CONFESSIONS
SEASON AHEAD
by Richard T.
Williams, CFA, CMT
Director, ICAP Equity
Research
July 5, 2006
| Closing Prices | Support | Resistance | Yield % | ||
| Nasdaq | 2152.90 | 2125 | 2250 | S&P 500 EPS yield | 6.47% |
| S&P 500 | 1269.42 | 1240 | 1316 | 30 Yr. Bond yield | 5.28 |
| Dow Jones Indus | 11145.19 | 11125 | 11750 | Greenspan index cheap by 27% |
122.5% |
| Crude Oil | 74.46 | 68.00 | 75.50 | ST yield | 4.91% |
| Gold (spot) | 625.50 | 550 | 675 | Yen/dollar | 85.64 |
The market looks to us like it has completed a corrective bounce in a larger bear pattern Monday. The formation was a typical ABC bounce with A-up roughly equaling C-up after a long, drawn out B-down. The pattern took a long, long time to complete if as we think it now may have done. Many global indices have now retraced 50% of lost ground since May highs. Also Wilder momentum measures show bearish divergences in many stocks and senior averages suggesting that another down leg is coming soon. Our Supply/Demand models are showing preliminary Sell signals on the hourly and potentially complete corrective bounces where key indicators could not breach resistance lines as required. The confirmation of the early Sell signal for Hourly S/D would come with sustained prices below 1253 and again at 1242 support on the SPX. The end of wave-2 up would then be indicated for us with the expectation of a faster, higher momentum move downwards over the next few weeks. With pre-announcement season upon us starting with the close tonight and extending through next Monday night, there could be substantial uncertainties for buy-siders regarding potential land mines in their holdings.
After a fairly spirited rally questions naturally emerge about whether the selloff from May to mid June actually was significant despite serious concerns during the event. We see this as the normal process of developing a bear market with wave-2 bounces retesting breakdowns and giving a sense of relief or even newfound confidence in bulls. This occurs in part to draw cash off the sidelines, once again setting up a large imbalance between bulls and bears into news that causes substantial reconsideration of the health of the economy and future prospects of the market. Sentiment has jumped up to high relative levels once again supporting the complacency that has characterized the final stages of the bull run from �03 lows.
The evidence implying further downside seems to us to be quite robust with both technical and fundamental aspects. The technical readings show extreme overbought conditions as well as several bearish indicators failing to fully breakdown point to risks of further selling ahead. Wilder momentum on hourly charts shows that the rally has run out of steam after a weak volume buying spree. Retracements of lost ground in many stocks as well as most major averages around the globe cluster around a 50% bounce, consistent with bearish corrections. The larger wave count also points to a likely completion of an ABC wave-2 recovery. The projections from current levels argue for a decline below 1210 support and towards 1170 over the next few weeks. That pre-season confessionals are starting tonight after the close and continuing through next Monday�s close could provide ample reason for the return to bear control of the markets. Regular earnings season begins in the latter half of July and extends into early August, spanning roughly the same period as the projected wave-3 decline.
Inflation worries and Fed concerns remain major drivers of selling in the marketplace, but jobs could be an important factor as well. Early indications from private sector reports show a robust bounce back from May weakness. The LT trends in jobs could take us in a different direction, however, should correlations break down between BLS data and private surveys. The fact that Greenspan�s many changes to CPI shifted the benefits of low inflation readings throughout the housing boom will now turn into a big problem for his successor, Chairman Bernanke, who is tasked with controlling price stability. The impact could easily be to push senior averages sharply lower as the Fed continues to hike rates out of concern of price spirals. Since the distortions of the Greenspan era, the public�s perception of gov�t inflation data, and many other reports as well, have turned into disbelief further complicating Bernanke�s task. The risks of the Fed overshooting with rate hikes is commensurately high due to its reliance on PCE as the main inflation gauge; accordingly it will have under estimated actual inflation relative to input prices, persistent fuel costs and spiraling housing expenses. This misperception by the Fed may have already induced the FOMC to overshoot in its bid to control inflationary expectations. We suspect based on the charts that jobs will be the key indicator looking forward in terms of spotting the actual onset of recession and perhaps a coincidental bear market decline, but that will take 2+ negative months to confirm.
For us the data appear to be overwhelmingly bearish for the economy and therefore for the markets. Still there are risks inherent with mapping fundamental or macro forces onto charts. The charts win every time! So the prudent investor or trader will use the charts to lay out the possible outcomes and monitor the reaction to macro and fundamental news rather than to the news itself. As with the proverbial beauty contest, it is not which contestant that is prettiest that matters, but which one the majority believes is the top choice. Hence the need for caution is important going forward until confirmations are achieved. With a wave-3 decline the probabilities for a fast breakaway move increase significantly over other turning points, but full commitment or leveraged commitments often perform best by allowing the momentum to shift prior to action.
