Lower Tops

As Bull Markets mature, leadership narrows. What this means is that parts of the market top before others and those which top end up in a series of lower highs and lows, while the markets put in higher highs and lows.

First, I want to show the areas that are failing. The first to top tend to be the ones that get hit hardest in the next Bear Market. The first to top in 2006 were the Real Estate Finance companies and the Home Builders.

Healthcare


Utilities


Energy



Taiwan


The UK



Microsoft
That is one potentially huge top. The 38.2% retracement level (MSFT $24.90) has held and this retest of it needs to hold over the next few days, or else a large component of the S&P 500, DJIA and NASDAQ is going to be working against the market.


Others include Austria (EWO – the proxy for Eastern Europe), Australia (EWA), Netherlands (EWN), Global 100 (IOO), American Express (AXP), Mastercard (MA), Visa (V), Alcoa (AA), 3M (MMM), Chevron (CVX), Exxon (XOM), JNJ, Merck (MRK), AT&T (T)

Heavy Selling on Follow Through Day +2

First off, John Wooden passed away yesterday at 99. He was an amazing man and had deep roots in my community. I will stick with some of his thoughts today –

“If you're not making mistakes, then you're not doing anything. I'm positive that a doer makes mistakes” – seems to be fitting these days.

“Failure is not fatal, but failure to change might be” – seems to fit going forward.

We had a Follow Through Day this week on the NASDAQ, but most of the strength that day was the result of Obama saying that the Job creation numbers for Friday would be great. Biden echoed his thoughts. You can see the move here –



The real numbers were released yesterday and they stunk, so the markets gave back all of Wednesday’s gains. You can see that the SPX made a new closing low for this move, but is stuck in a 12-day trading range. The trading range is right below the 200-day averages. A recovery above 1,067 followed by a reversal down, probably gets a lot of the asset allocation strategies out of stocks. A break above 1,103 will probably force the allocation models back into stocks –



Leadership has been in US Small/Mid Cap. They played catch up to the downside yesterday. Being on a Follow Through Day, these were the areas I wanted to buy and the setups were there, but did not trigger. Here is the chart of the Small Cap 600 ($SML). The trigger was a move above the 20-day (Blue Arrow). Mid Caps and Equal Weight (RSP) had similar setups and they failed to trigger as well.



If 1,068 is not retaken early next week, then the next set of key levels below here are SPX 1,010 and 950. Again, the average decline after a move similar to the one off the March 2009 low takes SPX down to 964. That would mean that SPX has made 60% of its average decline (about -150 points) and still has another 40% to go (about -100 points). This is not a prediction. Nobody knows the future! It is just looking at the averages of what has occurred in the past.

Technically, the markets are on a Follow Through Day, but distribution a few days after the Follow Through Day are the best way to kill a rally. It simply means that the big boys are using rallies to sell.

My goals now are –

If the markets hold these levels and the rally starts, then I want to know where I get stopped back into holdings.

If the markets take another leg down from here, then I want to know where the key levels are to anticipate a reversal and look for patterns that would get me in at these levels.

There were a lot of rumors on Friday. They all revolve around insolvent European nations defaulting on their debt (Hungary is the newest example) and the banks which hold that debt going out of business. There were rumors that a large European bank would pull a Lehman this weekend and blow up.

They call it “the slope of hope”, because you spend the whole decline hoping that somebody will save your stock market holdings from imploding. The G20 met over the weekend and Germany and the EU told Geithner and the Keynesians that they were not going to print more money and were going to cut spending. This was yet another hope potentially dashed. Things are starting to sound like a replay of 1937!

I will be posting a lot of charts tonight. I will break them down into three categories –

Leadership (holding the 200-day)
Line of Death (holding onto support for dear life)
Broken (rising wedges from lower lows)

Another Big Decision Has Arrived

There was clearly intervention yesterday morning in The Euro. The Euro (FXE) needs to hold the $121 level that has been serving as support since May 18th. It has either found support and building for a breakout, or it has had a horribly weak bounce and will resume its implosion. A decision of major consequence seems to be coming in the very near future.

In the end, there are only two choices for Greece and the other countries in a similar debt situation, which was to devalue their currency or default on their debt. Because of the Euro, those countries can`t devalue their currencies, so default is inevitable for some of them. It just doesn’t have to be this week…



We are obviously at a critical juncture. The S&P 500 has been consolidating between the 200-day EMA (1,101) and the low of the flash crash (about 1,040). A close below 1,068 opens the door to testing the 38% retracement level at 1,008 and the 50% retracement level near 943. The most Bullish scenario is a retest of the 1,040 low that puts in a higher bottom. Then a break above 1,103 would make the trend higher and force a lot of Market Timing money into stocks.



