Market Trend: "Giant Sideways"
By Frank Barbera CMT. March 27, 2007
While Tuesday ended on a down note, on the whole, the past week has seen a nice lift for the stock market, with the Dow kicking off the latest rally on Wednesday, March 21st with a rally of 159 points or 1.30% in the wake of the Fed announcement post the March meeting. With the statement, “Future policy moves will depend on the evolution of the outlook for both inflation and economic growth," the Federal Reserve appears to have stepped back from its hawkish stance on rates, and adopted a more neutral bias.
This reversal comes potentially just in time, as all of the economic evidence rolling in over the last few weeks has had a distinctly bearish tinge. Of concern to many economists has been the trend in Capital Spending (CAPEX) which appears to be weakening over the balance of the last few months. “The weakness in capital spending is alarming,'' says Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. "If capital spending is weak and getting weaker, the next thing companies will do is slow hiring." That sentiment was echoed by economist Allen Sinai, chief global economist for Decision Economics Inc. based in New York, "When earnings growth slows and margins narrow, American business is very quick to cut back on expenses, -- if this turns out to be a case of business-sector-initiated weakness, the Fed will be late in defending the economy.''
Elsewhere, we learned today that downside pressure on housing prices, falling stock prices and rising gasoline prices appear to have negatively impacted Consumer Confidence with the Conference Board Index falling to 107.20, down from 111.2 in February. The bigger than expected decline in Consumer Confidence to a five month low has led my weakness in the forward looking expectations index which fell to 86.90 down from 93.80 in February. The expectations index is a forward looking gauge, and was supported by polls showing that Consumers expect that it will be harder to find a job in 6 months, and that incomes will continue to lag behind price increases, as has been the case now for some years. In the poll “Jobs Hard to Get” increased to 16.50% from 14.20%, while “Jobs Plentiful” showed a decrease with the latest reading ticking down to 12.70% from 13.30%. The Confidence data appear to validate the negative sales outlook and was revealed in Monday’s release of New Homes Sales, which fell sharply for the second consecutive month tumbling by 3.90% in the latest report.
Of course, we have seen many occasions in the past when “bad news” on Main Street was actually good news for Wall Street with the stock market often trying to game Fed policy. Yet, a closer look at the action of the last few days strongly suggests that bulls take a second look as a number of technical gauges appear to be fairly weak. Mind you, for the last few weeks we have been in the bull camp, forecasting a recovery rally back up toward the 1430 to 1440 zone on the S&P 500 as early as Tuesday, March 13th in our article entitled, “Torpedoed By Sub-Prime — Again,” and then re-iterating that call the following week in our March 20th article entitled, “Let the Sunshine In” in which we said with the S&P at 1411,
“We continue to view this advance with the broad stock market as very likely akin to the ‘eye of the storm,’ wherein the sun can shine brightly for a brief period of time. In our view, the stock market rally now underway should still most likely be viewed as a ‘right shoulder’ rally which would still be targeting prices above 1425 to 1430, and as high as 1450”.
So far the high close on the S&P has been 1436.11 on Friday of last week, with the S&P finishing today at 1428.61. On a very short term basis, odds are still high that there could be one more ‘push’ to higher highs on the S&P above 1438, toward the 1440 to 1445 zone over the next few days. While there are never any guarantees in the stock market, normally the market will tend to rally heading into the end of the quarter and during the first few days of the new quarter. Any move below 1425 in the near term would probably be a very negative sign, and would call into question the market's ability to rally further. In this vein, I believe that for the stock market, the real trend in the weeks just ahead is very likely — sideways, meaning prices vacillating up and down between the 1440/1450 high-end and 1380/1390 low-end of a range.
Above: S&P 500 hourly chart sketching in what could be a final push to higher highs into end of quarter and then another downside reversal during the first few weeks of April.
Turning to some of the daily indicators, to this point in time, the action on the Daily A/D Line for a broad universe of stocks has not been all that bad. Indeed, since the lows of March 14th the A/D Line has recovered rather nicely, more than keeping pace with the action of the major averages. Yet, despite the healthy recovery, momentum levels for the broad market are dropping noticeably, suggesting that any sizeable downside reversal in the major averages in the weeks ahead could start showing a lot more obvious signs of damage to the mass of individual stocks. We are on “air pocket” alert as a rise in the number of sudden, one day, ‘gap down’ daily plunges is normal during a transition phase from bull market to bear market, with the reporting of 1st quarter numbers in the next few weeks we enter a ‘high risk’ zone. Those of you contemplating getting long individual stocks should be taking a hard look at the companies in question, and asking whether any trends in the last few months could be negatively affecting the upcoming quarter. Now is a good time to do this exercise as prices are buoyant and ample bids abound.
