Technical Update Key Markets
By Frank Barbera CMT. June 12, 2007
Last week, the stock market declined sharply amid rising long-term interest rates and bearish Unit-Labor Cost and Productivity data that suggested that the Federal Reserve may be 'on hold’ longer than most expect. In addition, Central Banks continue to raise short term interest rates around the world, putting equity markets under selling pressure. To readers of this column, the setback in the stock market should have come as no surprise as we were warning of a pull back on the order of 2% to 3% over the last two weeks, both in these pages and in our newsletter. Back on May 22nd, in “Tales of a Rolling Boulder” we stated that,
“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. Any near term decline should find initial support in the area of the rising moving average at 1485 to 1500.”
Thoughts on the S&P 500 Index
As can be seen in the S&P hourly chart below, the sell off last week bottomed at an intra-day reading near 1487, with prices quickly recovering back toward 1500. This was a bit near the low end of our target window and probably sends a message that the S&P is becoming somewhat ‘weaker than expected” relative to our original analysis. As a result, while it is still possible that the S&P could make token new highs above 1540, or match 1540, we suggest that at this juncture, the odds of that happening are fading. Instead, we would expect a ‘failing’ counter-trend rally with the S&P moving back up toward the 1525-1530 level.
While we know that the market moved down aggressively today, (Tuesday, June 12th), we also believe that last week's lows saw a sufficiently near-term, oversold reading on the major indices in order to establish a reasonably solid short-term low. Today’s action looks, thus far, very much like a ‘retest’ of last week's lows. As a result, we expect that the major stock indices should hold here and begin a counter-trend advance. In our view, a near-term rally should allow the market to continue to “hold up” over the next 5 to 8 market sessions and that rally should begin fairly soon likely over the next day or two.
On the upside, the island reversal gaps on the S&P near 1530 look like a ‘reasonable’ objective with 1530 likely very strong resistance. We would consider our near-term bullish analysis in doubt were the S&P to close below 1482 for more than one or two hourly closes.
Keep An Eye on The Shanghai Composite Index
Shanghai Composite Index
Yet another market that we expect to “Hold Up” a little while longer is the Shanghai Composite Index. Last week in our article entitled “Will the Real Slim Shady Please Stand Up” we showed the chart above of the Shanghai Composite. That was the very day of the low and as can be seen we ‘sketched in’ the idea of a rally to new all-time highs. Well, flash forward one week and we see the Shanghai Composite Index closing back above 4,000 last night with a close of 4072.13, within easy striking distance now of the old high near 4,300. The updated chart through last night can be seen below.
Shanghai Composite Index with 'Sketched-In' Scenario
On this chart of the Shanghai Composite Index, the space on the graph separates actual data from our ‘sketched in’ idealized scenario. Looking ahead, we believe a final high on this market could be seen on June 25th, plus or minus 1 market day at approximately the 4,500 level. Might we be off in our judgment? Of course. The Chinese stock market is like an angry rattle snake very difficult to pinpoint the exact moment it will strike but we believe that our estimate will hopefully at least be in the ballpark. Our concern with regard to Shanghai: A Double Top leading to a major crash in the weeks ahead.
C-R-A-S-H Coming?
In the next chart shown below, I plugged in a few numbers over the next 5 to 10 weeks for Shanghai to see just what kind of a case we could build for a major crash in the Chinese markets. Once again, we come back to the ‘Pendulum’ concept, simply using the 9 week RSI. RSI, like many technical gauges, is bounded to a fixed scale and must oscillate back and forth between +70 overbought and +30 oversold. We wanted to know what a kind of a decline would it take on the WEEKLY Chart to bring about a traditional RSI reading below +30. The results: Not Good at least a reading of 2,400 on the Shanghai Composite over the next two months in order to register even a minimal, sub +30 oversold reading.
IF the market continues to power ahead in the near-term toward 4,500, a decline from 4,500 to below 2,400 would total a hefty 47%. Chances are this will not be a ‘gentlemanly” decline and will not follow the rules of Emily Post Polite. It will be a great crash as in all capital letters: C-R-A-S-H. In our view, it is very likely that Shanghai’s pivot and reversal will mark a broad scale psychological inflection point in all markets and that the forth coming decline in equity markets will unfold on a global stage.
