Bear Rally in Stocks Over?

Last week we discussed the important juncture the market was at, and we have repeatedly commented on the sub-par breadth and volume of the rally in the S&P and suggested that a bear market rally was taking place.  Since then the major averages tested their 200 day ma resistance levels and have declined sharply off of them with volume and breadth.  Another distribution day Wednesday has turned out indictors away from having a bullish bias for the first time since mid-March, and with another high volume and weak breadth close below the 50 day ma our models will turn bearish once again – something that bears close watching. 

 
Chart 1:  S&P putting in peak off of 200 day ma resistance in zone projected?  Courtesy Bloomberg

 
Chart 2:  Nail-biting time again as bonds retest critical support that would hurt many markets if broken.  Crtsy  Bloomberg

Stocks have us nervous – so do bonds, the dollar, and base metals here.  Bonds did not rally strongly on the very weak day Wednesday, making us wonder if they will be able to act as a potential cushion to stock weakness if it develops further.  Inflation fears are flaming.  Bonds would complete an ominous looking top that could be the secular peak for bonds for many years in what we view as a long-term shift from the disinflation era to more moderate global inflation.  A break by TLT’s under 89.6 would likely wreak havoc upon stocks and even some commodity bull markets and bears close watching here.  A more likely scenario if stocks clearly break down first, would be for bonds to rally mildly and remain in a trading range while stocks retest the lows.  The action in bonds will be critical in the period ahead.

The action in the dollar is critical as well.  A dollar rally has been underway since mid-March and the recent decline has aborted that rally.  Now the market must signal whether it will enter a long-term trading range or a renewed bear decline.  A breakdown under the rectangle shown in chart 3 would suggest a new leg down in the dollar underway.  This would help underpin commodity rallies and would likely imply that bonds will be able to hold above support at least for a while.
 
Chart 3:  Dollar rally aborted but confirmed new leg down needs rectangle breakdown.  Courtesy Bloomberg

 
Chart 4:  Breakdown by three of base metals today has possible bearish economic implications.  Crtsy Bloomberg
Adding to our economic concerns was the action in base metals today.  Nickel, lead, and zinc all made new lows today, and the breakdown by Nickel shown in chart 4 is particularly ominous looking.  Base metals are said to have a Ph. D. in economics because they have such a good track record of anticipating future economic growth shifts.  Further confirmation lower in base metals would argue toward further economic weakness developing ahead.

Note also that since the mid March lows we have not had a period of 5 trading days or longer when our Top RS/EPS New Highs list outpaced our Bottom RS/EPS New lows list by 40 or more each day – which signals a good environment for adding net long exposure in leading groups and stocks.  We are still not there, and now new highs, after a spurt last week, are again dropping like a rock.  Steels, E&P’s, natural gas, fertilizers, rails, and export oriented big cap techs have had decent runs in this rally so far, but the leadership list has not expanded strongly to emerging other groups as much as normally would occur in a new bull market – at least not yet.  That means we continue to suggest lower degrees of allocation and potential short-hedging to all net long stock exposure now.   If Bottom RS/EPS New Lows Expand further and move consistently above Top RS/EPS New Highs, this bear rally will likely be toast, and either a substantial retest of the March lows or new lows will become likely.  We doubt that we’ll get a clearly negative enough market to lead to substantial net short opportunities, but less let the action tell the tale.  Our bias is to suspect that the Fed will act aggressively if new lows are made. 

Our long/short strategy is now long AGU (raise stops under the 50 day ma) and SID (raise stops to under 47 level to lock in profits), and short CKR (lower stops to just over 10.5 level to lock in profits).  These trades with stops moved are all nearly break even or very low risk trades now.  There were not valid trades or close calls in the action of the last week.    We now have to watch carefully to see if the leadership in our Top RS/EPS New Highs can recover and rebuild or if Bottom RS/EPS New Lows will begin to dominate and the market will rollover at the 200 ma resistance zone.  Next week’s action may be critical in this regard.

For those not familiar with our long/short strategies, we suggest you
review my book “The Hedge Fund Edge,” my course "The Science of Trading," my video seminar, where I discuss many new techniques, and my latest educational product, the interactive training module. Basically, we have rigorous criteria for potential long stocks that we call “upfuel," as well as rigorous criteria for potential short
 stocks that we call "down-fuel." Each day we review the list of new highs on our "Top RS and EPS New High List" published
on www.midasresourcegroup.com for breakouts of four-week or longer flags, or of valid cup-and handles of more than four weeks. Buy trades are taken only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts are similarly taken only in stocks meeting our
down-fuel criteria that have valid breakdowns of four-plus-week flags
 or cup and handles on the downside. In the U.S. market, continue to only buy or short stocks in leading or lagging industries according to our group and sub-group new high and low lists. We continue to buy new long signals and sell short new short signals until our portfolio is
100% long and 100% short (less aggressive investors stop at 50% long
 and 50% short).

The chart below shows that Top RS new highs (available on www.midasresourcegroup.com) flirts with being 40 over Bottom RS/EPS New lows for a day or so but then drifts back.  This is disappointing action and the differential must grow to new high’s favor quickly for this market rally not to begin to deteriorate.