Here is the hourly chart of the SPX. You can see that it is in a 3-day consolidation. A breakout from here has obvious consequences, with 1,103 so close. You also have key support at the closing low for this move near 1,070. A break above 1,103 today on strong volume would potentially be a Follow Through Day, so anything can happen. The NYSE, Russell 2000, Dow, NASDAQ, Mid Cap 400, Emerging Markets and EAFE all have the same hourly pattern.

This may end up being the retest of that Reverse Symmetry Triangle I showed last week for The NYSE.

Also, the Percent of Stocks Above their 50-day is trying to put in a higher bottom here at 12.9% versus 10% last week.



One more thing – are Semiconductors replaying the last correction?

Australia Resource Tax Reversal

http://www.thestreet.com/story/10767515/1/aussie-rallies-on-talk-of-super-tax-retreat.html?cm_ven=GOOGLEN

This was probably the single stupidest tax ever proposed, and in my opinion it had a big roll in the recent market crash. Markets always seem to get blasted when politicians talk about things the harm business profits (see Barney Frank from yesterday).

Lots of News

Yesterday the markets opened down hard and then reversed during the course the day. They ended mostly flat, after the Dow traded down almost 300 near the open. They shook off a litany of bad news.

Volume was heavy, coming in over 40% higher than yesterday.

There were several news items yesterday which are new and could have forced some money back in to cover shorts –

ECB Rumor
There was a rumor this morning that the ECB would cut their version of the Fed Funds Rate by 0.50%
That rumor came out early in trading and at the very least did not hurt things. So far it has proven to be unfounded.

The rumor has now morphed into the Fed lowering the swap rate it charges for Europeans borrowing from the Fed from 1% to 0.5%.

Geithner In Europe
Tim Geithner is supposedly telling Europe that they need to run a “Stress Test” to get confidence back into the markets. The goal of the stress test was to drive institutional investors back into banks. The TARP was used to finance the purchases of bank shares. Now that Europe has this $1 trillion facility set up, the money is there to start the next round of capital raises for European banks.

Remember, German has the least capitalized banking system in Europe. It is becoming clear that they made shorting illegal to protect their banks from extinction. Spain was not so smart and has seen a lot of turmoil in their banks this week, as about 9% of their banking system has merged in the last few days.

Now we are being told that Spanish bank Banco Bilbao (BBVA) was unable to renew $1 billion in commercial paper in the US. That probably explains a lot of the plunge in European Financial stocks this month. BBVA is down over 35% in recent weeks, but is only down -2.5% today. So maybe a lot of news is already baked into BBVA.

It is clear that a major capital raise must come soon for European Banks. If you have lamented the fact that you did not buy US Banks on the cheap last year, then you may get another chance with cheap European banks – or they may just all implode…

Barney Frank
If you don’t think some of the recent selling is the result of attempts to regulate US Banks, then look at how the market bottomed yesterday when Barney Frank said that banks and their customers should be able to use Derivatives to trade and hedge positions.

Larry Summers (senior economic advisor to Obama)
Larry started to talk about a Second Stimulus today. He specifically talked about aiding States, so that they would not have to lay off Union workers. I’ll be watching Muni Bonds closely to see if they start pricing in another free gift from US Taxpayers.

Most of the stuff listed above is new and all has the capability to turn the markets higher. Will they? Are we currently in the “slope of hope”? Or have we put in a real bottom?

VIX
The VIX measures the Volatility reading that is used for the pricing of Options. The higher the VIX reading, the more you have to pay to protect your portfolio with Options. The VIX is now near levels that rival LTCM, 9/11, Worldcom and the beginning of the Iraq War 2.0. There is a lot of fear right now.



Currently only 10.25% of the stock on The NYSE are above their 50-day. That is an extreme reading, and tells you how oversold things are right now. Oversold can become more oversold, so this is a secondary indicator. But it is one of the first readings to tell you when a possible turn is occurring, so it is worth watching.

The Euro Standard
Europe has to run structural Deficits to keep its economies from imploding. But the Euro Agreement mandates that countries can only run a 3% deficit. With The Euro in place, countries cannot turn on the printing presses to inflate away their debt and devalue their currency (like the US, UK and Japan can). So the weak countries are potentially trapped in Deflation as the strong countries have low inflation.