Above: the S&P 500 and the Daily A/D Line
The Financials would be first on my ‘watch list’ at the current time, with Energy and Mining the least concern. In the next chart, we take a longer term view of the S&P 500 with my Daily Detrend Oscillator based on A/D Line of Operating Companies Only, where we find that once again the stock market is still quite overbought on a primary trend basis. In the realm of overbought readings, there are two kinds: “kick off” overbought readings, normally following extensive declines, and “ending” overbought readings, showing the finality of a trend. At the moment, I strongly suspect this latest set of readings is a cyclical bull market killer, and that after a number of weeks in a broad topping prices, prices will begin to roll over on the downside.
Above: S&P 500 Detrended Above and Below 200 day Moving Average.
In addition to the overbought readings seen on the Detrend Oscillator, I would also suspect that the market is both overbought and now diverging in bearish fashion on its longer range RSI. In this case, the RSI is plotted on the Daily A/D Line (below), where it is plain to see that while the A/D Line is matching former highs, internally momentum is not as robust. While divergences like these can take some time to play out, it is usually a bearish indication that the primary trend is topping. For now, I am inclined to simply “trade the range” and at least partially reserve judgment on the larger trend until we see more evidence develop over the course of the next few weeks.
Above: S&P A/D Line (top clip) with 100 day RSI on A/D Line (lower clip)
Above: McClellan Summation Index (operating companies only) and S&P 500.
Moving along in our assessment of the stock market, I also find it worthy of note that the Medium Term ARMS Index (a) never reached a fully oversold value, and (b) has very quickly retreated back down the range now rapidly closing on fully overbought values. Usually, this kind of quick reversal is a big ‘red flag” and again, suggests a ‘go slow’ approach near term with a possible eye toward trading the market from the short side.
Above: GST Medium Term ARMS Index with S&P 500
Other sectors of note include the Retailers, which normally weaken ahead of a consumer slow down. Over the last few days, my Retailing Index of 50 stocks has recovered the bulk of its prior decline, while the internal A/D Ratio has remained lackluster and is now the balance of the last 6 months. Note that the A/D Ratio for retailers is already in a downtrend with the 200 day average moving lower despite the fact that prices remain buoyant. While I do not want to predict a change at this juncture, I believe that if the economy is indeed charting a course toward recession later this year, that weakness in the Retailing Stocks will be a big metric to watch with regard to leading that contraction. Under the header of an important “note to self,” we want to be keeping a close watch on the trend in this sector as it is unusually good at sorting the consumer spending ‘wheat from the chaff.’
Above: GST Retailing Index with Daily A/D Ratio and 200 day average lower clip
As can be seen in the next chart (which plots the S&P 500 on the top clip and the Relative Strength Ratio of Retailers versus the S&P in the lower clip), back in 1990, the R/S Ratio went into a head long nose dive in advance of what turned out to be a pretty good sized recession. Note that during the 2000-to-2002 bear market, the R/S Ratio of retailers to the broad stock market was moving up, in part because the group never ran up to the same degree as the market in 1998-1999, but also in part because, despite the severe CAPEX decline in Technology, consumer spending never slowed down very much with the 2001 “recession,” one of the shallowest ever seen. In the current instance, the R/S Ratio could be double topping with its early 2006 peak, something that will make interesting viewing in the weeks ahead.
Above: Relative Strength Ratio of Retailers versus S&P 500
Finally, as noted earlier, the trends for CAPEX spending have been moving down in recent months, with most CEO’s and CFO’s still fairly negative. This is remarkable when seen against the backdrop of a fair number of new product launches set to roll out in the technology space during the 2007. In my view, the recovery in tech stocks to this point is highly suspicious, and while it is true that technology multiples are no longer as extreme as they once were, they are a long, long way from cheap, leaving lots of downside risk in the event of a bear market. For the NASDAQ Composite Index, a wide swinging range of 2490 to 2360 is likely in the weeks ahead, with major support ‘filling in’ at the 2360 range. Ultimately, if the recent lows between 2340 and 2360 are broken on the NASDAQ, that would be another major warning that a more serious downturn is getting underway.
Above: the GST High Tech 50 (50 large cap tech stocks) with the Daily A/D Line,
-- note that the A/D Line is not performing well during the recent recovery move.
At the close, the DJIA ended down 71.78 index points to close at 12,397.29, with the S&P 500 down 8.89 index points at 1428.61, and the NASDAQ Composite down 18.20 index points to finish at 2437.43. Among secondary indices, the Russell 2000 ended down 6.58 at a reading of 802.36. The 10-Year Treasury closed at 4.61% and is now in a rising configuration with 4.70%, the next target above the market. Nearby Gold ended slightly lower at $663.10, with Oil finishing up slightly at $63.02.
© 2007 Frank Barbera