Welcome Back!

I apologize to those consistently checking for new posts, and I thank you for your dedication. As the school year came to an end, I didn’t feel comfortable posting without giving my undivided attention to the current events in the market. The markets are dynamic and require constant interpretation.

Having said this, I’d like to reiterate my positions and price targets. I am still bullish on the financial sector, as well as the overall market. I can see both the DJIA and the SPX testing 10,000 and 1000 respectively before any significant resistance and/or retracement. During last week’s move higher, the trading volume spiked above the 10 day average, about 5B. This week is setting up for a huge move, many will suggest lower, but I believe we could see the mother of all short squeezes. As of the end of March, there was approximately $3.9 trillion in money-market fund assets and about $3.4 trillion in equity mutual fund assets. This unusual proportion implies that the current rally could pick up steam, and fast. From August 2008 to March 2009, there has only been one month where equity assets have increased, December. Although February to March did increase, April’s numbers will be more telling. Money-Market assets have consistently increased from September 2008 to January 2009, remaining essentially constant from January to March. May of 2008 boasted excess of $6 trillion in equity assets suggesting the current position could almost double. The price impact of this large of a monetary influx would be tremendous. Yesterday’s decline was short lived, and it should be noted that tech did not decline as much as the rest of the market.

After the market closes I will continue the post.

Passing The Stress Test

DJIA

DJIA

SPX

SPX

Nasdaq Composite

Nasdaq Composite

XLF

XLF

 The real stress test has already happened, but these results won’t be publicly recognized. For the last few weeks, the major indices have tested upside resistance multiple times tempting the bears to get back into the game. The remaining uncertainty in the market is significantly less than at the beginning of the year, and the Government’s Stress Test and auto industry turmoil account for a large percentage of the overall market volatility. The results of the Stress Test have been delayed three days, to May 7th. The delay stems from disagreement between the banks and the regulators, and while only delaying the inevitable, is perceived as a positive. There is only one reason the banks would disagree with regulators over the results, because the regulators made a mistake, miscalculated or estimated incorrectly. If the regulators were to overestimate, the banks would never raise attention to it. The disagreement has positive market implications, particularly because most, if not all, negative news has been priced in. This week’s volume was below average, but this is to be expected. Smart money is either already long, or they are awaiting the results of the Stress Test so they can jump into the “healthy” banks. The bears had plenty of opportunities to take this market lower, but failed to succeed, even in the light of a worse than expected GDP.

The first chart is the Dow Jones Industrial Average over the last 20 years, monthly. The Fibonacci retracements suggest important resistance at 8240. Closing above 8240 resistance at the end of May would imply the market has its sights set on the next level, 9650. At the end of May, when the markets have closed above the 8240 level, the uptrend march will  continue. I can see the DJIA testing 10,000 during the summer, but do not expect this to last. Expect the DJIA to retrace all the way back to the 8240 level after touching 10,000. This retracement would be extremely healthy, and would establish a base, or support, on top of current resistance. Establishing support on top of previous resistance has bullish implications, and is exactly what each of the major indices is currently doing.

The second chart is of the S&P 500 over the last 10 years, monthly. The Fibonacci retracements again suggest we are approaching important resistance levels, 880. Closing above 880 for May implies 1014 is next. Again, after touching this level, I expect a retracement to 880. The third chart is of the Nasdaq Composite over the last year, daily. No surprises here, the Nasdaq is also nearing important resistance at 1760. Closing above 1760 for the end of a day would imply 1900. However, I expect the Nasdaq to fill the gap at 1950 before retracing. Depending on the relative strength of the market at this time, I do not necessarily expect the Nasdaq to retrace as significantly as the DJIA or SPX. The fourth chart is the XLF Financial SPDR over the last year, daily. Fibonacci retracements are deliberately not drawn here. Over the last month, the XLF has gapped higher and begun to consolidate. This consolidation is similar to what the indices are doing, except the XLF’s next move is contingent on the results of the Stress Test.