Something has to give. The PIIGS were spending well above this 3% deficit bogie and had turned their Financial Sectors into de facto money printing presses. Now the game is up. The banks can’t print anymore and European countries have to reduce their deficits.

How bad is the problem?
The average European country is running a 6% structural deficit for FY 2011. So if they all follow the Euro mandate, then they have to cut spending in Europe by 3% across the board.

To give you an idea, the US is running an -8.2% structural deficit! This allows the politicians to claim that GDP is growing by 4% this year. Our Debt to GDP ratio will hit 100% in 2011.



I am not writing about the merits of Deficit Spending. I think it makes future Taxpayers have to pay for current consumption and think it is unfair. But what is is, and with Geithner in Europe, you know that he is telling them they need to do what we are doing – print money and use taxation to transfer wealth from the strong to the weak to maintain civil order.

I am waiting for a Follow Through Day to tell me that this will happen sooner, rather than later. So far, the European politician have been very disappointing in their actions…

Bearish News Weighing Heavily

The markets got sold hard in the last few minutes today and are down hard overnight.

Some news items that could have impacted stock prices since right before the close today –

Spanish Banks
Spain has a network of enormous savings banks. These banks are run by local politicians and dole out money to their cronies. As one can imagine, these banks ended up making ill-advised loans and are now going insolvent.

Spain took over one this weekend with something like $16 billion in assets. Tonight, 4 others are merging in some sort of bailout. This new bank will have $135 billion in assets!

http://www.nytimes.com/2010/05/25/business/global/25peseta.html?src=busln

The German banks are the least capitalized banks in Euro. Are they next?

Congress
The Collins Amendment to the Financial Reform bill would remove Preferred Bank Stock from Tier One Capital. This asset class represents 13% of the assets for Citibank, B of A, JPM Chase and Wells Fargo (over $108 billion).

This amendment would destroy the banking system in one shot, because so many little banks have loaded with this stuff on their balance sheets. I know I wrote about this in late 2008, because the truth was that if any of the large banks went under, they would take down a huge block of small banks whose balance sheets were loaded up with the Preferred Shares.

Who are these idiots running our country? Can’t they read a 10-K or a Balance Sheet?

http://www.zerohedge.com/article/collins-amendment-will-eliminate-108-billion-bank-holdco-regulatory-capital-will-reduce-big-

They now want to quadruple the tax on a barrel of oil.

http://www.breitbart.com/article.php?id=D9FTDV7O1&show_article=1

They also are proposing having the US Taxpayer bail out Union pension Plans to the tune of $165 billion. It is bad enough that we just got stuck with their Healthcare expenses…

http://www.foxbusiness.com/personal-finance/2010/05/24/lawmaker-introduces-b-union-pension-bailout/

California wants to raise taxes by $4.9 billion.

http://www.reuters.com/assets/print?aid=USN2427330520100524

Korea
Kim Jung II is threatening war.


http://globaleconomicanalysis.blogspot.com/

Euro Panic

IBD wrote the following late last week –

“While the losses in the indexes have been significant since they marked their highs in April, they aren't unusual.

Rebounds from history's nastiest bear markets have involved a huge move up of 50% to 100%, then a significant correction, and finally a second leg up. The average correction was about 21%, the median 19%.

So if this correction proves typical, it may have a bit more to go before the indexes find a bottom, turn up and deliver a follow-through day.

Historically, the second leg up offers a much smaller percentage gain than the first leg. The median gain was 27%.”

O’Neil lays out an idea of how bad things can get. Do they get that bad? Nobody knows for sure, but you can start to be proactive by looking into the internals of the market and identifying what is working and what is not. When you get into periods of weakness, you are better able to see areas of strength.

You can also anticipate key zones and see how markets act in those areas.

Oversold
The Percent of Companies trading above their 50-day MA has fallen to 12%. This is an extreme reading and tells you that the markets can bounce higher at any moment. In the last Bull Market, these extreme readings were buying opportunities and led to nice rallies. However, in the last Bear Market, they only led to bounces or pauses that allowed the markets to work off their oversold conditions before falling to new lower lows.

The obvious question now is does this oversold condition lead to a strong rally or a weak bounce?