The dilemma posed by global oversupply of goods and services, brought on by easy money from Japan in Asia and other parts of the world, threaten the World economy as much or more than the relatively ST inflationary threat that excess liquidity has incurred since Y2k. Central Bank�s hold an extremely tenuous position with the need to raise rates to stanch inflation expectations while at the same time not accelerating deflationary pressures from abroad. Domestic problems of excess debt in a rising rate environment threaten consumer spending levels which account for 70% of GDP. But ultimately it is jobs growth that enriches countries rather than small fractions of the wealthiest growing wealthier through wealth effect. The Fed has painted itself into a corner thanks to rookie mistakes of delineating inflation comfort ranges that subsequently were exceeded narrowing the available options to sustain the expansion phase of the economy through troubled waters.
The GSE�s pose a big threat if rates run up too far or too fast to adequately be hedged with derivatives. The Street cannot be trusted to help because as in the time of LTCM in �98 once intentions are known, large hedgers no longer can find willing counterparties with which to trade. Banks could be at risk through lax lending standards as defaults begin to run up. The media recently noted that complaints about debt collectors have risen 6-fold in a short time. Investors can expect similar stats for mortgage borrowers as banks flush defaulted properties out of their portfolios by hitting whatever bids are available. This will further erode the �family ATM� of home equity to the point that refinancing is no longer an option and disposable income takes the commensurate hit as rates rise on the mountain of debt held by consumers and companies. Further speculation and hedging from derivatives could ruin otherwise healthy banks should counterparties fail as they did in the Asian Flu. The risks come in so many forms that it is difficult to list them all in the space allowed. The real question is why the market hasn't come down hard already. The answer must lie in low rates, easy money and incipient derivatives.
Our conclusion is that the decline is only just beginning to gain traction and the marketplace is largely fixated on why it can't liquidate securities rather than why it can't wait to do so. The sentiment, momentum and volume all argue that we have a rough period coming in the year or so ahead. And the election may not provide much if any help if the Fed's hands are tied.
RTW
SPX Hourly Price Chart
Source: Bloomberg Charts
SPX may have completed a corrective wave-2 bounce before turning lower
Daily SPX Price Chart
Source: Bloomberg Charts
SPX has retested its upper trend resistance line at 50% retracement of lost ground
Weekly SPX Price Chart
Source: Bloomberg Charts and ICAP Technical Research
Wave �C� down could follow the Y2k wave �A� bear market down in duration and in magnitude
Money Supply Growth Rate Chart
Source: ICAP Technical Research
Liquidity isn�t flowing to help the market � for the 1st time since �03 lows � a major policy change!
Hourly SPX Supply/Demand Chart
Source: ICAP Research
The Hourly is just now issuing a Sell signal � price confirms below 1253 if sustained
1-hour Volume-adjusted Price Chart for S&P500
Source: ICAP Research
VAP is turning down and Moment is falling faster and deeper � a trend change in the ST?
1-year Supply/Demand Chart for SPX
Source: ICAP Research
Daily S/D is coming off a corrective bounce � It failed to breach trend lines as required for a LT Buy!
1-year Volume-adjusted Price Chart for S&P500
Source: ICAP Research
VAP is strong, even extended - Momentum didn�t rise enough for more than a ST corrective bounce
ISM Services Indicator Chart
Source: Bloomberg.com
ISM is lagging, threatening to decelerate at a crucial time for the economy and the market
30-yr Treasury Bond Price Chart
Source: Bloomberg.com
Bonds have now retested resistance at 108+ and now are testing the recent lows!
30-yr Treasury Bond Yield Chart
Source: Bloomberg.com
But until the widely watched yield breaks out above key resistance at 5.35% rates are contained
Copper Price Chart
Source: Bloomberg.com
Copper has hit retracement limits and is turning lower on divergent momentum � economy slowing ?
5-year Supply/Demand Chart for SPX
Source: ICAP Research
Weekly Sell signal becomes operative once again below 1240 on SPX
5-year Volume-adjusted Price Chart for S&P500
Source: ICAP Research
Momentum has stayed weak and VAP as well � suggests more downside ahead�
Russell 2000 Index Chart
Source: Bloomberg.com
Small and mid-caps have retested trend resistance and the 50% retracement level
Non-Farm Employment Chart
Source: Bloomberg.com and ICAP Technical Research
Jobs are key to economic health - the double top with RSI bear divergence bodes ill for the summer month reports
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© 2006 Richard T. Williams, CFA, CMT
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Richard T. Williams, CFA, CMT
ICAP Enterprise Software
Jersey City, NJ
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