses sustained by political upheaval in Egypt, Libya, Tunisia, and Bahrain. It has shrugged off the Japanese earthquake, nuclear partial meltdowns, and supply chain disruption. It has shrugged off 3 oil as shown in new highs in retailers.
Three Stock Market Scenarios
As I mentioned in my “Intermarket Analysis and Drivers” piece last week on Thursday, and earlier in my “Brushing dirt off shoulder” piece two weeks ago, I think the market is continuing a consolidation phase that began in February. This process takes time and can unfold in two possible scenarios: 1) an inverse head & shoulder (H&S) pattern and 2) a flat correction. I already spent a moment discussing a flat correction two weeks ago in, “Indices Brushing Bear Dirt Off Their Shoulders” so I’ll spend more time on a possible inverse H&S pattern-which has only recently become a possibility.
Now, I can hear you saying, “Everything is a head & shoulders pattern with you technical people”, however, keep in mind that it's very prevalent because it’s seen in virtually every trend reversal. Higher highs and higher lows are interrupted by a lower high first (right shoulder), and then confirmed by a new low (neckline break).
Now here’s a curve ball for you: H&S patterns can also be continuation patterns. What do I mean? These are patterns such as triangles that breakup a trend in the middle and serve as a consolidation zone before a trend can continue. I believe there’s the possibility that an inverse (upside down) head & shoulder pattern may be forming in the major equity indices. It represents a bullish consolidation zone that started in February that has been necessary to cool down the powerful stock market trend that began in September last year.
Such a scenario would unfold as follows:
-February correction: Left Shoulder
-March Leg down: Head
-April leg down: Right Shoulder
-Neckline: 1340
-Shoulder Support zone: 1300
-Breakout Target: 1430
Now, for this pattern to complete we need a few things. We need a short-term bottom in the S&P 500 here (likely). We need to rise and breakout above 1340 (the neckline). Successfully hold any retest after the breakout at 1340. I believe this pattern would fail if we break down below 1300; in which case, a flat correction down to the February lows would be in the cards instead (see brushing dirt off shoulders article linked previously).
The third possible scenario here is a double top in the stock market indices. While a low possibility in my opinion, many bears are pounding the table on such a pattern. For that to happen, we need to trend down towards the February lows. A break of that low would confirm and complete the double top pattern. A projected target of that pattern would take us back down to the summer 2010 highs near 1159 on the S&P 500, 10660 on the Dow Jones Industrial Average, and 2391 on the Nasdaq Composite.
The Bearish Case
If the market were to change its character from currently neutral to bearish, then I’d expect a couple of things to show up on the charts: 1) the 14-day RSI momentum indicator needs to drop below 40. Such a move would flag weakness and a bearish shift in equity indices. 2) We need to see at least one 90% down day to show a mass exodus and not just sector rotation and churning in the markets. 3) Moving averages need to roll over. You can use two exponential moving averages such as a 13-day EMA and a 34-day EMA to watch for a cross to the downside; just be warned of whipsaws in this indicator should we continue to consolidate sideways. Moving averages are only useful in trending markets. Nevertheless a sell signal is a sell signal when the faster moving average crosses below the slower moving average. 4) The percentage of stocks above the 200-day moving average for the S&P 500 needs to cross below 80 percent as a sell signal which it did briefly on 3/16 and then whipsawed back above on the 17th. Currently 87.15 percent of the S&P 500 issues are above their respective 200-day moving average. Currently, as far as I see it in my technical indicators, the onus is on the bears and the contrarians to prove this market wrong. As Stan Weinstein says, “There’s still more right than there is wrong” with the long-term trend in the equity markets. 5) Lastly, we'd need a breakout in the VIX indicator, currently near the lows over the past few months.
