Market Observations with Frank Barbera CMT

Frank Barbera CMT

Tales of a Rolling Boulder

By Frank Barbera CMT. May 22, 2007

While Saturday Night Live has had its share of “hits” and “misses,” I often joke around with my family recalling a skit that was shown several years ago. At the time, it was one of those things that just got me laughing with a skit entitled, “Tales of a Rolling Boulder.” In this warped skit, totally innocent people would be standing or sitting around the most innocent places and then ‘Bang-O,’ they would get blindsided and run over by a rogue ‘rolling boulder.’ Very dark humor to be sure, perhaps even tasteless! But as with everything else in life, it was all in the presentation and the timing, and somehow it was inescapably funny. It also made a point about timing, as the unfortunate victims in the plot line were all in the “wrong place at the wrong time,” and hence ended up being squashed by the rolling boulder. So it is in the stock market, where overstaying ones welcome can be financially negative to your wealth, a bear market being the financial equivalent of the proverbial ‘Rolling Boulder.’

In my view, we are at that point in the stock market cycle where it is time to take ‘defensive action’ — where it is time to be some place where you won’t, or can’t, be hit by the rolling boulder. In the stock market, that “place” has a name, and it is called “cash.” In my view, this is the time to start raising cash in order to insure that you will not become a victim of the upcoming down cycle. While there are several groups that are unusually depressed, like Precious Metals and REITS, and that by default could have more of a near term bounce, overall most equity sectors are quite extended (overbought) and are becoming vulnerable.

My emphasis at this juncture would be on ‘locking in’ gains, especially in over-extended cyclical stocks. As we have tried to outline in the preceding weeks, the broad US Economy is clearly slowing and with inventory levels on gasoline drawing down to record lows for this time of year; higher gasoline prices at the pump this summer is a virtual sure thing. Higher gasoline prices in turn act as a tax on incomes, and tend to negatively impact discretionary spending. Mind you, there is something of a multiplicity of negatives already impacting discretionary spending, starting with the slumping housing market where Mortgage Equity Withdrawal over the last few years has been a key driver for consumer spending of all sorts. At the very excellent blogging website, paper-money.blogspot.com, I recently noticed two outstanding charts on Discretionary Retail Sales overlaid against a Rate of Change on Housing Prices which together, make quite a negative statement about the current trends in consumer spending.


Source: PaperMoney.com blog

In addition to a massive shut down in Mortgage Equity Withdrawal (MEW), higher food prices, and now rising gasoline prices are adding up to a trifecta of pain for the average household balance sheet. Who says we are in a mild stagflation? At any rate, a slowdown on the horizon is probably now obvious to most, except of course to most US Economists who can only identify these ‘events’ after the fact. OK, in all fairness, Paul Kasriel, chief economist at the Northern Trust, stands out as the exception, pointing out in a recent piece that, ex-the US, the rest of the world is not in such good shape where domestic spending is concerned.

Getting back to the broad stock market, the current situation is recognizable as familiar territory, namely “the beginning of the end.” In the case of the S&P 500, probably the most important and widely watch US Equity market index, the near term hourly chart has volume of important information for us to digest. To begin with, note the 45 degree angle of the rising trendline connecting a number of the short term reaction lows seen during the advance post the mid-March lows. Notice also how the 200 hour rising moving average for the S&P is roughly paralleling the same 45 degree slope seen by the trendline. This tells us that the stock market still has an underpinning cushion of high upside momentum and that any near term decline should find initial support in the area of the rising moving average at 1485 to 1500. I spotlight this zone on the chart below with Point A. Note when we are talking about short term movements, there is a great deal of ‘wiggle’ room, and that it is not impossible for this market to overshoot to the downside wherein a decline as far as 1460 could still be seen.