Shanghai Composite Index With Plugged In 9-Week RSI
Above: Shanghai Composite with some plugged-in numbers for the 9 week RSI. A
reading below 2,400 in the next 10 weeks would be required to achieve an ‘oversold’ value.
That’s a lot of downside risk.
Other Areas of Concern
HomeBuilding Index with Super Trim Long-Term
Above: Homebuilders with SuperTrin
Home Building Sector
Other areas we continue to watch are sources of ongoing concern include the Home Building sector. Yep, these are the stocks that “everyone loved" just 18 months ago! How times have changed. In the chart above we see what could be the sounding the ‘death-knell’ for the HomeBuilders in the form of the GST SuperTrin. This is a proprietary very long-term ARMS Index, which we have used in our sector work now for many years.
The ARMS Index, in its most basic form, compares the amount of buying pressure taking place on advancing stocks versus selling pressure taking place on declining stocks with the formula (Advances/Up Volume)/ (Declines/ Down Volume). Readings on a single-day basis of 1.00 are neutral. So too is the GST HomeBuilders SuperTrin with 1.000 as the middle horizontal line in the chart above.
Now, there are a couple of nuances that are key. In Bull Markets, the Super Trin tends to operate with the following parameters, 1.25 or higher oversold, 1.00 neutral and .85 overbought. In the chart above, these three levels are delineated by the three horizontal lines. Notice, that during the great Homebuilder Bull Market, the spikes above 1.25 in late 1999 and late 2002 corresponded to major lows.
Next, we move on to Rule #2. In bear markets, the parameters will ‘shift’ in what we call a ‘scale shift’. Essentially, in bear markets, markets crunch down and reach much deeper levels of ‘oversoldness.” This means they reach much higher values on the ARMS with BEAR MARKET oversold values normally 1.50 or higher.
We ‘ink in’ the 1.50 line in the chart above using a horizontal dashed line. In Bear Markets 1.50 or higher is oversold, 1.25 is Neutral and 1.00 is overbought, and readings of .85 or lower are simply never seen. Thus, the Bull Market scale literally ‘shifts up’ an entire notch.
So where’s the problem, Barbera? Well, take a good look at the chart above. The high point on the SuperTrin was the 1.71 reading seen on July 26, 2006. Since that massively-oversold “bear market” oversold value, the counter-trend rally of the last 9 months has been in effect. More recently, at the late December high of 2006, the SuperTrin tagged a fully overbought reading of .99, below 1.00 the relative ‘overbought’ value for a bear market. Now, most recently, the primary Bear Market downtrend appears to be re-asserting itself with the GST Home Building Index, (our own unweighted gauge of 20 to 30 stocks) and is threatening to break down below the 430 support level, which has held over the last few years.
The chart suggests that with the SuperTrin is still in very neutral territory. Closing last night at 1.13, we are a long, long way from being ‘oversold’ and Housing Stocks have a free pass in here to begin the next major leg down. Again, while we expect the S&P to hold up over the next 1-to-10 days, (and that may lend some support to the homebuilders), it will be interesting to see if the group begins to move lower even ahead of the S&P. Using the SuperTrin and a reading of 1.50 or higher as a benchmark for a bear market oversold value, a major, major decline in the Homebuilders appears to be on the verge of getting underway. In our view, the next intermediate term decline for the HomeBuilding stocks looks likely to be a full 50% haircut from current levels and should unfold over the next 12 months. This will not be pretty.
10-Year Bond Yield
Finally, we are closing this week's update with a look at the chart of the 10-Year Bond Yield, which over the course of the last few days has turned in what looks to be a major long-term breakout to the upside. As Gomer Pyle used to say, “Well, Surprise, Surprise!” Worse, the upward surge in yields is being very well confirmed by a swath of momentum indicators, suggesting that the world of rising long-term rates will continue for some time to come. In addition to strong upside momentum, yields are also moving up around the world, in China, in Australia, in France, in Japan, a major recipe for a toxic-stew in the equity markets.
Above: the 10-Year Bond Yield with upside breakout from long-term base.
That’s all for now,
Frank Barbera
© 2007 Frank Barbera
Contact Information
Frank Barbera CMT
Editor, Gold Stock Technician
PO Box 48072
Los Angeles, CA 90048
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