The markets are clearly narrowing, with the Bullish Percent now below 50 (Red Arrow), so fewer than half of the NYSE stocks are trading in uptrends. Boy this spike down sure looks like the first Lehman panic in the Summer of 2007…



Strength
Remember, as Bull Markets mature, there are areas of the market that lift prices higher and other areas that hang on for the ride up. Things may be different this time, but history has taught you to focus on the leaders.

Several areas of the market are still holding above their 200-day EMA (Exponential Moving Average). This is the line used by trading services, like Mutual Fund asset allocation newsletters, to determine if stocks are in Bull Markets (Above the Line) or Bear Markets (Below the Line).

The indexes for Small Caps, Mid Caps, The NASDAQ and the S&P 500 Equal Weight are all above their 200-day EMAs.

Sectors like Industrials (XLI), REITS (IYR), Semiconductors (SMH), Retail (RTH), Consumer Staples (XLP) and Consumer Discretionary (XLY) are all above their 200-day EMAs.

Obviously, breaking these levels from here would be very bearish.

Line of Death
The following are barely holding on at support and need to get defended soon or they will put some serious pressure on the Indexes.

The S&P 500, The DJIA, Large Cap Technology (XLK), Basic Materials (XLB) and South Africa (EZA) all have very important support right below current prices. They are below their 200-day EMAs and underperforming leading areas.



Potential Reversal Patterns
I noted the following pattern for Silver (SLV) a few weeks ago –

“Here is the daily chart of Silver (SLV). I have highlighted the expanding price volatility pattern. It looks like a cone. This tells you there is significant indecision in the Institutional Investor camp. Again, this is one of the best reversal entry patterns there are.”

There was an overshoot on the upside, but the pattern played out, with SLV having a nasty correction over the past 7 trading days.



The reason I bring up this pattern, is that it is potentially setting up in many markets, sectors, countries and commodities. They may all fail, but it is worth noting that a very good potential reversal pattern is in place for lots of key stuff.

Keep in mind, than the pattern does not always play out like what occurred with SLV. Sometimes it fails completely, other times the reversal is simply a small bounce or a pause in the current trend. That is why I also wrote the following about SLV that day –

“I would like to see Silver reverse lower from here and give me an entry point near $17.75. If it shows up I may take. If it doesn’t then I will buy pullbacks from higher levels.”

Failures of this pattern have often led to some pretty extreme trends.

Areas with this pattern are The NYSE ($NYA), Energy (XLE), Australia (EWA), Emerging Markets (EEM) and South Korea (EWY).



Potential Tops
As the Bull Market matured in 2006 and 2007, key leadership sectors began to top out and roll over. When the markets would rally to new highs, these areas would not. When the markets would correct, these areas would put in lower bottoms. The following areas look pretty nasty –

Healthcare (XLV), Biotech (IBB), Utilities (XLU), International Developed (EFA), The EU Zone (EZU), Latin America (ILF), Taiwan (EWT), China (FXI) and Brazil (EWZ). The commodities have rolled over with China and those stupid tax laws proposed in Australia, but that could change on any day, and all it would take would be a policy change inside of China to allow for more leverage or some new “stimulus”. So be watching these areas closely for new policy decisions.

Is a 123 Lower Top now in place for Latin America (ILF)? Brazil (EWZ), Europe (EZU, EFA) and Taiwan (EWT) look worse.



Leadership
There are still leading stocks that look great, but they are getting fewer and farther between and their price volatility is incredible.

There are also a number of past leaders that are failing – Google (GOOG), Priceline (PCLN) and Green Mountain Coffee (GMCR) come to mind.

Conclusion
The market fear is similar to the “Panic of 2008. Foreign credit and equity markets are under stress. There has been intervention in the Euro market, and also some short covering, but the US equity market needs all the help it can get from a rebound in the Euro.

It was not a system error when the market tanked last week. The SPX 1055.69 low Fri took out the 2/8/10 1056.51 low close, so that is obviously technical damage, and this is not a normal correction in a bull cycle, but it is a “Euro Zone” panic that is taking the US market along with it.

If the SPX and INDU don`t reverse and hold their 200DEMA`s on the next rally, the market timers and many hedge funds will be forced to reduce allocations even more, which will accelerate the selling and, then the SPX 38.2% Retracement at 1,010 and 50% Retracement 943 will be in play SPX. The bearish hype by the media will snowball it the SPX declines -20% or more, which is the 975 level.

Keep in mind that the June 2009 correction only was 23.6% of the uptrend and the January 2010 correction was 38.2% of its previous uptrend.