While I consider that outcome less likely, it is definitely not impossible. The most likely outcome near term is for the S&P to react toward 1500, and likely just a bit below 1500. Following a near term sell off, it is then almost a given that the index will rally back up off that 1485-1500 low, and either make a margin new high, or simply match the recent high at 1525-1530. The key to the next rally will be to note that it will be unfolding against a flattening 200 hour moving average and narrowing Bollinger Bands. Ultimately, any matching price high — two weeks from now — will likely create a truly major set of bearish divergences which will ultimately establish what should be the bull market peak for this cycle. At the moment, in a shorter term sense, the MACD Gauge seen on the lower clip is presently failing (pt. C) and in the process of crossing over to the downside, alerting us to the prospect of several choppy days directly ahead.

However, the precise shape of the upcoming topping process ultimately develops, be it a small Double Top (shown in prior chart), or a Broadening Top, a Rising Wedge, or a Head and Shoulder Top; going forward, a reversal pattern is most likely in the cards and ultimately, a downside penetration of a declining moving average will be the key confirmation that the final S&P highs have been seen. Now I know I have waxed on poetically without providing enough medium term supporting evidence (due to some time constraints today) regarding the backdrop factors arguing for a major S&P high, but rest assured we will cover these in detail in our updates over the next few weeks. For now, the key focal point in our analysis is the short term outlook, and whether or not the S&P will BEGIN to roll over in the next few days. In our view, an initial sell off on the order of 2% to 3% is what we expect and should that come to pass, it will speak volumes about where the market is really headed over the next few months. For the record, we were bearish back in late February as the S&P moved into its late February highs, bullish at the bottom in mid-March, and are only today — May 22nd — beginning to turn bearish. For very short term traders, Profunds has an ETF — the “SDS” that tracks the S&P quite well and that could offer a good scalping trade over the next few days.

Another hint of what could be on the way, comes from the U.S. Steel sector, where today’s market saw bull market leaders such as Precision Cast Parts (PCP), US Steel (X), Arcelor Mittal (MT), AK Steel (AKS), Chaparral Steel (CHAP), Cleveland Cliffs (CLF) all posting serious losses. At the present time, these stocks as a sector are exceptionally overbought, with the Medium Term ARMS Index near .70 implying there is serious downside potential in these stocks in the weeks and months ahead. In addition, the ARMS Index for Steel Stocks made a higher low over the last few days, above the April 2006 low and the March 2005 low. This is a sign of progressive weakness where each impulse wave up over the past two years has had less buying intensity, a sure sign that a more serious downside reversal is on the way.

Yet what does a trend reversal in Steel Stocks tells us about the global macro picture? In my view, the only reasonable answer is that a decline in steel companies would be forecasting a global slow down a few months out. Odds are high, given that the Chinese stock market is virtually parabolic, that such a slow down would also engulf China along with other economies that are presently not doing as well. Think “Declining Demand,” leading to another wave of ‘deleveraging’ in the markets. Another hint: Just look at the super extended move on the DJ Spot Commodity Index, now above a rising 200 day moving average for the balance of the last five years. When will "The Correction" be seen in the commodity markets?

Above: the Dow Jones Spot Commodity Index — all by itself and moving at a very steep 45 degree advance…. Global recession ahead?

Above: the Dow Jones Spot Commodity Index and the S&P 500 overlaid -- one and the same? -- Could a slow down in the global economy derail the synchronized bull?

In my view, while we are not there yet, any further sell off in commodity markets and equity markets over the next few days would be a huge “Red Flag” that the time to be raising cash is at hand, and to that end, the key to becoming a winner in any one of the cycles is to practice capital preservation and not become the victim of a ‘Rolling Boulder.’

At the close today, the Dow Jones Industrials ended down 6.83 index points at 13536.06, the S&P 500 down .98 at 1524.12, the NASDAQ Composite up 8.91 at 2587.70. Nearby June Gold edged lower to a reading of 659.10, -$4.60/oz while the 10 Year Bond moved higher to close at 4.83%.

That's all for now,

Frank Barbera

© 2007 Frank Barbera

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Gold Stock TechnicianFrank Barbera CMT
Editor, Gold Stock Technician
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Los Angeles, CA 90048
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