One small indicator that concerns me in the intermediate-term trend is the relative strength improvement for healthcare and consumer staples sectors over the rest of the market. Relative strength means how much one thing is performing over another. If consumer staples go up 4 percent and the S&P 500 goes up 3 percent, we say that consumer staples’ relative strength is improving versus the market. We can also take a look at consumer discretionary stocks versus consumer staples. If consumer staples are performing better, we can say that consumer discretionary relative strength is declining versus the staples. The current sector rotation into staples suggests investors believe a market top is in and February was the time to get defensive. I discussed this in more detail last week during the industry group analysis. Some of Thursday’s top performers in the S&P 500 were consumer staples including the food stocks: Supervalu, Safeway, Kroger, and ConAgra Foods based on Supervalu’s blowout quarter.
Side note: The same relationship also occurred during the May to July 2010 correction in the stock indices, but did not result in a long-term top in the market. The bullish trend resumed in September 2010 and the relationship reversed. So a defensive portfolio stance during a three-month consolidation period does not, by itself, determine a new bear market. It only makes sense that stocks of a lower beta move down less than stocks of a higher market beta. Interestingly though, staples are rising on an absolute basis and not just a relative basis.
Short-Term Considerations: HAMMER TIME
Now let’s get micro on this market. The intraday movements in the S&P 500 have been telling of a short-term bottom here as depicted in a hammer candlestick in the early morning as well as a hammer candlestick on the daily chart. In addition, we’ve finished a 5-wave leg down in the 15-minute chart of the S&P 500. We gapped down at the open today, fell near 12 points in the S&P from yesterday’s close, and then proceeded to rally throughout the day to a positive close on the day (barely). This morning’s gap down was closed – bullish. The short-term trend has likely turned bullish. We may see a test of the consolidation zone’s bottom near 1310, but today’s hammer is an indication that the bulls are taking back control of the short-term trend.
Bullish flags warning short-term trend reversal:
- Bullish divergence in the RSI as the indicator put in a higher low versus the former low when the S&P 500 price hit a new low (point 5 on the chart) this morning
- S&P 500 closed up on the day, closing the gap down in the morning (2nd red circle)
- Short-term trend channel has broken
We gave back about 2 points on the S&P 500 in the last half hour trading Thursday. I would have liked to have seen us close near the highs adding more bullishness to the indicator; however, the gap that was closed today was very bullish. Tie the gap closure to a positive close and you get two very bullish short-term indications of a short-term bottom. So far, that bottom has produced 12 points on the S&P 500. I’m going to be watching how deep we’re able to back-fill this week’s down trend to determine whether we’re looking at a flat correction or a head & shoulder continuation pattern.
Conclusion
Remember how this week started off with a selloff in crude oil and other commodities? Crude oil’s chart looks just fine.
So does precious metals.
The stall in the markets last week foretold that the market would be vulnerable to an intermediate trend down unless we got a new catalyst. Well, the catalyst came on Monday in which traders and investors sold their commodities and commodity stocks because Goldman Sachs told them to. Interesting fact: this is options expiration week and a huge premium chunk was probably taken out of option contracts for oil, metals, and agriculture commodities. Gasoline stocks had a huge draw down last week as reported yesterday. People aren’t slowing down their consumption due to $113 oil while pundits are talking about demand destruction…I don’t see it in the inventory data or in car sales.
There are three possible scenarios as we continue to consolidate sideways since February: flat correction, inverse head & shoulder continuation formation, or a double top. There are a lot of indicators that suggest this market’s long-term trend is still bullish with a higher advance decline line, more new highs versus new lows, and a high percentage of stocks above their respective long-term moving averages. The short-term trend may be turning up now with reversal indications in Thursday’s session. The intermediate-term turned down with a break in the intermediate trend, a MACD sell signal yesterday, and a bearish high in the RSI indicator near 60. I’ll be watching next week for either a backfill of this week’s decline or a breakdown in possible H&S shoulder support around 1300 to get a better idea of which scenario looks more likely as we continue to consolidate from the long-term bullish trend.
Google announced $8.08 versus $8.10 cents in after-hours. Earnings were $6.76 a year ago. Earnings are up 19.5 percent versus a year ago and the stock is down $40 or 6.8 percent from where it traded a year ago currently in after-hours. Google has found buying support near that price twice in the past 6 months, only to rally up 14.7 percent.