As I mentioned already, these results will eliminate a lot of the uncertainty surrounding the financial sector, and will likely be the necessary catalyst to lift this market higher. It is not a coincidence that the markets appear to be searching for a catalyst, especially since reasons for the market to trade lower have not caused any significant decline. Much of the negative news regarding the banks and any forced capital increases has already been priced in. Citigroup and Bank of America, 2 of the 19 banks preparing to receive results of the Stress Test next week, have been shorted heavily. Rumors turned fact concerning additional capital has hit both Citigroup and Bank of America hard, but most analyst do not expect significantly negative remarks from the Government. Citigroup has already announced the conversion of preferred shares to common at the conversion price of $3.25. The short interest in Citigroup is about 23%, and any relatively good news will cause a huge squeeze. I expect to see Citigroup double before expiration of the June option contracts. The open interest for the June $5 calls is over 1.7 million. The derivative markets are quiet indicators of what’s to come.

Markets do not like uncertainty, and when the banking and auto industry issues have been resolved, expect a continuation of this bull market rally. The three largest contributors to the recent market decline was housing, banking and the auto industry. The housing issues were resolved some time ago when the Government took control of Freddie Mac and Fannie Mae. However, it took until a few weeks ago to empirically support a housing bottom. The recovery of the banking crisis began with the failure of Bear Stearns, showed signs of improvement with the consolidations of Merrill Lynch into Bank of America and Wachovia into Wells Fargo, government intervention with AIG, and the collapse of Lehman Brothers. Thursday’s Stress Test results will conclude the banking industry’s roller coaster ride, and mark the beginning of the financial recovery. The finalization of  the Chrysler/Fiat deal and the restructuring of General Motors will consummate this entire financial crisis. Although it is clear that the auto industry was not initially involved in this crisis, the threat of systemic risk implied by the collapse of the industry exacerbated fear and volatility in the markets. As each of these issues are put further and further in the past, less overall market uncertainty and volatility will exist. This directly implies steady growth, in my opinion, similar to the growth seen in the 90’s. Low volatility and steady growth are characteristic of secular bull markets.

Building a New Foundation

SPX

SPX

The SPX has broken out above the 877 Fibonacci retracement level. This is extremely bullish, and from a technical standpoint suggests the SPX is headed to 934. Closing above 877 is important and will confirm the suspected rally. I expect to see the DJIA test 9000 and the SPX to test 950 over the next couple of weeks. If the markets create support at the current levels, enough consolidation will have occurred to support a substantial rally in the near future. The talking heads on CNBC are finally catching on and have suggested the possibility of DOW 10k by the end of the summer. Please review my archived newsletter http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_4-7-09_%7C_Cautiously_Optimistic_2009-04-07.html, to see that I have been suggesting this possibility since April 7th, when the DJIA closed at 7790.

Here is one of the articles on CNBC’s website suggesting DOW 10k. http://www.cnbc.com/id/30478135 However, my reference is to the anchors on CNBC’s television show.

Sell in May and Go Away?

Friday the major indices ended their impressive six consecutive up week streak[1]. During the streak, the SPX averaged 4.15% return per week with the first week boasting a 10.71% increase. Regardless of what the media or the bears are saying, this rally has substance. A rally of this magnitude should not have lasted as long if the underlying fundamentals were not changing. The real question is whether or not American citizens will pay for this rally in the future. The answer is yes, and they will pay for it in the form of double digit inflation. For the future of this country, let’s hope unemployment begins to decrease before inflation begins to increase.
 
The major indices declined Monday and Tuesday on fears that the Swine Flu would turn into world-wide pandemic. As of Wednesday night, there have been 93 confirmed cases in the United States and one death. The one death in the United States was a 22 month baby in Texas, but the baby was not an American citizen. The baby was a Mexican citizen and was visiting Texas to receive medical attention. Although it is suspected that as many as 160 people have died in Mexico only 8 deaths have been confirmed. Swine Flu is suspected of sickening more than 2,500 people in Mexico, but only 99 cases have been confirmed by the CDC[2]. While this could escalate into a world-wide pandemic if the virus is able to spread to enough people, it is likely to be less serious than the attention it is receiving. Only people from Mexico have died, a fact that scientists cannot explain thus far. It is likely that Swine Flu will pass faster than Bird Flu or SARS[3]. Some of the confirmed cases in the United States did not know they had the virus, which may suggest the virus can be controlled with proper precautions.
 
Last Thursday, jobless claims[4] decreased by less than expected, implying an economic recovery. Although the existing home sales[5] were worse than expected, new home sales[6] exceeded expectations. This mixed housing data supports the notion that the housing market is bottoming. On Tuesday, consumer confidence posted[7] the largest one-month jump in four years. This data sparked an early morning rally, but low volume and Swine Flu concerns caused a late afternoon fade. GDP[8] contracted more than expected for the first quarter of 2009. This news, along with the Federal Reserve meeting, acted as the catalyst for Wednesday’s 2%+ rally.
 
