The S&P500 lost 0.6% last week on light, but growing volume. The down week, the second in a row, is suggesting that the post Japanese tsunami rebound is losing steam. The last several weeks have all the makings of a dead cat bounce.
The big picture in the economy is deteriorating. During the last week, several large Wall Street banks have announced major revisions–downward–to their 2011 economic growth forecasts. Last week, we learned that the US trade imbalance grew larger, and more importantly, larger than expected. Retail sales also rose less than expected. Initial jobless claims jumped back solidly into the grim 400,000 range; they were expected to fall to 380,000. Producer prices rose a bit less than expected (good news); but core PPI rose more than expected (bad news). Consumer prices met expectations; core CPI rose less than expected. Industrial production was better than expected, but this is often a lagging indicator.
Other developments also raised warning flags. Several key (first quarter 2011) corporate earnings results were very disappointing. Alcoa’s sales missed expectations. Bank of America missed badly on the bottom line–even after making several positive accounting adjustments. And Google disappointed. All three were hammered in the stock market losing between 5% and 10% each.
Technically speaking, the dead cat bounce over the last four weeks could be the second top of the bearish double top formation.
What makes this second “top” bearish are the multitude of indicators that did not rise nearly as much as prices rose—prices almost recovered to the February highs.
For example, volumes behind the second top were notably lower than the already anemic volumes behind the first top.
Also, momentum waned. The momentum indicators during the peak of the second top were far weaker than they were during the first top’s peak.
Breadth also faltered. The difference between the number of stocks setting new highs and the number setting new lows measures how broadly stocks participate in a rally. The more breadth, the stronger the rally. But that’s not what happened during the second top. A comparison of new highs to new lows, and their derivative indicators (the McClellan Oscillator and Summation Index), show a deterioration in breadth during the second top.
Another important breadth indicator also faltered. The percent of stocks above their 50 day moving average was much higher during the first top compared to the number above their 50 day moving average during the second top.
Finally, the money flow indicators also weakened during the second top. More money flowed into the stock markets during the first top than during the second top.
What does all this mean? Does the appearance of a double top guarantee that the stocks will now correct severely?
The analysis doesn’t guarantee anything—just as a meteorologist can’t guarantee that it will rain a week from now. But it does help establish the odds. And the odds suggest that there’s a better than 50/50 chance of rain over the next two weeks.
It might make sense to bring along an umbrella…..just in case.