Wait for market verdicts to clarify.

We’ve been discussing a number of markets at unresolved critical points.  Some of those are starting to resolve, but most have not yet.  Let’s therefore wait until the market’s verdict is clear before discerning where things are likely going completely.  Stocks did NOT close under the 50 day ma on strong volume and breadth, and instead got support off of the 1469 late April lows we suggested were critical to watch.  Volume and breadth were still both stronger on the decline off of the 200 ma resistance than they have been since early April, but until we get a clear breakdown we could be in for a trading range affair for a while.  A high volume strong close with substantial breadth above 1430 would imply more upside in this two-way market environment.

 
Chart 1:  S&P Needs to break 1369 to signal further weakness – or over 1430 to signal strength.  Crtsy StockCharts.com

There has been a marked tendency for markets to bend but not break critical levels recently.  The EURO and dollar have both tried to break the recent range in different directions and have toyed with key levels but neither has confirmed the move in the other, and they ultimately came back into the range.  The S&P, bonds, and oil have joined the bent but not broke markets recently.

TLT’s or bonds have tried to break the critical 89.60 level early in the day, only to close above that level and rally for the next few days.  However they rallied back up to the 200 day ma and have fallen off that level quite sharply.  A high volume weak close by TLT’s under last week’s lows would set the trend more clearly down and likely begin to have more contagion effects from stocks and commodities than the move down has had thus far.  A high volume strong close over both the 200 and 50 day ma’s would be necessary to turn the trend back up.

 
Chart 2:  TLT high volume weak close under last week’s lows would be ominous.  Courtesy StockCharts.com

Last week we suggested that oil was also at a critical juncture and that a correction was becoming increasingly likely.  Oil reacted poorly to positive news, sentiment reached historical extremes, spread had turned to contango, implied volatility had peaked, and volume increased substantially on the downside.  Oil has corrected further this week, but on its first test of important support, the up-trend channel shown in chart 3, it has rallied sharply.  Oil therefore needs to break down beneath the up-trendline and the 50 day ma before clearly confirming a correction underway.  This is another market that has bent but not broken clearly thus far.

 
Chart 3:  Oil needs to break trendline and 50 day ma to confirm correction underway.  Courtesy StockCharts.com

The dollar index is also in an undecided rectangle pattern shown in chart 4.  The dollar got strong impetus from Bernanke’s comments earlier in the week that he was watching the dollar and would be mindful of the dollar decline’s impact upon higher import prices and inflation gauges.  The dollar is usually the Treasury responsibility and the markets took this comment as seriously indicating the Bernanke would not cut rates further and would try and prevent further downside in the dollar from developing.  Yet today’s hawkish comments by the ECB that makes rate HIKES likely in Europe despite economic weakness has led to a reversal down in the dollar and reasons for the EUR to strengthen.  The rectangle remains unresolved therefore, as does the clearly signaled direction of the next move in the dollar.

 
Chart 4:  Dollar index also not clearly breaking rectangle in either direction yet.  Courtesy Bloomberg

 
Chart 5:  AUD and FXA are holding up quite well despite dollar rally so far this week.  Courtesy Bloomberg

Some time back we suggested as an alternative asset class trade, buying the FXA (or AUD in forex) on a breakout of its triangle to the upside.  FXA broke out and has been in a tight range so far.  It has received support at the breakout level however, and should it make new highs here soon, those long could raise stops to nearly break even under the lows of the week.  The CNY also is still in its potential head & shoulders bottom that we would add to on a clear breakout. 

We have also recently been suggesting watching the base metals quite closely because of downside action in a number of them.  These have continued to slowly drop further and copper has gapped down again and appears set to test 200 day ma support as well as support from the March lows that would suggest a move to 300 if broken (and would signal more substantial global economic weakness than the markets are currently discounting).

 
Chart 6:  Copper looks set to test support at 345 and 200 ma – a breakdown would be quite ominous.  Crtsy Bloomberg

 
Chart 7:  Grains setting up to breakout on the upside again following soybeans higher?  Courtesy Bloomberg
 
Grains have corrected since March but today both Soybeans and SoyMeal broke out strongly of a triangle pattern to the upside and look poised to test all-time highs.  The move in beans and meal helped propel the JJG, the grain ETF, sharply higher.  A clear breakout over 65.55 in JJG is a buy signal and sets up a new leg up to test or break the highs of March.  Higher food prices now would not help the global economy.

Since the mid March lows we have still 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 would signals a good environment for adding net long exposure in leading groups and stocks.  As the chart below shows, now our Top RS/EPS New Highs have plummeted and are often below Bottom RS/EPS New Lows – which are still not rising enough to signal good consistent shorting environment either.  While Steels, E&P’s, natural gas, fertilizers, rails, and export oriented big cap techs have led the rally since March, they may be starting to breakdown here, and if the market falls sharply, this rally may be toast.  Thus 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 over, 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, but further bond rate increases could prevent this. 

Our long/short strategy is now long AGU (raise stops under the 50 day ma), took nice profits on SID on trailing stops last week, we got a valid long in MON this past week,  and we got a valid short in LVS this week as well.  Even if the rally ends here we will have made a bit of profit on the move, something that is not always easy in a contra-trend situation.  There was a valid trade long in MON, and short in LVS in the latest week. We also had close calls on the long side in MATK and CMP, and a close call on the short side in CCOI.  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 off of the 200 ma resistance zone.  Watch the 50 day ma for potential support. 

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) are above bottom RS/EPS new lows but have remained below a +40 edge.  This is disappointing action and the differential must grow to new high’s favor quickly for this market rally not to continue to deteriorate.  Bonds, stocks, the dollar, base metals, grains, and oil are at critical levels that bear close watching.