The results of the Stress Test will be announced Monday, May 4th. There have been many rumors surrounding the release of these results, specifically in regards to some of the banks needing additional capital. Citigroup will likely announce the conversion of preferred shares for common shares at the conversion price of $3.25 on Monday following the release of the Stress Test results. The conversion will be an attempt to improve their tangible common equity, one of the main metrics of the Stress Test.
 
Market Fallacy expects the major indices to trade significantly higher over the next seven trading days. Current targets[9] for the SPX and DJIA are 950 and 9000 respectively. Following this explosion to the upside, an ensuing retracement is highly probable. The major indices have established new support above the previous resistant levels, an extremely bullish sign. The markets are preparing for a significant move in either direction, with a slightly higher probability for a move higher. It is not impossible for a retracement over the next two weeks, but unlikely. Market Fallacy now has a blog, which will attempt to provide insight into individual questions concerning the markets. Please visit the blog to receive personal attention regarding the markets. http://www.marketfallacy.wordpress.com
 
[1] SPX, synonymous with S&P 500, closed down 0.39% for the week beginning April 20
[2] Center for Disease Control and Prevention
[3] Severe acute Respiratory Syndrome
[4] Jobless claims consensus 651,000 vs. 646,750 actual
[5] Existing home sales consensus 4.72 million vs. 4.57 million actual
[6] New home sales consensus 330,000 vs. 356,000 actual
[7] Consumer confidence consensus 30.0 vs. 39.2 actual
[8] GDP consensus -5.0% vs. -6.1% actual
[9] S&P 500 target 950 and Dow Jones Industrial Average target 9000

7 Weeks?

Nasdaq Composite

Nasdaq Composite

Apple (AAPL)

Apple (AAPL)

Google (GOOG)

Google (GOOG)

Research in Motion (RIMM)

Research in Motion (RIMM)

Russell 2000

Russell 2000

Citigroup (C)

Citigroup (C)

The markets are closing in on the gap between last Friday’s close and the 7th week of consecutive up weeks. Actually, some of the indices have already filled this gap. The Nasdaq Composite, representing smaller and technology based companies, which is positive year-to-date, has already filled the gap. In the charts above, the Nasdaq Composite, Apple, Google and Research in Motion are all currently establishing a new floor or support levels. Similar action is occurring in the Russell 2000. Both the Nasdaq and the Russell 2000 indices have consistently led the rally. Put another way, the Nasdaq and Russell 2000 have foreshadowed both the rallies and the declines for the last couple of months. It is for this purpose, that I reference them and point out the consolidation activity.

I also want to address Citigroup’s behavior. Citigroup is the only large bank that is not taking part in the current rally. Large banks here refer to Citigroup, Goldman Sachs, Bank of America, JP Morgan Chase, Wells Fargo and Morgan Stanley. The days following Citigroup’s earnings announcement, have seen the stock drop by approximately 20%. Citigroup has declined the last couple of days on lower than normal volume. However, yesterday’s candle on Citigroup was a hammer, a bullish sign. If Citigroup closes above $3.30, today’s candle will be a bullish engulfing candle. This would confirm yesterday’s bullish suggestion.

The importance of volume cannot be stressed enough. The higher the volume, the more valid the market movement. If the SPX closes above 870, extending the consecutive week streak, and does so on high volume, this will confirm my expectation the markets are setting up for the next move higher. The 10-day average volume for the SPX is about 6.1B shares. Currently the SPX has traded about 3.5B shares halfway through the trading day.

Volatile Outlook

Early market volatility suggests uncertainty surrounding the Stress Test results. Look for the possible release of this information tomorrow to be a major upside catalysts. For the most part, the results should be within expectations, but any negative surprises will cause an equity specific sell off. By the same token, any positive surprise will provide more momentum for the current rally, as it is being led by the finanials. I expect to see a continuation of the intraday volatility, but do not expect a significant breakout either way. If there is a breakout it will be foreshadowed by the Nasdaq and the Russell 2000. If the markets bounce back to near even, and the Nasdaq and the Russell 2000 lead the rally positive, the rally will have substance. If this happens look for a substantial move higher, particularly if it happens during the late day.

