It was a very interesting day today. The U.S. dollar was up 0.26 points and the euro was down 0.008 points yet stocks and commodities (risk-on investments) rose as Treasury bonds (risk-off investments) fell. It’s probably a result of short covering in risk-on investment and profit-taking in risk-off investments. The chief market technician of Oppenheimer Funds, Carter Worth, thinks the market is going to get a bounce and said they are buying here on Wednesday’s Fast Money show on CNBC, here. In addition, JP Morgan technical strategists were recommending a 25% purchase here and 75% purchase near the March low. In the absence of any driving headlines to drive the market today, traders and investors will likely turn to technical analysis. On that note, there are a few things to discuss in how the day’s markets traded.
Let’s talk about a couple drivers today and then delve into the technical setup. The first to discuss is the ECB meeting. The headline on Bloomberg reads “ECB’s Trichet Signals July Interest Rate Increase” but if you read Trichet’s exact words, that’s not quite the title befitting his speech. It should read “might” increase rates in July. The article writes (underlined for emphasis):
“Latest data confirm “continued upward pressure on inflation” and “strong vigilance is warranted,” Trichet said. “It means that we are in a mode where there might be in the next meeting an increase of rates, but we are never pre-committed. We are not signaling any particular pace for the next decisions on our interest rates.”
So the euro fell on the news, probably on profit-taking. Despite the “strong vigilance” talk towards inflation, inflation expectations are moderating in the Euro zone amidst the possibility of a slow growth scenario and borrowing cost concerns for the peripheral countries. The technical concern here is if the euro fails to breach $1.50 or forms a lower high as of yesterday, then the possibility of an intermediate or maybe a long-term top in the euro grows. This would spill over into the U.S. dollar index to create an intermediate-term bottom and possibly a long-term bottom as well. The long-term trend and the intermediate trend in the dollar have been down since June 2010 and January 2011, respectively. Recent dollar weakness since May 24th has helped to buoy commodity prices while equities have continued to decline, but the short-term trend of commodity strength will be threatened by a dollar rally should the dollar bottom scenario unfold.
In addition to the ECB comments, the U.S. trade deficit narrowed fairly substantially from $48.2 (revised to $46.8) billion in March to $43.7 billion in April. Because the data indicated that exports increased despite auto setbacks in the U.S., there was hope today that trade will add more to growth than what has been baked in the cake with the drop in the ISM-manufacturing number last week. This is especially the case should electronic and auto parts arrive sooner than expected from Japan. It’s more encouraging that exports were up even after a large increase in March ($165.2 to $173.4 billion). With the dollar low and commodity prices off their highs, today’s trade report gave hope that exports will provide a boost to the second quarter GDP number lifting the dollar, U.S. equities, and bond yields.
Gaps, Vacuums, and Windows
Turning now to the technical landscape, if you believe the S&P 500 is in a trading zone, as I do, then you’ll want to look at oscillators, gaps, and demand zones. Gaps are created when the market closes at one point and opens the next day, higher or lower from the previous days’ close. The Japanese chartists called them windows. They believed there was always a tendency for the market to revisit these windows at a later date to close them. Martin Pring said, “There’s a saying that the market abhors a vacuum, which means that most gaps are eventually filled.”
The S&P 500 found some support at an important gap near 1279 this morning. The gap was created on March 21st when the S&P 500 opened at 1281 after closing near 1279 on the previous day. That day launched a 20 point rise on strong buying pressure. This is the second time the market has responded to gap support since the May decline.
Demand Zones and Supply Zones
The other subject to talk about in a trading market is demand and supply zones. Think of these zones as players on a tennis court or pong on the Atari. When the ball is hit to a player or pong bar, it’s going to get returned. Likewise, in a trading market, when the market price hits a demand zone, a bottom and reversal typically takes place. Let’s look at some demand zones that have occurred on the way down since the May decline and the extreme zone we may hit near the March bottom. The March bottom represents an extreme buy zone, one that many technical analysts are advocating that investors start to buy near as stated above by JP Morgan and Oppenheimer.
Once a support zone is broken, it often becomes a resistance zone or supply zone such as in today’s top. The April low that caused a bounce in the market was at 1294.70 on April 18th. Once we broke below that number on Monday, it reversed its role and served to rebuff today’s rally. The high today was 1294.50. Close enough!
In technical analysis, you can’t survive on one indicator or market alone, you need to bounce the behavior in the equity markets off of commodities, bonds, and currencies. You can’t just look at supply and demand zones, you need to look at breadth, volume, and other indicators. One that I’ve spent a good amount of time watching is the percentage of stocks, in the S&P 500, above a moving average. I use a 10-day moving average for short-term moves, 50-day moving average for intermediate, and a 200-day moving average for long-term changes in market breadth. Looking at the percentage of stocks above the 10-day moving average, it puked out over the last two days and suggests the market is oversold. Now does that mean the market automatically reverses and you begin a new short-term trend higher? No, it just means that you should begin shifting your psyche towards looking for other bottom tells from the market. I’d post a stockcharts chart here but they don’t offer this chart.
Looking at a longer-term indicator like the percentage of stocks above the 50-day moving average can remove some of the noise in a shorter-term indicator. The percentage of stocks above the 50-day moving average within the S&P 500 is also nearing oversold levels. We’re currently matching the August 2010 and March 2011 levels that represented buying opportunities.
A final indicator I wanted to present is the VIX fear index. We haven’t seen the indicator break above 20 like it did in the March correction. In addition, the put-to-call ratio recently was 1.19. The last time it was that pessimistic was on March 16th, and before that, around August and July of last year. So from a contrary opinion point of view that’s encouraging.
Conclusion
The S&P 500’s short-term declining trend has stalled this week. Indicators are oversold and the market is ripe for a rally. So far, the S&P 500 rallied 9 points off of the lows to break 6 consecutive days of declines in equities, but it has failed to breach above 1296. 1296 use to be a demand zone, but now serves to supply shares. If we don’t break above 1296, we’re likely headed right down to the March demand zone between 1249 and 1260 where ultimately I think a lot of buying will step in. I’ve been hearing many strategists suggest that it’s not panic selling we’re seeing, but a lack of demand for stocks that is causing equity prices to fall. I have to agree. I haven’t seen a 90% participation in an up day on the market since May 31st, and that was completely eclipsed by the ISM non-manufacturing decline on Tuesday. There have been some positive economic indicators that have been released since that number, but they have widely been shrugged off as market psychology turned negative on that day. It will probably take cheaper prices or more positive economic news to change people’s minds.
