Breaking Bad

In last weekend’s SA article, I noted that the primary moving averages (50 and 200 day) were converging on the current price level in all of the major U.S. equity indexes. The read was that we were near a break out…or a break down. For many weeks now I have also been advising readers to take note of the U.S. dollar index testing resistance at 80. Today the dollar has broken 80 on the third attempt, and is currently near the high for the session.

At yesterday’s close, both the large cap S&P 500 and the small cap Russell 2000 finished a losing trading session right at the 50 day. Today they have both broken to the downside on increased volume. Yesterday the NASDAQ Composite broke, and continued down today. The Dow Industrials, recently the strongest of the bunch and the only one to hold the 200 day, has broken that mark and bounced off the 50 day (there are only ~170 Dow points between the two). The Transports are a step ahead, and have broken the 50.

Unless this is a head fake, and the Fed meetings this week produce something to move the markets higher, today’s trading should be seen as a warning to investors and traders sitting on long positions to pay attention. The dollar is rallying, U.S. Treasury yields are down sharply as Italian yields spike, stocks are selling off, and crude oil is currently looking at a $5 daily loss. You could theorize that the smart money is trying to drive risk asset prices down ahead of another round of QE so they can buy in lower, or you could take the price and volume action at face value.

Returning to the S&P, since the summer swoon the 1,200 level has alternately formed support and resistance. The index is at 1,214 as of this writing, so I would be looking for a test of that support level very soon. A failure to hold it would open up the November low around 1160, and possibly on to the October low in the 1,075 – 1,100 area. Be careful out there!


The “Super Committee” and the Markets

Over the weekend, reports that the deficit cutting “super committee” was on the verge of failure began to circulate openly. I suppose we shouldn’t be surprised, but our purpose here is not to analyze politics and public policy, but to try to figure out what is going on and how it will affect our portfolios.

In this particular instance, our cue should come from the S&P downgrade of U.S. debt. Some observers were puzzled that the Dollar rose and Treasury bond yields fell. That seemed counter-intuitive. This morning we are seeing the same action at the market open: Dollar up, equity and commodity prices and Treasury yields down. In other words, the response from the markets is a pure “risk off” rotation.

Certainly, we cannot look at this in a vacuum. Much is going on in the world, and especially in Europe where things are still very much unsettled. If you subscribe, however, to the idea that we should be tune out political noise and look to the markets for a more reliable signal, this should tell you much about the standing of the U.S. in the global economy.

My specific read, as detailed in the weekend article at Seeking Alpha, is that the risk asset markets are under pressure. We are most likely looking at a move back into the summer trading range in equity indexes, perhaps even a re-test of the early October lows, in the near term. In the longer term I am still bullish on America, so this would represent an opportunity to buy more quality assets at discounted prices.

S&P Technical Update

It’s been a week since the last update, and in the interim, the S&P 500 has been moving sideways in a tighter range, continuing to form a symmetrical triangle pattern on the chart. I am concerned that the 200 day moving average has been tested and failed three times, and now the index is backing off that level. We also see the MACD rolling over and on balance volume stalling out.

This week has seen more troubling developments in the European bond markets, which are still dominating the news and moving the U.S. financial markets. The bond market is basically saying that the policy response has yet to address the problems sufficiently.

With the balance of risk to the downside, and deteriorating technicals, my stance on the markets is moving to defensive. I just don’t like the action we are seeing here.

(click on chart to enlarge)

Technical Note on the S&P

Quick technical note on the S&P 500. Today we are looking at price, volume, and moving averages. Below is a chart of the index since the October 4th key reversal. Note that this reversal day has the highest trading volume on the chart. We then go into a rally that culminates with a breach of the 200 day moving average on the 27th, which is the 2nd highest volume day.

Since then, the price advance is rejected sharply on Oct. 31, comes back up above the 200 day on Nov. 8 – but reaches a lower high – and is rejected a second time. The two highest volume sessions since the 27th high are the down days of Nov. 1 and Nov. 9.

Where does this leave us? To me we are at a critical juncture. Repeated failure to hold the 200 day is bearish. If we keep failing at the 200 day, reaching lower recovery highs, and seeing higher volume on down days than up days, it would turn out outlook bearish.

(click on chart to enlarge)

Greece Done, Italy on the Clock

Tuesday’s announcement that Italian PM Berlusconi promised to resign coincided with a rally in U.S. markets. Was it the cause? Maybe.

This morning things are looking a bit less sanguine as the bond vigilantes have appeared, and Italian yields spiked. The U.S. dollar index moved to its highest level since February and, as of this writing, we are looking at a >2% down day in equities.

The markets just can’t shake off these news-driven whipsaws. Caution is the watchword here.

The Halloween Massacre, and Papandreou Goes All In

A couple of quick notes before the markets open for November business:

The big Halloween selloff was no surprise – my weekly outlook at SA called for a near term correction, which was an easy call given the size of the move we saw during October. The McClellan Oscillator had given seriously overbought readings on both the NYSE and NASDAQ last week, as mentioned in the article.

Even with the size of the losses yesterday, we didn’t see a great deal of technical damage. Volume was not impressive, and 5 of the 9 S&P sectors are still above their 50 and 200 day moving averages. We still can’t feel good about a 2.5% down day, but it’s no reason to change our outlook.

Over in Europe, which has been provoking so much financial market volatility, we had a bit of a shocker come out of Greece, where PM Papandreou has decided to put last week’s agreement to public referendum, and called a confidence vote on his government in parliament.

This is not likely to end well. I haven’t written much on the Greek situation lately, but my long term outlook remains what it has been all along: there is little probability Greece can remain in the monetary union. Not necessarily for technical reasons, though I do think that is enough (there’s no way to make the numbers work), but because the Greeks are…Greeks.

A descent into chaos in Greece has to be seen as a real possibility, and that in turn has to be seen as a real threat to the financial markets, but I’m not sure it would be enough to change the primary direction of the U.S. markets. My outlook is still bullish into the end of the year, but we will continue to monitor the market reaction to events, and change course when the data and evidence call for it.

Finally, a note on the U.S. dollar, which is driving everything. My article suggested that the index had found support at 75, which would cap the risk asset rally. Well, not only has it found support, but we have seen a large move into the mid 77s as of this writing. I would like to see that moderate, but with Europe squarely back into the mode of uncertainty, we can’t take anything for granted. This is a tough market and you have to work for your money.

Fog Begins to Clear in Europe

No, this blog is not venturing into the weather forecasting business. We’re still all about the financial markets. Though many details remain to be fixed, we have the beginnings of some clarity in the European debt crisis. In yesterday’s post my speculation was that anything short of a 60% haircut on Greek paper would be well received. The number appears to have come in at 50%, and the European equity markets have reacted favorably. So far so good.

Also worthy of note, as of this writing the U.S. dollar index has broken below the 76 support level, and the euro is above $1.40 resistance – for some time its own support. Should this condition prevail, our bullish outlook on the equity markets will be reinforced, although I still would not be surprised by further consolidation in the U.S. after a brief rise in reaction to the news. Since October 4th, when we called the stock rally, it seems to me that the market, which had been priced for a European catastrophe, began to reprice itself for something more like what we have just seen. All of which is to say, we are probably pretty fairly valued at the moment, and it’s likely we will see volatility contract and a return to a more normal trading pattern for a while.