Existing home sales fell more than expected last month, but this should come as no surprise. I find this to be a huge positive in regards to forming a bottom, even though the markets disagree. If the existing home sales increased a second month in a row, I’d be concerned with the results. For this to be the “worst real estate decline since the Great Depression,” bouncing back on consecutive months should warrant concern. This reconfirms that the real estate markets have bottomed. Although, next month’s existing home sales need to be better than March, they do not necessarily need to be positive like February. It should also be noted that while real estate prices have declined nationally, a majority of residential real estate is not losing significant value. The areas losing the most are the areas that had the highest growth potential. In regards to academia, higher growth potential comes with higher risk, or higher risk is compensated with higher growth opportunity. The areas hit the hardest are areas where there was extreme speculation, and real estate was being purchased, with debt, and with the intent to make a quick profit.

Since the beginning of this post, the markets have bounced a little. I expect a progressive increase throughout the remainder of the trading session, with a late day rally of about 1%. The markets are subconsciously thinking about the consecutive weekly gain streak on the line. The streak, currently at six weeks, has been the largest percentage gain streak since the Great Depression. SPX 832 is the current support level to consider. Closing below this support level implies further declines.

Bull Market Rally

Monday the major indices made their largest single day move in six weeks[1]. The decline was fairly consistent throughout the day, and the indices closed essentially at the day lows. Bank of America’s pre-market earnings announcement Monday appeared to be the selling catalyst. Even after Monday’s huge decline, the Nasdaq Composite[2], remains positive year-to-date.

The leading indicator[3] release during the day Monday added to the decline as the indicator lost 0.3% last month. According to the release, “the recession has been long and with no end in sight though whether it is deepening in intensity is still unclear.” The indicators that decreased last month were building permits, vendor performance, factory workweek and jobless claims. It is not a surprise that jobless claims continue to decline as employment is generally viewed as a lagging indicator. The jobless claims report attempts to provide more timely information than the employment situation[4], but neither should forecast the direction of the economy. The two indicators that showed the most improvements were interest rates spreads and money supply which attempts to reflect active government intervention to stimulate the economy. These two factors reveal much more than the other indicators do about the state of the economy. In general governments attempt to spend their way out of economic contractions. Read my blog post for further analysis on the history of U.S. Recessions https://marketfallacy.wordpress.com/2009/04/20/1000-point-rally-coming/. These two indicators suggest the government is willing to do anything necessary to end this economic contraction, even at the possible expense of future Americans. Whether this is the government’s role is topic for another article.

AT&T, Boeing and Apple all rallied following the release of their earnings announcements. Of the three companies, AT&T was the only one to actually beat expectations, but Boeing and Apple provided commentary suggesting the current economic conditions are not as bad as perceived by the majority of Americans. High-end or luxury goods are showing increased sales which implies the wealthy are bargain hunting. This behavior is the pre-requisite to an economic recovery. Spending has to increase, and the easiest market for it to increase in is in high-end or luxury goods. As more companies report over the next two weeks, the outlook for the future will become more clear.

Although the market gapped down huge Monday morning, the major indices showed much resiliency Tuesday bouncing back and reducing significant amounts of Monday’s losses. Until the last hour of trading on Wednesday, the indices recovered most the losses from the early parts of the trading session, but were unable to sustain the rally. However, the Nasdaq did remain positive on the day. Small cap stocks[5] and technology companies[6] will continue to lead this rally.

Market Fallacy expects the major indices to end the week higher and add to the consecutive week streak. From a technical aspect, if the SPX can close above 875[7], the trend will be significantly higher. Market Fallacy expects another 15% increase before any significant retracement or consolidation period. As evident by Tuesday’s movement, this rally is not ready to end. The bears have had every chance to take the markets lower, and have had no such success. Monday’s decline was healthy and extremely bullish. Market Fallacy now has a blog, which will attempt to provide insight into individual questions concerning the markets. Please visit the blog to receive personal attention regarding the markets.

[1] SPX synonymous with S&P 500 lost approximately 4%
[2] Nasdaq Composite is a stock market index of all the common stocks and similar securities listed on the NASDAQ stock market, YTD up approximately 4%
[3] A composite index of ten economic indicators that should lead overall economic activity
[4] Employment situation releases the unemployment percentage whereas the jobless claims reports the number of of individuals who have filed for unemployment insurance for the first time
[5] Small capitalization stocks can be tracked by the Russell 2000
[6] Technology companies can be tracked by the Nasdaq
[7] Intraday high and now upside resistance