A Potential Double Bottom or Wash Out

I keep looking at the Line of Death charts and recognize that the markets are at a very key level. Yesterday, the SPX touched 1,042 held (actually it went up 1.53% in about 30 minutes). Somebody (the FED?) is defending price right there.

The line at 1,060 is important, because it gives you a visual reference for where the equilibrium is between buyers and sellers. One camp will win out and the markets will make their next big move, either up or down.

SPX 1,040 is important because it was the low of February and the low for the November 2009 rally.

SPX 1,100 is important because it is where the 200-day average is and this is the average that drives the decisions of so many market timers (price above = buy and hold, price below = sell and hold cash). The powers that be understand that a move below 1,040 forces still more money in these models out of stocks and into cash.

This is only my opinion, but as long as the lows of May hold, prices have a chance at bottoming here. If the lows fail, then I become focused on the 38% retracement level (SPX 1,010) and the 50% retracement level (SPX 960). I think the markets will either find their footing here and rally or fail here and find their footing at either of these two lower levels.



So I have to treat this as if it may be a bottom. The old saying goes – you have to buy a bottom, because you are not certain as to whether or not it will turn into THE bottom. If the markets do bottom here and I miss putting some money to work then I will be forced to chase it and make emotional decisions. If they fail here, then I run the potential of taking a small loss and trying again at lower levels.

Nobody can tell the future, but they can prepare to look for bottoming patterns at obvious support levels. This is potentially one of them. There is a time cycle next week around June 14 – 16. The markets have been very technical, so I will be on alert for any plunges or reversals up.

Equal Weight, Mid Cap and Small Cap have been holding up the best. They will be my areas of focus. The great thing about corrections is that they let you sell what is failing and move your money into leadership.



Here is a chart of how potentially volatile the current markets are. This is the Reverse Symmetric Triangle pattern. It is one of the best potential reversal patterns. This chart is the Large US Energy stock ETF (symbol XLE). The trigger is a close above the high of the low day, but that would have gotten you in at $54, so the trade was not taken.

XLE has been consolidating for 14 days in a triangle. It can break up or down. I don’t know the direction of the break. I only know that I expect it to be a violent move on way or the other. My entry point today was a move above the 20-day near $53.30. Price failed to get there, telling me that the big boys were not yet ready to move the price of XLE out of the consolidation.

If XLE breaks down from here, then I look for another potential entry at lower levels.



Financials (XLF) are extremely important to the markets. You can see that $13.90 has been tested three times in the past few weeks and a break below will probably test support at $13.50. That $13.50 level had better hold, for if it breached, then prices had better snap back above it very quickly, or the markets will probably be in very deep trouble.



Semiconductors (SMH) need to hold $26. It has held here on numerous occasions since the beginning of May. Semiconductors lead, they do not follow and if they fail here, that just adds to the evidence that the Economy is in big trouble.



Prices aren’t all at risk of breaking support, the US Treasury 7-10 year ETF (IEF) is on the verge of breaking out to new highs. Or it may be setting up a double top.



Natural Gas (UNG) may have finally found a bottom, with Crude now on the Government’s hit list.



Here is an energy company that is actually on the brink of new highs! VQ doesn’t have much volume, but it is in the IBD Top 100. Just be ready for the potential of a 40% drop in about three weeks. I am not recommending anybody buy it, I am simply showing a pretty picture.



Here is a Gold stock that looks like a Cup & Handle. Again, I think it is a pretty picture and I am not recommending you do anything with it.



So, the next few days may see a resumption of a violent trend. The only question is will the trend be up or down?

One last thing. I want to show the charts of some High Yield bond funds. They have pulled back with stocks and may be an early warning of a reversal or validate any future weakness. I will be watching them closely.

Line of Death Charts

The S&P 500 and the Dow Jones Industrial Average are at support and had better hold -



These are the charts at critical support. In my opinion, they had better hold here, or there will be that much more pressure on the Indexes.

Financials, Regional Banks, Brokers


Materials


Technology


Consumer Staples



Emerging Markets, Singapore, South Africa, Latin America


Cisco, Hewlett Packard, Dell, IBM, Intel
Who says that this market isn’t technical? Cisco is sitting in a Bear Flag, right on top of the 38.2% retracement level. Next big volume move wins –either a potential retest of recent highs, or the NASDAQ breaks into a Bear Market.



Bank of America, JPMorgan, Travelers


United Technologies

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…