Technically Speaking

The S&P500 rebounded 2.2% last week, but most of the bounce came on Monday (on low volume), while losses resumed on Thursday and Friday (on higher volume).

Last week’s economic data were mixed.  The US Treasury budget for April came in well below expectations.  In fact, at -83 billion dollars, this was the worst April in the history of the US.  Even in 2009, during the depths of the recession, the April deficit was only 21 billion dollars.  Jobless claims remain at the recessionary mid-400,000 range.  The 30 year Treasury auction was a little scary–rates were higher than anticipated and Direct Bidders were at a record high level.  If the Federal Reserve wants to “support” prices while massive supply continues to pour into the market, then this would most likely show up in a higher Direct Bidder take down.  Retail sales were better than expected, but when auto sales were stripped out, they were worse than expected.  Industrial production rose more than economists had forecast.  And consumer sentiment was lower than anticipated.

Let’s review some technical data in more depth than usual.

First, as mentioned already, there’s been a persistent pattern–over the last year–with volume.  When prices rise, volume falls.  When prices fall, volume surges.  This is not at bullish sign; it certainly does not fit the pattern seen in most bull markets.  It does, however, make sense when one considers the Fed-fueled liquidity injection boosting all asset prices over the last year. 

The VIX (or fear) index has made a decisive turn over the last three weeks.  Volatility is surging, and this also does not bode well for stock prices.  As investors increase hedging and pay more for the privilege of doing so, they will help cause the very thing they’re buying insurance against:  lower stock prices.

The basic price charts in the S&P are also pointing to the strong possibility of a major turning point.  Prices literally collapsed the week ending May 7–slicing through both the 50 day and 200 day moving averages, which is a bearish development.  And last week, as valiantly as they tried to rally, the recovery reversed course–badly–by the end of the week.  This suggests that the price breakdown that began at the end of April is strong and fully intact.  More worrisome is the amount of “open air” still left beneath current prices and longer term support levels.  Prices rose to such overbought levels since February that they–like an overstretched rubber band–can snap back much more severely than they have over the last three weeks.

A sentiment indicator–the S&P500 Bullish Percentage Index–is still at generally optimistic levels, closer to levels we saw in mid 2007.  It is nowhere near the lower levels generally associated with a scared, pessimistic and oversold market.  This also suggests that prices have more room to fall.

How about the broader distribution of stocks within the S&P500?  The percent of firms above their 200 day moving average (a very common indicator of long-term trends) quickly jumped above 80% by July 2009–and stayed there essentially until last week’s crash shoved it down below 80%.  This implies that stocks across the board are breaking down and could be poised for more price drops.

Putting it all together, it’s easy to conclude that a major caution signal has lit up.  While these technical data do not–yet–sound the red alert warning, they do suggest that anyone who’s been riding the rally for the last year ought to be careful.

If this breakdown continues, the charts are signalling that there’s a lot of room for prices to fall.  And over the next two to three weeks, we’ll learn how accurate these warning signals actually were.

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